CBPP Report Confuses Two Issues; Ignores Budget Reform Opportunity

 
 
January 08, 2009

Yesterday, the Center on Budget and Policy Priorities released a report rejecting a suggestion by Sen. Mitch McConnell (R-KY) on Sunday that any stimulus package providing funds for state infrastructure spending be in the form of loans, not grants. Here are McConnell's words:

Congressional Democrats have talked about sending hundreds of billions of dollars to the states. If we loan these funds, rather than give them away, states will be far less likely to spend it frivolously. And the taxpayer would have greater assurance their money is well spent.

McConnell is worried (as are many people, including Democrats) that the latest stimulus/bailout bill will become a giant Christmas tree on which every congressman hangs pet pork projects, ones that would never pass muster in ordinary times. The packed-with-waste 803-page "wish list" submitted by the U.S. Conference of Mayors illustrates that danger.

The reason "shovel-ready" has now become part of our everyday language is that according to even the most avid fans of economic stimulus through infrastructure spending, the spending surge has to be immediate or it won't work.

The CBPP report confuses the infrastructure-spending part of the proposed stimulus package with the bailout-of-state-governments part. These are two very different proposals, each with different pros and cons. For example, CBPP warns that states could not accept loans because most forbid accepting loans to balance their operating budgets. This is true, but irrelevant: the loans could only be for infrastructure spending, not budget shortfalls. McConnell's statement could have been clearer, but the context indicates that he was referring to the infrastructure.

CBPP also makes the broad statement that state budget shortfalls (which total around $93.7 billion over the next year and a half, according to the National Conference of State Legislatures, much lower than CBPP's eye-popping $350 billion over 2-1/2 years) "stem from the recession, not from fiscal mismanagement." It's surprising that serious analysts would make such a blanket statement absolving state officials of any responsibility for their plight.

As we've covered on our Tax Policy Blog, the circumstances vary widely by state. Ten states are still in surplus, and not all of them are oil- or coal-producing states. Those states in the worst positions are those with the worst business tax climates, the biggest run-up in spending during the boom, the largest emphasis on using the tax code to pick winners and losers, the smallest commitment to rainy day funds, and the heaviest reliance on volatile revenue sources like capital gains, high-income earners, and corporate profits. Perhaps "mismanagement" is a too strong word for such failures, but it's not just the recession at work here. Does the CBPP seriously allege that California, which hasn't de facto balanced its budget in a decade, isn't in its tough situation because of a failure by its citizens to equalize the amount of taxes they're willing to pay and the amount they want to spend on state services? And Michigan: when a budget shortfall is the same size as a foolishly generous tax subsidy for film production, isn't that mismanagement?

Of course, whether the money's a federal loan or grant, it's more government spending that taxpayers will have to make up, but loans help ensure that the projects are worthwhile because a repayment obligation will keep cost-effectiveness criteria in the minds of state and local officials.

Our criticism of states now in trouble could be likened to Monday morning quarterbacking. But if a bailout of the states is what it's come down to, how about requiring states to do some fundamental tax reform? Unlike the blank check that CBPP evidently wants to write, I propose that states should only get bailed out if they commit to fixing what broke in the first place:

  • Reduce reliance on volatile sources of revenue like capital gains, high-income earners, and corporate profits
  • Set up a mandatory rainy day fund (to be filled after the present crisis)
  • Strict spending controls
  • Eliminate targeted tax credits in the income, corporate, and sales taxes

We recognize that recessions are tough for state governments, with their combination of dropping revenues, increased demand for services, and balanced budget requirements. Yet most states are handling it by reprioritizing spending and drawing down rainy day funds. That's sound management. Whether these strategies can continue working into 2010 remains to be seen. But a bailout without strings attached just rewards the worst offenders of state fiscal practices.

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