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Thirteen years ago, the state of
Indiana
followed most of the rest of the country into recession, after
enjoying almost a decade of uninterrupted growth.
That downturn triggered a fiscal crisis in state capitals
across the country, as dwindling tax receipts followed the economy
south. At the height of
the storm, in the year 1991, the combined budget deficit of all
fifty states was almost $10 billion, measured in today’s dollars.
The recession of 2001, by most measures, has been similar in
severity to the one that preceded it.
But the hangover in state capitals has been much worse.
Through 2002, the most recent year for which data are
available, the combined deficits of states is over $50 billion.
That’s roughly 4 percent of state and local spending, and
five times worse than 1991. Why
was this recession such a rough ride for state treasuries?
Recently published research by the Chicago Federal Reserve Bank
addresses that very question. As
we drown in a tidal wave of election season rhetoric, their
dispassionate analysis of the situation is like a breath of fresh
air.
Just about everything has gone wrong for fiscal
balance sheets in state government over the last several years.
Increases in broad-based taxes like the income and
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sales tax, used in past recessions to prop up
revenues, are political suicide today.
As the health care and services sector of our economy continues
to grow, the base of the sales tax, which exempts most of their
activities, continues to shrink. And
the growth in state government’s role in financing education and
Medicaid shows no sign of letting up.
The Rockefeller Institute calculates the changes in state tax revenue
for each state that are due to policy changes, and those that are due to
the ups and downs of the economy. In
response to the 1991 recession, states left no stone unturned in raising
taxes. Hikes in personal
income, sales, tobacco, and motor fuels taxes ultimately produced about
8 percent more revenue.
The situation today is completely different.
In fiscal year 2002, at the peak of the recession, tax rate
changes in the fifty states produced no revenue changes whatsoever.
States actually reduced personal income tax rates slightly, which
were offset by tiny increases in business income taxes. Even
in fiscal 2003, with most states in unprecedented budget difficulty, tax
rate changes brought in only about 1.5 percent more revenue, mostly from
hikes in narrow-based taxes on tobacco and casinos.
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Meanwhile, the obligations of state government,
particularly in education and Medicaid, continue to grow.
Even after correcting for inflation, health care expenditures by
states are 40 percent higher today than they were in the 1991 recession.
Roughly half of all nursing home bills are now paid by Medicaid.
What emerges from all of this is a clear picture of a budget deficit
situation that is structural. There
is an imbalance between revenue growth and expenditure growth that is
not related to the state of the economy, and that faster economic growth
will not cure. And what will
cure it is not popular.
On the revenue side, states like
Indiana
need broader-based taxes. By
exempting spending on things like services and internet commerce, the
sales tax not only becomes increasingly unfair, but also less effective.
Relief on the expenditure side, especially for Medicaid, requires
some help from the Federal government.
The experience of the 1990’s with welfare reform, which greatly
improved the stress of those programs on state budgets, shows us that
real reform is possible.
Patrick M. Barkey
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