RALEIGH — As many folks welcome the New Year and the new opportunities and experiences it will bring, many legislators and public officials across America feel at least as welcoming – because of what they consider to be a surprising improvement in state governments’ fiscal conditions.
Since 2001, most states and many local governments have experienced significant budgetary problems. Some of these would best be classified as wobbles, but others were so deep and scary that politicians lost their jobs (think California in 2003 and a host of other states in 2002) or were “forced” to take actions that may still imperil their jobs (think major tax increases in places such as New Jersey and North Carolina). During just the first six months of 2003, the combined projected budget deficits of American states and localities reached $55 billion.
But then in the third quarter of 2003, the situation more than righted itself. States and localities ran a combined $13 billion surplus from July 1 to October 1 – and if California’s $30 billion gap is subtracted, the national situation looks even better.
What happened? Well, the obvious fact to consider is that many if not most state fiscal years end on June 30. Lawmakers were compelled by their balanced-budget laws to take appropriate actions to close their deficits before the start of the third quarter. Yes, some opted to rely heavily on the tax-increase option. But the National Governors Association reports that the total state tax hike was $9.6 billion, not enough the explain much of the swing in fiscal fortunes even if you assume that half-again as much was also collected from taxpayers in the form of higher local taxes.
The most popular option among states was to restrain spending, thank goodness. Investor’s Business Daily reports that states’ General Fund spending grew by an average of just 0.6 percent in 2002-03 and is expected to rise only about 0.2 percent in 2003-04. According to another source, Alan Greenblatt of Governing magazine, state budgets are actually going down in 2003-04 for the first time in 20 years, after having increase by an annual average of 6 percent. Medicaid and higher education were among the others most affected by this state budget trimming, which makes sense because they have been among the biggest drivers of state spending growth in the past.
Even this new-found fiscal responsibility, however, cannot fully explain why the states and localities went from big deficits in early 2003 to a sizable net surplus in the third quarter of 2003. IBD thinks it has found the answer, and I think the newspaper is correct. Looking back over decades of economic data, it concluded that state revenues track closely with nominal growth in the gross domestic product. For every $7 in GDP growth, state revenues go up by about $1. A strengthening economy, in other words, is very good for state governments’ bottom lines.
Now, let’s see. What could have happened in the third quarter of 2003 to generate a revenue bonanza for states and localities? Well, there’s this little matter of a mind-boggling 8.2 percent increase in the GDP, the fastest quarterly growth rate since 1984. And what could have led to this remarkable growth spurt? Many economists are pointing to two events, the rapid victory of American forces in topping the Ba’athist regime in Iraq (which reduced the uncertainty previously hanging over the markets) and the passage of substantial reductions in federal tax rates, as key factors in inducing higher rates of business investment, consumer spending, and entrepreneurial activity.
It’s worth contrasting this real-world experience with what critics of President Bush’s foreign and fiscal policies warned about earlier in the year. Many critics of the campaign in Iraq had argued that it would set off a double-dip recession, or at least weaken an already sub-par economic recovery. Didn’t happen. As far as the federal tax cuts were concerned, many state officials were apoplectic. They argued that states would get walloped twice – once because of insufficient federal funding for costly state programs such as Medicaid, and then again as Bush’s income-tax cuts led states to conform their income tax codes to the federal one, thus further reducing state revenues. Again, reality intruded. For one thing, states did get a one-time gift of federal cash as part of the tax-cut legislation. Moreover, as tax-cut supporters predicted and opponents dismissed, the federal tax changes helped to induce economic growth that actually aided states and localities by boosting their collections of sales, property, and business taxes. Far from forcing state governments into a more difficult position, the Bush tax-cut package helped them recover their fiscal equilibrium through economic growth.
Alas, North Carolina isn’t in the best position to benefit. Our state is uncharacteristically lagging behind the national economic recovery, no doubt in part due to the fact that our governor and legislature chose to rely more on tax increases than virtually every other state in the union since 2001. And while the average state posted only negligible increases in General Fund spending in 2002-03 and 2003-04, North Carolina will follow up a small GF reduction in 2002-03 with a 3 percent increase in authorized 2003-04 spending and a 5 percent increase in 2004-05.
Blame for our fiscal problems cannot be trucked northward up I-95 to Washington. The facts reveal that it deserves to stay right here.
Hood is president of the John Locke Foundation and publisher of Carolina Journal.