Monday, December 14, 2009

UA Economist Marshall Vest: State Budget Crisis "Looks To Be Unsolvable"

Posted By on Mon, Dec 14, 2009 at 8:11 PM

UA economist Marshall Vest became the latest Cassandra to warn about the state government’s impending financial collapse.

Vest and fellow Eller School big-brain Gerald Swanson delivered their annual financial forecast last week. Guess what? The news is not good.

Although the private sector is creeping out of the recession (at least at the national level), in Arizona “it’s especially grim for the public sector,” says Vest.

That’s because, as we’ve been noting all year, the state has yet to hit bottom in plummeting tax collections. Meanwhile, the state keeps spending borrowing enough money to pay the bills because spending remains out of control.

Vest, who has been studying the Arizona economy since, well, forever, puts it in simple terms: The state is on track to spend roughly $10.1 billion, but it’s only collecting $6.4 billion in taxes. Even after you throw in stimulus funds and various other gimmicks, you still have a shortfall of $2 billion this year and $3 billion or more next year.

Here's his take:

After cutting budgets significantly during the past two years, the state of Arizona this year is spending roughly $10.1 billion, but revenues of only $6.4 billion will be collected. $1.1 billion of federal stimulus money, coupled with additional cuts, fund sweeps, and sales of state buildings reduces the current-year shortfall to about $2 billion. The gap will grow to $3 billion-plus next year, and a structural deficit of similar size looms for as far as the eye can see.

The budget gap cannot be closed through spending cuts alone. K-12 education spending totals roughly $4 billion, Medicaid and health $2 billion, community colleges and universities $1.3 billion, prisons $1 billion, $700 million for welfare, and $1 billion for everything else. Health-related spending is mandated either by the federal government or voters, K-12 is formula-driven and voter-mandated, and federal stimulus dollars for K-12 and higher education are subject to “maintenance of effort” clauses that limit further cuts without forfeiting federal dollars. The bottom line is, you could lay off every state employee and not begin to balance the budget. You could entirely eliminate funding for higher education and not come close. Ditto for welfare programs such as food stamps, TANF, the disabled, unemployment insurance, assisted living, and programs for children such as child abuse, child care, and foster care.

Given the current political environment, Vest tell us: “It looks to be unsolvable. You cannot balance the budget by cutting spending alone.”

At the same time, a tax increase looks unlikely, “given the rules that have been put in place over the last few years and given the ideological blocs that exist,” Vest says. “But we desperately need to augment revenues.”

He also has a message for anti-tax Republicans:

Before rejecting out-of-hand the idea of a tax increase on the grounds that it will hurt the economy, consider that the series of tax cuts enacted since the mid-1990s has carved an estimated $2.6 billion from annual collections (in today’s dollars). Had legislators not passed permanent tax cuts based on temporary increase in revenues, we wouldn’t be in such a mess today. Permanent cuts were favored rather than adequately funding the Budget Stabilization Fund, which was quickly drained. So what would be so bad about simply reversing the earlier-enacted tax cuts? (The lion’s share targeted the individual income tax).

Moreover, spending cuts hurt the economy just as much as tax increases. Some argue that spending cuts are even more damaging. Nobel prize winner in economics, Joseph Stiglitz, prescribes that the way to inflict the least damage on the economy is to raise income tax rates on the highest tax brackets. A significant portion of the extra revenue raised comes from

savings and therefore doesn’t directly affect consumption.

Voter mandated spending absent of funding, mismanagement of the tax base, ideological roadblocks, and the two-thirds “super-majority” required to raise taxes, have created a crisis environment that’s inflicting substantial long-term damage on public institutions and infrastructure. (The super-majority actually gives power to the minority! It only takes 11 senators to block a tax increase.)

No one knows how this catastrophe will play out. Neither legislative leaders nor the governor are subject to sanctions if they don’t produce a balanced budget. The state can (and is) borrowing to pay its obligations, and that will work as long as banks are willing to lend the state money. If a balanced budget is not produced, banks may cut off the state, leaving it to issue IOU’s (like California did a few years ago). Interest rates on state borrowing will surely rise. A shutdown of state government and bankruptcy are real possibilities. It will take years to recover from the damage that is being wreaked.

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