WSJ: The Coming Reset in State Government
My fellow governors and I are likely facing a permanent reduction in tax
revenues.
By MITCH
DANIELS, Governor of Indiana
State government finances are a wreck. The drop in tax receipts is the worst
in a half century. Fewer than 10 states ended the last fiscal year with
significant reserves, and three-fourths have deficits exceeding 10% of their
budgets. Only an emergency infusion of printed federal funny money is keeping
most state boats afloat right now.
Most governors I've talked to are so busy bailing that they haven't checked
the long-range forecast. What the radar tells me is that we ain't seen nothin'
yet. What we are being hit by isn't a tropical storm that will come and go,
with sunshine soon to follow. It's much more likely that we're facing a near
permanent reduction in state tax revenues that will require us to reduce the
size and scope of our state governments. And the time to prepare for this new
reality is already at hand.
The coming state government reset will be
particularly wrenching after the happy binge that preceded this recession.
During the last decade, states increased their spending by an average of 6% per
year, gusting to 8% during 2007-08. Much of the government institutions built
up in those years will now have to be dismantled.
For now, my state's situation is far better than most, but it won't stay
that way if we fail to act in Indiana. At present, we are meeting our
obligations, without raising taxes, and still have over $1 billion in reserve.
But the dominant reality is that even assuming the official revenue projections
are accurate (and they have been consistently too rosy for the past two years),
the state of Indiana will have fewer dollars to work with in 2011 than it did
in 2007. Most other states face similar or worse prospects.
And, unlike the aftermath of past recessions,
odds are that revenues will take a long time to catch back up to their previous
trend lines—if they ever do. Tax payments have fallen so far that it
would require a rousing economic rally to restore them. This at a time when the
Obama administration's policies on taxes, spending and more seem designed to
produce the opposite result. From 1930 to 2008, our national average annual
real GDP growth rate was 3.49%. After crunching the numbers, my team has
estimated that it would take GDP growth of at least twice the historical
average to return state tax revenues to their previous long-term trend line by
2012.
I doubt even that would suffice to rescue most
states. Instead, historical forecasting models need to be revised. One-third of
state revenues (over half in seven states) come from sales taxes, but it's hard
to imagine them snapping all the way back up to where they were just a few
years ago. Americans are now saving much more then they used to relative to how
much they are spending. This sudden shift will mean that even in good economic
times to come consumers will likely spend less and therefore pay less in sales
taxes than they did during bubble years.
Even if Americans wanted to go back to their high-spending, high-borrowing
ways, will anyone lend them the funds to spend like it's 2007 all over again?
Consumer credit will remain tighter as a matter of both sound business practice
and new government regulation. Home equity appreciation is gone as a huge
source of collateral, even if lenders were either willing or permitted to loan
freely against it.
The "progressive" states that built
their enormous public burdens by soaking the wealthy will hit the wall first
and hardest. California, which extracts more than half its income taxes from a
fraction of 1% of its citizens, is extreme but hardly alone in its overreliance
on a few, highly mobile taxpayers. Both individuals and businesses are fleeing
soak-the-rich states already. Those who remain in high-tax states will be
making few if any capital gains tax payments in the years to come. Even if the
stock market comes roaring back to life, the best it could do is speed the
deduction of recent losses.
Sadly, the political impulse to protect government largess leads many states
to aggravate their dilemma. Already more than half have raised taxes, often on
businesses, serving only to chase them and their tax payments away and into the
open arms of states like Indiana. Our traffic flow of interested investors is
as heavy as it was in 2007. Since January we have welcomed the consolidation of
more than 30 firms that closed up shop elsewhere and chose us as the low-cost,
enterprise-friendly environment among their current locations.
Indiana was near bankruptcy five years ago but is relatively solvent today
because we have spent the intervening years making hard choices. We have
reformed state procurement, contracted out some jobs, cut costs, and
relentlessly scrutinized expenditures in pushing for annual improvement in
departments large and small. We've also reduced the number of state employees
by some 5,000 from the 2004 level.
In contrast to the national pattern, our per capita state spending has cut,
on average, 1.4% each of the past five years. Indiana is now the sixth
thriftiest state by this measure. And if we Hoosiers are realizing that we need
to re-examine what we can afford to have our government do, what must they be
thinking in Albany, Lansing or Trenton?
Truth be told, officials in those cities are
probably not thinking about this at all. But they will because state
governments will soon have to choose between a major downsizing or consigning
themselves to permanent decline. Wishing for an improbably huge boom while
chasing your own tail through self-destructive taxes won't prove much of a
strategy.
Unlike the federal government, states cannot deny
reality by borrowing without limit. The Obama administration's
"stimulus" package in effect shared the use of Uncle Sam's printing
press for two years. But after that money runs out, the states will be back
where they were. Even if Congress goes for a second round of stimulus funding,
driven by the political panic of bankrupt Democratic governors, it would only
postpone the reckoning.
The time to plan and debate is now. This is a test of our adulthood as a
democracy. Washington, as long as our Chinese lenders enable it, can practice
denial for a while longer. But for states the real world is about to arrive.
Mr. Daniels, a Republican, is the governor of Indiana.