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Monday, July 3, 2017

The Austerity Storm: State Budgets Eroding

Nationwide, states and local governments are responsible for about 40 percent of total government spending. In total, federal, state and local government spending add up to a bit less than a third of the total U.S. economy. This share is below the average for developed, industrialized welfare states, but it is still high enough to have notable economic effects.

The worst of those effects do not show up in regular economic analysis, nor are they visible in regular statistics. They do not show up until government is pushed to the brink of fiscal panic.
As I explained last week, the threat of such panic is real and something that our state legislators need to take very seriously. (So should, by the way anyone contemplating a gubernatorial run next year.) The real problem, namely, is that so many states are in fiscal trouble and are rapidly emptying out their ability to pay for their current and promised expenses. In fact, the National Council of State Legislators reports rising budget problems for states all across the country:
For the first time since the end of the Great Recession, a significant number of states find themselves facing budget shortfalls. For the fiscal year (FY) 2017 fiscal year or the current biennium (for states that enact a two-year budget), 22 states reported that their state had addressed, or would address a budget shortfall before the end of the fiscal year. No overarching characteristic defines states facing budget shortfalls, except that revenue collections are not in line with spending plans.
However, these budget situations are not new. Even though the NCSL hints that these are exceptional fiscal problems, that is not at all the case. On the contrary, states in general have been over-promising on the spending side for a long time. 

On the surface, everything looks relatively good. A comparison of total state revenue to total state expenditures for all states combined, for the period 1992-2014 (the latest year for which comprehensive data is available),  shows a deficit for only six out of 23 years:

Figure 1

Source: Census Bureau

However, total revenue includes federal funds and - to the extent it exists - revenue from local governments into state coffers. In order to get a more accurate picture of what states can actually afford, let us deduct all revenue that does not come from the state's own revenue sources. 

A troubling trend merges:

Figure 2
SourceCensus Bureau
 
Slowly but steadily, states are becoming less able to pay for their total spending. In the years after the Great Recession, 2011-14, states could pay for 56.1 percent of their total expenditures out of their own pockets; in 1992-95 that share was 65.7 percent. It is worth noting that the years in the early '90s also represented a recession recovery period; in other words, in both periods, entitlement spending would be higher than usual, relative revenue.

The gradual decline in state self-sufficiency (at a later point, we will look at Wyoming numbers specifically) shows that states have taken on spending promises that they are increasingly unable to pay for. This can be demonstrated in yet another way, namely by extracting direct expenditures from total expenditures. Including capital outlays, but excluding utility, insurance and debt payments, direct expenditures paint a good picture of what it actually costs to operate state governments. 

As it turns out, for the period 1992-2014 there is not a single year when states, in total, could pay for their direct expenditures out of their own revenue. Not one. In fact, Figure 3 accumulates those deficits, showing how much money states would have had to borrow over time (cumulatively) if they had in fact been forced to rely on their own revenue for their direct expenditures: 

Figure 3
SourceCensus Bureau
 
There are two reasons why states continue to operate without catastrophic fiscal consequences: money from the federal government, and one-time budget tricks such as (here in Wyoming) drawing down savings. However, savings drawdowns (which, technically, include borrowing, such as in New Mexico where they borrow against severance taxes) can only take you so far; as Wyoming experienced earlier this year, that leads to credit downgrades. 

As for money from the federal government, betting your state's budget on cash from Uncle Sam is like trusting a man with maxed-out credit cards (and his own credit downgrades) to make your mortgage payments.

In short: states have a structural spending problem, and soon - sooner than most state legislators realize - we are going to see a storm of fiscal panic across the country. It will come from the state capitals, and we here in Wyoming will not be spared.

Quite the contrary.

More to come. Stay tuned.

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