By Request: State Budgets
Sam Penrose asks:
Why do states have to balance their budgets every year?
One answer is “it’s not a very good idea.”
Another answer is that there’s no real reason and, in fact, they don’t really “have to” do it at all. As this primer from the National Conference of State Legislatures makes clear the nature of the balanced budget requirement varies from state-to-state in a number of respects, up to and including the fact that Vermont has no such legal requirement.
The practical issue is that no state has the capacity to issue the sort of routine, revolving debt instruments that are used to finance the federal deficit. I don’t think there’s anything actually stopping a state from trying to change its laws and build this capacity. I do suspect that if a state did try to move toward funding a structural deficit that people in other states might start to worry about what the broader consequences would be of Louisiana or Michigan defaulting on its debt and perhaps you’d see some kind of move to formalize the tradition of state balanced budgets.
But better than balanced budgets would, I think, be some kind of federal requirement for rainy day funds. States would, ideally, be made to sock away an amount of money equal to such-and-such a percentage of annual state expenditures. The funds would be “deposited” in some kind of federal account and then “released” by some kind of fiscal policy board that would also, obviously, have the authority to suspend the contribution requirement. I suppose there might be constitutional issues with this, though it’s not obvious to me that that’s the case.
39 Responses to “By Request: State Budgets”
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December 24th, 2008 at 3:06 pm
Have you listened to Patterson babbling about “the need to balance our budget, put our house in order” lately? He makes Hoover look like a genius.
December 24th, 2008 at 3:11 pm
I think one reason for balanced budget requirements is that no one really trusts the state legislature to be responsible about running surpluses during booms in order to fund deficits during contractions. Any individual politician would rather run deficits all the time, unless he/she expects to be in office for a long time and to be held accountable when things go badly. Matt’s suggestion would be one way to get around this.
December 24th, 2008 at 3:15 pm
Indeed, it is hard to justify the balanced budget requirement. I don’t think that the state of Massachusetts (for example) is less credit-worthy than Italy or Belgium.
December 24th, 2008 at 3:25 pm
I suppose there might be constitutional issues with this, though it’s not obvious to me that that’s the case.
Well, since we have a federal government of limited and enumerated powers (ha!), perhaps you can point out where in the Constitution the federal government would get the authorization to do this.
December 24th, 2008 at 3:35 pm
Except that ‘issuing short-term debt instruments’ really means ‘printing money’. Are you ready for a flood of cashable short-term bonds, signed by the Treasurer of the great state of Louisiana? Or, perhaps, pursuant to the Authority of the County of Orange?
December 24th, 2008 at 3:49 pm
MattF – what’s the issue here? Plenty of local governments issue bonds. I guess most of those are longer-term, but what difference does that make?
December 24th, 2008 at 3:56 pm
As minderbender points out, state and local governments can already go into debt by issuing bonds. I really don’t think they need the ability to go further into debt. As screwed up as the state of California is, imagine how bad it would be if they didn’t have to at least pretend to balance the budget every year. We’d have a state debt in the hundreds of billions of dollars.
December 24th, 2008 at 4:05 pm
The question is how to finance a budget deficit. The Feds do it by printing money, or, more euphemistically, by ‘injecting’ capital into the banking system– I’m supposing that states would circulate debt instruments that would have the same function.
December 24th, 2008 at 4:16 pm
Constitutional issues be damned! The same thing would happen to these revenues as has happened to the Social Security surplus — it would be spent on tax cuts and general federal operations and would not be available when needed.
December 24th, 2008 at 4:19 pm
Most states have reserve funds:
http://www.ncsl.org/programs/fiscal/rdfaxa.htm
December 24th, 2008 at 4:21 pm
The right answer is that *no* state balances its budget, by the standard the Federal government uses. States divide their budget into operating and capital budgets. Sensibly, they borrow to fund capital expenses but not operating expenses. The Federal government doesn’t split up its budget this way, it just lumps capital and operating expenses together. So to claim the the Federal government doesn’t have to balance the budget, but state governments do, amounts to comparing apples to oranges.
By the way, Matt’s link makes this point quite clear.
December 24th, 2008 at 4:32 pm
Another post that you pulled straight out of your gilded Harvard ass, Matt.
States issue debt instruments all the time.
December 24th, 2008 at 4:43 pm
As people have pointed out, states do issue long-term debt, but in general US states don’t issue debt beyond about 20% of GDP. The reason appears to be a series of state defaults in the 19th century and the legal precedents they set, in particular for how state sovereign immunity affects how one gets states to pay the debt they issue. For this reason state credit deteriorates rapidly once state debt levels go up and states don’t try to borrow more than 20% of their GDP.
December 24th, 2008 at 4:43 pm
Capital markets trust the Federal government’s capacity to continue to service a huge number of bonds, if only by doing more borrowing. To a degree that’s a self-fulfilling thing –capital markets trust the Federal government, hence the Federal government can borrow to pay off the capital markets. The difference with California is instructive — Cali is well over 10 percent of the national economy, and no one will buy their state bonds now. (It’s also because there are no real legal limits on Federal budgetary borrowing, which there are in the states). But basically, just as Jefferson predicted during the national bank debate, nationalizing the debt sucked fiscal capacity away from the states.
