Tag Archives: GSP

Government Spending and Economic Growth in Nebraska since 1997

Mercatus recently released a study that examines Nebraska’s budget, budgetary rules and economy. As the study points out, Nebraska, like many other states, consistently faces budgeting problems. State officials are confronted by a variety of competing interests looking for more state funding—schools, health services and public pensions to name a few—and attempts to placate each of them often leave officials scrambling to avoid budget shortfalls in the short term.

Money spent by state and local governments is collected from taxpayers who earn money in the labor market and through investments. The money earned by taxpayers is the result of producing goods and services that people want and the total is essentially captured in a state’s Gross Domestic Product (GSP).

State GSP is a good measure of the amount of money available for a state to tax, and if state and local government spending is growing faster than GSP, state and local governments will be controlling a larger and larger portion of their state’s output over time. This is unsustainable in the long run, and in the short run more state and local government spending can reduce the dynamism of a state’s economy as resources are taken from risk-taking entrepreneurs in the private sector and given to government bureaucrats.

The charts below use data from the BEA to depict the growth of state and local government spending and private industry GSP in Nebraska (click on charts to enlarge). The first shows the annual growth rates in private industry GSP and state and local government GSP from 1997 to 2014. The data is adjusted for inflation (2009 dollars) and the year depicted is the ending year (e.g. 1998 is growth from 1997 – 1998).

NE GSP annual growth rates 1997-14

In Nebraska, real private industry GSP growth has been positive every year except for 2012. There is some volatility consistent with the business cycles over this time period, but Nebraska’s economy has regularly grown over this period.

On the other hand, state and local GSP growth was negative 10 of the 17 years depicted. It grew rapidly during recession periods (2000 – 2002 and 2009 – 2010), but it appears that state and local officials were somewhat successful in reducing spending once economic conditions improved.

The next chart shows how much private industry and state and local GSP grew over the entire period for both Nebraska and the U.S. as a whole. The 1997 value of each category is used as the base year and the yearly ratio is plotted in the figure. The data is adjusted for inflation (2009 dollars).

NE, US GSP growth since 1997

In 2014, Nebraska’s private industry GSP (red line) was nearly 1.6 times larger than its value in 1997. On the other hand, state and local spending (light red line) was only about 1.1 times larger. Nebraska’s private industry GSP grew more than the country’s as a whole over this period (57% vs 46%) while its state and local government spending grew less (11% vs. 15%).

State and local government spending in Nebraska spiked from 2009 to 2010 but has come down slightly since then. Meanwhile, the state’s private sector has experienced relatively strong growth since 2009 compared to the country as a whole, though it was lagging the country prior to the recession.

Compared to the country overall, Nebraska’s private sector economy has been doing well since 2008 and state and local spending, while growing, appears to be largely under control. If you would like to learn more about Nebraska’s economy and the policies responsible for the information presented here, I encourage you to read Governing Nebraska’s Fiscal Commons: Addressing the Budgetary Squeeze, by Creighton University Professor Michael Thomas.

State government spending hits new heights

There is a large literature in macroeconomics that examines the extent to which federal spending “crowds out” investment in the private sector. Basic theory and common sense lead to the conclusion that government spending must replace some private sector spending. After all, dollars are scarce – if the government taxes Paul and uses his money to build a road Paul necessarily has less money to invest in his landscaping business. In theory government spending on public goods like roads could be a net gain. This would occur if the additional value produced by spending one more dollar on roads was greater than the additional value produced by investing one more dollar in Paul’s landscaping business. But even in this scenario, Paul himself may be worse off – he’s one dollar poorer and he may not use the new road – and there is still a dead-weight loss due to the tax.

In reality, the federal government does a lot more than build roads, especially productive ones. In 2014, only 1.9% of federal income tax revenue was spent on transportation. And most of the other stuff that the government does is way less productive, like shuffling money around via entitlement programs – Medicare, Medicaid, and Social Security – and investing in businesses that later go bankrupt like Solyndra. So while it is possible that a dollar spent by the government is more productive than a dollar spent by a guy like Paul, in a country with America’s spending habits it’s unlikely to be the case.

