Governors’ budget proposals reveal debate over how state government can best respond to economic distress

The Center for Budget and Policy Priorities (CBPP) has a useful recent report that summarizes the budget proposals for fiscal year 2012 of 48 Governors. (Fiscal year 2012 runs from July 1 2011 to June 30 2012 in most states.)  The report is entitled “Governors Are Proposing Further Deep Cuts in Services, Likely Harming Their Economies”, which is an accurate summary of the report’s perspective. The report was written by Michael Leachman, Erica Williams, and Nicholas Johnson.  The report is up to date as of March 21, 2011.

I think this report is well worth reading by advocates for early childhood programs. It puts their state’s policy debates in a broader context. Even if you are primarily focused on programs in your own state, it is worth remembering that these same policy issues are being debated in most states.

Most states face fiscal problems due to the length and breadth of the Great Recession, rising costs for services such as Medicaid, and declining federal aid to states as most stimulus funds expire.  How are states responding to these fiscal problems? In most cases, by emphasizing public service cuts more than tax increases. According to CBPP, 39 states are proposing major public service cuts. Only 7 states are proposing significant revenue increases.

Even in the face of these fiscal problems, 7 states are proposing tax cuts. Significant corporate tax cuts are being proposed in 6 states. A primary purpose of such business tax cuts is to encourage state economic growth.

These service cuts include early childhood programs. According to the CBPP report, cuts in pre-k are being considered in 6 states, including Georgia, Iowa, North Carolina, Pennsylvania, Texas, and Washington.

Educational programs in general are also being cut. 19 states are proposing cuts in K-12. 20 states are proposing cuts in higher education.

What might be the possible impacts of these state proposals on state economies, both in the short-run, and in the long-run?

First, cutting state spending has more negative effects on a state’s economy in the short-run than the alternative of increasing taxes. This is because cuts in state spending tend to fall more heavily on goods and services produced in the state, by both the public and private sector. In contrast, a larger proportion of any tax increase would have instead been spent on goods and services produced out of state.

Closing state budget gaps through either spending cuts or tax increases damages a state’s economy in the short-run.  (That is one of the rationales for federal stimulus aid to states, which boosts the national economy by reducing the damaging actions that states are forced to take to close budget gaps.) But states right now appear to be considering budget closing options that will maximize the short-run economic pain.

In some simulations we did for the Michigan budget and economy back in 2003, my colleague George Erickcek and I examined the relative economic damages caused in the short-run by state tax increases versus state budget cuts.  On the various economic measures considered, such as jobs, personal income, and gross state product, state spending cuts were at least 40% more damaging than a similar magnitude of state tax increases.  Although obviously the details of such simulations would depend on the state, the time period, and the exact taxes and spending changes considered, I think the broad conclusion we reached would be robust in many states’ circumstances.

Second, across the board business tax cuts are likely to have disappointing economic payoffs, especially in the short-run, but likely also in the medium run and long-run. Holding other factors equal, such as the quality of public services, state business tax cuts will boost long-run economic growth. But the amount boosted is modest compared to the size of the business tax cuts. As I discussed in a previous blog post, per dollar invested in across the board business tax cuts, we would expect the present value of state residents’ earnings (my definition of “economic development benefits”) to increase by $0.51. In other words, the earnings benefits are less than the costs.

In contrast, as this previous blog post also discussed, business tax incentives are much more efficient than across the board business tax cuts. They are more efficient because they are more targeted at new investments of export-base businesses. Targeting new investments that really boost the state economy is more efficient than less-targeted business tax breaks.   Furthermore, customized services to business can be even more cost-effective than even the best-designed business tax incentives.

Third, these large cuts to pre-k, K-12, and higher education may cause serious issues for some states’ long-run and short-run economic development. In the long-run, these cuts may reduce some states’ labor force quality, making it more difficult for these states to develop new and better jobs. In the short-run, these cuts may make some states less attractive to parents looking out for their children’s future. (Most of the blog posts at this blog have focused on these issues, so I’m not going to provide specific links.)

Of course, it could be claimed that some of these spending cuts may lead to reforms that may significantly reduce spending without decreasing the quality of educational services. This is a more convincing argument to the extent that the cuts are actually accompanied by well-structured reform measures that increase the efficiency of educational services.  My sense is that in many states, the state government is not directly addressing reforms; rather,  the state government is putting pressure on school districts or universities to make reforms in the course of dealing with major spending cuts.

Cutting pre-k does not suggest that there will an increase in the efficiency of educational services.  Because pre-k has a higher bang for the buck than other educational spending, pre-k spending should be increased as part of a policy package to make educational spending more productive.

How do we boost state economies when states are in economic distress? Current state policies assume an answer to that question that cuts educational spending and avoids increasing taxes or even reduces taxes. Alternative policies might include tax increases, more efficient business incentives, and reforms to increase the productivity of educational spending from early childhood on up.

About timbartik

Tim Bartik is a senior economist at the Upjohn Institute for Employment Research, a non-profit and non-partisan research organization in Kalamazoo, Michigan. His research specializes in state and local economic development policies and local labor markets.
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