Self-Inflicted Pain Hobbles States

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Politicians, the bureaucrats who serve them and the media who cover them often blame government’s fiscal woes chiefly on the problems of the larger economy. Underlying this way of thinking is the notion that it is rarely the actions of those in government itself which produce budgetary crises. Rather it is external forces—a souring economy, bad policy on the part of someone else—that are mainly the root of their troubles.

We’ve seen several examples of this thinking in recent days (and we’re sure to see more in coming months), including a story published by the Associated Press last week, and widely picked up media outlets, with the headline, “Many States Appear to Be In a Recession.” Based on a new fiscal report by the National Conference of State Legislatures, the story offered none of the conventional evidence of a recession—job losses or declining gross product in states, for instance. Instead, the piece declared that many places were in recession because states’ budgets were under stress. “Whether or not the national economy is in a recession is almost besides the point for some states,” the story quoted the NCSL. “The fiscal situations have declined so much that they appear to be in a recession.”

Reading this story you would think that government budgets are simply made up of revenues that rise or fall as the economy changes. The story makes only a passing mention of the other half of the budgetary equation, which is spending. That’s a pretty big omission, considering the way our states have been splurging. Judging by figures compiled by the National Association of State Budget Officers, our state governments went on a spending spree for the last several years, as collections poured in from a variety of taxes, including some volatile sources like realty and mortgage recording taxes that were bound to turn down. From 2004 through 2007, states collectively increased their spending by almost 25 percent, a far larger gain than inflation plus population growth. The gains included a whopping 9.3 percent increase in 2007 alone, even as warning signs of a possible economic slowdown were emerging. These spending increases quickly soaked up any extra revenues produced by the super-heated economy of those years, which is one reason why so many states are facing shortfalls so soon after recording big surpluses. In the coming weeks you are sure to read about all of the programs that states are being forced to cut back as tax revenues decline, with little reference to all of the spending that they added when revenues were surging.

In some states, in fact, there has been only a slim relationship between spending and external economic conditions. New York State, for instance, can boast of only a mediocre economic performance even during the flush years. From 2005 to 2007, the state ranked 45th in job growth, and even in the midst of the boom years, Moody’s predicted the state would lag national economic growth. Yet the state’s combined budget increase for the last three years equaled about 21 percent, far above inflation and population growth (of which New York State has virtually none). New York built this spending on a slim, volatile tax base--high-earning Wall Streeters whose big bonuses sharply boosted personal income tax collections—with little sense of how the state would pay its ever increasing bills when finance’s go-go years ended. That’s characteristic of many states which often seem to add new programs without a plan for how to pay for them over time.

What often happens, instead, is that as soon as times get tough the states begin haranguing the federal government to bail them out. This brand of tin-cup federalism was on display last week in an opinion piece published in the Wall Street Journal by Arizona Governor Janet Napolitano, and we’re sure to see more of this too. In the piece the governor blamed the feds for a host of the states’ fiscal problems, including the growing cost of subsidized health care, which states have been expanding rapidly and which now consumes a hefty 22 percent of state budgets. Among other things, Napolitano scored the Bush administration for not expanding the State Child Health Insurance Program to pay for coverage in families earning up to 250 percent of the federal poverty level. Some readers must have wondered how a failure to expand a program would cost the states money. What Napolitano didn’t say is that many states—in fact 40 of them-- went ahead and extended their Schip programs on their own, and now many can’t afford them. One of the states with the worst budget crises, New Jersey, has extended its Schip program to families earning 350 percent of the federal poverty level, or about $72,000 in annual household income for a family of four. Since 2001 New Jersey has faced persistent budget problems and has raised taxes some 35 times, totaling about $5 billion, and it still can’t pay its bills. But some lawmakers in Jersey are talking about going further even than Schip and enacting universal health care legislation in the state. This is what passes for long-term budget planning among the states.

Napolitano’s WSJ piece is a good example of the kind of budgetary passing-the-buck one hears from state officials as their deficits grow. Beyond failure to expand Schip, she blames state fiscal woes on, among other things, temporary business tax cuts in the 2008 federal stimulus package, because many states tie their own taxes to federal rates and therefore will collect less as businesses pay less to the federal government. In other words, under Napolitano’s formulation, federal tax policy’s intent should be to protect state taxes or, failing that, to provide billions of dollars in aid to the states for their revenue declines, which is what her piece was really angling for.

But perhaps before she complains further about federal corporate tax cuts (even temporary ones), Napolitano should take a look at a Tax Foundation study showing the burden that businesses bear in Arizona, and how that compares with corporate tax rates around the world. According to that study, the combined federal and state corporate tax burden on businesses in Arizona is a whopping 39.5 percent. That’s higher than the federal and state (or equivalent provincial) tax rate paid by businesses in any of the other 29 countries of the Organisation for Economic Co-operation and Development except one, Japan. In fact, in 22 of 29 countries in the OECD including Ireland, New Zealand and Spain, there are no state (or provincial) corporate income taxes on top of the federal tax rate. As the Tax Foundation notes, perhaps somewhat naively, “state officials should be champions of substantial cuts in the federal tax corporate tax rate” to improve America’s competitiveness.

Apparently the worthy folks at the Tax Foundation never met a real-life governor.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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