Tag Archives: state budget

Do a majority of Americans prefer tax hikes to state budget cuts?

According to an ABC/Washington Post poll, the real third rail of politics isn’t Social Security it is state budgets. According to the poll results, 55 percent of Americans favor freezing wages for state employees and 51 percent are for reducing pension benefits for new hires.

But when asked more specific questions about cuts, 89 percent oppose laying off firefighters, 86 percent don’t want teachers or police officers laid off. Seventy five percent of people reject cuts to state aid for schools, 76 percent reject cuts to Medicaid, and 76 percent also oppose closing parks. At the same time, significant majorities oppose tax increases (though not as robustly). Sixty-three percent of those polled oppose increases in state income taxes, 61 percent oppose sales tax hikes.

What to make of these results? People don’t like tax hikes, and they really don’t like service reductions. They are also not confronted with the full bill for public services upfront.

State aid, debt, income tax withholding, spending deferrals, intergovernmental transfers contribute to fiscal illusion, by obscuring the full cost of spending and making spending look less expensive than it is.

More direct forms of taxation such as the property tax tend to be less popular for a reason. The property tax is more directly observed – both in paying for it and seeing how it is spent. (though it is also argued that renters experience fiscal illusion since they do not pay property taxes upfront).

New Jersey’s property tax crisis is an example of this. While the state instituted an income tax in 1976 to help defray the cost of public school spending on the local level, property taxes continued to rise over the period – in recent years to crippling levels for many residents. In 2010, when confronted with reductions in state aid and revenues and the request by teachers unions to grant salary hikes, New Jersey voters rejected the majority of school budgets for the first time since 1976.

It is not surprising that people will want to maintain or increase spending as long as the bill remains hidden. More than half of state Medicaid programs are sustained by federal transfers paid for with deficit spending, continuing to participate in this fiscal illusion has serious consequences for our economic future.

Tyler Cowen writes in The New York Times about how this disconnect between spending and revenue (identified by James Buchanan), results in institutionalized fiscal irresponsibility. Ultimately, we don’t recognize what it will take to pay off the debt we have accumulated at the federal level. It will take eroded savings, “…there is a rude awakening coming. One way or another, some of our savings will be taxed away to make good on government commitments, like future Medicare benefits, which we currently are framing as personal free lunches.”

 

When the Long Run Shows Up Today

A spate of recent articles regarding the fiscal situation of states and localities have lumped together their current fiscal problems, stemming largely from the recession, with longer-term issues relating to debt, pension obligations, and retiree health costs, to create the mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown.

That is the beginning of a new report by Iris Lav and Elizabeth McNichol of the Center on Budget and Policy Priorities. 

A lot of people in policy circles like to draw a distinction between the short and the long run.  For some, the idea is that the long run is when we should deal with fiscal problems, but in the short run, we can’t afford not to spend. In my view, this allows people to appear sober-minded about the long-run fiscal problems of the states while endorsing more reckless decisions today. 

This is an old idea (“in the long run we are all dead,” said Keynes, dismissively).  But I think it has become increasingly dangerous.  Politicians have every incentive in the world to think about today and very little incentive to worry about tomorrow (and according to the GAO, the states’ long-run problems are quite significant, requiring spending cuts or revenue increases of 12.3 percent, sustained for the next 50 years).

A few months back, I wrote a paper examining the factors that contributed to large state budget gaps during the Great Recession (I actually used CBPP’s data on the size of the gaps). Among other things, I found that the size of a state’s gap in FY2010 was positively related to per capita spending growth over the 2 decades that preceded the recession. I take this as some evidence that the short and the long-run are pretty tightly-connected and a failure to focus on fiscal problems in the short run can manifest itself in pretty serious problems over the long haul.

Still short an accurate accounting

FY 2011 is a year in which states are having to reset their expectations. The stimulus is spent and the federal government is not likely to appropriate more to filling state budget gaps. Pamela Prah writing at Stateline reviews the reforms that are being considered which include block-granting Medicaid, and allowing states to declare bankruptcy.

While many officials know the future isn’t bright for state budgets, they haven’t quite admitted to exactly how big the bills are. States are still calculating their pension obligations based on flawed assumptions.

Assorted Links

Jeff Dircksen at the National Taxpayers Union writes about a new ranking of state governments:

There’s a new ranking that looks at how well states are run, or in some cases not so well run.  According to its web site, “24/7 Wall St. has completed one of the most comprehensive studies of state financial management ever performed by the mainstream media. It is based on evaluation principles used in the award-winning Best Run States In America ratings published by the Financial World Magazine during the 1990s. These studies were used by state governments to evaluate the efficiency of their own operations. The new 24/7 Wall St. study is meant to help businesses and individuals examine state operation with an unbiased eye.”

