Dissecting State and Local Finances

A look at past, present and future issues that have been swept under the fiscal rug.
September 13, 2012 AT 5:00 PM
Penelope Lemov
By Penelope Lemov  |  correspondent
Penelope Lemov is a GOVERNING correspondent. She was GOVERNING's health columnist and was senior editor for several award-winning features.

Three pounds and an ounce or two: That's what my kitchen scale tells me the new book by Robert D. Ebel and John E. Petersen weighs. It was the last major opus written by Petersen, a longtime Governing columnist, before his sudden death this past spring. And while it may be hefty, The Oxford Handbook of State and Local Government Finance, is also packed with insights. It is a compendium of 35 essays by knowledgeable and thoughtful thinkers on a broad range of subjects within the purview of state and local finances. In a recent conversation, Ebel, an economist who has worked in and for state governments across the country, and I discussed the need for the book, some of the timely issues covered and a few of its surprising revelations. Here are edited excerpts from that discussion.

Why did you and John decide to produce this book?

Throughout the 2000s, many states and localities oriented their fiscal systems to a broad model of continuing growth and, in particular, a sustained housing boom. A "this day will never end" era of narrowing of tax bases and permanent reductions in tax rates set us up for a Great Recession. That led to massive structural unbalancing of state and local finance as budgets quickly moved from surpluses to deficits, and as rainy day funds were depleted and the resilience of the U.S. system of federalism was brought into question.

In January 2010, John gave me a call with a plan to look at the "entire sweep of issues that had been swept under the fiscal rug." After an intensive but rewarding year of collaborating with 60 renowned scholars of U.S. intergovernmental economics and finance, we pulled together a book that directly addresses the urgent need to find a balance between the public's demands for services and its willingness to provide resources to deliver them. The resulting overarching theme of this book is that getting the state and local financial system "right" is the key to achieving our nation's broader objectives of social cohesion and economic and political stability.

What makes this handbook different from other "state and local finance" books?

Its scope is much broader than the typical discussion of "finance". The first several chapters set the platform for the financial chapters to come. Here one will find a primer on the national and state constitutional frameworks for the public's finances and a straightforward history of, warnings about and future options for federal-state-local relations. Next one can turn to the revenue side of the budget -- but not just on the important discussions of specific revenues, but essays on often overlooked matters such as the new methodological challenges facing revenue estimators. There's also a chapter on the "what ifs" of sweeping changes in the federal revenue system, such as the adoption of a national consumption tax. In following sections, there are analyses of expenditure policy, the state/local capital market, public-private infrastructure practice and financial emergencies.

Speaking of the latter, there's a chapter on default and bankruptcy. Have you been surprised at how relevant that is today?

The Great Recession generated renewed concerns that state and local governments would begin to default on their obligations. Some even now fear that the long and successful history of state and local borrowing in the capital markets is destined to end as states look to find an easier way out of public debt than repaying it as promised. In his chapter, James Spiotto explains and valuates the various mechanisms that might deal with municipal and state defaults and insolvencies. He concludes that current responses are painful, expensive to apply and leave a wake of uncertainty that in the long run ends up costing taxpayers more than they save. He then explores ideas for a new generation of debt resolution mechanisms.

I was struck by the chapter on fiscal sustainability that brings up the question of political will for expenditure change and the absence of knowledge on how to change.

Robert Ward has a superb essay on this topic. He first investigates the usual lineup of budget-busting culprits, with the proliferation of entitlement programs standing at the head of the line, and then goes on to identify the decay of a state and local "budgetary culture" as a major issue in achieving sustainability, making it clear that the issue of budget culture is separate from how large or small a government might be. According to Ward, one of the deepest problems facing state and local governments may, ironically, stem from the nation's success. One of his major alerts, which is the same that Tim Conlan and Paul Posner identify in their essay on federalism, is that the nation's long run of political stability and prosperity has engendered powerful special-interest constituencies that have low visibility.

If new state legislators asked you which three essays they should read to get a quick grasp of the challenges that lie ahead, what would you recommend?

It depends on their legislative roles. If one is on the tax committee and grappling with how much to spend on tax administration, the paper by Billy Hamilton on the "five gaps" facing revenue administrators is a must. Or, if that legislator focused on how to tax business enterprise, David Brunori's analysis on why the corporate profits tax has become obsolete neatly fits with the paper by LeAnn Luna, Matthew Murray and Zhou Yang that explores gross receipts and value-added tax alternatives.

For the legislator on the budget committee, John Petersen's paper with Richard Ciccarone on the dramatic changes in the financial markets and debt and debt management is a key primer on finance, as is Carolyn Boudreaux and Bart Hildreth's examination of how different states handled the challenge of unplanned declines in state revenue collections. Both of these essays give a very different perspective than one will get from discussions that treat budget process as an orderly sequence of preparation, approval, execution and evaluation.

Now, if one is looking for three must-reads (in addition to Alice Rivlin's preface), then consider:

John Kincaid's political-science masterpiece on the U.S. and state constitutional fiscal frameworks. John walks one through our constitutional history from the Federalist Papers to the present day federal-state-local tensions. In the process he challenges many myths of what the U.S. Constitution says and does not say about state and local government.

Sally Wallace's essay on the evolving financial architecture of state and local governments. Sally examines state and local governance through the prism -- well, matrix -- of the nation's economic structure, demographic composition and institutional arrangements in order make "fiscal sense" for a 21st century public sector.

And finally, Rudolph's Penner's essay on the fiscal austerity and the future of U.S. federalism. Penner documents the federal government's unsustainable tax and spending policies and makes the case for why state and local governments should become strong advocates for federal budget reform.