Forgetting the Economic Cycle Already?

In boom times, states forget the bust years. That’s worrisome as revenues show signs of life.
 

Maybe it’s just our nature, but we tend to be pretty optimistic when things seem to be going badly. Conversely when conditions appear to be improving, we get fairly nervous.

As states and local governments begin showing signs of economic life, we find ourselves in the latter circumstance. We’re not saying the big turnaround is right around the corner -- just that the corner is clearly in sight. Revenue estimators have become exceedingly cautious so that when the upturn arrives, it likely will result in surpluses on state and local books. They may not be the kinds of surpluses that come as a result of an unforeseeable windfall; some may even be bolstered by American Recovery and Reinvestment Act funds still flowing through the budget. But as time goes on, it seems inevitable that surpluses will be ever more prevalent.

And that worries us. In past years, much of the mess we’ve seen in the states has come from bad use of allegedly excess cash. And that leads us to offer up a few potent cautionary tales from relatively recent history.

In fiscal year 2000, Connecticut recorded its ninth consecutive operating surplus. The state made reductions in health-care provider taxes, gave a sales tax holiday to consumers, lowered the corporate and business tax rates, reduced the gasoline tax and continued to phase out the inheritance tax. And that’s not all. Based in part on a belief that the good times would roll on forever, Connecticut went a step further. It became one of two states (Illinois being the other) that used the tobacco settlement to provide additional tax relief.

Take a look at Connecticut today. It has one of the worst funded pension plans in the nation, sky-high debt burdens and is about to sell bonds to balance its budget, albeit fewer than anticipated because the economy appears to be rebounding somewhat. But imagine how much different Connecticut’s current fiscal condition could be if the state hadn’t forgone so many revenue streams a decade or so ago.

And more recently, Louisiana has faced a similar situation. After Hurricane Katrina, the state was buoyed by federal dollars pouring in -- but it used some of those one-time funds to significantly cut taxes, totaling about $600 million annually in revenue. According to Jim Brandt, president of the Public Affairs Research Council of Louisiana, there’s a coincidence here: This is the shortfall amount the state had to deal with in the recession.

“We went from record surpluses to a record shortfall in a matter of years,” says Brandt, who has held his current position for nearly 12 years and observed state and local government for 40 years. “We made some very short-sighted fiscal policy decisions as a result of the notion that good times would last forever.”

In fairness, Louisiana spent some of its cash on strategic investments, putting money into deferred maintenance and technology. It also set aside some money to match funds for coastal restoration and protection projects.

The “boom times will last” phenomenon, although widely ignored in all the hoopla about California’s budgetary woes, has been the source of many of that state’s present problems. Mark Baldassare, president and CEO of the Public Policy Institute of California, says that during the prerecession years, California already was in a structural deficit situation, and if the state had handled the fiscally healthy 1990s differently, “This decade might not have had the roller coaster ride that [it] did.” But it didn’t. Based on the up cycles of the California’s extremely volatile tax system, the 1990s saw spending reach unsustainable levels. Proposition 98, which passed in 1988, contributed to this as it provided automatic increases to K-12 education. Meanwhile, taxes were cut and cut again.

Some states may have thought that by putting money into rainy day funds, they were making up for potentially hazardous decisions in times of surplus. This is good business, to be sure. But as the National Association of State Budget Officers recent Fiscal Survey of States points out, when hard times hit, these balances can be spent very quickly. Right now, for example, 14 states have balance levels below 1 percent.

We would suggest that if states and cities aren’t moved by these cautionary tales, perhaps they should turn to the Bible, if not for religious reasons, then for economic ones. Remember Joseph? Here’s a little quote from the Book of Genesis from Joseph’s interpretation of Pharaoh’s dream: “Seven years of great abundance are coming throughout the land of Egypt, but seven years of famine will follow them. Then all the abundance in Egypt will be forgotten, and the famine will ravage the land. The abundance in the land will not be remembered, because the famine that follows it will be so severe.” Sound familiar?

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