Wealthy States Get in Line for Federal Handouts

Published January 1, 2009

California, New York, and other wealthy states are facing large budget deficits, and lawmakers and governors are proposing fixes ranging from higher taxes and less spending to requests for federal handouts.

California lawmakers reported to the state capitol on November 7 for the start of a special session to deal with a budget deficit the state says is $11.2 billion but which many analysts say is larger. Less than two months earlier, lawmakers had approved a budget they declared balanced.

California’s special session came just a few days after the governors of New York and New Jersey asked Congress for a federal bailout to deal with their own budget problems.

California’s special session started with Gov. Arnold Schwarzenegger (R) announcing support for a temporary increase in the state sales tax, from 5 percent to 6.5 percent. His administration projects the higher tax would bring in $3.219 billion more in 2008-09 and $6.606 billion more in 2009-10.

Problematic Policies

Though Schwarzenegger and many state lawmakers place much of the blame on falling housing values and the economic slowdown, others say the real problem is state tax and spending policies.

“We have the highest marginal income tax rates, the steepest progressive rates, and we’re in the top 10 in state sales tax,” said Jon Coupal, president of the California-based Howard Jarvis Taxpayers Association. “We have a good case for [not using] tax increases to address the budget. It’s going to be bloody. We’re $15 billion upside-down in a budget that we were told six weeks ago was balanced.”

Coupal said California’s high taxes and heavy business regulations have been driving high-income earners and jobs—and the taxes they pay—out of the state.

“Schwarzenegger has signed AB 32 [a bill he signed in September creating a carbon cap-and-trade regime and requiring reduced carbon emissions], the greenhouse gas thing, which will kill business. He’s all for high-tech stuff, which is great, but there is not this desire to get down and look at the spending side and really try to drill down to remove waste, fraud, and abuse, of which there is a lot,” Coupal said.

Borrowed Money

The California special session came one month after Schwarzenegger asked the Bush administration to lend the state at least $7 billion. Schwarzenegger said the state needed the federal loan because it could not find willing private lenders. Shortly after making the request, though, California officials announced the state had lined up private financing.

Meanwhile, in New York, Democrats in the November general election took control of both houses of the legislature and the governor’s mansion for the first time since 1935, leaving many political observers to speculate citizens could see higher spending and taxes.

Gov. David Paterson (D) has said he opposes raising taxes to address a budget deficit estimated to hit $12.5 billion next year, but less than a week before the election Paterson appeared with New Jersey Gov. Jon Corzine (D) before a Congressional committee and pleaded for a federal handout.

That same week, Paterson and governors of five other states asked Congress for financial help for U.S. automakers.

Wealth Transfers

Paterson justified his plea for federal help in part by arguing New York receives much less in federal help than it sends to the federal government.

“While all states are hurting and deserve support from the federal government, I think it is incumbent on me to note that New York faces unique circumstances with respect to this crisis,” Paterson said. “First, we are at the epicenter of the crisis on Wall Street, and the failure of financial institutions impacts our revenues and unemployment situation more than any other state.

“Second,” Paterson continued, “New York has been shortchanged for years when it comes to aid from Washington. In 2007 alone, New York sent $86.9 billion more to the federal government in taxes than it received in return—again, more than any other state.”

E.J. McMahon of the Empire Center for New York State Policy think tank scoffed at the notion New York could ever get back more than it pays in federal taxes.

“We are always going to send the federal government more than we get back. That’s been true since 1790, literally,” McMahon said. “Even when there were no taxes but only tariffs it was true. Unless we’re going to change the nature of federalism, it will always be true.”

Redistributionist Policies

McMahon said this is because of the redistributionist nature of federal taxes.

“High-income states like New York always send more to Washington than they get back. So when Congress gets through paying for the stimulus package Paterson and other governors are seeking—on top of paying the bill for the bank bailout, the auto industry bailout, and the distressed homebuyer bailout—New York will end up paying a disproportionately large share of the bill.”

McMahon also pointed to past policy decisions and wastes of resources to argue the state itself brought on much of its financial problems.

“Half of the budget deficit can be attributed to current law baseline spending requirements—Medicaid, education, state agency operations, and retirement and health benefits for government employees,” McMahon said. “We’re finding ourselves sinking rapidly in large part due to the need to make good on collective bargaining agreements.”

Steve Stanek ([email protected]) is a research fellow at The Heartland Institute and managing editor of Budget & Tax News.