Money

The Best and Worst Ways to Fix the Budget

| by The Heartland Institute

By John Nothdurft | Budget and Tax Legislative Specialist

Legislatures in at least 40 states will have to take steps by the end of this fiscal year to eradicate budget deficits totaling nearly $50 billion. And if you think that task will be difficult, consider that legislators will also have to face up to the fact that their states' budget crises are in large part due to years of excess spending.

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And face that fact they must: Resorting to tax increases and debt are examples of what not to do, especially during times of economic uncertainty.

In the short term, states can address budget gaps by eliminating wasteful "economic development" subsidies and privatizing non-core functions. But even these steps in the right direction will be ineffective in fending off future deficits unless long-term reforms--such as enacting sensible tax and expenditure limits and reforming unfunded pension and health care liabilities--are also made.

The budget problems facing states will be neither easy nor painless to fix. Here's a quick rundown on some of the "do's and don'ts" for dealing with the current crises and preventing them from happening in the future.

DON'T ...

1. Increase taxes. Increasing taxes doesn't fix budget deficits and instead slows the economy further. Consider Michigan. Last year Gov. Jennifer Granholm, facing a $1.75 billion budget deficit, pushed through tax increases, including one that raised the state's income tax rate from 3.9 to 4.35 percent. Today Michigan has the highest unemployment rate in the country (10.6 percent) ... and a new $1.5 billion budget deficit.

2. Hike sin taxes. The Maryland legislature passed a $1 cigarette tax hike last year, saying it would be a reliable source of revenue. The raised $117 million less than the $255 million Gov. O'Malley projected, contributing to the state's budget deficit. Many lawmakers present cigarette tax hikes as a "silver bullet" that will fix their budget while affecting only smokers. But cigarette taxes hurt all taxpayers ... and they deflect attention away from the discussion of much-needed spending reforms.

3. Hike corporate, capital gains, or "millionaires" taxes. In Rich States, Poor States, authors Stephen Moore and Arthur Laffer explain how California helped create its own budget mess. "When California faced a $14 billion deficit in 2003, a major cause of this was "millionaire migration" due to the high top income tax rate (9.3 percent). "Out of the 25,000 or so seven-figure-income families, more than 5,000 left in the early 2000s, and the loss of their tax payments accounted for about half the budget hole."

4. Borrow or use accounting tricks. Borrowing money or raiding restricted funds merely "kicks the can" down the road to future taxpayers, who will have to foot the bill for even larger deficits.

DO

1. Cut spending and eliminate so-called "economic development" schemes, including film tax credits, government-owned golf courses, and publicly financed stadiums. For years states have been manipulating the market and favoring certain business sectors, or in some cases individual people. Subsidies such as these distort the economy, create few economic benefits, and strain state budgets.

2. Enact tax and expenditure limits (TELs). Colorado's Taxpayer's Bill of Rights is the most widely known TEL. As the National Taxpayers Union points out, "by slowing the growth of government spending in good economic times, the Taxpayer's Bill of Rights has been instrumental in reducing budget deficits. Smaller budget deficits mean fewer cutbacks during tough economic times." The Colorado measure limits the growth in taxes and expenditures to the growth in population and inflation. While not perfect, the measure does foster better spending decisions and helps to hold government accountable.

3. Consider privatization of public services. Chicago Mayor Richard M. Daley has been a leader in privatization, although he has failed to accompany his headline-getting moves with long-term budget reform. This year, in order to fill a half-billion-dollar budget deficit, Daley accepted bids of $2.5 billion for Midway Airport and $1.16 billion for downtown parking meters. The city will receive large infusions of cash upfront and will be relieved of ongoing maintenance costs.

4. Adopt public-sector workforce reforms. Expensive and excessive government workforces are putting great pressure on state budgets. The rapid rise in government hiring, and the $13.41 per hour higher average cost for each public-sector worker, are forcing some states to enact hiring and pay freezes. Other creative short-term strategies include Utah's four-day work weeks and California's worker furloughs. Long-term solutions must focus on reforming public pension and health care systems--a $750 billion unfunded liability that states clearly cannot afford.

5. Think differently about budget priorities. Too many legislators look at the spending side first: They add up the expense of ongoing mandatory programs and discretionary spending wish lists, and only then consider how to get the money to pay for it all. They have it backwards: Just as individuals and families must do, lawmakers should first estimate revenues, without even thinking about the spending side. Only after they've figured out how much money they can realistically expect to have, should they think of spending. They should start by totaling up their required spending and matching that to revenue. What's left over should go not to new projects outside the core functions of government, but to a rainy day fund or tax relief. That's the way to set spending priorities, consolidate agencies, get rid of redundant programs, eliminate non-core programs, etc.

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