The same crowding out that occurs at the federal level can occur at the state level. In fact, in many states state spending as a percentage of gross state product (GSP) exceeds federal spending as a percentage of GDP. The graph below shows state spending as a percentage of GSP for all 50 states and Washington D.C. in 1970, 1990, and 2012 (data). The red, dashed line is federal spending as a percentage of GDP in 2012 (21.9%).

state spending gsp graph

As shown in the graph, nearly every state increased their spending relative to GSP from 1970 – 2012 (triangles are above the X’s). Only one state, South Dakota, had lower spending relative to GSP in 2012 than in 1970. In 2012, 15 of the 50 states spent more as a percentage of GSP than the federal government spent as a percentage of GDP (states where the triangle is above the red, dashed line). In 1990 only two states, Arizona and Montana, spent at that level.

It used to be the case that state and local spending was primarily focused on classic government services like roads, water/sewer systems, police officers, firemen, and K-12 education. But state spending is increasingly looking similar to federal spending. Redistributive public welfare expenditures and pension expenditures have increased substantially since 1992. As an example, the tables below provide a breakdown of some key spending areas for two states, Ohio and Pennsylvania, in 1992 and 2012 (1992 data here, 2012 data here). The dollar per capita amounts are adjusted for inflation and are in 2009 dollars.

ohio spending table

penn spending table

As the tables show, spending on public welfare, hospitals, and health increased by 120% in Ohio and 86% in Pennsylvania from 1992 to 2012. Pension expenditures increased by 83% and 125% respectively. And contrary to what many politicians and media types say, funding for higher education – the large majority of state education spending is on higher education – increased dramatically during this time period; up 250% in Ohio and 199% in Pennsylvania. Meanwhile, funding for highways – the classic public good that politicians everywhere insist wouldn’t exist without them – has increased by a much smaller amount in both states.

The state spending increases of the recent past are being driven in large part by public welfare programs that redistribute money, pensions for government employees, and higher education. While one could argue that higher education spending is a productive public investment (Milton Friedman didn’t think so and I agree) it is hard to make a case that public welfare and pension payments are good investments. This alone doesn’t mean that society shouldn’t provide those things. Other factors like equity and economic security might be more important to some people than economic productivity. But this does make it unlikely that the marginal dollar spent by a state government today is as economically productive as that dollar spent in the private sector. Like federal spending, state spending is likely crowding out productive private investment, which will ultimately lower output and economic growth in the long run.

Economically Free States see 30 Percent Faster Job Growth

In my last post, I mentioned a couple of business climate indices. There is a new paper by Jed Kolko, David Neumark, and Marisol Cuellar Mejia which examines these types of indices in depth. They find that states with high rankings in economic freedom indices tend to have faster job growth, greater wage growth, and greater growth in gross state product.

There are a lot of indexes out there that attempt to rank states in terms of their business climates and the results of their rankings often conflict. As the authors write:

[A]cross all 50 states, every state but one ranks in the top 20 in at least one index, and every state ranks in the bottom half in at least one index.

However, it turns out that when you dig deeper, the indices can be grouped into two general categories and there is actually a lot of consistency within these categories.

Economic Freedom Indices:

The first category examines what the authors call “taxes and costs” and what I might call economic freedom. It includes factors such as the cost of doing business, the size of government, tax rates and tax burden, regulation, litigation, and welfare and transfer payments. The following five indices tend to capture these types of factors:

The economic freedom component of the Freedom in the 50 States Index by Sorens and Ruger would almost certainly fall into this category too, but since the authors focused on indices that have been around for several years, they do not include it.

