Research & Commentary: The Best And Worst Ways To Eliminate A Budget Deficit

Published February 20, 2009

Research & Commentary: The Best And Worst Ways to Eliminate a Budget Deficit

Legislatures in at least 39 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.

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.



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.



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.


Ten Principles of State Fiscal Policy
This booklet provides policymakers and civic and business leaders with a highly condensed yet easy-to-read guide to state fiscal policy matters. It presents the 10 most important principles of sound fiscal policy, from “Above all else: Keep taxes low” to “Protect state employees from politics.”

State Budget Shortfalls Present a Tax Reform Opportunity
This special report completed by the Tax Foundation outlines how states with tax codes relying on small tax bases are more susceptible to large budget deficits. It points out that eliminating tax favors, lowering tax rates, and broadening tax bases can lead to a more sustainable and economically appealing tax code.

Virginia Needs Spending Reform, Not Higher Cigarette Taxes
This Research & Commentary, written in response to Virginia’s proposed cigarette tax, outlines the three main reasons to be wary of the tax and explains how spending reforms are more important.

A Decade of TABOR – Ten Years After: Analysis of the Taxpayer’s Bill of Rights—ten-years-after-analysis-of-the-taxpayers-bill-of-rights
Colorado’s TABOR (Taxpayer’s Bill of Rights) is a constitutional amendment for tax-and-spending limitation. Its stated mission is to “reasonably restrain most of the growth of government.” It allows only those tax rate increases approved by voters; while fees are not directly restricted, state government spending is limited to the growth of Colorado’s population-plus-inflation in the prior year.

Reason Foundation’s Annual Privatization Report
The Reason Foundation’s Annual Privatization Report finds states are increasingly partnering with the private sector to build roads and reduce traffic jams that have become one of the biggest complaints among taxpayers living in nearly every mid- to large-sized city in the country. The report analyzes the latest developments in privatization and government reform in the areas of transportation, aviation, education, local government services, telecommunications, and eminent domain.

Ideas for Balancing the State Budget Without Raising Taxes
Washington legislators are faced with many tough choices. Without significant reforms, future legislatures will face similar problems. It will take leadership and innovation from state policymakers to solve the current fiscal problems and restore trust in state government. A conservative estimate of the savings generated by the fundamental reforms proposed in this paper offers the prospect of immediate change and long-term budget stability. Taken together, these reforms would reduce the cost of state government operations by nearly $1 billion.

Governors Begin Reforming Public-Sector Workforce
This article takes a look at how different states are cutting the costs of their expensive public workforces. It points out the considerable gap between the costs of the public and private workforces and their growth.

Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
This Research & Commentary compares defined contribution and defined benefit pension plans. Most firms in the private sector have already switched to defined contribution pension systems to reduce long-term liabilities and promote individual control. Most public-sector entities, by contrast, have kept the defined benefit system … and now face billions of dollars in unfunded liabilities.


For further information on the subject, visit the Budget & Tax Issue Suite at and The Heartland Institute’s Web site at

Nothing in this message is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. If you have any questions about this issue or the Heartland Web site, you may contact Legislative Specialist John Nothdurft at 312/377-4000 or [email protected].