ConservativeHome's Big Ideas blog

The coming state fiscal crisis we don't talk enough about, and what we can start doing to get ahead of it

Ryan Streeter

State fiscal crises are a huge deal. And given everything else going on in Washington, the issue is left off the national policy debate docket - left to states, as it were, in a kind of devolutionary ignorance.

If we keep ignoring it, get ready for another bailout debate. Sympathy for bailing out states is higher than budget hawks might like to think.

Matthew Mitchell has a good starter idea in his Wall Street Journal column. He proposes that states replace faulty tax-and-expenditure limitation (TEL) policies, such as Florida's, with better versions such as we see in Colorado.

A TEL pegs government spending to some other factor, such as income or population - which often only increases spending more rapidly than necessary. Florida's, which 12 other states also use, is pegged to income and has driven up state spending as higher-income people have moved in. 

Colorado's formula is inflation-plus-population growth calculation. Mitchell writes:

Colorado enacted this type of TEL in 1992. Between 1997 and 2001, the state collected revenue in excess of the limit set by the TEL, allowing it to refund over $3 billion to the state's taxpayers. Colorado prospered, experiencing the country's fastest economic growth between 1995 to 2000.

On top of this kind of TEL, lawmakers should consider additional policies, all of which are state-tested:

• Adopt stronger balanced budget procedures, as most states get around the laws they currently have requiring budget prudence.
• Implement a super-majority rule for tax increases.
• Adopt the "item-reduction veto," which allow a governor to single out items in the budget for lower amounts than what the legislature has authorized.

Let's hope the silver lining in today's state fiscal crises is a willingness to experiment with reforms such as these. 

The impending state debt crisis: voters should demand Congress prohibit federal bailouts of profligate states

Ryan Streeter

Tired of too-big-to-fail? Well, get ready, because it encompasses a lot more than just propping up big banks. We are sitting on the brink of some possible bailouts of states whose fiscal profligacy could likely become the burden of US taxpayers as a whole. Think California and Illinois, to mention a couple likely candidates.

Now, most states' problems are the result of bad spending habits that political leaders have little incentive to try to correct. But, secondarily, many states are increasingly burdened by debt that has - as in the financial crisis - grown more complicated and is often held by foreign investors. It's bad enough as it is, but it gets worse: the federal government has been helping subsidize bonds for states that it will be on the hook to pay for if and when states cannot pay the bondholders. The feds' involvement in providing these bonds is not lost on investors any more than it was lost on purchasers of mortgage-backed securities backed by Fannie and Freddie.

Steven Malanga of the Manhattan Institute has an important article in the Wall Street Journal on this issue today. It is worth quoting him at length:

Build America Bonds were created to re-energize the municipal bond market, which contracted sharply in late 2008. Investors had become wary that the credit crunch would spread to municipals, as insurers who back state and local bonds got hurt in other markets and stopped insuring public debt. Facing declining tax revenue and growing deficits, some local governments suddenly couldn't borrow.

The Obama administration responded with a new kind of taxable bond that offered a 35% federal subsidy on the interest rate. Washington designed the subsidy to appeal to investors such as pension funds and overseas buyers who don't buy traditional municipal bonds because they can't take advantage of their tax-free status. The federal subsidy allowed states and cities to offer these investors an attractive return. The catch: Congress authorized the program only through 2010, to allay concerns that BABs would become a permanent bailout.

States and cities jumped deeply into this new market. California alone has issued some $21 billion in BABs, mostly as a substitute for its general obligation debt to support everything from school construction to sewer projects. New Jersey has used up to $500 million to recapitalize its depleted transportation trust fund. Columbus, Ohio, issued $131 million in BABs to start construction of a downtown convention hotel. And in Dallas, Texas, when no private operator would finance a new convention hotel, the city went ahead with a government-subsidized hotel, courtesy of $388 million in BABs.

Now dozens of governments and other municipal issuers (like New York's Metropolitan Transportation Authority and the University of California) have hired lobbyists to push Congress to extend BABs beyond this year. And in its 2011 budget, the Obama administration proposed making Build America Bonds permanent, with an interest-rate subsidy of 28%.

These bonds are the tip of the iceberg. State finances get even worse when we start looking at pension funds and wasteful spending. Voters who sent a message to Washington on November 2 would do well to demand that Congress pass a law prohibiting federal bail-outs of states that default on bond obligations - for starters.