Good Government

Don't Bail Out the States

January 6, 2009

Brian M. Riedl

State governments from New York to California are begging Washington to bail them out of a combined $48 billion budget shortfall estimated for 2009.

It's a terrible idea, on several counts.

For starters, it's a shell game. Sending federal aid to states wouldn't save taxpayers a dime because state taxpayers are also federal taxpayers. Hiking federal taxes to keep state taxes from rising is like running up your Visa card to keep the MasterCard balance from rising. Either way, you'll pay. All that changes is where you send your payment.

Governors typically respond that a federal bailout is preferable because it could be funded with deficits rather than new taxes-an option that 49 states with balanced-budget requirements lack.

But nobody forced these states to enact balanced-budget requirements. And they're free to repeal them anytime they can convince their voters to go along.

Furthermore, the inclusion of such a bailout in an economic "stimulus" package makes little sense. State spending doesn't suddenly become stimulative if it's funded by Washington instead of state governments. Either way, all spending "injected" into the economy must first be taxed or borrowed out of the economy. It doesn't matter which level of government is doing the taxing, borrowing, or spending.

Congress already sends $467 billion a year to state and local governments-up 29 percent after inflation since 2000. This is well beyond what's needed to reimburse states for federal mandates (and Washington has imposed few new unfunded mandates on the states since 1996).

The feds continue to give heavy subsidies to state health, education, and transportation programs. But apparently that's not enough.

You'd think that, being so dependent on income-tax revenues-which are very volatile-states would build up their rainy-day funds during booms to cushion the inevitable recessions.

Instead, states keep responding to temporary revenue surges with permanent new spending programs. Between 1994 and 2001, states flush with new revenues expanded their general-fund budgets by 6.2 percent a year.

All booms eventually end, and these free-spending states left themselves totally unprepared for the 2002-2003 economic slowdown. Yet instead of sufficiently paring back their bloated budgets, the states demanded-and got-a $30 billion bailout from Washington in 2003.

Bail out someone who's behaved irresponsibly, and you encourage future misbehavior. And that's just what happened: After the 2003 bailout, states went right back to spending-with annual budget hikes averaging 7.2 percent over the next four years. (Some also built up their rainy-day funds-but not enough.)

So, here we are again. Another economic slowdown, another round of bailout calls. How will states learn to budget responsibly if they know they can keep returning to the federal ATM?

It's time for the states to face facts: Set priorities, make trade-offs, and reduce unnecessary spending. Any federal aid to state governments should come in the form of loans to be fully repaid (with interest) within three years.

Don't hold your breath, though. Expect to pay for an expensive federal bailout-which will set up more bailouts in the next recession.

Brian M. Riedl (M.P.A., Princeton University) is the Grover M. Hermann Fellow in Federal Budgetary Affairs at The Heritage Foundation.

Differing Philosophies on Bailouts

In a December 2 column in The Wall Street Journal ("Governors Against State Bailouts"), Gov. Rick Perry of Texas and Gov. Mark Sanford of South Carolina showed that not all governors are looking for a handout.

"In Texas and South Carolina, we've focused on improving ‘soil conditions' for businesses by cutting taxes, reforming our legal system and our workers' compensation system," they wrote. "We'd humbly suggest that Congress take a page from those playbooks by focusing on targeted tax relief paid for by cutting spending, not by borrowing. ... We can weather this storm if we commit to fiscal prudence and hold true to the values of individual freedom and responsibility that made our nation great."

Meanwhile, here in Oklahoma, the Tulsa World reported December 3 that "Gov. Brad Henry, who was among the governors meeting with Obama on Tuesday, said the president-elect expressed a strong commitment to a package that would create jobs and invest in infrastructure such as roads and bridges. ‘We have many needs in our state, particularly in the improvement of our transportation infrastructure, and I will be pushing to make sure Oklahoma gets the funding it needs and deserves as the recovery package is drafted,' Henry said in a statement."