A task force that has been investigating the budget crisis affecting many states across the country is calling for major changes in the ways that states handle their budgeting and financial reporting.

The State Budget Crisis Task Force, co-chaired by former Federal Reserve chairman Paul Volcker and former New York State lieutenant governor Richard Ravitch, released its final report Tuesday after nearly three years of studying state budget problems.

"We need only look to Detroit where debt was leveraged time and time again with no ability to pay, to see that reforms in financial reporting and oversight by states and localities are prudent and necessary,” Volcker said in a statement. “The ultimate victims of unsustainable, patchwork budgeting and overextended finances are the citizens dependent upon essential public services."

The task force recommends several specific approaches for financial planning and reporting, including modified accrual budgeting by states and localities. The report noted that the practice of cash-based budgeting facilitates “gimmicks” and "one shot" measures that obscure actual financial conditions. Where appropriate, using consistent, accrual-based budgeting would facilitate comparison and avoid budgets based on inaccurate representations of future obligations or revenues, according to the task force.

Another recommendation involved multiyear financial plans. The task force recommended that states should include meaningful, forward-looking financial plans as part of their annual budget submission and adoption process. A comprehensive annual budget presented by the governor and reviewed and approved by the legislature should serve as a key element of the forward-looking multiyear financial plan. These plans should encompass both operating and capital expenditures and should set out the basic assumptions regarding revenue and expenditures, showing clearly when future costs of promises, such as debt service and leasing balloon payments, are due. The capital plan should also indicate the source of financing to be used for projects.

In addition, the report called for the use of reserve funds, often called rainy day funds, saying they should be required and should be adequate to meet any reasonably anticipated eventuality. ?

Another recommendation was that borrowed funds should never be treated as revenue. Proposed and adopted operating budgets should not be dependent on borrowed funds disguised as revenue, according to the task force. At times, governments must borrow to meet intrayear cash flow problems, the report acknowledged, because tax revenues are not necessarily received on the same schedule as expenditures, or to address sudden revenue shortfalls within the year. While it is recognized that, due to sudden revenue shortfalls, cash balances at times may need to be bolstered with the proceeds of short-term borrowing, that borrowing should never be treated as an element of revenue and provision should be made for its repayment.

Where appropriate, the report also suggested, individual states should consider strengthened oversight of local financial reporting and communication. The report pointed out that periodic reporting by local governments and timely review of financial data by state governments is essential to anticipating and dealing with the threats to public services. Thus, states should have statutory processes for imposing corrective actions on localities where financial positions indicate a high risk of their ability to meet their obligations to the public.

Budgeting standards should include definition of the nature of revenues, limitations on the use of nonrecurring items, multiyear planning, fair presentation of pension and other benefit liabilities, and the size and pace of funding of reserve funds, the report also recommended.

Financial reports should also be easily understandable, according to the task force. Standard-setting bodies should work with associations of states to develop rules for the creation of concise, timely and readable financial reports, the task force recommended. “The typically convoluted, sprawling nature of state financial statements make them of limited use for public understanding,” said the task force. “Both budgetary and asset-based information for all special funds should be easily accessible and be used in disclosure statements for borrowing.”

To build upon these proposals, a newly founded group known as the Volcker Alliance will press for implementing action by states and cities. "The Task Force Report has highlighted serious problems that demand attention,” said Volcker. “Open, honest budgeting and financial reporting are essential elements for responsible and effective decision-making, and for maintaining trust in every level of government. The Alliance, as its name suggests, will be working with other interested parties, certainly including knowledgeable representatives of state and local governments."

Volcker and Ravitch also want the federal government to be more aware of the effects that its actions have upon the fiscal condition of the states and localities. The federal government should require an analysis of the impact on state and local finances and services of federal actions and policies, they suggested. The task force found that no mechanism now exists for determining, assessing, and communicating the fiscal impact of federal actions on state and local governments.

They also believe the Securities and Exchange Commission should insist upon adequate disclosure of the terms, conditions and risks of municipal finances. The task force noted that the current jurisdiction of the SEC with respect to municipal finance issuers is narrowly limited to fraud due to the so-called “Tower Amendment.” But no other body has the affirmative obligation or authority to require full transparency and disclosure of risk, they noted. The task force recommended that the Tower Amendment should be revisited or other arrangements be made to assure sensible disclosure requirements as well as robust accounting standards.

“What is at stake is the strength of our educational institutions, of our infrastructure, our health care and judicial system, and the safety and security of our homes and streets—all of which in our federal system are heavily dependent upon the management and financial integrity of our states and their political subdivisions,” said Ravitch.

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