The difference between state and Federal fiscal capacities is very real. California is in the most severe debt crisis of their history right now, but their projected deficit as a percent of gross state product is a bit over 1.5%. Over the 33 years since 1975, I think the Federal deficit as a percent of GDP has only been lower than that over for the 1996-2000 period. It was higher over the whole period 1973-94, and also pretty much every year from 2001 on (except maybe 2006 it might have been as low as 1.5% of GDP, not sure).
Matt’s suggestion could be done as a voluntary insurance fund, there are lots of policy proposals for that around. But I sometimes wish that the situation would be handled by genuinely redistributing fiscal capacity somewhat. Right now, there are too few fiscal restraints on the Federal government and probably too many on the states.
December 24th, 2008 at 5:00 pm
Yeah, not your finest post. First, states issue debt all the time. Second, most states already have rainy day funds which are raided all the time in non-emergency times.
But let’s get to the real point: governments have no obligation to balance their budgets (and they don’t) because at the end of the day they can just issue debt and rely on the promise that they will tax in order to pay for those debts.
December 24th, 2008 at 5:02 pm
As far as the idea of a required rainy day fund, wouldn’t that require a constitutional ammendment?
I know the kool kidz believe any respect for state sovereignty in the face of what seem to be manifest federal public needs is hopelessly outre, that the Feds can do whatever they want with regard to this and to that public problem simply by raison d’etat, the states be damned, but we remain a constitutional order (despite the last eight years).
If Matt’s off-the-top-of-his-head idea about rainy day funds is to come off (which it shouldn’t), the Constitution would need to change.
Or am I being too much of a strict constructionist here?
December 24th, 2008 at 5:06 pm
One related issue is ‘why doesn’t a state or the federal government just borrow lots of money, spend it on good stuff and then default?’ It turns out that the answer seems to be that blowing up the society’s financial system is a big deterrent to default by large borrowers like the federal government, but not to default by small borrowers, like (most)states. If Vermont could borrow 200% of its state GDP to build infrastructure and then default without bringing down the US financial system, it would be the right thing for Vermont to do. Hence people don’t lend Vermont that sort of money.
December 24th, 2008 at 5:23 pm
If Vermont did that, no one would ever lend to Vermont again.
I agree on the violation of state sovereignty involved in directly mandating state budgets, although no one in DC gives a shit about that. The way to do a “required” rainy day fund would be to have a Federal match on an insurance fund that states could pay into.
December 24th, 2008 at 5:52 pm
Which would still make defaulting on debt of 200% of its GDP a very good deal for Vermont.
December 24th, 2008 at 7:40 pm
But better than balanced budgets would, I think, be some kind of federal requirement for rainy day funds…
My idea: a national VAT (in conjunction with progressive tax code reform) with a fixed formula allowing for federal-state revenue sharing. When times are bad, Washington would make up the difference of what the state would be getting in a non-recessionary environment. You could obviously institute revenue sharing via other means, but this would provide for “rational,” predictable numbers basis — and that would enhance the ability of states to forecast and plan.
December 24th, 2008 at 7:41 pm
Which would still make defaulting on debt of 200% of its GDP a very good deal for Vermont.
How do you figure that? Forever is a mighty long time.
December 24th, 2008 at 8:02 pm
What the fuck, Matt? States and municipalities issue bonds all the time.
December 24th, 2008 at 9:02 pm
What the fuck, Matt? States and municipalities issue bonds all the time.
qjk: Nearly all the states have laws or constitutaional amendments requiring a balanced budget, so Matt is indeed correct. I’m not 100% certain how this squares with your point about bond issuance, but it probably has something to do with a differing classification for capital projects. Or else, they can issue debt, but not net debt (ie., they can issue paper short term to smooth out cash flow, but the books have to be balanced at the end of the year).
December 24th, 2008 at 9:07 pm
“I’m not 100% certain how this squares with your point about bond issuance, but it probably has something to do with a differing classification for capital projects. Or else, they can issue debt, but not net debt”
It’s the first. The state-level balanced budget requirements apply to operating budgets, not capital budgets.
December 24th, 2008 at 10:16 pm
Why do national governments care less about not balancing their budgets? Well, simply put, they can print their own money. Now, granted, the whole sale printing of money is a bad idea for inflationary reasons – which is why having an autonomous Fed is key for a stable economy.
Sadly, individual states don’t have this option. If they are struggling with debt load, they can’t just print up more money to pay off that debt. That means, if they want to secure their bond ratings, and access to affordable capital, they really have to be more fiscally disciplined.
December 25th, 2008 at 1:17 am
Because Uncle Sam has (and states do not)the Seigniorage power, which it kindly outsources to federal reserve banks.
“Seigniorage…is the net revenue derived from the issuing of currency.”
http://en.wikipedia.org/wiki/Seigniorage
“It has been called “the most astounding piece of sleight of hand ever invented.” The creation of money has been privatized, usurped from Congress by a private banking cartel… Federal Reserve Notes (dollar bills) are issued by the Federal Reserve, a private banking corporation, and lent to the government. Moreover, Federal Reserve Notes and coins together compose less than 3 percent of the money supply. The other 97 percent is created by commercial banks as loans.”
http://www.webofdebt.com/articles/dollar-deception.php
December 25th, 2008 at 7:36 pm
Thanks for the answer Matt and the discussion everyone — very informative.
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