Take a look and see how your state does.  Spoiler alert:  Wyoming is the best and Kentucky is the worst.

On an unrelated note, Joe Henchman at the Tax Foundation cautions against the use of the Center on Budget and Policy Priorities’ state budget gap data (note: I used this data in my paper on budget gaps—in part because it was timely and because it is so commonly cited). Joe writes:

The number is probably accurate from their methodology, but is ultimately meaningless. Here’s why:

  • A state “budget deficit” is the revenue projected (usually by the Governor’s office) minus hoped-for spending according to some formula, in the initial budget plan. For instance, say a state raised and spent $10 billion this year, but wants to spend $20 billion next year, projecting $11 billion in revenues. Ultimately they settle on spending $11 billion. That state has “closed a $9 billion budget deficit” even though revenues and spending are up from the previous year.
  • The exact method of estimating next year’s spending varies by state, with some starting with last year’s budget while others throw in additional wish list programs. Adding up all the states’ numbers is adding apples and oranges.
  • States must balance their budgets so there really is no cumulative state budget deficit in the end, at least on paper.
  • It’s routine for states to want to spend more than they actually can, at least at first, and having a deficit in the initial plan happens even in flush times. Thus, CBPP’s numbers overestimate the scope of actual state budget deficits.
  • CBPP also presents the deficits as a percent of each state’s general fund. While the general fund is usually the largest and most important part of a state’s budget, in many states it can represent less than half of the total budget. This number thus exaggerates the seriousness of a budget deficit.
  • A budget deficit could exist because of overly ambitious spending plans that are whittled down to reality, overly optimistic revenue projections, fiscal irresponsibility, or structural imbalance. CBPP’s tale of the recession causing everything and federal aid being the only salvation doesn’t fit the facts. For instance, California’s deficit this year includes unpaid bills kicked over from last year, so it’s the same money being double-counted. This irresponsibility is glossed over in CBPP’s report.

What Caused the State Budget Gaps?

I know the conventional answer: the recession. And surely there is validity to the conventional answer. The recession was the proximate cause: it sent revenues in a free fall at the same time that it put extra demands on the states’ welfare systems.

But the budget gaps were pretty different from state to state. For example, California faced a 2010 budget gap that was 65 percent of its General Fund while North Dakota faced no budget gap at all. Might differences in state policy and differences in state institutions explain the vast difference in gap size? This was the motivation for my recent working paper, State Budget Gaps and State Budget Growth.

In it, I conclude that large gaps were the result of rapid growth in per capita spending, a lack of economic freedom, and weak balanced budget rules.

To arrive at this conclusion, I performed a series of statistical tests, focusing on the size of state budget gaps, measured as a share of state general funds. In these tests, I controlled for various factors that might influence the size of a state’s gap (its population, income level, demographic makeup, etc.). After controlling for these factors, I was able to estimate the impact of certain policy choices and institutions on the size of states’ budget gaps. In particular, I focused on:

  • Budget size relative to state income,
  • Growth in per capita spending in the two decades preceding the recession,
  • Levels of economic freedom, and
  • Stringency of state balanced budget requirements.

I found that states that spent a large share of state income—and have done so for many decades—had smaller (percentage) deficits. This may be because states grow accustomed to making their budgets balance or it may be because the same factors that permit steady revenue streams also permit large budgets. But this doesn’t mean policymakers should go on spending sprees and expect smaller budget gaps. In fact, a spending spree is likely to make a state’s budget gap worse. Other factors being equal, states whose per capita spending increased the most in the two decades preceding the recession had budget gaps that were nearly 20 percentage points larger than states whose per capita spending increased the least. Since the median state’s budget gap was 23 percent of its general fund, going from the slowest to the fastest-growing state can make a huge difference.

Economic freedom (characterized by low taxes and minimal regulation) makes an even greater difference. Using Jason Sorens and William Ruger’s measure of economic freedom, I found that other factors being equal, the most-economically free states tended to have budget gaps that were 25 percentage points smaller than the least-free states.

Lastly, states with weak balanced budget requirements had larger budget gaps. While every state but Vermont is required to balance its budget, some requirements are weaker than others. It turns out that those states with weak balanced budget requirements encountered larger deficits to begin with: theirs were 8 to 10 percentage points larger than those with strong balanced budget requirements.

So what caused the budget gaps? Policy makers may be all-too-happy to pin the blame on the recession. But my research suggests that policy choices in the decades preceding the recession made a big difference. Rapid growth in per capita spending, a lack of economic freedom, and weak balanced budget rules caused the gaps. The recession just exposed these underlying problems.

Christie’s Property Tax Cap Evolves

A key component of Governor Chris Christie’s spending and tax reduction plan is his proposal to place a hard cap of 2.5% on property tax increases, based on Massachusetts’ Prop 2 and 1/2. A compromise was reached with the Legislature this weekend to create a 2% cap with several exceptions for pensions, health care, and debt.

