Saturday, July 1, 2017

America's Austerity Storm: The Threat Is Real

Wyoming is not the only state with budget problems. Short term, our problems are not the worst, but long term they are at least as bad as the situations other states find themselves in. Like us, they have failed to realize the combination of slow macroeconomic performance and government spending that is designed to grow faster than the state's tax base. 

The similarities between our state and others present us with both a challenge and an opportunity. The challenge lies in learning from their mistakes; the opportunity lies in doing right what they do wrong.

To start with the challenge, there is plenty to be learned from other states. I have already compared Wyoming to Alaska on numerous occasions, and although the Last Frontier State has a lot to teach us, the truth is that our outlook is to some degree even worse than theirs. While they have at least come to the realization that tax hikes may actually not be the only solution on the table (though in fairness they still have to act on that new insight) the legislative leadership here in Wyoming remains dead set on adding to taxpayers' burden for an already over-bloated government.

A quick review of other states can teach us a lot about tax hikes. The obvious starting point is Illinois, where years of budget fighting has now basically made inevitable the state's higher income tax that went into effect in 2011. Originally meant to be a temporary measure, the five-percent rate (up from three percent) was supposed to sunset in 2014, which it temporarily did (the rate fell to 3.75 percent). Now, three years later, the big fight in Springfield is over how much and how fast the income tax can return to its five-percent rate. 

The crisis has led to population flight from Illinois, a problem Wyoming shares with the Land of Lincoln. We also share their legislative ineptitude in producing real fiscal and macroeconomic solutions, although with their back up against the abyss, the Illinois state legislature has made at least some progress toward passing a budget:
The Illinois House moved a $36 billion spending plan to passage stage with a bipartisan 90-25 vote that was intended to show the world that compromise is possible, even in dysfunctional Illinois. To be clear, House members didn’t give the necessary final approval to the spending plan nor to the tax-increase legislation needed to pay for it. But the vote showed they could do so if some other things fall into place. And Democrats and Republicans didn’t really clasp hands, unless you count congratulatory handshakes. But they did say nice things to each other, and they acted like long-lost friends for a few brief minutes.
Now, this is of course not the end of the Illinois budget crisis, not even in the same universe. It is not the beginning of the end either. But, to paraphrase Churchill, perhaps it is the end of the beginning of a solution. But just to show how addictive tax revenue can be, the Wall Street Journal on Saturday (July 1) reported that the legislature once again failed to start a fiscal year with a budget. 

As I have explained before, the Illinois crisis is relevant to Wyoming. However, it is not just their crisis that matters. There is a virtual fiscal epidemic sweeping across the country. From Maine to California, state governments are grappling with unending budget problems. According to the Wall Street Journal on June 28 (print edition):
As Maine lawmakers are trying to avoid a government shutdown, they are debating whether to keep a new tax on high-income earners that voters backed seven months ago. If lawmakers can't hash out a deal during budget negotiations before the fiscal year ends Friday night, the state known as "Vacationland" risks shutting down just ahead of Independence Day.
Governor LePage, a Republican, declared himself "willing to risk a [government] shutdown to avoid passing a two-year budget he believes would cause lasting damage" to the state, a promise he actually delivered on (as did New Jersey Governor Christie). 

The extra tax on high incomes in Maine is a lesson for tax hikers everywhere, including Wyoming. The tax could take $175 million a year away from Maine's highest-earning taxpayers. Targeting only 3.4 percent of taxpayers, it burdens 25 percent of total taxable personal income in the state. If only one in five of those taxpayers would leave Maine as a result of the tax, and if the state wanted to persist in disproportionately taxing high incomes, it would have to add another 0.75-percent tax on incomes above $200,000. Then, if one fifth of those taxpayers left as a result of the higher tax, the tax rate would have to go up to 4.68 percent.

And so on. The simple, basic lesson here is - hardly surprisingly - that a strategy to tax government out of a fiscal hole does not work. Or, in the words of the Wall Street Journal:
In Massachusetts, lawmakers recently voted to put a proposed surtax on income over $1 million on the 2018 ballot. Meanwhile, in Connecticut, Democratic Gov. Dannel Malloy has backed off from additional taxes on higher income earners because previous increases haven't solved the state's persistent fiscal problems. 
Let's take that last part of that last sentence one more time:
because previous increases haven't solved the state's persistent fiscal problems
As I explained recently, Connecticut has tried to tax away its budget problems since 1990. If that is not enough to discourage tax hikes to solve deficit problems, then what will it take? 

Even in New Mexico, legislators have slowly woken up to the realization that higher taxes can't solve their problems. After an extraordinarily long budget fight, the legislators in Santa Fe agreed with Governor Martinez (R) to defer tax increases - but also to defer spending cuts - by relying on the state's Severance Tax Bond program. A Severance Tax Bond is an IOU that the state sells in order to bridge over budget deficits. The debt is repaid through the state's bond fund for severance tax revenue. In essence, this construction allows the state to defer spending tax revenue, but it also gives the state a false impression of having more money than it really does. Sooner or later the state bounces up against the limit on how much it can borrow under the Severance Tax Bond program.

This program fills the same fiscal-policy function as the savings drawdowns here in Wyoming. They are good for a while, but eventually the realization sets in that you can only spend a saved dollar once. 

On a brighter note, over in Ohio (of all places) legislative Republicans are trying a different strategy to balance the budget for FY2018:
The Senate plan also includes: — Across-the-board agency cuts averaging 3 percent to 4 percent, for savings of $20 million; — Additional targeted agency cuts gleaned with help from the administration of Republican Gov. John Kasich, worth $100 million; — A $200 million Medicaid reduction while preserving coverage for the most vulnerable populations; — $20 million in cuts to the prisons budget found by working with the department on savings
Ohio used to have enormous fiscal problems, but that has changed thanks to hard work by Governor Kasich, a realistic fiscal conservative, and prosperity-minded, business-friendly Republicans in the state legislature. Not being afraid of spending cuts, the Republicans in Columbus have put the Buckeye State back in business again. 

The problem in Ohio is that their spending cuts are only buying them time. The reductions in outlays are discretionary in the sense that they alter a current spending bill, but do not change the long-term spending trajectory. The growth drivers in spending programs remain. To change them, the GOP in Ohio would have to reform their entitlement programs from the ground up. That can be done, as I have explained on this blog on numerous occasions, but it takes long-term focus, legislative persistence, political fortitude and commitment to economic and individual freedom.

By insisting on tax hikes; by postponing spending cuts or only doing defensive ones; state legislators all over the country are setting themselves up to be targeted by an austerity storm the like of which America has never seen. When it comes bearing down on us, it will wreak havoc like nothing we have experienced. 

How bad will it be? As a hint, consider what Swedish economist Assar Lindbeck said after visiting South Bronx in New York some time in the 1970s. Rent control - the cap on apartment leases that made it cheaper for landlords to burn their buildings to the ground rather than allowing tenants to live in them - was, Lindbeck said, more effective at destroying cities than the hydrogen bomb. 

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