'Perpetual fiscal crisis' afflicts too many states
by Neal Peirce
WASHINGTON POST
tallahassee.com
Could it be true that the $40 billion worth of budget deficits the governors and state legislatures now face aren't temporary? That the red ink will keep flowing even when the recession ends? That without some major system corrections, our state governments are headed for "perpetual fiscal crisis"?
That alarming prognosis comes from no less a figure than Ray Scheppach, respected economist and veteran executive director of the National Governors Association, which is holding its annual midyear meeting in Washington this weekend.
Scheppach notes the cumulative deficits, reported from the 41 states that are currently running in the red, are twice the total figure in the last recession in the early '90s. California's shortfall is estimated at a staggering $12.4 billion. In New York, the current deficit is $3 billion. In New Jersey, it is $2.4 billion; Michigan, $1.4 billion; Massachusetts, $1.35 billion; Virginia and Florida, $1.3 billion each.
States have no choice: They have to balance their budgets. Anxious to avoid tax hikes, especially in an election year, it's clear they'll look first to cuts, including secondary and higher education, transportation, and the health and welfare programs critical to the poorest Americans.
But why won't solvency return when the current recession - apparently a fairly light one - goes away?
That's where the painful Scheppach formula comes into play.
First, he notes, the states have a deteriorating tax base - one built for the manufacturing economy of the 1950s, "not the high technology, international and service-oriented economy of the 21st century." State tax systems focus heavily on taxing goods but exempt most services - even though services, from legal and accounting to real estate and information technology, are "where the action is in today's economy." That failure is amplified by growing numbers of transactions - especially business-to-business - conducted over the Internet on an interstate basis and effectively tax-free.
The ideal sales tax, says Scheppach, has a low rate on a broad base. Right now we have the opposite - rising rates on an artificially limited base.
And corporations, he adds, have exploited countless loopholes to get around state taxes. Many take their profits offshore or into states with no or very low taxes on profits.
That leaves income taxes - the one way left to capture practically all economic activity (and in equitable ways). But states' income tax yields have dipped dramatically. One reason: The big capital gains affluent taxpayers paid during the stock market boom of the late '90s have virtually disappeared.
So why not, in this recession season, raise income taxes the way a number of states (California, Connecticut and New Jersey, for example) did in the early '90s? Scheppach doesn't emphasize the point, but the fact is many governors are spooked by the negative politics their predecessors experienced then. Taxpayers, in a post-Sept. 11 world, may not gang up so quickly as before against political leaders who raise taxes to pay essential government costs. But governors, like generals fighting the last war, do seem intimidated, failing to request income tax hikes even in the face of massive deficits.
Only Indiana Gov. Frank O'Bannon, a Democrat, has proposed an income tax hike this year. Notwithstanding California's massive deficit, Gov. Gray Davis, also a Democrat, limits his recommendations to "a combination of cutbacks, deferred spending, internal borrowing and accelerated revenue."
And it's not just taxes that are driving states to "perpetual fiscal crisis," says Scheppach. It is their health care costs, too. Competition diminishes as hospitals get swallowed up by chains. Ditto medical laboratories. New drugs, which the market demands, are patent protected and often extraordinarily expensive.
One result is that Medicaid - the program begun for women and kids, subsequently expanded to cover the indigent elderly - is growing by leaps and bounds, up to 20 percent of state budgets. Its inflation rate sank as low as 5 percent a year in the late '90s, perhaps because providers feared the Clinton administration would regulate drug prices. But overall health care costs average 27 percent of state budgets, rising an alarming 11 percent a year.
Costs for nursing homes and medications are rising fast. The big health providers and pharmaceutical firms are formidable campaign spenders. Major reform is needed - maybe the federal government assuming fuller responsibility for the aged, leaving the states to look after children and the working poor. But right now, official Washington isn't listening. The states are left with a gargantuan, growing responsibility.
The massive deficits of '02 call out for some form of federal revenue sharing - to reach the states as well as their seriously strapped local governments. But in the long run the states will have to get serious about modernizing their own tax systems and remaking health systems.
And Washington will have to recognize that this is a national, not just a state, dilemma. With two successive former governors as president, we ought to be doing a lot better.
Contact Neal Peirce at nrp@citistates.com .
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