The Asbury Park Press covers how the cap evolved this weekend.

My reservations over the property tax cap boil down to a basic theoretical observation. Capping one source of revenue only shifts the bill. The problem in New Jersey does not lie with the property tax, per se, but in the evolution of an intergovernmental aid system, and state spending mandates that have eroded Home Rule.

Local budget watchers will want to keep an eye on how local governments choose to navigate the cap this year. Pension costs and health care are set to consume the state’s budget in the coming decade. Cap or no cap, as the Governor knows,  New Jersey has plenty left to cut.

Why This Isn’t A Time to Worry that Government Is Spending Too Little

Last week, Ezra Klein wrote that state budget shortfalls constituted a massive “anti-stimulus” which might overwhelm the Federal Stimulus (implying the need for further federal spending). I responded with a post arguing that, while Klein’s story is plausible, the numbers just don’t add up. The massive increase in federal spending in the last few years has more-than made up for any decreases in state spending.

This, in turn, prompted an interesting response from Harry Moroz over at Huffington Post. Mr. Moroz writes:

Obama’s efforts to counteract the economic downturn…accounted for only 34 percent ($205 billion) of increased spending in 2009. The rest of the increases have little to do with stimulating the economy….A comparison of federal spending and aggregate state spending is irrelevant. Comparing federal stimulus spending and state spending cuts is only appropriate and useful because both are responses to the economic downturn.

In other words, Mr. Moroz would prefer that we not look at overall spending increases because most of these increases were not intended to be stimulative. (I trust that Mr. Moroz will correct me if I am mischaracterizing his assertion.)

I agree with Mr. Moroz’s point that most of the spending increases were not stimulative (that’s kinda the problem). But the much-ballyhooed Keynesian model—on which proponents of increased government spending hang their intellectual hats—makes no allowance for intentions. Instead, they assert that all government spending, no matter what it is spent on, is stimulative. Here is Lord Keynes on the subject:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again…there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

For his part, President Obama made a similar claim in February of 2009:

Then you get the argument ‘well, this is not a stimulus bill, this is a spending bill.’ What do you think a stimulus is? That’s the whole point. No, seriously. That’s the point.

And though Mr. Moroz would not like to count President Bush’s $700 billion TARP bill either, the fact remains that that president, too, thought he was stimulating the economy.

The real question is: Intentions aside, does government spending actually stimulate the economy? Over the long run (when Lord Keynes said we were all dead) the answer is almost certainly “no.”

Using international data, a number of peer-reviewed studies have examined the relationship between government size, somehow measured, and economic growth. Here is a sample: Barro (1991 and 1989); Folster and Henrekson (2001); Romero-Ávila and Strauch (2008); Afonso and Furceri (2008); Chobanov and Mladenova (2009); Roy (2009); and Bergh and Karlsson (2010). Each of these studies finds a strong, statistically significant, negative relationship between the size of government and economic growth.

What about the short run? Here again the evidence seems weak at best. Consider new research by Harvard’s Robert Barro and Charles Redlick. They find that for every dollar the government spends on the military (read: takes out of the private economy), the economy gains just 40 to 70 cents. Spending a dollar to obtain 40 to 70 cents does not a good deal make. Or consider another study by Harvard’s Laruen Cohen, Joshua Coval and Christopher Malloy. They rely on the fact that the federal government tends to spend more money in districts whose congressional members are chairs of powerful committees than in districts whose members are just rank-and-file. They find that firms actually cut capital expenditures by 15 percent following the ascendency of a congressman to the chairmanship. Moreover, firms seem to scale back employment and experience declines in sales.

It seems to me that by just about any measure, we are currently conducting a large-scale experiment in massive government spending. Moreover, I believe the results of previous experiments predict that this one will lead to slower growth and less economic opportunity. This is not the time to worry that perhaps we have spent too little.

I may be missing a nuance in Mr. Moroz’s argument. I hope he will disabuse me of my errors with a reply.

Will We Learn From Greece?

A few weeks ago Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, warned, “Greece is a lesson for us…. We shouldn’t be so arrogant to think that that couldn’t happen to us.” Mr. Hoenig was talking about our “very, very significant deficit” at the federal level.

Mr. Hoenig is right to worry about the Federal Government’s financial footing, but as a growing number of commentators have argued, the comparison between Greece and the U.S. states may be more apt than that between Greece and the U.S. Federal Government.

