Tuesday, June 5, 2018

S&P: State Deficits Will Get Worse

Never bark at the Big Dog. The Big Dog is always right.

I have been repeating, ad nauseam, that recent glimpses of positive news about our state budget are greatly exaggerated. The uptick in tax revenue is only a reprieve: the state's structural fiscal imbalance remains very much in place, and our next governor must make it a top priority to bring a permanent end to it. 

If not, he or she will be trapped in a quicksand of deteriorating state finances and escalating fiscal panic.

As always, my warnings are months ahead of those issued by others. On May 30, Standard & Poor Global Market Intelligence issued a rather stern report about the fiscal ailment of states in general. Much of what they write applies directly to Wyoming, including the introduction that starts with the good news:
The untold story of the year for the states might be just how improved their budget conditions are on the eve of fiscal 2019 (which begins on July 1 for 46 of them). State policymakers have a lot to cheer. Through December 2017, total state tax revenues had surged 9.4% above the prior year, which was up from 2.7% from the year before that, according to new data from the Rockefeller Institute of Government. And, thanks to a slowdown in new signups for Medicaid—a major cost driver in state budgets—there is less pressure on spending. 
Governor Mead is sitting under his desk still crying over the fact that he never got Medicaid Expansion. I am sure the Wyoming Republican Party will give him a fat consolation prize and an eastbound airline ticket after the election.

The report also mentions that only two states have received credit downgrades so far in 2018, as opposed to a total of 17 downgrades in the last two years (with Wyoming being one of them). They go on to explain:
For lawmakers charged with crafting state budgets, these are the pleasant byproducts of accelerating economic growth. Yet, despite this good news, we believe caution is in order. Some of the revenue upside might be a one-time windfall from taxpayers that accelerated nonwage income into the 2017 tax year. It's also possible that the current economic cycle is approaching a peak. 
The first point is largely irrelevant to Wyoming, since we have no income tax. Its effects on sales-tax revenue is limited by the fact that our personal-income growth has been among the slowest in the country for several years. However, the Trump tax cuts have sent some well-needed relief our way by easing the burden of the federal personal and corporate income taxes on our state's families and businesses. Combined with improvements in the minerals industry and other Trump-cycle related multiplier effects, this accounts for the entire uptick we have seen in economic activity and state revenue thus far this year.

However, notes S & P, this is only temporary:
Aided by an unanticipated burst of federal fiscal stimulus from tax cuts and a large spending package, we forecast that GDP growth will top out at 2.9% in 2018. Thereafter, we expect growth will decelerate until reaching its underlying trend rate of 1.8% in 2021. 
The swings will be more pronounced than that, probably from 3.5 percent this year to less than two percent already in 2020. One of the reasons that these forecasters will get it wrong is that they likely have not understood the practical consequences of the very design of Trump's tax reform. I said already last fall that the reform would only have a temporary positive effect on the economy, that it entrenches the welfare state and won't solve Washington's decades-long budget problem. Standard & Poor have just confirmed my analysis.

Then they make a point that our lawmakers and candidates for governor here in Wyoming really need to listen to, understand and deal with once elected:
There is mounting evidence that this is too slow for the states, most of which operate according to decades-old fiscal arrangements entered into when GDP growth typically exceeded 3%. 
Here, S & P are referring to the welfare state, the ideological project that defines two thirds of federal government spending and about half of Wyoming state spending. It is absolutely true that economic growth nationwide averaged more than three percent back then, but it is even more important to point out that the entitlement programs that constitute the welfare state are not designed to break even at three percent growth. They are designed to redistribute income and consumption among citizens, under the premise that government will always be able to pay for the related expenditure.

For this reason, it would be foolish of us here in Wyoming to believe that we will balance our state budget if only we return to three percent growth per year. In Greece they had years of more than 3.5 percent annual growth and still hit the fiscal brick wall in 2008. Their welfare state was simply too excessive, and the country's politicians entirely unwilling to accept that.

The S & P report also call our current state tax systems "anachronistic" and "developed for a 1950s-era economy". That is irrelevant, but an understandable attempt at balanced analysis. In reality, no tax system can pay for a full-blown egalitarian welfare state, but any tax system can pay for a small, fiscally sustainable government that does not engage in economic redistribution. 

These are important factoids to keep in mind. As the S & P report explains, the calm and quiet we are enjoying right now is pretty much of the before-storm kind: 
The Congressional Budget Office forecasts that after federal fiscal year 2018 (Sept. 30), Medicaid expenditures will increase by 5.5% annually, exceeding the expected revenue growth rates of most states. ... States also face significant long-term funding obligations, not least for the pension benefits promised to their employees. Even after a nine-year bull market for equities, state pension systems have assets equal to only 68% of their aggregate liabilities. Growth in nondiscretionary spending for retirement benefits and Medicaid will outstrip revenues under the most optimistic of scenarios. There is little room in this equation for the states to upgrade their existing infrastructure or boost funding for higher education. Ironically, such supply side investments might be among the antidotes needed to reverse the economy's eroding capacity for growth. 
Wyoming, fortunately, has money in the bank which can be used in part as a down payment on the structural spending reforms we need.

What we don't need is to put off these reforms any longer. We need a new governor who is willing to lead on this issue, and we need legislators who are willing to work with our new governor to get the necessary reforms started - and not in 2021 or 2020. 

We need to start those reforms in 2019.

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