Productivity and Quality of Life:

The second group of indices tends to measure what the authors call “productivity or quality of life.” These indices include measures of quality of life; equity; employment, earnings and job quality; business incubation; human capital; infrastructure; and technology, knowledge jobs, and digital economy. It appears to me that a number of the indices in this group focus on outcomes (are there a lot of “knowledge jobs in the state”?) while others in this group focus on policy inputs aimed at improving the quality of life (has the government invested in business incubation and human capital?). The indices that tend to fall into this category include:

  • The State New Economy Index by the Progressive Policy Institute, the Information, Technology and Innovation Foundation, and the Kauffman Foundation,
  • The Development Report Card for the States—Performance by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Development Capacity, also by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Business Vitality, also by the Corporation for Enterprise Development, and
  • The State Competitiveness Index by the Beacon Hill Institute.

The distinction isn’t always clear cut and I’d note that the Beacon Hill State Competitiveness Index, for one, also seems to capture a lot of economic freedom-type factors. The authors categorize an eleventh index, the Fiscal Policy Report Card on the Nation’s Governors by the Cato Institute, as falling somewhere between these two broad groups.

The authors examined the degree to which these indices predicted job growth, wages, and Gross State Product (controlling for other factors that might influence economic growth, including weather and historical industry mix). They found that the quality of life indices generally do a poor job of predicting these positive economic outcomes. In contrast, the economic freedom (aka “low taxes and few regulatory costs”) indices are strong predictors of job growth, wages, and GSP. In particular, the authors found “the corporate income tax structure and base matter for wage and GSP growth, though not necessarily for employment growth.” furthermore, the relationship, “does not appear to be driven by the top marginal tax rate, but rather by other factors such as the simplicity of corporate taxation…” They also found that greater welfare and transfer payment spending was associated with slower economic growth (they have reason to dismiss most concerns about reverse causality; but I’ll leave that to the reader to investigate).

The two indices with the best record for predicting economic progress were the Economic Freedom of North America index by Fraser (“the strongest and most robust evidence”) and the State Business Tax Climate by the Tax Foundation. Looking at the Fraser index, they found that moving a state from the 40th to the 10th place in terms of economic freedom “would increase the rate of growth of employment by 0.317 percentage point.” Given that the mean employment growth rate is 1.15 percent, this amounts to about 30 percent faster employment growth.

Lastly, the authors found that “footloose” industries such as manufacturing that are less-tied to the geography of the state tend to be more responsive to the policies captured by these indices.

——–

Update: I have fixed a broken link to the article.  Thanks to alert readers! 

New Jersey’s Pension Crisis: New Research

Eileen Norcross and Andrew Biggs have a new paper out this morning entitled “The Crisis in Public Sector Pension Plans: A Blueprint for Reform in New Jersey.” While it’s focused on New Jersey, it does an excellent job of outlining the larger problem with state pension plans nationwide and what policy makers can do about it.

Here’s the abstract:

New Jersey’s defined benefit pension systems are underfunded by more than $170 billion, an amount equivalent to 44 percent of gross state product (GSP) and 328 percent of the state’s explicit government debt. Depending on market conditions, the state will begin to run out of money to pay benefits between 2013 and 2019. The state’s five defined benefit pension plans cover over 770,000 workers, and more than a quarter million retirees depend on state pensions paying out almost $6 billion per year in benefits. Nationwide, state pensions are underfunded by between $2.8 trillion and $5.2 trillion, some 20 to 37 percent of America’s annual output as much as $3 trillion, approximately 20 percent of America’s annual output..

This path is not sustainable. In order to avert a fiscal crisis and ensure that future state employees have dependable retirement savings, New Jersey should follow the lead of the federal government and the private sector and move from defined benefit pensions to defined contribution pensions. While significant liabilities will remain, the first step to addressing the pension crisis is capping existing liabilities and providing new employees with more sustainable retirement options.

Specifically, the paper recommends that policy makers:

  • Extend the defined contribution plan already available to state university faculty and staff and the state’s Defined Contribution Retirement Program to all state employees.
  • Reduce or freeze cost of living adjustments (COLAs) to reduce the state’s unfunded liability.
  • Transition non-vested workers to defined contribution plans.

Whole thing here.