Like Greece, nearly every state in the union faces a major budget gap. The National Governors Association and the National Association of State Budget Officers estimate that these gaps total $127.4 billion for the remainder of 2010, 2011 and 2012. Like Greece, these gaps manifested themselves during the recession but their underlying cause is unsustainable levels of government spending. Like Greece, the states have made unrealistic promises to their public employees in the form of unfunded pensions and health benefits. Like Greece, these promises loom as the single largest threat to fiscal solvency in the coming years. And like Greece, the states have a limited number of ways to deal with the situation: they may not declare bankruptcy and they may not inflate their way out of the mess.

In both situations, however, the governments can appeal to the next level of government for aid. In the US, the states received some $135 billion from the Federal Government in the stimulus package passed last spring. And in Europe, the EU has promised to bail out Greece to the tune of $146 billion. These actions send the signal that the US and the EU apparently think that some governments are too big to fail. They also establish a strong incentive for US state and EU member nations to live beyond their means.

The Economist recently noted another similarity between Greece and the US states: as in Greece, many leaders at the state government level are reluctant to make the tough choices necessary to deal with the problem.

This last comparison, however, may prove false. That is because the Greeks may finally be on the verge of addressing their problem. This week, the ruling Socialist Party, PASOK, unveiled their reform proposals and on Friday, the government agreed to the bill. According to Reuters, “The reform cuts benefits, curbs widespread early retirement, increases the number of contribution years from 35-37 to 40 and raises women’s retirement age from 60 to match men on 65.”

My colleague Eileen Norcross has just written a paper with AEI’s Andrew Biggs which reveals the scope of the pension problem in the state of New Jersey. They found that the pension system there is underfunded by as much as $170 billion. Note that this one state’s pension problem dwarfs the $127.4 billion sum total of all state budget gaps over the next two and a half years.

Worse, these unfunded liabilities will come due soon. A series of studies by Joshua Rauh (Northwestern) and Robert Novy-Marx (University of Chicago) find that seven states will run out of pension money by 2020. And when they do, the costs will be enormous. When Illinois’s pension system goes broke in 2018, for example, the state’s pensions costs will be nearly half the size of the entire 2008 state budget.

If Mr. Hoenig is right and Greece is a lesson, let’s hope that policy makers in the US learn it before the pension crisis hits.

What Spending Contraction?

Eileen has a great response to Ezra Klein’s piece on the “anti-stimulus.” Klein writes that “[state] budget shortfalls are the equivalent of a massive anti-stimulus, which some experts believe has overwhelmed the $787 billion stimulus passed by the federal government in 2009.” Have state budget cuts really overwhelmed federal budget expansions?

The National Governors Association, in conjunction with the National Association of State Budget Officers, recently released their “Fiscal Survey of States. In it, they show that, indeed, aggregate state general fund expenditures declined by 4.3% in 2009 and 6.8% in 2010. Assuming fiscal stimulus actually works (and that is not a point that should be readily conceded), it is plausible that these huge declines would be enough to offset any increases in spending by the federal government. But the fact is they come nowhere close to offsetting the Federal Government’s massive spending spree.

If you pop over to the White House’s Office of Management and Budget website, you can see what the Federal Government has been up to. At the same time that aggregate state spending was falling by 4.3% and 6.8%, federal spending was increasing by a whopping 17.9% (2009) and 5.8% (2010). This, combined with the fact that the Federal Government spends trillions while states spend hundreds of billions (in the aggregate), means that the state spending contraction comes nowhere close to offsetting the federal spending increase.

In the chart below, I combine the data from NGA/NASBO with the data from the White House Office of Management and Budget. You judge for yourself. Does this look like a massive fiscal contraction to you?

Governors Revolt!

What’s gotten in to the governors? Across the country, a number of them seem to be fed up with their respective budget crises and are proposing bold action. As Eileen has written in the New York Post, New Jersey’s Governor Christie has shown remarkable resolve in tackling “the third rail of New Jersey’s budget: union-negotiated contracts and control.”

On Tuesday, I wrote about New York’s Governor Paterson and his plans to lay-off nearly 10,000 government workers (effective upon his successor’s first day in office). Now the Governor has gone a step further, announcing that he is “taking over” the budget cuts in order to keep the state afloat. After weeks of fruitless negotiations with state lawmakers, the state budget is more than 2 months overdue and there seems to be no consensus about how to deal with the $9.2 billion gap. So Paterson plans to impose dramatic cuts by including them in an emergency spending plan.

A little further west, in Illinois, Governor Pat Quinn and the state legislature are wrestling with a yawning $13 billion gap. Yesterday, the governor declared his intention to make the tough cuts that legislators seem unwilling to make. Of course, when pressed for details, he declined to offer a substantive plan. Hopefully, he’ll come around.

Hopefully, all of the governors will come around. A new report by the National Governors Association and the National Association of State Budget Officers (NASBO) will be released this morning. According to the Wall Street Journal (gated), it shows that states across the country still face a $127 billion gap over the next two years.