The Minnesota Legislature will convene in St. Paul and the Wisconsin Legislature in Madison this week to grapple with giant budget deficits. A new Congress also goes to work in Washington and, facing a growing deficit, will likely add to it rather than try to reverse it.
Why do state budget deficits merit frenetic corrective actions while those at the federal level are greeted with a yawn?
The answer is rooted in politics more than economics.
Minnesota, like many other states, has a provision in its constitution requiring a balanced budget. Yes, the state can borrow money by selling bonds to pay for capital improvements such as state building of roads. But it cannot borrow to pay college teachers or snowplow drivers.
Anyone who took an economics course in the last five decades knows that John Maynard Keynes and other economics argued that governments should run budget surpluses during periods of prosperity and deficits during recessions. He also argued that governments should loosen money supply in down times, when people tend to hoard money.
The objective was to manage macroeconomic parameters such as inflation and unemployment. For several reasons, that’s easier for federal than state governments. To start with, states don’t control money supply. They also can’t keep the effects of economic incentives from spilling outside their borders.
Today, economists’ confidence in Keynesian policies is much more circumscribed than it used to be. But if we disregard the objective of managing the economy and accept that government budgets ought to be balanced in the long run, a valid question remains: Why should Minnesota or any state be required to balance its budget over a two-year biennium as opposed to four, five or eight years?
The principal answer lies in a fundamental distrust of government. We don’t trust state legislatures and governors to balance the books without a law that forces them. We may have the same mistrust of the federal government. During the writing of the U.S. Constitution, there was substantial discussion of the pros and cons of federal borrowing. But since the federal government is responsible for defense, the ability to borrow for wars or national emergencies trumped any fears of fiscal irresponsibility.
For a clear argument why states should be forced to balance their budgets, look at Brazil and Argentina. Both have a long history of fiscal irresponsibility at the state level with repeated bailouts by the national government.
In Argentina, the Duhalde government’s inability to strike a pact that limits provincial spending is an important reason the country has been at loggerheads with the International Monetary Fund for nearly a year. And the toughest challenge for new Brazilian president Luis Ignacio da Silva is to keep state deficits from overwhelming national fiscal restraint.
Without constitutional clauses or other firm constraints, skeptics argue, states such as Minnesota would soon have the finances of a banana republic.
I am not convinced of this. But the shenanigans that go on at the state Capitol whenever there is a crunch don’t inspire confidence.
Minnesota frequently has moved large payments from the last day of one fiscal period to the first day of the following one to reduce an apparent deficit without changing anything substantive. Of course, Minnesota isn’t alone in such smoke and mirror tricks, but they don’t say much for lawmakers’ fiscal integrity.
All that said, would Minnesota be better off if we balanced public budgets over the business cycle rather than on a biennial basis?
The answer clearly is yes.
Raising taxes or cutting spending does not help the state or local economies in a recession. Smoothing the flow of both revenues and spending over longer terms could results in greater efficiency and fairness.
Statutory requirements for biennial balance were imposed at a time when state revenues came largely from property taxes. Today, sales and income taxes, which rise and fall with the overall economy, play a larger role.
And on the spending side, general assistance, state portions of Medicaid and other social programs increase when times are tough and decrease during prosperity. Imposing the straitjacket of biennial balancing has social and economic costs.
It would be a mistake, however, to disregard the warnings of those who are skeptical about politicians and deficit spending. There are many historical examples of countries, states and even cities where populist impulses to spend more and tax less led to fiscal disaster. Usually the guilty political leaders move on before the mess has to be cleaned up.
Though it’s hard to make good long-term policy during a short-term crisis, Minnesota’s leaders would do the state a great service if they would devise effective structural measures to balance state budgets over the long term without incurring more debt.
That might involve repeal or modification of the requirement to balance the budget. It might also involve building substantially larger reserves in time of prosperity.
Minnesota will get through the next few years, but the political processes won’t be pretty and the outcomes won’t be fair or efficient. Before the whole cycles goes around again, we need a better approach.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.