The Fiscal Outlook for U.S. States
By Arnold Kling
The analysis here suggests that some of the recent debate about state fiscal situations has been misfocused. Attempts to reduce the power of government employee unions, or to reduce the generosity of pensions for state and local employees, may well be sensible policy changes, and they have the potential to reduce state and local expenditures. These changes can do little to avoid the looming fiscal crisis, however, because that outcome is driven far more by rising health-care costs. In particular, changes in union or pension policy can reduce the existing stock of net debt, but they do little to slow expenditure growth rates.
He argues that the states will run up unsustainable levels of debt over the next few decades. For me, this is counter-intuitive, because many states have constitutions that require balanced budgets. Miron seems to assume that this does not matter, and instead he projects spending growth (8.5 percent per year in nominal terms) faster than revenue growth (7.2 percent per year). He justifies this based on the averages for 1962 through 2008. My guess is that the difference represents growth in transfers from the federal government. I believe he assumes that those transfers stop growing, which may be a reasonable assumption. But then it seems to me that you have to assume that those balanced-budget requirements will start to bite.
I should note also that revenue growth of 7.2 percent per year would mean that states would grow their way out of current indebtedness, including pension obligations. I am not sure I would count on that. For example, if you have growth in real GDP of 2.5 percent per year and inflation of 2.5 percent per year, then you only get 5 percent growth. If we get inflation higher than 2.5 percent per year, then my guess is that those pension obligations will grow faster than what I assume is implicit in Miron’s calculations.
Anyway, I don’t think Miron’s simulations really say anything about the fiscal health of the states. I think they tell us something about a scenario in which spending on the New Commanding Heights (education and health care) is shifted more to the states. The way I read the projections, if overall public spending on the NCH continues to rise relative to GDP while the federal government share shrinks, then state governments will have to raise taxes significantly relative to GDP in order to maintain budget balance.
Meanwhile, I do think that pension costs are an issue, unless nominal GDP grows spectacularly relative to pension obligations. Under more conservative assumptions, my guess is that states will have to devote an ever-larger portion of their budgets to paying retired workers, leaving less to pay for current services.