Policy Documents

Policy Tip Sheet- Spending Reforms

July 17, 2012

Problem

States across the country continue to struggle with balancing their budgets as a result of increasing spending and a lagging economy. Many states also have accumulated massive amounts of debt that taxpayers will have to pay due to years of overspending combined with state employee pensions and benefits.

Thirty-one states have projected deficits for 2012, and their legislatures will have to take steps by the end of this fiscal year to eradicate budget deficits without adding to the more than $900 billion in off-balance sheet liabilities.

As we've seen all too often, surging property values, strong retail sales, and other factors that drive up government revenues are often used as an excuse to expand government. Before long, the locked-in spending drives demand for still more tax revenue. Higher tax rates then burden families, weaken businesses, and act as a further drag on the economy, creating a cycle of tax hikes and revenue shortages.

Policy Facts

In 2011, six of the top 10 states in debt per capita were also in the top 10 in highest income taxes.1

In 2011, five of the top 10 states with the largest budget deficits were also in the top 10 in highest income taxes.2

Government spending is not free: An additional dollar of government spending increases GDP by less than one dollar. NBER's results suggest a multiplier on total GDP of around 0.5.3

Policy Solution

Tax and expenditure limitations, pension reforms, privatization, and other cost-cutting measures are increasingly being considered by lawmakers trying to fix their short- and long-term budget problems instead of raising taxes. That's the right approach. The following are some tried-and-true solutions.

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 and individuals.

Enact tax and expenditure limits (TELs). Tax and expenditure limits are an effective way to limit government spending. These measures limit how much government officials may tax and spend, holding the growth in government spending and taxes to reasonable levels.

Privatize public services where possible. Not all services can be contracted to private companies, but many can be administered inexpensively and more efficiently through the private market. This not only reduces the cost of government but also creates private-sector jobs.

Adopt public-sector workforce reforms. Expensive and excessive government workforces are putting great pressure on state budgets. Long-term solutions must focus on reforming public pension and health care systems—a multibillion-dollar unfunded liability states clearly cannot afford.

Policy Message

Point 1: Government spending is not a cost-effective way of generating economic growth.

Point 2: Every dollar the government "puts into the economy" through spending or so-called stimulus is done so by first taking that dollar out of the economy.

Point 3: Increasing taxes does not fix budget deficits or reduce long-term debt. Instead, tax hikes slow the economy.

Point 4: Tax and expenditure limitations keep more money in the pockets of families and job creators.

References 

1 "Analysis of total state debt shows Alaska, New Jersey, and Hawaii among states in worst fiscal situations." State Budget Solutions. <http://www.statebudgetsolutions.org/publications/detail/analysis-of-total-state-debt-shows-alaska-new-jersey-and-hawaii-among-states-in-worst-fiscal-situations>
2 "10 States With the Largest Budget Shortfalls." U.S. News & World Report. <http://www.usnews.com/news/articles/2011/01/14/10-states-with-the-largest-budget-shortfalls>
3 Valerie A. Ramey, "Government Spending and Private Activity." University of California, San Diego and National Bureau of Economic Research. <http://www.nber.org/chapters/c12632.pdf>