The Comptroller's Budget Watch List for the 1997-99 Biennium

I. Convert to Generally Accepted Accounting Principles (GAAP)

Issue Summary
In 1993, the Connecticut General Assembly enacted Public Act 93-402, which authorized the use of Generally Accepted Accounting Principles (GAAP) for the preparation and maintenance of the state's annual financial statements and the preparation of the state's biennial budget. Originally, conversion to GAAP from the modified cash basis of accounting was scheduled for the 1995-96 Fiscal Year. That implementation was postponed for two years -- largely due to the cost of amortizing the accumulated GAAP deficit. The conversion to GAAP is currently planned for the 1997-99 biennium and planning should begin immediately so implementation can proceed on schedule.

Background
Connecticut currently prepares its state budget on a modified cash basis of accounting. In short, this accounting practice allows the state to overcount revenues and undercount expenditures, thus creating an inconsistent and potentially distorted picture of the state's true financial position. Under modified cash accounting the state counts revenue that is or will be due, but has not yet been collected; however, money that the state owes is not recorded as an expenditure until the payment is actually processed and a check is issued. Through this accounting practice, it is possible to create a budget surplus in a current fiscal year by delaying payments into the next fiscal year. GAAP requires revenue to be recorded when the payment is due and measurable, and expenditures to be recorded when the obligation to pay is incurred without respect to when the actual check is issued. Accordingly, the date of receipt of a revenue source, and the date on which a check is issued to pay a bill are not relevant for GAAP purposes.

Analysis
The accounting profession developed GAAP as the standard for a fair and accurate presentation of financial data. It is the accounting method used by private businesses. Businesses use GAAP because they need an accurate representation of receipts and spending in order to determine what products and services are most profitable in a given year. The state should bring this same disciplined approach to its financial management. It is extremely difficult -- if not impossible -- to determine the success of state-provided services without an accurate accounting of how much those services cost. Connecticut uses the motto: "the state that thinks like a business." It is time for Connecticut to start keeping its books like a business. This office conducted a survey of twenty-eight states and discovered that Connecticut's current accounting practices are the least conservative of any of the states surveyed.

Under the provisions of Connecticut General Statutes, Section 3-115b, GAAP budgeting is scheduled to be implemented during the 1997-1999 biennium. GAAP budgeting has already been delayed once and the implementation schedule should not be postponed again. GAAP budgeting will introduce a fiscal discipline that will ultimately save the state money. Under the current accounting system, it is possible for agencies to overspend their appropriation in a given fiscal year by delaying the processing of some bills until the next fiscal year. Therefore, the present accounting system creates the potential for higher than anticipated spending during the course of the fiscal year, and makes it difficult to match fiscal year spending to program results for that year.

Through years of overcounting revenues and undercounting expenditures, a cumulative GAAP deficit has resulted. That cumulative GAAP deficit now stands at $640 million -- up $63 million from last year. The miscounting of expenditures and revenues under the current modified cash basis of accounting becomes larger each year as prices rise and revenues grow, thus increasing the accumulated year-end GAAP deficit. Therefore, until each annual budget is prepared in accordance with GAAP, the cumulative GAAP deficit will tend to grow. Current law requires that the cumulative GAAP deficit be amortized over fifteen years beginning in Fiscal Year 1998-99, resulting in an annual amortized budget cost of $42.7 million. In addition to paying off the accumulated deficit, future budgets must be prepared in accordance with GAAP beginning in Fiscal Year 1997-98. This will require the annual appropriation of an additional $40 million, above the amortization cost, to prepare each year's budget in accordance with GAAP. The additional annual appropriation requirement will fluctuate based on state revenue and spending patterns. (The $40 million annual cost is based on the average annual GAAP adjustments over a five-year period.)

Recommendation
While the concept of GAAP budgeting may appear somewhat complicated, the goals are not. GAAP-based budgeting and accounting will present a more accurate picture of our state's finances and will help enforce fiscal discipline that will save state tax dollars in the long run. The conversion to GAAP should proceed on schedule. This recommendation is supported by the Auditors of Public Accounts in their 1996 Annual Report to the Connecticut General Assembly.

II. Assess Tax Reduction Commitments

Issue Summary
Tax reductions totaling $383.9 million are scheduled for implementation in the upcoming biennial budget. This figure does not include $300 million in various tax reductions that went into effect in the current fiscal year. Legislators should exercise fiscal caution so that the tax reduction obligations for the biennium and any new proposals are funded responsibly.

Background
One of the core responsibilities of the Comptroller is to provide clear and accurate financial information to the state's legislators, policymakers and citizens. This is especially important as the legislature comes into session to develop a state budget for the biennium. The GAAP-based analysis of the state's finances in this report shows that the picture remains mixed. The state's economy is improving, jobs are being created and tax revenues have increased. At the same time, the state has posted nine straight years of operating deficits and net state debt has increased 45 percent since 1990 on a per capita basis. Before considering any new large-scale spending programs or revenue reductions, the state needs to assess its financial condition and work harder to improve it.

