Of the $787 billion in “stimulus” money Barack Obama authorized with his presidential pen on February 17, at least $144 billion was earmarked for a particularly unstimulating purpose: covering the budget deficits of state governments. The 12-digit sum, touted as “state and local fiscal relief” on the administration’s glass-half-full website recovery.gov, quickly exposed a fault line between the nation’s governors. On one side were a handful of fiscal conservatives, led by Republicans Bobby Jindal of Louisiana and Mark Sanford of South Carolina, arguing that bailouts and federal mandates create moral hazards and unfunded liabilities requiring future tax hikes. The other, more powerful side was represented by moderate Republican Arnold Schwarzenegger of California.
“Gov. Sanford says that he does not want to take the money, the federal stimulus package money,” Schwarzenegger told ABC’s This Week on February 21. “And I want to say to him: I’ll take it. I take it because we in California…need it.”
But does California, or any other state, really “need” federal money during this economic downturn? Only if you accept the premise that state budgets should roughly double every decade.
When Gray Davis, a Democrat, became California’s governor in 1999, the state’s budget was $75 billion. Tempted by dot-com windfalls and beholden to public-sector unions, Davis bumped that number to $104 billion in four short years of boom and bust, after which he was bounced out of office for his fiscal irresponsibility and replaced by a Milton Friedman–quoting action hero who promised to bring “fiscal sanity” back to Sacramento. Five years later, after facing another boom, another bust, and a series of bruising political defeats at the hands of public-sector unions, Schwarzenegger had hiked the budget to an astonishing $145 billion. In 10 years, state spending in nominal terms increased 92 percent.
One good way to measure fiscal stewardship is to see whether state spending growth exceeds the rate of population growth plus inflation. Under Davis, budgets rose an average of 6.7 percent a year, as opposed to a population/California price index growth rate of 4.8 percent. Under Schwarzenegger, spending has increased 6.8 percent annually, compared to a population/inflation rate of just under 5 percent. A governor who was swept into office by damning Davis’ $38 billion budget deficit, vowing not to raise taxes, and mocking his predecessor’s vehicle license fee hikes announced on February 20 that he would address his own $42 billion budget deficit by raising taxes and doubling those same fees.
Asked to explain the contradictions on This Week, Schwarzenegger praised the federal stimulus (“a terrific package”), urged Republicans to be “team players” for Obama (who, he said, was doing a “great job”), and unleashed a spectacular metaphor in favor of abandoning a limited-government philosophy. “You’ve got to go beyond just the principles,” he said. “You’ve got to go and say, ‘What is right for the country right now?’ I mean, I see that as kind of like, you go to a doctor, the doctor’s office, and say, ‘Look, can you examine me?’ The doctor says, ‘You have cancer.’ What you want to do at that point is you want to see this team of doctors around you have their act together, be very clear, and say, ‘This is what we need to do,’ rather than see a bunch of doctors fighting in front of you and arguing about the treatment. I mean, that is the worst thing. It creates insecurity in the patient. The same is with the people in America.”
But if the people in America have fiscal cancer, it’s just the latest in a long series of relapses.
There They Go Again
In 2002 the National Governors Association issued a press release saying the “states face the most dire fiscal situation since World War II.” In 1990 The New York Times reported that states and cities faced a “fiscal calamity.” Fire up Google, pick almost any year, and you’ll find plenty of stories about a “fiscal crisis” around the nation.
For decades statehouses have followed a predictable schedule. In good economic times, they collect a lot more tax revenue than they really need. But instead of giving the money back to taxpayers or putting it in a rainy day fund, they pretend the good times will never end. When the good times do inevitably come to a close, governors plead poverty and either ask the federal government for help or raise taxes on their beleaguered citizens. Eventually, the economy rebounds and the vicious cycle starts again.
In the 2009 version, the liberal Center on Budget and Policy Priorities warned in February that governors faced a combined funding shortfall of $350 billion, causing “at least 40 states to propose or enact reduced services to their residents, including some of their most vulnerable families and individuals.” That same month, Corina Eckl, fiscal program director for the bipartisan National Conference of State Legislatures, described the budget figures as “absolutely alarming, both in their magnitude and the painful decisions they present to state lawmakers.” Across the country, newspapers have been filled with stories of closed parks, furloughed state workers, cigarette tax increases, and even, in California, IOUs instead of tax refund checks. “The easy budget fixes are long gone,” Eckl said. “Only hard and unpopular options remain.”
Is that true? Consider the boom cycle preceding this latest recession. In the five years between 2002 and 2007, combined state general-fund revenue increased twice as fast as the rate of inflation, producing an excess $600 billion. If legislatures had chosen to be responsible, they could have maintained all current state services, increased spending to compensate for inflation and population growth, and still enacted a $500 billion tax cut.
Instead, lawmakers spent the windfall. From 2002 to 2007, overall spending rose 50 percent faster than inflation. Education spending increased almost 70 percent faster than inflation, even though the relative school-age population was falling. Medicaid and salaries for state workers rose almost twice as fast as inflation.
Recessions exert a great deal of pressure on state budgets. As economic activity declines, governments collect less tax revenue. As people lose their jobs or suffer drops in income, there is more demand for services such as job training, health care support, welfare, and unemployment compensation. The combination, it is often argued, throws state budgets out of balance and, because states are generally required to enact balanced budgets, often leads to tax increases, dramatic cuts in services, or both. These actions, it is argued, further dampen consumer demand and worsen the economic situation. The chief rationale for federal support of state budgets is to counter this cycle.
By studying the period from 2002 to 2007—that is, the period that began as the economy came out of the mild 2001 recession—we can judge how states spent money when times were better and their services weren’t as desperately needed. In this period, unemployment dipped to around 4 percent, a historic low in modern times; gross domestic product posted steady gains; and most economic measures pointed upward. Meanwhile, the states indulged in fiscal irresponsibility from which no taxpayer should feel eager to bail them out.
The top-line figure for state funding is total revenue. It encompasses every dollar available to state governments: tax revenue, money from the federal government, income from trust funds, earnings from investments, even state employee contributions to pension systems. In 2002 total combined state revenue was $1.097 trillion (see Figure 1). In 2007 this figure had risen to almost $2 trillion. That’s an 81 percent increase, at a time when prices plus population increased 19 percent. So total revenue increased more than four times faster than inflation and population growth.