State government budget problems are not like household budget problems

The average voter may think of state government budget problems as if they are analogous to the voter’s budget problems. For the average voter, if somehow household spending exceeds household income, the easiest and most natural response is just to cut back on spending.

However, state governments are not like households. The best solution to state budget problems is not the same as a household’s best solution to its budget problems. Both Ezra Klein and Karl Smith make this point in recent blog entries.

Here are some of the key differences between state budget problems and their solutions, and household budget problems and solutions.

First, unlike households, it is much easier for state governments in the short-run to adjust income rather than expenses. A state government can easily adjust income by raising tax rates. A household would probably need to work additional hours, which may be hard to do.  In contrast, a middle-class household in many cases finds it relatively easy to make significant cutbacks in some of the luxuries and frills in its budget. In contrast, short-run dramatic slashes in state government spending often severely disrupt the operation of needed public services and may even increase long-run budget deficits. Karl Smith makes these points in greater detail in a recent blog post.

Second, during a recession, governments, including state governments, are called on to spend more to fulfill the government’s “safety net” function. Therefore, actually cutting state government spending during a recession, rather than cutting projected spending, may make it difficult for government to fulfill its safety net function. This would not be true of most households.  It might be true of a few households, for example of households in cases where some former household members lose their job and move back in. Under such a circumstance, households as well would find it difficult to cut back on total food spending.

Third, government spending and taxes affect the overall economy. So do household decisions about spending and work, but many of these effects are quite different.  For state governments, both spending cuts and tax rate increases have negative economic effects upon the state economy. But the negative effects of spending cuts are greater than the negative effects of tax rate increases. More of the spending cut will be felt in reduced demand for goods and services produced within the state, whereas much of the tax rate increase will be felt in reduced demand for goods and services produced in other states.

Therefore, when faced with a budget shortfall during a recession, it is better for a state government to have short-run increases in taxes rather than short-run cuts in spending.  Ideally, these short-run increases in taxes should be designed to expire as the state economy recovers. Furthermore, state governments should certainly always be exploring budget reforms that would more effectively deliver government services at lower costs. However, such budget reforms typically require some up-front costs and take time to be implemented.

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.
This entry was posted in Uncategorized. Bookmark the permalink.