One area that requires attention are the tax reductions that are already on the books and are scheduled for implementation during the 1997-99 biennium. According to Office of Fiscal Analysis estimates, the cumulative General Fund revenue losses associated with these tax cuts total $383.9 million. A summary of these tax changes is presented below and an unabridged list appears in Appendix A of this report.

Existing Tax Reduction Commitments
for Fiscal Years 1998 and 1999 (in millions)

Recommendation
These tax reductions were passed in previous years, but will take effect during the next biennium. The budget document for the 1997-99 biennium is currently being prepared, and it will have to account for these revenue losses. The budget process will offer the legislature the opportunity to reassess these tax reductions as well as assess any new proposals to ensure that they are funded responsibly and accurately reflect the tax reduction needs and priorities of our state's citizens.

III. Establish a Welfare Reserve Fund

Issue Summary
With the passage of welfare reform on the federal level, states will be reimbursed differently for welfare-related expenses. Instead of a federal matching formula, the state will receive block grants and greater flexibility in terms of how the money can be spent. Initially these block grants will provide Connecticut with more revenue than under the old formula. This pattern will not continue indefinitely, however. While some may advocate the use of these additional federal dollars to fund other long-term commitments or as a budget balancing tool, Connecticut should avoid this course of action. Welfare reform will present ongoing challenges that require prudent fiscal planning to succeed, especially given the cyclical nature of welfare spending (i.e., more people need help during bad times). As such, the state should use the additional federal block grant dollars to establish a welfare reserve fund in order to help alleviate the effects of future economic downturns on programs that serve low-income individuals.

Background
Connecticut's welfare system has undergone several transformations over the last few years. In 1992, the General Assembly established the Task Force on Restructuring Public Assistance, which resulted in the creation of an initiative called "A Fair Chance." This initiative resulted in substantial changes to the state's Aid to Families with Dependent Children (AFDC) program. These changes emphasized getting people off the welfare rolls and into jobs. Job training, continuing education, child care, benefit time limits on a pilot basis, and financial incentives to make work more attractive were essential elements of the Fair Chance program.

The current version of welfare reform in Connecticut is called "Jobs First." This initiative was passed by the state legislature in June of 1995 and a federal waiver to allow the state to operate outside of federal AFDC guidelines was obtained. The Jobs First program builds on and expands many provisions of the Fair Chance program; but, it places less emphasis on job training and education, which may compromise the long-term success of the program. Educational attainment levels and success in the job market are strongly correlated. While Connecticut was moving to implement the provisions of the Jobs First program in 1996, Congress passed and the President signed the Personal Responsibility and Work Opportunity Act. This act transformed federal oversight of the AFDC program. The new federal guidelines were consistent with many of the provisions of the state's Jobs First program.

Analysis
From a state finance perspective, the most significant provision of the federal act is its change in the federal reimbursement system for the state's welfare-related expenses. Prior to passage of the new federal law, the state had received a federal match for each state dollar of AFDC and related spending. Under current federal law, the state will receive block grants for its welfare-related spending. The law created a Temporary Assistance to Needy Families (TANF) block grant that will replace federal reimbursements under the AFDC, AFDC administration, Emergency Assistance, and Job Opportunities and Basic Skills program. The federal law also provides three funding streams for child care: 1) the Child Care Development Block Grant; 2) a state-guaranteed child care payment to replace AFDC-related child care programs; and, 3) a matching grant based on the state's under age thirteen population. Under the federal provisions, both the TANF and the Child Care block grant funds must be appropriated by the state legislature.

Federal approval is pending for Connecticut to receive its TANF block grant funds, retroactive to October 1, 1996. During the 1997-99 biennium, under the combined TANF and child care block grants, Connecticut will receive approximately $110 million more in federal funds for welfare and child care expenses than it would have received based on Fiscal Year 1996 spending patterns under prior law.

With the additional federal funds come additional challenges that the state must meet. By Fiscal Year 2002 the state is obligated to have 50 percent of its single parent AFDC clients in jobs or approved job training programs. This 50 percent requirement builds incrementally beginning at 25 percent in Fiscal Year 1997. A state's block grant will be reduced by 5 percent ($13.3 million) the first year it fails to meet the job participation targets. An additional 2 percent ($5.3 million) block grant reduction is applied for each subsequent year of non-compliance to a maximum reduction of 21 percent ($56 million).

Under the new federal law, states are permitted to reduce their dollar commitment to welfare programs funded under TANF. States must spend at least 80 percent of their Fiscal Year 1994 expenditure for welfare-related purposes. However, in order for a state to qualify for additional federal contingency funds, its spending must equal at least 100 percent of its historic welfare-related spending.

In recognition of the cyclical nature of the AFDC caseload, federal law permit states to establish a TANF reserve or "rainy day" fund. During Connecticut's last economic recession, which began in 1989 and ended in 1992, the state's AFDC caseload increased 46 percent from 37,452 recipients to 54,657 recipients. During the same period state AFDC expenditures increased 48 percent from $244 million to $360 million. During the state's recent recovery caseloads and spending have dropped 4 percent and 17 percent respectively. The cyclical swing in Connecticut's AFDC caseload provides ample evidence for the need to build a TANF reserve.

