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Jewish World Review Jan. 6, 2002 / 3 Shevat, 5763

Michael Barone

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Consumer Reports

Crunch time |
California's Gov. Gray Davis will tell us this week how he expects to deal with his state government's projected shortfall, which could reach $35 billion over the next 18 months. That's right, $35 billion-about as much as the sum of the currently projected shortfalls of the other 49 states combined.

Yes, the figures may be a bit impressionistic: The projected shortfall was pegged at just $21 billion back in November when Davis won re-election. But whatever the number, it's still a huge chunk of an annual state budget that currently totals $99 billion. How did Davis, an intelligent man with nearly 30 years of experience in California's state government, get into such a mess?

The answer, sadly, is the same way almost everyone else did-only more so. California is an extreme case, but most state governments have similar problems, and so does the federal government. Stories about budget shortfalls and revenue shortfalls are a staple right now in papers from Massachusetts to Arizona. Framing the issue this way-current taxes are not bringing in enough revenue-suggests an obvious solution: raise taxes. Davis is likely to ask for higher taxes this week. Republican Govs. Mike Huckabee of Arkansas and John Rowland of Connecticut already have.

But there's another way to look at the states' fiscal problems. And that is to look at spending. In good economic times, governments got into the all-too-easy habit of increasing spending faster than the economy was growing. State government spending was up 39 percent from 1996 to 2001. In the four years Davis has been governor, California's annual budget has soared from $74 billion to $99 billion, a 34 percent increase. For a time, that spending increase was fueled by the Silicon Valley boom: Capital gains yielded $17 billion to California in fiscal year 2000. But did California's politicians and budget analysts really think tech stocks would soar forever? From fiscal year 2000 to 2001, state spending rose 14 percent even as the high-tech sector plunged downward. One of the lessons of California's woes is that progressive taxes, which may be desirable for public-policy reasons, produce dangerously volatile revenue streams-huge amounts in good years, next to nothing when the stock market is falling. States that rely on progressive taxes should be especially careful not to overspend when revenue comes gushing in.

Fiscal discipline. Not all states overspent in good times. In states like Colorado, governors and legislatures showed more restraint and built up larger rainy-day funds for the leaner times. In recent years, the federal government has not been a model of restraint either, even when Republicans controlled Congress. Newt Gingrich's first year as speaker produced a disciplined 1996 budget, but by 2001 annual federal spending had spiked 19 percent. And the feds have often offloaded spending onto the states through unfunded mandates and expensive requirements for Medicaid, whose costs are rising rapidly.

Governors and legislators complain eloquently about the pain of "cutting" planned spending increases. But the formula governments typically use-spending must rise by the increase in the population served, plus inflation-is based on the flawed assumption that government has achieved maximum efficiency and that any cut will reduce output. Anyone familiar with the workings of large organizations knows this is wrong. In good times governors like Davis were able to get by without nipping and tucking, improving efficiencies and reducing waste. Now it is crunch time, and they must do the things they should have been doing all along.

How will the current dilemma affect most citizens? Some will notice cutbacks in state programs or spending. For most, however, the big effect will be macroeconomic. In 1996 through 2001, robust increases in state spending contributed to growth of the domestic product. Now tax increases threaten to take away consumers' disposable income and impede economic growth. The states will be retarding recovery.

There aren't a lot of easy choices or answers at the moment. The scheduled Bush tax cuts have put the federal government in a fiscal crunch, with congressional appropriators cursing the limits set by Office of Management and Budget Director Mitch Daniels. Shortfalls in state revenues have put the state governments in a fiscal crunch. Both have to deal somehow with sharply rising healthcare costs. As in the war against terrorism, so as in fiscal policy, we seemingly have moved suddenly from easy living to crunch time. But when we look back, we can see now that we should have realized it was crunch time all along.

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Michael Barone Archives

JWR contributor Michael Barone is a columnist at U.S. News & World Report and the author of, most recently, "The New Americans." He also edits the biennial "Almanac of American Politics". Send your comments to him by clicking here.


©2002, Michael Barone