States, Localities Are Spending Themselves into Trouble, Reports Show

Published October 8, 2008

State and local spending has been outpacing revenue growth three to one, according to figures reported by the Bureau of Economic Analysis.

Second quarter spending jumped 7.8 percent compared to 2007, while revenue rose just 2.5 percent in the same period.

On July 31, USA Today reported state and local governments will spend more than $2 trillion for the first time in 2008. New employees and higher compensation are a primary cause of higher spending.

“It’s the strangest thing,” Jack Kyser, chief economist at the privately operated Los Angeles County Economic Development Corp., told USA Today. “Government keeps hiring even when times are tough.”

Revenues Up 41 Percent

State and local tax revenues have grown 41.4 percent since 2002, according to a report by Ernst & Young and the Council on State Taxation—from $926 billion in FY2002 to more than $1.3 trillion in FY2007. (See table.)

Though the growth of state and local taxes is projected to slow over the next year, Chris Edwards, director of tax policy studies at the Cato Institute, points out recent tax revenue trends show most states are facing deficits due to overspending, not weakening revenues.

“Government revenue growth has slowed from the large increases of recent years, but that is hardly a fiscal crisis. Indeed, it indicates a needed respite for overburdened state and local taxpayers,” Edwards said.

Reporters Miss ‘Hard Facts’

Edwards points to the “curious way” many newspapers have reported on state budget issues, “devoid of hard facts about actual dollars spent by the states” and treating any needed spending restraint as a crisis.

Edwards says states should be more concerned about the longer-term problems of rising Medicaid spending and the growth in debt and unfunded retirement promises to state and local employees.

“Because of these problems, the real crisis in coming years might be headlined, ‘States Slam Taxpayers with Huge Hikes,'” Edwards said.

More In, Much More Out

Economist Arthur B. Laffer and Wall Street Journal senior economics writer Stephen Moore analyzed budget and spending growth trends for all states over the past few decades and found overspending by states during high-growth economic periods is a predictable and verifiable trend.

In their 2007 book Rich States, Poor States, Laffer and Moore wrote, “States often find themselves in fiscal trouble because they spend far too much during economic expansions. They are like the scorpion that is carried on the back of the frog across the river that then stings the frog, causing them both to drown. … It seems that overspending when the coffers are flush is in the nature of state legislatures.”

Evergreen Freedom Foundation President Bob Williams says states have abdicated their responsibility to taxpayers by increasing spending at an unsustainable rate.

Williams points to the June 2008 Fiscal Survey of States by the National Association of State Budget Officers, which reports state general fund spending increased 6.5 percent in 2005, 8.7 percent in 2006, 9.3 percent in 2007, and 5.1 percent in 2008.

“Compared to revenue growth during the same period, this is highway robbery. All the handwringing, ash-heaping, and finger-pointing by legislatures and governors is misdirected. They dug their own grave, and now they want taxpayers to lie in it by paying higher taxes,” Williams said.

California Rejects Fiscal Discipline

California is in particularly dire straits, facing a $15 billion deficit in the wake of huge, multi-year increases in education, transportation, and health care spending.

John Matsusaka, vice dean and professor at the University of Southern California Marshall School of Business, says the state’s fiscal woes are attributable to overspending, not revenue shortfalls.

“Revenue is up almost 40 percent from four years ago. This should have been more than enough to fund an orderly growth in state services. The problem is clearly overspending,” Matsusaka said. He noted many people doubt they are benefiting from the additional spending, so it is difficult to justify higher taxes on them.

Only a Handful Benefit

Much of California’s spending has been channeled into projects benefiting a few narrow interest groups, such as higher salaries for teachers and prison guards, instead of the public at large, Matsusaka said. This kind of exclusionary spending “seems especially pronounced in times of huge revenue windfalls, such as we had in the last four years,” he noted.

Matsusaka, Williams, Laffer, and Moore all agree strict tax and expenditure limitations are a good way to keep states from going overboard during economic expansions.

“The most advisable path to avoid future fiscal crises is to keep spending and tax receipts at a manageable and justifiable rate, usually population growth plus inflation,” Laffer and Moore wrote.

They caution against tax hikes as a response to an economic downturn: “If history is any guide, states that try to respond to slow revenue growth and budget deficits with tax hikes will not gain tax revenues; they will lose businesses, jobs, and families,” Laffer and Moore note.

Amber Gunn ([email protected]) is director of the Economic Policy Center of the Evergreen Freedom Foundation in Olympia, Washington.