Stateline Story

Who's to Blame for the Budget Crisis?

  • March 26, 2003
  • By Jason White

Is overspending during the "go-go `90s" a primary cause of the state budget crunch?

The question is a political Rorschach test, and how you respond could reveal your political leanings. If you said yes, you're probably a fiscal conservative. If you said no, you're likely to be a liberal.

But the correct answer might be to avoid the yes/no trap altogether.

"States had an opportunity to do various things. And they did spend on salaries, they did expand programs, they did expand eligibility for Medicaid and the State Children's Health Insurance Program. But they also returned billions of dollars in tax rate reductions. And states were building up their reserves to the largest levels in 20 years," said Arturo Perez, a fiscal analyst for the National Conference of State Legislatures.

Perez also points to the slumping economy as a primary cause of state budget problems.

"It's been something of a perfect fiscal storm that states have had to contend with. Three years in a row we've seen down markets on Wall Street, the first time since 1939-41. It is a time we've seen unemployment continue to rise," Perez said.

Some analysts also say a "structural" problem with state sales taxes is also to blame. State sales tax systems generally tax goods, such as cars and books, and not services, such as financial advice, at a time when services are growing in their relative importance in the economy, the experts explain.

As heated as this debate can get, North Carolina Gov. Mike Easley (D) doesn't think playing the blame game is all that profitable. His advice to new governors is to avoid it.

"[D]on't look back and play the blame game Who did what wrong? How we got to where we are?" he said in an interview with Stateline.org. The question governors should be asking, Easley said, is: "Now what do we do?"

A Spending Boom

During the mid-to-late 1990s, the booming economy allowed states to greatly increase spending. The increases were so large they more than made up for slow growth earlier in the decade.

"States as a whole increased spending quite significantly [during the 1990s] by 28 percent, after adjusting for inflation and population growth. Put differently, state government per person increased by more than a quarter," said Don Boyd, fiscal chair of the nonpartisan Rockefeller Institute at the State University of New York, Albany.

Boyd adds that this growth, though significant, was not necessarily abnormal.

"While the pace of state government growth in the 1990s was exceptional, the direction of change was not, and was part of a much longer trend of rising state and local government influence in the federal-state-local fiscal system," he said.

But other analysts say this trend is precisely the problem. "States always find themselves in this same boat. They always spend, spend, spend in the good times and then say, well, we can't balance our budgets," said Stephen Moore, chairman of the Club for Growth, a political action committee that backs free-marked oriented candidates.

Moore said he believes state lawmakers should bring their budgets into balance by cutting spending, not raising taxes. Then, once budgets are balanced, he'd like to see future growth limited to a benchmark, such as population growth plus inflation, the standard in Colorado. This benchmark lets state government grow with population and inflation, but no faster.

Gov. Easley recently proposed holding North Carolina government growth to a different standard individual income growth. He said this would let state government grow at a rate of roughly 5.9 percent.

"What you want in place is that cap so that when the economy comes back and states do have money again, they don't go on a spending binge that puts the state back in the hole the next recession," Easley told Stateline.org. "The overspending of the 1990s has at least as much to do with the deficits as the recession of the past two years."

 Tax Cut Crazy

On the other end of the political spectrum is the "blame tax cuts" argument.

Advocates of this view believe state budget problems are really a revenue problem, not a spending problem. They say state lawmakers cut taxes too deeply during the mid-to-late 1990s, permanently depriving themselves of a key revenue source although the period's revenue explosion was temporary.

"The ongoing loss of state tax revenue resulting from the next tax cuts enacted from 1994 to 2001 is more than $40 billion per year," said Nick Johnson, a fiscal analyst at the left-leaning Center on Budget and Policy Priorities.

Johnson said 43 states enacted large tax cuts during the period, totaling roughly 8.2 percent of state tax revenue nationwide. If states had socked this money away in rainy day funds, they would have no trouble weathering the current fiscal storm, he said.

The problem with this argument is that many economists believe tax cuts are good for economic growth: the money is not lost because it spurs growth, which pumps more money into state coffers in the long run.  

An Unsound Structure

State budget analysts say most states face severe "structural" problems with their tax systems.

"[S]tate tax systems were developed for the manufacturing economy of the 1950s, not for the service-oriented, high technology, international economy of the 21st century. Sales tax revenues are being eroded by the change in the 'mix' of products purchased by consumers and the growth in electronic commerce, which is largely tax exempt. Most states do not tax services which have grown from 41 percent of household consumption in 1960 to 58 percent in 2002," Ray Scheppach, executive director of the National Governors' Association said in a Stateline.org op-ed article.

Scheppach said states could update their tax systems by expanding the sales tax to include services while lowering the overall rate in order to keep the total tax burden roughly the same.

This fix has political problems, though. Lawmakers tend to be skittish about changing tax systems, because history says they often pay for these changes with their jobs.

 It's The Economy, Stupid

The first signs that all was not well came in 2000, when the manufacturing sector nose dived, dragging the budgets of many manufacturing-heavy states down with it.

"Manufacturing output continued to decline one month over the next. That affected states like Michigan, Ohio, Illinois, Indiana, Kentucky, South Carolina, North Carolina states that depend more on manufacturing than other states," NCSL's Perez said.

The fiscal damage spread when the teetering U.S. economy was pushed over the edge by the terrorist attacks of Sept. 11, 2001. "That was the push down the stairs at a time they [states] were already falling," Perez said.

Consider this tax data from the Rockefeller Institute of Government:

Aggregate state tax revenue growth started slowing in the final quarter of 2000, increasing just 1.5 percent over the same quarter the year before. This compared to 7, 8 and even 10 percent growth in previous quarters.

  • The slow growth of late 2000 continued into 2001, going negative in the 3rd quarter, when revenue declined 5 percent from the same period the year before. This reflected in part the Sept. 11 terrorist attacks. 
  • The negative trend continued through 2002 with the largest decline in the 2nd quarter, when revenues declined 13 percent. This was due largely to a horrible April that saw income tax revenue fall sharply, sending tremors through the 41 states with broad-based income taxes.

This month-to-month drop in tax revenue is unlikely to continue much longer, if only because the baseline is now so low. But even if revenue simply limps along at its present level, states will continue to struggle. Population growth, especially among school age children, exhaustion of one-time fixes, such as tapping rainy day funds, and pent-up demand for state services will see to that, experts said.