That’s according to Bo Zhao and David Coyne, two economists who have been using the phrase as a measure of the long-term fiscal sustainability of states and localities.
The overall state- and local-sector trend gap has been growing over the past three decades and has accelerated in the last 10 years, say Zhao and Coyne in a new working paper for the Federal Reserve Bank of Boston. By 2010, the gap reached more than $1,000 per capita. Put another way, excluding short-term cyclical influences, the revenue-raising capacity of governments fell short of the amount needed to meet public service demands and fulfill long-term obligations by more than $1,000 per person. The trend gap varies greatly from region to region. The Pacific states had the highest gap of about $1,600 per capita on average, followed by New England states at $1,250 and the East-South-Central states at $750 per capita.
While the most recent figures find that revenues have increased nationwide since the 2008 recession, the authors project that growth will be essentially flat nationwide this year. The trend gap, however, will be influenced by the continuing rise in costs for state and local governments’ long-term obligations -- including Medicaid (where spending grew 10 percent annually, outpacing the 6 percent annual average of state revenue growth) and public pension obligations. The failure of states and localities to address the trend gap, the authors write, will have several negative consequences.
First, it could shift the fiscal burden to future generations of taxpayers, creating intergenerational inequity.
Second, state and local governments will have to cut back significantly on public services to balance budgets. Such a disruption to public services would harm residents’ quality of life and the local business environment.
And last, credit ratings could suffer, driving up borrowing costs. In the most extreme case, a severe lack of fiscal sustainability might cause investors to leave the municipal bond market, threatening the stability of the entire financial system.
The Federal Reserve paper is not the only one to address the gap. In April, the Los Angeles 2020 Commission issued the second of a two-part report, noting, “Los Angeles is barely treading water.”
The report, A Time For Truth, pulls together a challenging list of issues, ranging from widespread poverty and job stagnation to huge municipal pension obligations and paralyzing traffic -- even while noting the City of Angels is agleam with talent and resources, albeit becoming less globally competitive. “Year by year, our city -- which once was a beacon of innovation and opportunity to the world -- is becoming less livable.”
The issue of sustainability raises the question about what citizens want from their government and how much it will cost. Currently, the demand for public services from constituents is outpacing the ability of those governments to meet it -- even by raising taxes.
Public officials tend to focus on the next budget deadline or the next election. Increasingly, that short-term outlook fails to open a discussion on what services will have to cease as our generation consumes more without investing in tomorrow’s needs.
As one of the most thoughtful leaders I know told me, “Something’s gotta give.” He says that states and localities have been in such denial about “service level solvency” that he is now spending a third of his time on the issue. He believes the sustainability of state and local governments will be the most critical issue in the country over the next two decades.
