Tuesday, October 20, 2009

The Future of State Government Revenues Is Now

Back in the dim ages of, oh, three to five years ago, Utah’s politicians reveled in unprecedented ‘surplus revenues’ several years in a row. We had a popular pretty-boy governor with a big government agenda and a legislature that was busy figuring out its own priorities for growing state government. We even had to convene special legislative sessions on how to divide up the largess.

Times were good. Few cared about or paid attention to the expansion of state government. I was among the few voices in the wilderness crying out for austerity and preparation. Such voices were drowned out in the raucous revelry over how to dispose of billions of extra (taxpayer) dollars that had found their way into state coffers. Others were crying out for preparation as well. But these voices repeatedly called for more spending, which they conveniently labeled “investment.”

Hardly anybody seemed to care that all economic boom cycles must go bust. And those that did care were busy trying to nail down their share of the money while it was easy to come by. It was a good time to be a politician. It is so much more enjoyable saying yes to pleas for more funding than saying no, “And by the way, we’re going to have to take back some of what we previously gave you.”

Nowadays nervous state politicians try to find ways to scrimp just enough to keep the state solvent, hoping that the bust will soon return to a boom so that they can get back to business as usual. There’s only one problem. Indiana Governor Mitch Daniels thinks that what we’re seeing today is the new normal.

Writing in the Wall Street Journal last month, Daniels said, “What we are being hit by isn't a tropical storm that will come and go, with sunshine soon to follow. It's much more likely that we're facing a near permanent reduction in state tax revenues that will require us to reduce the size and scope of our state governments. And the time to prepare for this new reality is already at hand.”

Daniels notes that states, like their citizens, lived pretty high on the hog for the decade preceding the recession, when states increased their spending “by an average of 6% per year, gusting to 8% during 2007-08.” Although Utah continues to rank very well among states by fiscal measures, that’s like saying that you’re the best of the dregs, given that most state governments, as Daniels puts it, are being kept afloat only by “an emergency infusion of printed federal funny money.”

During the same time that Indiana cut spending 1.4% annually and reduced state staffing by 5,000, Utah joined most other states in growing spending and the number of government employees. Why did Indiana buck the trend? While Utah started out 2005 flush with cash, Indiana was teetering on bankruptcy. Hence its drive for governmental austerity while other state governments (including Utah’s) were growing by leaps and bounds.

While many politicians hunker down hopeful of a brighter economy just around the corner, Daniels lays out a grim picture of why they hope in vain.
  • Much of the spending that fueled the revenues of the boom years was based on borrowing that will not soon be repeated.
    • Loans have tightened significantly for businesses. This will continue to be the case for quite a while.
    • The home equity that was the basis of borrowing that fueled consumer spending is gone. Today’s realistic home prices aren’t going to rocket back to unsustainable levels anytime soon, so that source of revenue is kaput.
  • Even if the market roars back to life, it will take years before investors overcome their losses and have to start paying capital gains taxes.
  • Soak-the-rich taxes are producing far less revenue. Not only are there fewer rich to soak, the ones that are left have options to relocate to more tax advantaged settings.
Daniels notes that, unlike the federal government, states cannot keep themselves afloat by printing more money. Even if the federal government bucks public sentiment and does another ‘stimulus,’ it will only postpone what must be done: revise expectations and downsize state governments. The alternative currently being tried by many states, wishing “for an improbably huge boom while chasing your own tail through self-destructive taxes won't prove much of a strategy,” writes Daniels.

I find it interesting that so many are in denial about the path that state governments must take. As states come to grips with the reality of much lower revenues, the usual members of the dependent class will be seen shrieking at every possible instance. Eventually, however, there simply won’t be other options.

While state governments must contemplate actual reductions, the federal government is going the exact opposite direction at hyper speed, seemingly heedless of any limitation whatsoever. Daniels opines that this kind of extreme denial will only continue “for a while longer” and “as long as our Chinese lenders enable it.”

I find Daniels’ call to responsibility intriguing. He writes, “The time to plan and debate is now. This is a test of our adulthood as a democracy.” This is where I think Daniels got it wrong. I will elaborate on that in my next post.


Unknown said...

Hopefully I am not stepping on the toes of your promised next post, but if this is the new normal for state budgets (which would not really surprise me) does this hint at the possibility that as people realize the failures of current elected officials it might open the door for some fresh ideas?

Scott Hinrichs said...

You're way ahead of me on that one. I think that you are correct, but that people will first seek for more of the same approach that brought the problems. These will, of course, be packaged as fresh ideas.

We don't vote for politicians that bluntly tell us how things really are. We vote for politicians that spin beautiful fairy tales. We simultaneously want lower taxes and more government services, and we vote for politicians that promise stuff like this.

I think it will take events that make Americans face reality before we start looking for fresh ideas like truly responsible policies. A faux crisis won't do it.

Unknown said...

I would not call this a faux crisis but I would say that the severity of our circumstances is severely underestimated by the majority of the country.

Scott Hinrichs said...

That depends on what you mean by "this." Our housing crisis was manufactured by a coalition of stupid big government policies and rent seeking by big business.

But the credit freeze didn't really happen until Messrs. Paulson and Bernanke decided to take a critical moment and turn it into a ploy to increase the power of the Fed and the Treasury.

Then we actually had a crisis as credit markets immediately froze. But this crisis was still not huge on the scale of historic crises.

We have subsequently ratcheted up government spending in a way that will lead to a more serious crisis. But even that one may not be dramatic enough for people to stop and pay real attention to the causes. It will probably take something a bit more serious, but we're going there.