Wednesday, July 07, 2010

Are State Balanced Budgets Helping Our Economy?

This is an important question that has not been featured in the national news. The simple answer is … No, state balanced budget rules are deepening the recession.

The Fiscal Times tells us that a study by economists Joshua Aizenman and Gurnain Kaur Pasricha found that fiscal contraction in the states offset almost 100% of the fiscal stimulus at the federal level in 2009.

This fiscal contraction has been primarily caused be balanced budget rules in the various states.

Here, in Colorado, we have a strict balanced budget requirement, including a virtual prohibition on raising state revenues. The TABOR Amendment to our state constitution prohibits increases in state revenue that are greater than the national inflation rate plus the state population growth. During an economic downturn, the state must severely cut its budget and then cannot simply return to a normal budget afterward. (see below).

According to Keynes, to keep an economy out of depression, government needs to borrow and spend during a recession. Following the recession, during the period of growth, government needs to pay off the debt to put the government’s finances back in order and lessen the next recession.

The Federal Government has lived up to its duties during the current great recession. So have many other countries. However, the states are gumming up the works.

We tend to forget … Budget cutting means cuts in jobs. The largest cost, by far, of most things is labor. This is especially true for government which provides many more services than goods. The Center for Budget and Policy Priorities (CBPP) predicts a shortfall of 21 percent for FY 2011 in Colorado. Due to our balanced budget requirements, that means the State will have to cut its budget by 21 percent. This means cuts in jobs.

So, while the Federal Government is borrow and spending large amounts to keep us out of depression, the states are fighting against this fiscally sound policy. The CBPP found that states will have a shortfall of $200 billion in FY 2010. The states will have to cut their budgets by a similar amount; spend $200 billion less. That means that the states are reducing the Federal Government’s $800 billion stimulus by $200 billon.

Balanced budgets are important, but only over time, not at all times. If the states temporarily suspend their constant balanced budget rules and help the Federal Government by doing some temporary borrowing, we could get back to national economic growth much more quickly. Then we pay off the debts during the good times.

What’s wrong with TABOR? (1) The national consumer price index has little to do with inflation in government services and does not necessarily apply to Colorado. For example: Schools spend most of their money on construction and professional salaries. While the CPI remained relatively flat during the 1990s, the cost of construction and professional salaries soared, but school districts were not allowed to keep up. (2) Increases in population do not reflect increases in the cost of government. For example: Even if a school were to have constant enrollment, it will eventually have to replace its boiler. Because the school district cannot raise its revenues or spending, TABOR does not allow for replacement costs. (3) TABOR does not allow for recovery. During an economic downturn state revenues will automatically decrease. Following the economic downturn, the state cannot simply go back to the revenue level prior to the downturn. For example: The CBPP indicates a shortfall of 21 percent in Colorado in FY 2010. TABOR thus requires budget cuts of 21 percent. If the recession ended this year, the state could only raise revenues next year by inflation (3.00 % in 2005 (before the recession started)) plus population growth (1.81 % in 2009) or 4.81 %. This is only enough to keep up with inflation and population growth. We’ll never catch up.

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