Tough Love

Last week, Michael Powell over at New York Times’s Economix blog characterized my position as one of “tough-love.” That is probably a fair way to put it. 

In an example of un-tough-love, yesterday’s Grey Lady featured an article by Christopher Edley Jr. (dean of the University of California, Berkeley, School of Law). In it, Dean Edley argues that states ought to be allowed to borrow directly from the Treasury:   

[S]tates are managing huge budget crises with the only tools they have, cutting spending and raising taxes — both of which undermine the federal stimulus.

That’s why the best booster shot for this recovery and the next would be to allow states to borrow from the Treasury during recessions. We did this for Wall Street and Detroit, fending off disaster. It’s even more important for states.

From my view, such a policy would permanently enshrine the notion that states are too big to fail. We know that states have a spending problem. According to data from the Bureau of Economic Analysis, for the last 9 years, the inflation-adjusted average annual growth rate of state and local government spending was 2.6%. At the same time, the private economy—on which state and local governments depend for their tax revenue—only grew at an average annual growth rate of 1.4%. In other words, states are already spending at a faster rate than the economy can create wealth. Furthermore, they are doing this without the power to deficit spend (for general operating expenses) or the power of the printing press. 

Allowing states the permanent ability to rely on the Federal Treasury would, of course, change all of that. How might we expect them to behave under those circumstances? Important research by the University of Rochester’s David Primo gives us some idea. It turns out that while all states save Vermont have balanced budget requirements, these requirements vary considerably from state to state. Some are allowed to carry deficits over from one year to the next while others are not. Furthermore, others are required to balance their planned spending, while others must balance their actual budgets at the end of the year. Lastly, some states are checked by independent courts, while others are not. In sum, some states face strict balanced budget requirements while others face weak balanced budget requirements. In his analysis, Professor Primo found that state and local spending in states with strict balanced budget requirements averaged $3,336 per citizen. In contrast, in states with weak requirements, the average was $3,756 per citizen.

The Federal Government’s balanced budget requirement isn’t weak; it is nonexistent (you might say they are on the honor system). So what might we expect spending to look like if every state in the union could borrow from the Federal Government whenever it was expedient?  I prefer tough love.

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