The Source Of State Budget Woes

Ray Keating
©2003 All Rights Reserved

Why have so many state and local governments across the nation been staring at large budget deficits recently?

State Legislatures (NCSL) reported that state governments must still close a $21.5 billion budget gap for fiscal year 2003. The organization noted: “Entering their third straight year of budget shortfalls, state lawmakers have had to close a cumulative $200 billion budget gap.” Looking ahead to fiscal year 2004, NCSL estimates that “41 states face a cumulative budget gap of $78.4 billion.”

Those are some pretty big numbers. Many elected officials would like to blame such budget troubles on the rough seas the U.S. economy hit in the middle of 2000, and more or less has been caught in ever since.

Surely, a stagnant economy has played a part. Recession and a sub-standard economic recovery have restrained revenue growth for government. Likewise, a multi-year abysmal performance in the stock market has resulted in fewer capital gains tax revenues, especially compared to the dramatic rise in stock prices in the late 1990s. In addition, there was real economic damage done and uncertainty created by the terrorist attacks of September 11, 2001. Uncertainty persisted through the wars in Afghanistan and Iraq.

However, it is important to understand that these factors, while clear contributors, are not the main causes. As illustrated in a new report on state spending (“Big Spending in the States”) that I wrote for the Small Business Survival Committee, the main problem has been excessive government spending.

After adjusting for inflation and population, spending at the state level increased by significant amounts in recent years. For example, from 1992 to 2000 (most recent comparative data from the U.S. Census Bureau), per capita state total expenditures in the U.S. increased by 40%, while inflation over the same period registered 16.4% (as measured by the GDP price deflator). So, per capita state spending jumped by more than twice the rate of inflation.

During this same period, per capita state and local spending skyrocketed as well -- leaping by 37.6%, again compared to inflation coming in at 16.4%.

With some substantive spending restraint in recent years, the states would not have faced any fiscal troubles at all. If per capita spending had only increased by the inflation rate from 1992 to 2000, the states would have spent $654 less in 2000 for every man, woman and child in the nation, translating into savings of more than $183 billion in 2000 alone.

Factor in local government, and the savings grow substantially larger. That is, if per capita spending increases had been limited to the rate of inflation between 1992 and 2000, state and local governments would have saved $965 per person in 2000, for savings of more than $271 billion in 2000 alone.

Unfortunately, too many state and local politicians ignore the real source of their budget woes, choosing instead to raise taxes on individuals and businesses. Taking the spending-and-taxing path, though, only leads to more trouble.

Higher taxes do additional damage to the economy by discouraging investing and risk taking, increasing the costs of labor and capital, and reducing the purchasing power of consumers. Meanwhile, nothing serious is being done to redress the true source of budget woes, that is, too much government spending.

In the end, higher taxes merely whitewash government waste, and encourage politicians to continue wasteful spending into the future.

Raymond J. Keating is chief economist for the Small Business Survival Committee, and co-author of U.S. by the Numbers: Figuring What’s Left, Right, and Wrong with America State by State (Capital Books, 2000).

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