States' Finances Threaten Whole Country

EXPERT COMMENTARY

States' Finances Threaten Whole Country

By Emily Washington |
Jul 30, 2012

Individual countries across Europe have sent shock waves throughout an entire continent with their reckless fiscal policy, and leaders here at home would be wise to look at a similar situation arising among our own states. The underlying cause of economic and budgetary turmoil — in both the USA and the European Union— is unsustainable spending. We have a budgetary powder keg on our hands, brought on by the irresponsibility of many of our elected officials.

Like their European counterparts, American politicians for too long have employed tools that allow them to pay for today's spending tomorrow. These abuses are well known at the federal level, but they're often overlooked in the states — where the magnitude of the problem can swiftly reach Main Street, wielding disastrous consequences for taxpayers, businesses and public employees alike.

Economists look at states' and nations' debt-to-GDP ratios to determine the level at which debt starts to cause growing problems. A debt-to-GDP ratio of 90% is where many economists agree the negative consequences of debt become serious. At this level, residents will see more and more of their tax dollars going toward interest payments rather than the state services they enjoy, and economic growth is likely to slow down. Eight states— Alabama, California, Kentucky, Michigan, Oregon, Rhode Island, South Carolina and Wisconsin — are projected to reach the 90% threshold by 2030, according to a recent Mercatus Center study by Jeffrey Miron and Robert Sarvis. Many are likely to seek federal bailouts.

This is essentially what Illinois Gov. Pat Quinn did last year when he sought a federal guarantee of the state's pension bonds. With more than $10,000 of debt per resident, and a projected debt-to-GDP ratio of 90% percent by 2035, Illinois also raised personal income taxes from 3% to 5% for four years. State leaders claimed this tax increase, which resulted in $7 billion in new revenues, would solve their budget problems. But they spent the money instead and created a new deficit by skipping $2 billion in Medicaid payments, which must now be made up. Hospitals and other service providers are still waiting for their checks to arrive 

Illinois should look to the example of its eastern neighbor. Including its pension liabilities, Indiana has half the debt (as a percentage of GDP) that Illinois has. How has Indiana done it? By making the tough decisions that other states aren't willing to make: maintaining a strong reserve fund in good times, finding $2 billion in program savings and creating the Taxpayer Protection Act to ensure that excess tax revenues will go toward the state's reserve fund, pension debt and taxpayer refunds rather than increased spending. The result is a low tax burden, ranked the nation's 11th most competitive by the Tax Foundation's State Business Tax Climate Index, and a $2 billion surplus. Now Indiana can move on to building up its reserve fund and tackling pension liabilities.

Most policymakers on both sides of the Atlantic have failed to follow Indiana's lead, instead demonstrating they are incapable of taking the political risks required to plot a more sustainable course. This year, California is facing a $16 billion deficit. Democrats in the state legislature have proposed a budget that relies on voters approving higher sales taxes and an income tax increase for people who make more than $250,000 a year. Instead of looking at where they can increase taxes, California lawmakers need to stop the bleeding. European politicians have relied on a far higher percentage of tax increases than spending cuts, fearing the backlash that accompanies entitlement reform. Not surprisingly, this policy has been unsuccessful here and abroad.

The temptation to outspend tax revenues is enormous, as debt financing allows elected officials to provide a higher service level than their voters will support with taxes. And by the time the bills come due, today's public officials will no longer be in office.

Voters should take note of the failed policies of European countries, as well as the practices pursued in recently bankrupt American cities, and demand a different approach. Unsustainable current spending and promised future benefits cannot be maintained long term by hiking taxes, selling municipal bonds and underfunding pensions. Attempting to solve debt problems with tax increases is a proven failure. The only real solution is for politicians to face reality and get spending under control — starting now.

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