How much is a surplus?- Illinois Issues, July, 1980

According to financial experts and others, an ending balance in the state's general funds of about 5 percent of total expenditures is proper and sound

THE SINGLE most misleading word in state finance is "surplus." It conveys an image of a state treasury overflowing with unspent tax dollars.

For many, the perception has developed that the state of Illinois now has a huge surplus. State officials and the news media report that Illinois has a $500 million "surplus." Partly on the basis of such reports, legislative and administration proposals for tax relief abounded last year, resulting in the first step toward exempting food sales from the state's sales tax base. Tax relief is again a major issue this year, although the impact of federal budget cutbacks has diminished enthusiasm for tax relief. But the important question still remains: does a $500 million midyear treasury balance mean that Illinois has a large "surplus?" The $500 million balance is in the state's general funds, the largest and most important fund group. The general funds account for almost 70 percent of total state spending, including funding for education, public aid, mental health, state prisons, and countless other programs. The general funds are of primary interest to taxpayers on the revenue side, since the two main revenue sources are the state income tax and the sales tax.

The revenues which flow into the general funds are used to pay for government programs enacted by the General Assembly. The revenue-spending flows are not evenly matched, however, so that throughout the year there will be more or less in the general funds at any one time. (The same is true for over 200 other state funds.)

The ideal is to always have enough in the general funds in order to: (1) pay out when obligations are due; (2) meet increases in costs or to offset decreases in revenue because of unforeseen events; and (3) to help maintain investor confidence in Illinois finances. A healthy balance in the general funds is one signal to investors nationwide that the state is in good financial condition. Consequently, loans made to the state for construction will cost taxpayers less. It is for these three reasons that an adequate general funds balance level is a cornerstone in prudent financial planning by state government.

But as inflation and other forces push government spending upward, the protection afforded by the fund balance (working cash, protection for taxpayers and program recipients against budget uncertainties, maintaining state credit rating) will diminish unless the fund balance level increases along with spending. In 1970, for example, the ending balance was $269 million, about 11 percent of the $2.5 billion in state spending. By 1980, however, when state spending has reached $7.4 billion, the same ending balance of $269 million would represent only 3.6 percent of spending.

When the balance in Illinois' general funds was drawn down too low in 1976, the resulting cash shortage made national news. When the balance in California's general funds reached the extraordinary level of several billions, massive reductions in local property taxes resulted, and now efforts are underway to cut the state's income tax in half. Clearly, extremely high or extremely low balance levels can cause problems. But at what level should funds balances be maintained?

Available balance as percentage of state spending, 1960-1979 (General Funds)
Fiscal Year		Fiscal Year
1960	12%	1970	11%
1961	8%	1971	7%
1962	6%	1972	8%
1963	13%	1973	9%
1964	11%	1974	10%
1965	14%	1975	6%
1966	14%	1976	2%
1967	15%	1977	1%
1968	7%	1978	1%
1969	6%	1979	6%

According to the National Governor's Association of State Budget Officers report in Fiscal Survey of the States 1979-1980, "of the 19 states in which year-end balance to expenditure ratios exceeded 10% in 1979, ten states enacted state personal or corporate income tax cuts, six adopted reductions in state sales taxes, . . . ." Thus, it appears that a balance above 10 percent of total spending may be too much for government and taxpayers to tolerate.

Throughout the 1960's, the ending balance in the Illinois general funds never fell below 6 percent of annual spending, and it exceeded 10 percent in most years (see table). Comparatively high ending balances were also maintained in the early 1970's, partly as a result of the state income tax enacted in 1969. From 1976 to 1978, the ending balance was sharply lower in comparison to previous years, declining to just 1 percent of spending. During this time, unpaid bills accumulated and the state's credit rating was in jeopardy. In 1979, the ending balance was restored to $390 million, representing about 6 percent of state spending, the same level as in 1975, just before the cash-short years. A $390 million ending balance in 1979, and the expected $400 million ending balance in 1980,* are just about 6 percent and 5 percent of

*The reported balance is likely to be around $500 million. Unlike previous years, however, roughly $100 million of the balance will represent personal property tax replacement monies collected by the state and subsquently distributed to local governments. Under the former tax, these monies had been a local tax, collected and distributed by local government, and never showed up in the state funds. Subtracting this $100 million from the balance makes comparison to other recent years possible. The ending balance could be still lower, about $285 million, if the $115 million tax dividend program contained in the governor's budget were implemented before June 30, 1980.

state spending respectively, somewhat lower percentages than most of the historical values shown in the table.

According to a survey on the appropriate level for state general funds balance, the National Governor's Association and the National Association of State Budget Officers report that 5 percent of state spending is considered by various financial experts to be the target ratio. Survey results, described in Fiscal Survey of the States 1978-1979, stated: "A review of state budgetary practices and discussions with bond raters indicate that a 5% ratio of unobligated balances to expenditures is considered a reasonable target for a state, although individual circumstances may indicate a higher or lower balance."

The general funds ending balance exceeded 5% of spending in 17 of the last 20 years, and it exceeded the 10% level six years in the 1960's and twice in the 1970's

Each year state financial planning must take into account a variety of risks. In some years, the uncertainty is greater than in others. For example, if an economic slowdown is forecast as likely, it is prudent to maintain higher projected balances than if the outlook is for strong economic growth. Because of these variations in the national economy and others beyond the control of the state, increased flexibility in state financial planning is provided if a "safe" range is established for the ending available balance around the 5 percent target level. Such a range can be simply constructed based upon the notion that the state should have sufficient funds on hand at the close of a fiscal year to pay all outstanding bills. Over the last 10 years that amount would have approximately varied between 3.5 percent and 6.5 percent of annual spending. This range for the balance of 3.5 to 6.5 percent of spending is a useful guideline with which to evaluate the available balance. There may be times when an ending balance greater than 6.5 percent of spending may be necessary to build to and temporarily maintain comparatively high balances so that an extraordinary spending demand in the future can be met without increasing taxes. Such a tactic may be required in order to meet the initial costs if the state shifts to a prospective rate (cost containment) system for financing hospital costs for the poor.

Recent balance levels can be evaluated in terms of this range. Last year, 3.5 to 6.5 percent of state spending translated into a range for the ending balance of between $240 million to $440 million. The actual ending balance of $390 million (5.7 percent of state spending) was nearer the high end of the range. This year, the 3.5 to 6.5 percent range for the ending balance is estimated at roughly $260 million to $480 million. Again, both the projected $400 million ending balance and the alternative $285 million ending balance fall within the safe range (see footnote).

In sum, financial practices in Illinois over the last 20 years have generally kept the ending balance above the 5 percent level; specifically, the general funds ending balance exceeded 5 percent of spending in 17 of the last 20 years, and it exceeded the 10 percent level six years in the 1960's and twice in the 1970's.

The longstanding practice of maintaining an adequate balance could prove itself in coming months. The outlook for the nation's economy has become more pessimistic recently. In turn, the chances have increased that future state revenues will be lower than expected and state spending higher than expected. The latter effect arises because the higher level of unemployment associated with recession causes sharp increases in spending for the state's public aid programs. Under such circumstances, the balance in the general funds represents a source of emergency funds to ride out the financial strain.

Richard Kolhauser has worked under three governors in the area of state finances since 1970. He is currently deputy director of the Bureau of the Budget.