In addition to building reserve funds, we must recognize the strains that federal and state welfare initiatives will place on local social service agencies. For example, reforms to the federal food stamp program, which limit single people between the ages of 18 and 50 to no more than three months of benefits in a three-year period, have already resulted in about 6,000 people losing benefits. These individuals may have to rely on local services such as shelters and soup kitchens for support. In addition to food stamp reductions, federal Social Service Block Grant (SSBG) funding to Connecticut was cut by just over $5 million between Federal Fiscal Years 1995 and 1996. These SSBG funds are a main source of revenue for many local social service providers. Municipalities may call on the state to apportion part of its excess TANF block grant funding to support local social services.

Recommendation
Some states will be tempted to use current excesses in their TANF block grants as a budget balancing tool. By using federal TANF dollars to fund welfare programs that were previously funded with state dollars, the state dollars can be diverted to other areas with shortfalls. Several states are considering this course of action. Connecticut should exercise more fiscal restraint. The current surplus in TANF funds provides Connecticut with an excellent opportunity to build a reserve fund that will guard against economic downturns, and to support our municipalities as they assume a larger role in providing basic supports to low income individuals.

IV. Health Care-Related Spending

Issue Summary
According to a recent analysis, Connecticut state government spends about $3.7 billion annually for health care related services. This represents roughly 30 percent of total governmental spending. Almost $1 billion of this amount is spent on Medicaid long-term care services, such as nursing home care. Containing the rising cost of health care is essential to controlling overall increases in state spending. This is an area that will require ongoing attention from state policymakers and the General Assembly.

Background
There is general consensus that the present health care delivery system is inefficient. We are paying too much to insure too few people. As detailed in the demographic section of this report, 289,000 people in Connecticut lack basic health insurance coverage, including 80,000 children. To date, efforts to control the rising cost of health care in the state have relied heavily on reducing payments to health care providers. This has been achieved, for the most part, through the introduction of managed care. Major concerns have arisen regarding the effectiveness of holding down health care inflation through negotiated provider payment discounts and limiting access to care. Consequently, there is public pressure for increased state regulation of managed care organizations. In addition, managed care companies are beginning to raise prices as their ability to negotiate further payment reductions and introduce additional access constraints becomes more limited. The next generation of cost controls in health care will be based on emphasizing preventive care and restructuring the long-term care financing system.

Analysis
Connecticut, like most other states, has struggled to bring health care costs down. Controlling health care spending is an important component in keeping the state budget balanced. The state spends approximately $300 million a year to provide a health insurance package to its employees and retirees, and close to $2 billion to provide health coverage and services to lower-income individuals through the Medicaid program. The Office of the State Comptroller is responsible for procuring and administering health care coverage for 166,000 state employees, retirees, and their dependents. Through the introduction of a preferred provider network (PPO) the Office of the State Comptroller helped achieve $31 million in savings in the first year of operation. Likewise, in July of 1995, the Department of Social Services implemented a Medicaid managed care system for its Aid to Families with Dependent Children (AFDC) and related population. Most of the AFDC and related caseload are now enrolled in managed care. Thus far, the savings associated with the Medicaid Managed Care program have not been quantified. Both of these programs rely, in large part, on negotiating discounts from health care providers to achieve savings. In the future, these programs will be prone to inflationary pressures as medical technology improves and the ability to negotiated deeper provider discounts recedes.

The next phase in effecting health care savings will depend on preventive care and restructuring our long-term health care financing system. Research shows that dollars invested today in providing basic primary and preventive care to our children can save several times the cost in later years. In addition, Connecticut's population is aging. Between 1990 and 1995 the percentage of Connecticut residents age 65 and older increased from 13.5 percent to 14.3 percent. The average 65-year-old male consumes six times more health care services than a 25-year-old male. These demographic shifts and health utilization figures require attention now. The Department of Social Services is beginning to examine methods for better integration of health service delivery to older individuals who are eligible for both Medicare and Medicaid benefits. This effort will move forward in cooperation with the other New England states and holds the potential to create savings, particularly in long-term care.

Recommendation
The state is entering a new phase in its effort to control rising health care costs. These new efforts will emphasize preventive care and reforms in the financing of long-term care. By introducing reasonable, targeted changes to our health care delivery system today, we can preserve access and effect future savings. In the years to come, some will advocate for a radical overhaul of our health care system. As these overhaul proposals are evaluated, we should keep in mind that 170,000 Connecticut residents work in the health care industry -- one of the state's fastest growing employment sectors, with an annual payroll of over $5 billion. Drastic changes in the defense industry crippled Connecticut's manufacturing sector. We should not make the same mistake with health care. Incremental changes to the health care system can bring about real savings, while preserving access to quality care.

Two health care initiatives supported by Comptroller Wyman are designed to generate savings. The first involves providing health care coverage to many of Connecticut's 80,000 uninsured children. By securing proper levels of primary and preventive care for these children, the state will realize future savings. The second initiative uses provisions of existing federal law to offer individuals an insurance plan that covers their long-term health care requirements and protects their assets, thus reducing the probability that they will require state assistance through the Medicaid program. The legislature should support these initiatives and look for other innovative ways to improve our state's health care environment.

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