Fate of the States: The New Geography of American Prosperity (6 page)

Some of the gimmicks that chronic overspenders like New Jersey and Illinois have used to balance their budgets amount to little more than rearranging the deck chairs on a sinking ship. In 1991 New Jersey closed its budget gap by having the Turnpike Authority buy just over four miles of toll roadway from the state. New Jersey governors of both parties borrowed from the state’s pension fund to close gaps. In 1997 the governor invested state money in the stock market; you can probably guess how badly that worked out. In 2009 an amnesty plan for tax evaders netted New Jersey $725 million in delinquent taxes. Did the governor use the windfall to shore up the pension fund? No, he handed out property-tax rebates to citizens earning less than $75,000.
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The problems of New Jersey are so deep that even current governor Chris Christie—who came into office as an outspoken budget hawk—now appears to have been overly optimistic about what he could actually achieve as governor given the mess the state is in. Revenue expectations continue to disappoint, forcing Christie to cut infrastructure spending and back off a tax cut he once vigorously lobbied for.

Unfortunately, when revenues don’t cover costs, you have a sure prescription for disaster, and when there is too much debt, there is little, if any, margin for error. In fiscal year 2009 California’s spending outpaced revenues by 224 percent (in 2010 it was 92 percent), while New York’s spending outpaced revenues by 177 percent (89 percent in 2010). For Texas that same year the number was 136 percent (99 percent in 2010), and for Florida 166 percent (89 percent in 2010). A rebound in state revenues improved those numbers, but the core problem remained: Tax collections were still woefully below spending, rebounding only back to 2006 levels in 2010. During this same year, Florida was the only one of the twenty-five largest states (by GDP) to lower its spending.
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The economies of Florida, Arizona, and Nevada mirror that of California in that their GDPs are all lower than they were in 2007, with Florida down over 7 percent, Arizona 7 percent, and Nevada 9 percent.
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When nominal GDP is declining and fixed costs keep rising, states get caught in a vortex of spending cuts and layoffs, which put even more pressure on their economies. These states suffer lower tax receipts. (Tax receipts have gone up recently only because actual rates have been hiked. Repeated rate hikes are not only often counterproductive but also certainly unsustainable.) Lower tax receipts lead to wider budget gaps, more spending cuts, reduced consumer spending, and new job losses. This is a difficult cycle to break. The less desirable the economic opportunities are within a state—due to lack of jobs, education, training, or some other social services—the higher the probability that businesses and people will leave the state. In 2011 alone, pharma company Biogen Idec relocated three hundred R & D jobs from San Diego to Research Triangle Park, North Carolina; chip maker Intel decided to build a $3 billion research center in Hillsboro, Oregon, instead of at its Santa Clara, California, headquarters; and health-care company Medtronic announced the relocation of three hundred customer-service jobs from Los Angeles, California, to San Antonio, Texas. “They are going to save 30% to 40% on all factors versus Los Angeles,” said San Antonio Economic Development Foundation president Mario Hernandez of Medtronic’s move. “And [workers] can live very comfortably very near the facility.” According to a study by business relocation expert Joseph Vranich, the number of business relocations from California increased fivefold between 2009 and 2011.
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State finances are more or less a zero-sum game. Imagine a fixed pie of tax receipts that pay for the provision and upkeep of education, health care, roads and bridges, sanitation, public safety, debt service, pension payments, health care insurance, etc. So when more money goes to one program, less is left for another. If the federal government is at the top of the food chain—the ultimate “rich uncle” willing to lend states a hand when times are tough—the local government is at the bottom of the food chain, with the states somewhere in the middle. One of the first things a state can do, after asking for a federal money infusion, is to reduce monies to the local governments. This is where it really smarts for the local governments. In 2010, which is the most recent data available, 41 percent of local-government money came from state transfers, the rest by and large from property taxes. By comparison, 36 percent of the states’ monies came from the federal government.
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The process on the surface seems simple enough, but it has become far from simple over the past sixty years. Take fiscal year 2010, for example. States took in just over $700 billion in tax receipts but spent over two and a half times that amount, or $1.9 trillion. Cut another way, states spent $1.2 trillion more than they took in. In 2000, by way of comparison, states spent twice their tax receipts and spent $540 billion more than the tax dollars they took in. Needless to say, the trend has been going in the wrong direction. Some of this is explained by the increased demand for Medicaid and welfare assistance, programs subsidized by the federal government and administered by the states. In fiscal year 2010 states received roughly $585 billion from the federal government for these programs.
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If states want to raise money so they don’t have to take from one project to fund another, they have three options: raise taxes, increase taxes, or sell assets. Over the past decade, states have been more inclined to plunge further into debt and/or raise taxes than to sell assets. States have papered over the disconnect between tax revenues and spending by issuing unprecedented amounts of debt—some secured by taxes, some by specific revenue (like highway tolls)—and by looting the pensions of their current and future retired state employees. Between 2000 and 2010, states doubled the amount of municipal debt outstanding and took mostly fully funded pension plans and other benefit obligations into a deficit of close to $1 trillion.
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Although this kind of public-sector overspending was irresponsible and unsustainable, on one level it’s understandable, especially when the economy was robust. States and cities wanted to make capital improvements, and low interest rates made it inexpensive to borrow money. Officials in Jefferson County, Alabama, borrowed $3.2 billion from JPMorgan Chase and other lenders to finance a sewer system. Harrisburg, Pennsylvania, got burned by a trash-to-energy incinerator project that left the town $310 million in debt.
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“It was easy to borrow the money . . . too easy,” said political consultant Jeffrey Bell.
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What politicians so conveniently forgot is that borrowed money, no matter how low the interest rate, eventually has to be paid back.

