The Hopelessness of State Finances

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A new report from the State Budget Crisis Task Force received nearly universal coverage by the media. One reason is that the task force was led by legends Paul Volcker and Richard Ravitch. Another reason was that the product of their work painted a picture that is particularly grim — so grim that it is unlikely that concerns the report set forth can ever be entirely solved.

In the introduction to the document, the authors wrote:

While state revenues are gradually recovering from the drastic decline of the Great Recession, they are not growing sufficiently to keep pace with the spending required by Medicaid costs, pensions, and other responsibilities and obligations. This has resulted in persistent and growing structural deficits in many states which threaten their fiscal sustainability.

At the heart of these deficits are pension obligations that stretch into the hundreds of billions of dollars, an increase in Medicaid expenditures, uneven tax receipts and financial problems at the local government level. The suggested fixes for these troubles are unrealistic, because they do not take into account the impossibility that receipts can be brought into line with expenditures and promised expenditures. States will be forced to renege on some of their obligations. The recommendations of the State Budget Crisis Task Force almost certainly, with few exceptions, will never be taken.

The report’s authors claim that more transparency by states about their finances is a critical step toward solutions. That transparency is only likely to show how intransigent the problems are.

Another recommendation is that:

Pension plans need to account clearly for the obligations they assume and disclose the potential shortfalls and risks they face. Legislators, administrators, and beneficiaries alike need to develop and adopt rules for the responsible management of pension plans and mechanisms to ensure that required contributions are paid. States should recognize and account for post-employment benefits, such as healthcare, that they intend to continue.

States cannot pay out what they do not have and are unlikely to have in the foreseeable future.

States can raise taxes, and in some cases they have. There is a very real chance that these taxes are regressive and actually will slow a recovery by robbing businesses of capital that could be used for expansion and the addition of new workers. At the personal tax level, people already nervous about the recession cannot spend more money if their tax burden rises.

Another concern voiced by the group:

Federal health care reform, as upheld by the Supreme Court, will not change the fundamental imbalance between rising Medicaid costs and state revenues. The longer term cost pressures resulting from dramatic increases in the elderly population and the inexorable growth in health care costs continue to build.

That may be an astute observation, but it does not make a solution any easier to find.

The report concludes:

If these problems are not addressed soon, they are likely to worsen. The problems affect the national interest and require the attention of national policymakers. In addition, each state can sharpen its fiscal tools to improve its own decision-making process.

Addressing these problems would require a sharp reduction in spending and obligations and a rapid increase in tax income. The federal government has financial problems of its own, which means assistance from the federal level will not be forthcoming.

Just because a report authored by very intelligent people can set forth problems and solutions does not mean that these solutions come up against real-world issues that cannot be changed. State financial situations are beyond the reach of intelligence. They are so bad that most states will need to rapidly retreat from many of the programs they have promised their residents. The economy works that way.

Douglas A. McIntyre