If you’ve been reading this blog, you know that generally speaking I am against government intervention except when absolutely necessary. But I have also mentioned that I sometimes feel sorry for politicians — at least for the good, honest ones out there. True, there are probably only about three of them, but I feel sorry for those people. Reading the news the last month or so, I’m struck by the fact that every time state governments do anything at all, there’s a protest. The struggle that states are having to control their budget deficits highlights this problem, as almost every state has some form of balanced budget requirement. So what are state governments to do?
When New York’s Governor Patterson decided he would increase taxes on a variety of items to gain revenues to fight his budget deficit, he was met with protests. When California attempts to decrease spending to fight its massive budget deficit, and some state employees lose their jobs or have their hours cut, they are also met with protests. When states try to decrease the quality or quantity of services they provide, still more protests. And when states increase the price of government services (public transportation, for example), yet more protests. There are only so many things states can do to get their budget under control, and every one of them results in protests. If states need more tax revenues, perhaps they should put a tax on posterboard, wood sticks, and Sharpies.
This is one of the reasons that the Balanced Budget Amendment, at the federal level, has been defeated repeatedly. Having a BBA means that when tax revenues are low because of a recession (as they are right now), the government has to raise taxes or cut government spending to offset this. Both of these policies decrease output in the economy in the short run and make the recession worse, which is why Obama is doing the opposite right now. (Reducing spending is actually good for long-run growth, as the OMB’s report will attest, but nobody seems to care about that these days, so I won’t bother making that argument.) I’m not saying that states should abandon their BBAs. I have no doubt that would make some states’ situation even worse: can you imagine how much debt California would have if it were not legally required to actually do something to control its deficit? Scary.
I have a feeling that what the federal government is doing right now, providing large sums of cash to states for a variety of reasons, is just going to make this situation even worse. The reason is something called “moral hazard.” Every introductory economics textbook has a different definition of moral hazard, and none of them are great. Moral hazard is best discovered through an example, not a definition. When I don’t have dental insurance, I floss twice a day to avoid getting cavities; when a do have dental insurance and won’t have to pay for my cavities, flossing loses its appeal. The result is that when people have insurance, they engage in more costly behaviors since they do not bear the costs of those behaviors. When someone else is paying your costs, you don’t worry about controlling those costs. Part of the reason so many homeowners do not have flood insurance, especially in areas where they should have it, is that any time there is a natural disaster the federal government steps in and bails everybody out whether they have flood insurance or not. Why should I buy flood insurance when I know the government will bail me out if I don’t have it? Such will be the situation with state budgets. Why should states really work to control their budgets, facing protests at every turn, when the federal government will bail them out?
So what is the solution? I know I am going to sound like a doctor whose cure for a heart attack is to tell the victim he should have eaten fewer Baconators — that’s a great long-term strategy but it doesn’t fix the immediate problem of a heart attack. The truth is I don’t have a cure for the current financial situation — but neither do all the brainiacs in Washington, D.C., so I don’t feel too stupid. What I do know is that if states want to avoid facing these difficult situations in the future, they need to get smaller, not larger. I am hoping that the current budget shortfalls faced by almost every state will make them all realize that expanding the size of state government only makes difficult economic times worse. When you rely on increasing state taxes to fund expanding social programs, the effect of a recession in your state is magnified because state tax revenues drop by a larger amount, leaving you with a significant budget deficit that requires major adjustments. Just ask Arnold Schwarzenegger. And with the amount of federal taxes expected to increase in the next decade, I think many people would appreciate having lower state taxes to offset some of that. I know some people in California, the most heavily taxed state in the union, that are starting to realize this. Hopefully some people in Sacramento will realize it soon.
I am not sure what, in all of the horrible financial news at every level of government, makes some people say that the answer to their problems is even more government. What gives them such confidence that, despite the federal government’s ability to control its budget or deliver on most of its promises, it will work better when it is even bigger? We Americans are like the woman whose husband cheats on her again and again and we keep taking him back because he says he loves us; we know we should leave him but we just can’t do it because we’re scared of being alone. (As Dr. Phil would say, how’s that workin’ for ya?) What I glean from current state budget crises is that the leaner a state becomes, the more insulated it will be from economic fluctuations. Despite our relative success in the 1990s, the federal government cannot control economic fluctuations. The failure of dramatic government intervention in the last 6 months to have any appreciable effect on the economy has shown this clearly. The less you rely on government support, the less it matters if government spending is cut. To me, it’s just that simple.