U.S. States Learn to Save by not Spending

Worth A Look, Taxation, Frontier Centre

OTTAWA — With the single exception of Vermont, U.S. states are prohibited — either by constitution or by statute — from running budget deficits. In the past, when hard times hit, states often raised taxes, which naturally prolonged the lean years.

Now, more and more, they cut spending instead. And taxes, too.

The Washington-based Center on Budget and Policy Priorities, a bipartisan think tank, reports that states responded to the fiscal crises of 2001 to 2003 by cutting spending much more than by increasing taxes. “Indeed, spending cuts have been three times as large as tax increases,” the group said. “As a result, state spending has shrunk significantly since 2001 as a share of the economy.”

By 2004, it fell to 4 per cent of GDP, the lowest level in many years. Further, almost every state had already cut taxes or was getting set to cut taxes. Now they are rolling in revenue.

The U.S. economy stopped dead in its tracks on Sept. 11, 2001. New York City alone lost 100,000 jobs in one fell swoop. Four years later, New York ended its 2004-05 fiscal year with a budget surplus of $3.6-billion (U.S.), with which it will prepay 2005-06 expenditures.

(New York’s budget for next year is $50-billion, the largest municipal budget in the United States. Their spending is comparable to Ontario’s, except for Premier Dalton McGuinty’s deficits of the past three years.)

This is the same city that went bankrupt in the mid-1970s and that won’t completely emerge from state-monitored “bankruptcy protection” until 2008.

Yet Gotham’s back — all the way. New York has produced 20 balanced budgets in a row and its two most recent mayors, Rudolph Giuliani and Michael Bloomberg, have cut a wide range of taxes.

Although federally mandated expenditures still rise inexorably, as they do in many American cities, Mr. Bloomberg cut expenditures financed directly from the city’s own tax revenues by $3.6-billion in his first term. New York will exceed 40 million visitors this year, which is a record. And Standard & Poor’s has given New York its highest bond rating (A+) in 50 years.

Across the entire country, state tax revenues rose at the fastest rate since 1990. California collected 13 per cent ($3.4-billion) more than it expected. Massachusetts collected $2-billion in revenue in April, breaking the state’s all-time record for tax collection in a single month. It prompted Governor Mitt Romney to call for a whole new round of cuts in the state’s income tax. (The Massachusetts income tax rate is 5.3 per cent.)

After hurricane Katrina, Louisiana might have been expected to raise taxes to finance the reconstruction of New Orleans. Instead, it will cut state spending by $1-billion next year and enact tax cuts for both individuals and businesses.

Nearly every state that hasn’t yet cut taxes will do so, Democratic as well as Republican. In New Jersey, Democratic Senator Jon Corzine was elected governor this past month on a promise to lower property taxes. In Michigan, dragged down by an auto industry in decline, Canadian-born Democratic Governor Jennifer Granholm wants to cut business taxes by $1.4-billion. Elsewhere, though, reductions in sales taxes are by far the most popular.

Only three years ago, Massachusetts was in crisis. New York was in crisis. California was in crisis. Or were they?

Although headlines proclaimed fiscal crises from coast to coast, an unprecedented combination of federal, state and local tax cuts was already at work on the recovery. By themselves, the states enacted more than $40-billion in tax cuts.

As important as the tax cuts were, spending cuts were equally important. With these cuts, states showed that government spending need not increase all of the time, that so-called essential government spending is often discretionary and that fiscal restraint can be a mechanism for greater productivity and for economic recovery.

Colorado, with the most restrictive spending restraints in the country, is especially instructive. In 1992, the state entrenched spending limits (based on population growth and inflation) in its constitution and stipulated that surplus revenue must be returned annually to its taxpayers. Between 1997 and 2001, the state returned $3.2-billion in surplus revenue to its 4.5 million people — roughly $700 for each man, woman and child.

Although severely hit by the recession of 2001-03, Colorado has vroomed back to remarkable economic growth. It has the second-highest growth rate for personal income in the country, the second-highest growth rate for wages and salaries and the highest growth rate for per capita income. Its unemployment rate is 5 per cent.

Contrast Colorado with Ontario, where one Progressive Conservative government and one Liberal government tried to spend their way back to economic growth, increasing expenditures by more than 20 per cent, from $66-billion (Canadian) in 2001 to $80-billion in 2004. Ontario accomplished this extra $14-billion in spending by increasing the province’s debt from $132-billion to $146-billion, an extra $14-billion in debt.

Mr. McGuinty contributed his own distinctive policy combo of tax increases (the biggest in the province’s history) and debt.

Even with a revved-up economy and great gobs of federal cash, Mr. McGuinty will need another three years to balance the books. Nunavut will beat him to it.