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Unemployment, not budget practices, to blame for state woes

2010.05.27__Fig2HowBadChart_htm_opt.jpg

One of the responses I've gotten to my column on the anti-stimulus is that state budget deficits are the direct result of irresponsible state governments and so helping them out would be rewarding fiscal irresponsibility. I don't want to say that there's nothing to that perspective -- I favor tying aid to labor market conditions rather than budget deficits for exactly that reason -- but as this working paper from Wharton economist Robert Inman shows, it's not the underlying story.

The 2007-2010 recession has imposed significant fiscal hardships on state and local governments. The result has been state deficits and the need to increase state taxes, cut spending, and withdraw funds from state rainy day accounts. The primary cause of state budget “gaps” has been the rise in the level of state unemployment. There is no evidence that gaps are related to state political institutions, the state’s prior receipt of federal funding, or possibly favored access to key congressional budget committees.

In the paper, Inman tests factors in states' budgeting practices, politics and economies in order to figure out which correlates most heavily with their economic conditions. The runaway winner is unemployment. "States with a one standard deviation higher rate of unemployment (10.0%) will have a budget gap which is $222/person more than a comparable state with an unemployment rate one standard deviation lower than average (6%)," he concludes. Inman finds this to be a cheering prospect: "The good news from this analysis is that the states’ fiscal crises of 2009 do not appear to be linked to any obvious structural or institutional failures in state finances. It’s the economy."

A few other points from the paper: The states that have survived the recession best are not states with more competent governments. They're states that depend on natural resources – Montana, Nebraska, North Dakota, Texas, West Virginia, and Wyoming – for revenue. Budget cuts, as you might have expected, have hit aid to local education and transfers and services for lower income families hardest. And the stimulus covered, at most, 23 cents of each dollar of state budget gap -- and that's running out this year.

By Ezra Klein  |  June 22, 2010; 9:31 AM ET
Categories:  Economy  
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Comments

I think it's misleading to characterize 2004 and 2005 as recession years, especially 2005. National unemployment was only 5.1% in 2005 and the expansion was already four years old. Still, the states had a budget shortfall.

If states had run a $45 billion budget surplus in 2005 rather than a deficit (and presumably somewhat more than that in '06 and '07), then not only would there be more of a cushion in the budget but there would be well over $100 billion in funds to help plug the holes for 2009-2011.

I won't disagree that nasty recessions wreck budgets, but I think it's entirely fair game to say a large part of the story is that states were collectively running budget deficits back in the good years like 2005. Running budget deficits in good years is prima facie evidence of fiscal irresponsibility (such as when Bush and the Republicans were running federal deficits in '05).

Posted by: justin84 | June 22, 2010 9:59 AM | Report abuse

there is a part to the fiscal irresponsibility but as you say its by no means the over-riding factor although some states are more irresponsible than others.

As you say unemployment and the forgone revenue from taxes is what hurts the most. I'd love to see graphs that show tax revenue by state from 2004 to the current date. That being said it'd be nice to have a government that wasn't so anti-business. That to me is the "politically right approach" that Rep Barton should have taken. The idea that we can certainly "figuratively" burn BP at the stake but when and if we do, don't go complaining about the economy because of it. THere's a fine line between strict regulation and over-reach and businesses (right or wrong) believe this administration has trampled all over it.

Posted by: visionbrkr | June 22, 2010 10:01 AM | Report abuse

"believe this administration has trampled all over it."

How so?

We haven't had an anti-business gvmt in our lifetimes.

Posted by: Lomillialor | June 22, 2010 10:06 AM | Report abuse

Lom,

You may want to STOP posting parts of my posts to make your arguments.

Try the FULL POST.

THere's a fine line between strict regulation and over-reach and businesses (right or wrong) believe this administration has trampled all over it.


AGAIN, if businesses, right or wrong believe that the government is over-regulating (whether they are or they aren't) then they won't hire and the economy will continue to struggle. I've met with a lot of small business owners that are so frustrated with the government right now (more than at any other time) that they are ready to throw their hands up and "get on the dole" as they say. Again these aren't my words, they are my clients that I meet with daily.

Posted by: visionbrkr | June 22, 2010 10:17 AM | Report abuse

In general, the states that are struggling most on their budgets are those states that have created the largest expectation in the people for social services. Social services are very hard to turn off in a recession and they are very expensive.

Again, budget management is about reducing the expectations of the people for social services.

There are a couple models for this that we need to watch closely. First is Chris Christie in New Jersey. He understands that many in New Jersey have gotten accustomed to a way of life through public expenditures that was unrealistic.

An even better example is the new coalition government in Britain. The Cameron/Clegg/Osborne budget proposal appears to directly confront the enormous spending on public social services and show them for the unrealistic expenditures they are. The people have to be convinced through budgets that their expectations for what government can do was too high and that their just isn't enough money to cover all of these expensive social services costs.

Posted by: lancediverson | June 22, 2010 10:17 AM | Report abuse

States like California were running surplusses until Bush and enron stole 100s billions in the fake energy crisis of 2001, and then they were hit by the great recession, another Bush legacy, which made matters worse. CA's AG proved the scams in court. Google it.

There are indeed poorly managed blue states AND red states. But once the economy gets rolling again, most Blue states will see better times than the red states.

