Chaos reigns as states try to budget in the recession
The financial crisis affected millions of Americans, drove down property values, crippled the mortgage industry, spiked unemployment rates, and revealed the unwieldiness of the American banking system. In response, the U.S. government attempted to resuscitate the economy with a nearly $800 billion stimulus. Meanwhile, state governments have been struggling with falling revenues and mounting expenditures. The intensity of each state’s budgeting dilemma was determined by a confluence of factors: state constitution budgeting requirements, longstanding fiscal policies, and political culture. In some states, such as California and New York, weaknesses in all three areas made these states particularly vulnerable to the sudden economic downturn. If state governments do not reform these problematic policies, they in essence leave their citizens a legacy of unpreparedness for future financial crises.
Constitutional Constraints
California is Exhibit A in the case against certain constitutional constraints on state budgeting. The initiative and referendum system has not proven to be a reliable source of rational economic policies. Proposition 13, for example, capped property tax rates in California and required a two-thirds supermajority of the state legislature to pass tax increases and operating budgets. This popular measure did not foresee that dedicated partisans from either political party, with only a minority of the California State Assembly, could easily block necessary fiscal reforms. Such a deadlock occurred during the most recent budget deliberations, with Democrats intent on maintaining social services and Republicans opposed to any tax increases. Harvard Law School visiting professor Sanford Levinson told the HPR, “We are seeing an ongoing internal conflict as voters demand fewer taxes and more spending.”
Beyond California, balanced-budget requirements in many states have tied the hands of governors and state legislators. Voters have demanded that states control their budgets, and bond owners in particular want guarantees that their bonds will be paid in full. But Keynesian economics, which has reemerged as the dominant economic theory in Washington, holds that deficit spending during economic recessions is necessary to restore growth. State borrowing is typically forbidden; voters have refused to provide legislators with deficit-spending powers. As Harvard economics professor Gregory Mankiw told the HPR, “From an economic perspective, we should allow states to borrow and lend.” The inability to do so has left the federal government as the revenue source of last resort.
This year, many states incorporated funds from the stimulus package to maintain spending on education, unemployment insurance, and other social programs. New Hampshire State Sen. Peggy Gilmour (D-Hollis) summed up many legislators’ worries when she told the HPR, “This year, we could rely on federal stimulus money to fully fund programs. But, going forward we’re going to face an increasing challenge.” And even with the stimulus money, drastic cuts were necessary in many states. Balanced-budget requirements eliminated one fiscal tool that state governments could have used to combat the recession.
The Fiscal Trap
For years, New York, New Jersey and other states have relied heavily on a combination of income, sales, and capital-gains taxes to raise revenue. Unfortunately, actual revenues for these states fell dramatically short of projected revenues following the financial crisis. Perhaps the most significant instance of diminished tax revenues occurred with capital-gains taxes: when the market meltdown crippled stock values and wiped out earnings for investors, state tax coffers that relied heavily on these taxes were devastated.
Similarly, the economic recession has depressed the retail sector and eliminated many jobs, chipping away at the sales and income tax bases. Even New Hampshire, the only U.S. state without an income or sales tax, has had difficulty in budgeting because it depends heavily on business profits and business enterprise taxes. Arizona, meanwhile, depends heavily on property taxes; once the housing bubble burst, Arizona found itself facing a budget deficit about one-sixth the size of its operating budget.
At the same time, expenditures, especially on Medicaid, insurance for state employees, and social services, have markedly increased. Retired and unemployed citizens rely more on state services during recessions, even as balanced-budget requirements force states to slash spending. David Luberoff, executive director of the Rappaport Institute at Harvard University, told the HPR that the key question for state legislators to ask over the next few years is “What’s our social safety net?” If social safety nets cannot be maintained during recessions, when they are most needed, they constitute little more than false promises.
Another constraint on state governments is the often-difficult budget-passing process, in which legislators must decide which programs to salvage or dismantle. Sen. Gilmour told the HPR, “fulfilling state obligations to mandated programs and vital services takes first priority.” But inefficient programs are often phased out rather than eliminated, and department heads must always be consulted in such situations. Reforming programs can take time, and many programs have entrenched defenders. Taken together, all of these little requirements and constraints mean that states cut spending when they ought to increase it, lose tax revenue and cannot regain it, and slash programs that are in high demand instead of those that do not work.
Culture and Leadership
Another major stumbling block in the way of state-level fiscal reforms is a heavily ideological political culture. Partisan legislators can more easily block reform when assisted by structural obstacles, as demonstrated by California. And a combative political culture can always amplify existing problems. For example, the New York State Senate has historically been one of America’s most dysfunctional bodies, and its recent leadership crisis merely underscored the struggles that New York must face when attempting to pass any legislation, let alone a budget.
Strong leadership, however, can make the difference between gridlock and success. For instance, Massachusetts Gov. Deval Patrick recommended that his state end its reliance on capital-gains taxes. Patrick called for future budgeting processes to disregard capital-gains revenue; instead that revenue will directly supplement the state’s rainy-day fund. Such innovations can be dangerous, though: Massachusetts Secretary of Administration and Finance Leslie Kirwan told the HPR, “Many public officials will pay the political price [for Patrick’s reforms], but that is the essence of leadership.”
The pains of the financial crisis hold valuable lessons for state governments. States will need to work to overcome not only constitutional and legal obstacles to an effective budget process, but also precarious taxing and spending commitments and political cultures in which it pays to stand in the way of effective government. This is a tall order, but it is necessary to ensure that states are ready for the next big recession.
