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Oregon faces a $1.6 billion funding gap in the next two-year budget cycle despite record low unemployment and steadily growing state revenue.

(Michelle Brench/The Oregonian)

Oregon has never seen times quite like these.

Unemployment is the lowest on record. Wages are rising at a 4 percent annual clip. The state is enjoying an unprecedented housing boom, and even lagging rural areas are adding jobs at a steady pace.

For Oregon's budget, though, it's still not enough. Not nearly enough. The state faces a $1.6 billion shortfall in the next two-year budget cycle, and even if the economy stays healthy the gap is likely to grow again the next time Oregon tries to balance the books.

So what's gone wrong?

The short answer is the state committed to hundreds of millions of dollars in spending and tax limits without a clear plan to pay for it all. Health care costs, largely due to Oregon's Medicaid expansion, threw the state's books off by $1 billion in the next budget cycle - even as it brought down the rate of the uninsured in the state to just 5 percent.

That's the biggest piece of the funding gap, but the state's soaring public pension deficit plays a big role, too. And don't let voters off the hook - ballot measures they passed in November play an even bigger role in the shortfall than pensions, while property tax limits they approved in the 1990s shifted the burden of education funding to the state.

"Everything is actually coming to bear that we've known about for quite a long time," state Sen. Richard Devlin said last winter, as the severity of the budget crisis became evident.

At a December meeting of state policymakers and business leaders, Devlin said that the depth of the shortfall is so dire it cannot be overcome by the kinds of cuts lawmakers are accustomed to making during economic down years. And he acknowledged it's a particularly difficult issue to explain to voters, given the robust economy.

"One of the biggest problems is nothing looks like we're in trouble," said the Tualatin Democrat, who helps oversee the budget as the Senate co-chair of the Legislature's powerful Joint Ways and Means Committee.

Oregon's budget gap

State revenue in the coming two-year budget cycle is forecast at $19.7B, up $1.3 billion. But expenditures are rising twice as fast.

Here are the primary drivers of the budget shortfall.

$1 billion:

Health insurance costs, largely due to reduced federal support for Oregon's Medicaid expansion under the Affordable Care Act

$350 million:

Unfunded public pension costs

$357 million:

Unfunded ballot measures passed by voters last November

Source: Oregon Department of Administrative Services

The effects of potential cuts already are apparent at schools and public agencies around the state. Portland Public Schools, anticipating a tight state budget, presented a plan last week to eliminate 70 teaching jobs and 59 administrators.

Portland State University is preparing for staff cuts despite planning a 9 percent tuition jump. In fact, six of Oregon's seven public universities have plans to raise tuition by 5 percent or more.

Those are the kinds of hardships the state has come to expect during bad economies. State funding is notoriously volatile because of Oregon's extreme reliance on personal income taxes, which can fall sharply in bad economic times. As the Great Recession set in a decade ago, the general fund plunged by nearly 20 percent.

The irony is that Oregon's rainy day fund is now worth nearly $800 million, but lawmakers generally have access to it only when state revenues decline. There's no provision for what to do when the economy is good, revenues are up, and the state still faces a shortfall.

Forecasts suggest state revenues will climb by about 7 percent over the next two years, fueled by roughly 4 percent annual growth in personal incomes. Oregon's jobless rate fell to 4 percent in February, the lowest point in the 41 years for which economists have collected data. That compares with 4.5 percent the U.S. recorded in March.

Those are strong numbers, but in some ways they overstate Oregon's economic health. While rural parts of the state have been steadily adding jobs, they still haven't replaced all the jobs lost to the recession. Many communities continue to struggle: Grant County has Oregon's highest jobless rate, at 7.2 percent, and a handful of counties are pushing 6 percent.

Statewide, most of the employment gains since the recession have been at the top and bottom of the income scale. Middle-wage jobs, which pay between $30,000 and $50,000 annually, are down by 50,000 over the past decade.

And forecasters expect that growth to slow by a third over the next two years, to just 2,000 new jobs. Oregon lost nearly 150,000 jobs during the recession and while the recovery has been remarkably durable, it's far less dramatic than past rebounds.

"I wouldn't say the economy is great. The economy is doing well," said George Naughton, who tracks state spending as Oregon's chief financial officer. "It's kind of a slow or steady growth as opposed to really strong gains."

But that slow and steady rate holds down state revenues, and House Speaker Tina Kotek said it also drives up some costs.

In 2011 and 2012, when Oregon committed to the Medicaid expansion under Obamacare, she said the state forecast enrolling an additional 240,000 people on the Oregon Health Plan. With the economy continuing to lag, she said, the actual number topped 400,000.

"Wage growth has not kept up with the cost of living," said Kotek, D-Portland. "We still have a lot more people eligible for Medicaid than we anticipated, even in a good economy."

That's made the Medicaid expansion more expensive, she said. And while Oregon won a federal waiver in January to continue its insurance program for the poor, it didn't receive the additional funding it sought to go along with that waiver - money the U.S. government had warned the state it was unlikely to receive.

Meanwhile, the federal government is stepping down its level of support for states' Medicaid expansion, and Oregon's growing economy has triggered a further reduction in the amount the federal government contributes. That means Oregon must pick up $350 million in new costs itself.

Another $200 million in increases comes from inflation in medical costs and decreases in other funds, such as Oregon's tobacco tax, according to the Oregon Health Authority.

Lawmakers always knew there would be added costs associated with the Medicaid expansion, she said, but didn't realize how high they would be. Even so, Kotek said that she has no regrets.

"The policy goal is still the right goal, which was get as many people insured as possible," she said. "Now we're just dealing with the unknowns that have come up."

As lawmakers cope with those issues, they're considering a number of possibilities: They could cut jobs and public services, decline to implement the ballot measures approved in November, increase corporate taxes and reform state pensions.

Devlin hopes for significant health care savings with taxes on Oregon hospitals to recoup federal Medicaid dollars for the state. State Rep. Julie Parrish, R-West Linn, wrote an opinion article this week for The Oregonian/OregonLive advocating a program to cut costs in public employees' health insurance.

At this point, two months into the legislative session, lawmakers have not settled on what mix of options they will enact.

Portland State economics professor Eric Fruits co-authored a February analysis for the Cascade Policy Institute, a Libertarian think tank that is critical of the state's budget priorities. He advocates that Oregon drop its participation in the Medicaid expansion and make other spending cuts to work its way out of its budget hole.

"We knew those were coming and we still continue to expand programs we couldn't afford to expand," Fruits said.

Fundamentally, he said, Oregon has done a poor job setting priorities. Even with a growing economy, he noted that Portland's median income remains 3 percent below the national average. That, in turn, results in less revenue for the general fund.

"We spend like we're more affluent than we are," Fruits said. "We're not a rich state. We can't afford it."

Correction: Julie Parrish is a state representative, not a state senator.

-- Mike Rogoway; twitter: @rogoway; 503-294-7699