May 17, 2011

Mitch Daniels Sets the Example

This op-ed was published in the New York Times on May 17, 2011.

State officials are now adjusting to a “new normal,” realizing that expecting revenues to grow 6 or 7 percent a year is as much a phantom as the dot-com and housing profits upon which those expectations were built.

In some states, like Indiana and Arkansas, governors and legislatures have come together to recognize that spending must be prioritized to fit within expected revenues.

Indiana’s governor, Mitch Daniels, deserves special praise for ensuring that long-term expenses match long-term revenues, and for building on his predecessors’ work to ensure that government outcomes are measured and incentives for better performance are put in place. Arkansas, too, prioritizes expenditures as part of its legislative process, and if there’s no money left, the lower priorities do not get funded. The state cannot run a budget deficit.

In too many states, however, the attitude has been to put temporary patches on the budget in hopes that the economy will recover enough to avoid the pain of cutting spending back down to earth. These states have tried combinations of gimmicks like moving the last payroll into the next budget year, reliance on one-time revenue sources like federal stimulus aid or tax amnesties, temporary tax increases, and borrowing to pay operating expenses. These states need to understand that their tax collections will never return to the growth levels reached at the peak of the boom. The more they kick the can down the road, the worse the eventual correction will be.

California has excelled at this for over a decade, but even it did not go as far as Illinois, which conserved cash by not paying six months’ worth of bills. Earlier this year, Illinois’s Gov. Pat Quinn (D) and Connecticut’s Gov. Dan Malloy (D) pushed through large across-the-board tax increases that bridge this year’s gap between revenue and spending. But without structural changes, those budget gaps will reappear.

As part of a budget prioritization process, easy targets for cuts are targeted tax incentives. Although these tax breaks are politically popular because they enable officials to cut ribbons at a shiny new facility or take credit for a handful of new jobs created, the evidence suggests that they do more harm than good.

They work only if politicians are effective venture capitalists, picking winners and losers correctly. Existing businesses that pay their taxes year-in and year-out are usually not eligible, and the new facilities and jobs have a habit of disappearing as soon as the credits stop.

One example, and perhaps the most egregious of targeted incentives, is the tax credit for film and television production. Forty states offered $1.4 billion in credits to such production companies in 2010. Fortunately, the trend seems to be on the wane; this year 37 states will offer $1.3 billion.

New Jersey’s Gov. Chris Christie (R) and the former Iowa governor Chet Culver (D) both eliminated their states’ film tax credit programs, and New Mexico’s Gov. Susana Martinez (R) and Michigan’s Gov. Rick Snyder (R) have sought to cap the spending on their otherwise open-ended programs.

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