And by the way, poorer countries are doing better in this recession than richer ones, so I would not use them as an example as to how to run the US.

Posted by: Lomillialor | June 22, 2010 10:38 AM | Report abuse

Robert Inman's paper is a draft... perhaps needing a bit of math re-checking. While the carefully worded assertions are as correct as those in the Dartmouth Atlas, a closer look at the numbers undermines (or at least causes some concern regarding) inferences which many might draw from the specifically worded conclusions.

Based on the data presented, it's fair to say that the financial crisis in some states results not from unemployment but from over-zealous spending on welfare and pension programs.

Posted by: rmgregory | June 22, 2010 11:21 AM | Report abuse

Lom,

The state of CA wasn't defrauded out of '100s of billions', although Enron certainly did take advantage of CA for tens of billions - of course much of that money was probably paid by private customers, not the state but whatever. That said, looking at what Enron actually did, they just took advantage of a poorly 'designed' market for energy. While you can't blame the losses in 2000-2001 on Californian fiscal responsibility here, the overall trend in CA is for ever more social spending, which as lancediverson points out becomes difficult to maintain in deep recessions.

But back to Enron,I found this online, and given that it's a socialist website I'm sure it outlines some of the most appalling tactics (and they were appalling in a moral sense) Enron used: http://www.wsws.org/articles/2002/may2002/enro-m10.shtml

"One such strategy involved the company buying electricity from the California Power Exchange for $250 a megawatt-hour—the maximum allowed under state limits—and reselling it to states in the Northern Pacific for $1,200."

A state mandated maximum selling price (that existed even during a shortage) created an arbitrage opportunity between CA and OR/WA. Had there been no maximum price, CA could have quickly hiked its selling price to $1,200.

"one of Enron’s key strategies—code-named “Load Shift”—was to deliberately overstate the amount of energy its customers required. When energy supplies were tight Cal-ISO would pay traders a premium for providing more power than was required. Enron would deliver the promised amount and would then be paid a premium price for removing their energy from the grid."

A government bureaucracy was hoodwinked and overpaid because it didn't know energy supplies weren't actually tight.

"Enron also flooded the state’s transmission lines with more electricity than it could handle in order collect “congestion payments” from Cal-ISO to schedule energy transmission in the opposite direction or reduce their generation/load schedule. “Because the congestion charges have been as high as $750/MW [per megawatt], it can often be profitable to sell power at a loss simply to collect the congestion payment,” the memo said."

So the government structured the market incentives so that they paid more for overloading the system than serving customers.

Anyway, while the Enron traders were jerks - basically thieves in a moral sense - the CA government left the front door open with a sign saying 'rob me'! It goes back to Hayek's comment that "the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Posted by: justin84 | June 22, 2010 11:42 AM | Report abuse

It's bafflingly misleading to exonerate budget practices without even mentioning budget practices. States in the last several years before this recession spent money wildly, with many of them raising their budgets by 40% in three or four years. Ezra is trying to manufacture a crisis by suggesting that the recession is a terrible blow for states, when in fact they're only being expected to cut their spending back to where it was in 2006 or so.

Posted by: tomtildrum | June 22, 2010 12:40 PM | Report abuse

Never lose sight that 40 years ago state prison budgets took up 1-2 % of state monies. In 2007 that average was 6.8 (PEW Trust numbers)

States could employ a lot more teachers & or lower horrific tuition costs, IF we had the courage to repeal modern, drug prohibition. Speaking as a retired detective, 80% of state prisoners had a connection to prohibition -either selling (20%) or theft to pay sky-high prices (55%) to murder/assault of other dealers (5%)

States are missing out on 5 billion in sin taxes + wasting 11 billion in chasing Willie and Snoop Dog...just in cannabis prohibition.

Prohibition is a self-inflicted wound.

thanks for your time & excellent opeds.

howard

Posted by: wooldridge1 | June 22, 2010 1:43 PM | Report abuse

If budget cuts were the answer, wouldn't Mississippi be a leader in education and health care? Job creation is the key, not deficit concerns.
btw, I've been hearing great job search advice on the internet radio show at www.jobtalkamerica.com

Posted by: kcsam215 | June 22, 2010 1:50 PM | Report abuse

It's all about the housing market. The overheated housing market in the first half of '00's pumped up tax revenues from rising real property assessments and from capital gains and other income derived from property transactions. State and local gov't ramped up expenditures to meet the demand for infrastructure in new developments, to add more non-core government services, and hike pay for public employees.

The housing market collapse is forcing state and local gov't to provide services at a more sustainable level.

Posted by: tuber | June 22, 2010 3:20 PM | Report abuse

Second the call to end drug prohibition. What a fantastic waste of money. I'm sure Mexico would be thrilled...

Posted by: justin84 | June 22, 2010 6:20 PM | Report abuse

The Pennsylvania legislature balanced its budget using a multitude of deceptions on the revenue side and underestimating costs.
They issued bonds with no prospect of income to repay them ie: tolling I 80 and then spent the revenue which never materialised. The Supreme Court of Pennslyvania issued a 100 page opinion which stated that the unconstitutional payraise for legislators, state workers and Judges was legal for judges and the 25% increase in pensions for teachers and state workers was legal. The last three years of deficits were planned and the future generations will have to pay for them.

Posted by: duncan11 | June 22, 2010 6:24 PM | Report abuse

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