This is a “year of reckoning” for American states and American federalism, as governments across the United States scramble to cope with “gaping holes” in their budgets. John Locke Foundation President John Hood reaches that conclusion in an article for the latest issue of National Affairs.
“As budget gaps persist and pension promises and other obligations come due, several states may confront the possibility of genuine default,” Hood writes in “The States In Crisis,” a featured article in National Affairs’ Winter 2011 issue. “If they are to have any hope of avoiding the twin nightmares of default and a federal bailout, governors and legislators must get serious about changing their ways.”
“They need to employ all their creativity and foresight to avert fiscal collapse, correct budget imbalances, and improve the quality and efficiency of government services,” Hood adds.
Though fueled by the Great Recession, the states’ “fiscal calamity” predates the latest economic slump, Hood explains. “Their shaky financial foundations were in fact set long ago — through unsustainable obligations like retirement benefits for public employees, excessive borrowing, and deferred maintenance of public buildings and infrastructure,” he writes. “The result has been a long-building budget imbalance now estimated in the trillions of dollars.”
Thus the solution to the states’ problems involves more than just a recovery from the current economic woes. State officials “must confront the more troublesome structural gaps between current state revenue projections and massive future liabilities,” Hood writes.
States faced a combined budget shortfall of nearly $200 billion in 2010, roughly 30 percent of their combined total budgets. “Beyond its startling magnitude, the crisis is also widespread,” Hood writes. Other than a few states buffered by oil or mineral wealth, “the combination of declining tax revenues and rising unemployment has produced a painful budget squeeze.”
Hood documents the growth of state and local government spending, which has roughly doubled as a share of the national economy during the past 50 years, “from 11.56 percent of GDP in 1959 to 21.79 percent today.”
Much of that spending has been linked to “reckless promising,” included unfunded government pensions and other retirement benefits. Nationwide, The Pew Center on the States estimates an unfunded liability of $1 trillion for retirement benefits promised to public employees.
Hood also dissects the problems associated with $2.6 trillion in outstanding debts owed by state and local governments.
There’s plenty of bad news, but Hood says some lawmakers can use the crisis to reset state policies on the right track. “As they confront another tough year in 2011, they will be forced to cut their budgets swiftly and significantly,” he explains. “Smart lawmakers, though, will recognize the upside to their situation. Rather than simply enacting indiscriminate, across-the-board cuts — or seeking only the easiest, most immediately achievable savings — they will seize the opportunity to craft budgets that meet their states’ long-term policy needs.”
Reforms should keep some broad principles in mind, Hood writes. State balanced-budget requirements should leave little wiggle room for funding current operations with debt. States should set overall limits on spending. Meaningful tax and debt limits help. State line-item vetoes work best if governors can reduce as well as eliminate spending items.
“Even more important, state and local politicians will have to summon uncharacteristic levels of courage and backbone,” Hood writes. “The policy decisions that this moment calls for — from painful budget cuts to difficult structural reforms — have always seemd politically unachievable. But crises have a way of motivating people.”