Budgeting should be a simple process, but it’s not. The basic structure is supposed to work as follows: States collect income taxes or sales taxes in exchange for public services such as transportation, state agency services, higher education, and other locally administered programs. Local governments’ revenues are generated primarily through property taxes and nontax revenues such as transfers from states. For example, in 2008 local governments derived 33 percent of their revenues/funding from such transfers; by 2010 that number had risen to 40 percent. Local governments collect primarily property taxes in exchange for services largely related to K-12 education and police and fire service. Theoretically, states try to tie their budget projections to what they think their tax receipts and other revenues will be, but there is no requirement that they do so. In fact, today state expenditures have very little correlation to revenues. States’ expenditures are more closely linked to cost-of-living or inflation-growth projections. These numbers don’t always line up when times are good, so you can imagine what the past five years have been like. Local governments have increased property taxes and states have increased income-tax rates, but these efforts have failed to keep up with expenses. Even after laying off nearly 700,000 state and local employees, expenses are still rising, and revenues are not keeping up.

SOURCES: BEA AND MWAG

Originally, current taxes were supposed to cover current expenses. Over the years, however, the system has become more convoluted and incestuous. Today a dangerous system of dependency exists whereby states rely on the federal government for over a third of their spending, while local governments depend on states for 40 percent of their budget dollars.
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If either the federal government or the state gets into a financial bind, it always has the option to reduce monies flowing down the food chain. No one is lower down the food chain than the local governments.

In 2011 the single largest federal-to-state transfer in history ended with the expiration of the American Recovery and Reinvestment Act (ARRA). When ARRA was being debated in Congress, White House economist Christina Romer argued that unemployment would decline to 7.0 percent by 2011 if it was passed but soar to 8.8 percent if it wasn’t. Well, over the entire term of the ARRA program (from 2009 to 2011), states received over $480 billion in assistance in the form of contracts, grants, loans, and retirement benefits, and by the end of 2011 the unemployment rate stood at 8.9 percent.
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The ARRA money was supposed to go toward creating jobs, investing in infrastructure, saving schools, and generally stimulating a flailing economy. However, more than 37 percent of this money was simply used to cover state budget shortfalls, effectively “kicking the can” of tough cutbacks a few years forward.
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In other words, a number of states, both large and small, managed to ignore their reckless spending over most of the 2000s and then, handed extra money by the federal government, decided to use those funds to cover budget deficits instead of using it for its intended purpose: providing for residents. This was simply unprecedented.

Aside from piling on more federal debt, the real risk of this one-time stimulus was the enormous “cliff effect” it created for the states that received the monies. Rather than address the clear structural problems that had created the states’ fiscal mess, the federal government determined it was better to buy time for the states to recover. Ironically, this merely accelerated the time bomb. In fiscal year 2009 these monies cushioned 28 percent of the states’ shortfalls, and by fiscal year 2011, states were using these monies to pad 37 percent of their budget shortfalls. This ultimately did little for California, for example, which received the lion’s share of the ARRA funds at over $40 billion.
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As recently as May 2012, California faced a deficit of over $16 billion. Needless to say, the state’s unemployment rate is near the highest in the country. Much like the bailout of the banks, the money spent did little to fix the underlying problems.

The end of the ARRA stimulus money eventually forced states’ hands. In fiscal year 2011, Connecticut, Illinois, Maryland, and Nevada raised taxes at the state level, and in Illinois the hike was a whopping 66 percent increase. Meanwhile, cities and towns started to raise property-tax rates in order to offset declining assessments. But these tax hikes haven’t been enough to offset lower transfers from the states. Admittedly, tax receipts have rebounded from the lows of 2010, but they are still only tracking at 2007 levels.

States and local governments have already gone beyond increasing income and property taxes to increasing transportation and sales taxes, increasing taxes on luxury items, and increasing even further taxes on cigarettes and liquor. Some states and local communities have begun considering things that have been simply off the table until now: legalizing state gambling and allowing the sale of liquor in formerly dry counties. Politicians who once declared passionately, “We will never sell booze in this county” or “We will never allow gambling in this state,” soon were backpedaling, offering to “sell just beer and wine” or “allow a lottery and one slot machine.” In fiscal year 2011 Georgia, Florida, and Pennsylvania all voted to expand their gambling and gaming laws. Arizona, Michigan, New Jersey, and New York all voted to expand their lottery laws.

Even once-taboo options like privatization are suddenly on the table.

Confronted with the prospect of closing 70 of its 278 state parks, California elected to outsource the day-to-day operations of at least six parks. Arizona, also faced with the prospect of closing 13 of its 30 state parks, is considering auctioning off the day-to-day management of its parks to private companies. The fact is that current park fees are not covering the cost of upkeep, and states no longer have the resources to make up the difference. As an example, California’s Brannan Island State Recreation Area, near Rio Vista, cost California roughly $740,000 a year to operate, more than double what it took in from fees and concessions revenues. Rather than fight new management, most park goers are just happy their parks are still open. “We’re not talking about a private company putting up billboards,” a spokesman for the nonprofit California State Parks Foundation commented.
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