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Reconstructing the Structure: Fiscal Reform — Or Else

Mark Muro / Jan 14 2011

For Release Sunday, January 16, 2011
Citiwire.net

Mark MuroNationwide, the Great Recession is over. Economic output is expanding, modest job growth has begun, and housing prices are stabilizing.

At last thoughts are turning to building a new and more durable “next economy” in the U.S. and its regions.

And yet across the 50 states, a major problem intrudes.

Three years after the crash, the deepest economic downturn in memory has exposed and exacerbated a massive public-sector fiscal crisis that has the power to paralyze states, undercut growth, and turn states inward just when they need to look outward.

To begin with, almost all states are wrestling with large “cyclical” deficits that represent the temporary fallout of the recession and its aftermath (i.e., the sharp decline of taxable economic activity in states). These shorter-term shortfalls are in some places crushing but they will ease as the economy recovers.

But beyond that, the recession has also revealed the existence of longer term, and sometimes gargantuan, “structural” imbalances in states as diverse as California, Arizona, or Illinois.

Frequently the result of excessive tax-cutting or starry-eyed spending in better times, structural deficits reflect the emergence of the chronic shortfalls that result when revenue consistently fails to grow in tandem with expenditures. Yet now such chronic budget gaps — adding up to 10 or 20 percent of general fund expenditures in places like California or Arizona — have reached the crisis level.

And here is the crux: Essentially the end-point of business-as-usual, these massive imbalances are going to compel massive reform, or else they will degrade states’ ability to renew themselves for years. Let us hope policymakers rise to the task.

What is the business-as-usual that created the current mess? Myopia, rigidity, ideological warfare, and fragmented decision making explain most of it, as noted a recent report my team at Brookings Mountain West developed in partnership with the Morrison Institute for Public Policy at Arizona State University.

Look, for example, at the contrasting but related messes in California and Arizona — two of the Western states we studied in our report.

California’s deeply entrenched budget problems show how overly-optimistic spending, combined with voter mandates and institutional constraints (with none of it linked together), can lead to trouble. There, a popular initiative directing half of all new revenue to schools has combined with multiple state and local voter-approved limits on taxing and revenue raising to create a stunning fiscal train wreck. California now faces an astonishing $22 billion total deficit for Fiscal Year (FY) 2011, of which more than half ($12.7 billion) is structural and so is essentially permanent and has little to do with the current downturn.

Arizona’s fiscal problems, meanwhile, demonstrate how a single-minded emphasis on tax-cutting, combined with California-style voter mandates and institutional constraints, can also lead to calamity. Just as starry-eyed as California but in a conservative vein, Arizona basically gave away the store in better times by handing out a series of ill-advised tax cuts (total value, adjusting for inflation and growth: $2.9 billion since 1993) — all unaccompanied by spending cuts. True, major new education and Medicaid expansions in the last decade added to the problem. But for the most part a fiscal disaster resulted from the way the massive tax cuts combined with several voter mandates and a super-majority requirement for any revenue increase. The long-predicted result: The Arizona general fund for FY 2011 is now short some $3.4 billion, or a full 33 percent of the needed total, with fully two-thirds of that amount ($2.1 billion) associated with the state’s permanent structural gap.

The bottom line: Arizona and California got in trouble by combining rash, basically optimistic spending and tax decisions in good times with rigidity and narrowness. In each place the basic need to constantly compare and link spending and revenue-raising broke down thanks to ideology, a loss of consensus, and the recourse to voter mandates, all of which is now feeding on itself. And it’s a problem that is endemic — in Illinois, in New Jersey, in many other states.

What is the way beyond this mess? At the most concrete level, states need to break with business-as-usual in three fundamental ways. First, they will need to take unprecedented steps to close gaps — and the sooner the better (witness Illinois’ large, temporary new income tax increase). Second, states need to improve the quality of their fiscal policymaking by working to broaden, balance, and diversify their revenue bases while looking to the long-haul balance of taxing and spending. And third, these states need to improve the information sharing and budgeting processes through which fiscal problems are identified, analyzed, and addressed.

But to achieve any of this, states must break radically from habits of recent years. They need to reconstruct the budgeting process as a pragmatic give-and-take based on short- and long-term fiscal realities they actually face. That means, in the end, true political collaboration. Plus, they need to make it much more difficult for interest groups and others to pass budget-blowing ballot measures that blow holes in budgets, failing to recognize the overriding need to balance revenues and expenditures.

And, states need to foster collegiality and cooperation instead of the usual sloganeering and ideological warfare.

The return to fiscal health will be slow and painful. But steps can and must be taken now to reform the states’ dysfunctional budget dynamics and put states on a better footing as soon as possible. Absent those indispensable moves, the present inward-turning paralysis in state after state will be prolonged for years and preclude the broader, much needed economic reconstruction of America’s regions and states.


Mark Muro is the co-director of Brookings Mountain West and a senior fellow at the Metropolitan Policy Program at Brookings. He is a co-author of “Structurally Unsound: Cyclical and Structural Deficits in California and the Intermountain West,” a co-production of Brookings Mountain West and the Morrison Institute for Public Policy at Arizona State University.

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3 Comments

  1. Posted January 14, 2011 at 6:38 am | Permalink

    Your long term projection that we will return to normal fiscal health seem a bit rosy. On what planet do you spend most of your time?

    As a country whcih makes too little of what it consumes, which sends some 700 billion in wealth out of the country every year (trade deficits) & a work force that is woefully unprepared to produce (both book learning and will to work hard) where is the case for return to $$ health?

    The best average month of job growth in the Bush years was 200,000 per month. At that rate it will take some 20 years to get everyone employed again, given we still take in 125,000 LEGAL, unskilled immigrants every month. Average wages are falling so fewer can afford a $200,000 house.

    Please prepare a report on where America will have to cut its living standard, cut its empire in order not to go over the economic cliff. thank you for your time.

  2. Mike Koetting
    Posted January 16, 2011 at 11:10 am | Permalink

    Mark Muro’s column missed the obvious: in the 21st, global economy, does it still make sense to have 50 separate–mostly nonfunctional–economies marching to whatever drummer seizes the Statehouse for that particular 4 years? Perhaps the structural problem is not just economic; it a political structure inherited from a different era that has stopped working.

  3. Posted January 18, 2011 at 5:19 pm | Permalink

    Part of “business as usual” is creating new infrastructure that inflates nearby land values, providing huge windfalls to generally affluent landowners. Utilizing “value capture” would help make public works self-financing and reduce real estate speculation, thereby making homes and business locations more affordable.