May 09, 2006
Getting off the Roller Coaster
Can government introduce more stability to state finances?
Government budgets are inevitably tied to economic growth. When times are good, revenues rise and governments hear competing calls — for cutting taxes, increasing spending and creating reserves. When times are bad, governments face cutting services and raising taxes or fees.
According to the Center on Budget and Policy Priorities (CBPP), states later regret it when they cut taxes and draw down reserves. CBPP found that in 1999, eight of the 48 contiguous states had adequate reserves to maintain services in a recession without increasing taxes. A year later, five of the eight, including Minnesota, enacted tax cuts that erased the margin of safety.
When the economy began to weaken a year later, the “big tax-cutting states generally faced larger fiscal problems, and had worse economic performance, than other states that had been more cautious about tax cuts.”
We cannot repeal the business cycle, but we can get off the roller coaster that often accompanies it.
Further Reading:
Tax Cuts and Consequences: The States That Cut Taxes the Most During the 1990s Have Suffered Lately
Georgia’s Revenue Shortfall Reserve
What do you think?
1. How might the state better protect reserves or “rainy day funds” created during times of revenue growth?
2. What is the best use for limited “surplus” funds — making future investments in areas such as education and infrastructure, or maintaining reserves against future shortfalls?
Comments:
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1. Non-profits develop reserve funds that enable them to weather cycles in funding or operational cash flow. The funds may be drawn upon, but are also expected to be replenished within a given period. This practice provides a measure of security during down times, but also enforces long-term fiscal discipline.
Families do the same thing (at least, well-run families do), keeping a cash reserve for emergencies. But non-profits and families tend to have more consistent leadership and values that encourage the practice of good financial stewardship. Government suffers under successive political regimes that may see a previous administration's prudence as unjustly holding on to money the taxpayer could be spending.
I'd support creation of a reserve fund set as a percentage of the state budget, to be used to balance annual budgets or cover for temporary funding shortfalls. But any money disbursed from the fund must be repaid within a year or two. It could not be used to cover for tax cuts or to allow shifting of costs that could otherwise be funded.
How to set up such a fund that couldn't be raided or run to empty by politicians who object to government spending is the real problem, though, and for that I don't have an answer.
Families do the same thing (at least, well-run families do), keeping a cash reserve for emergencies. But non-profits and families tend to have more consistent leadership and values that encourage the practice of good financial stewardship. Government suffers under successive political regimes that may see a previous administration's prudence as unjustly holding on to money the taxpayer could be spending.
I'd support creation of a reserve fund set as a percentage of the state budget, to be used to balance annual budgets or cover for temporary funding shortfalls. But any money disbursed from the fund must be repaid within a year or two. It could not be used to cover for tax cuts or to allow shifting of costs that could otherwise be funded.
How to set up such a fund that couldn't be raided or run to empty by politicians who object to government spending is the real problem, though, and for that I don't have an answer.
Moderator is re-posting this comment for Kent Ficarra. A previous post on 6/28 went astray when I sent it....
I just read your comment so this is off the top of my head. What about passing a law which links the state reserve fund to the Federal Governments Index of Leading Economic Indicators (LEI's). When the indicators predict an economic downturn, the state would start spending from the reserve. When the indicators predicted a rebound,
the state would start restoring the fund to its statutorily required level. The size of the fund would be revised each year to take into account inflation, population and economic growth and any other factors that experts would determine are relevant. In theory this would prevent politicians from raiding or otherwise misusing the fund since there would be no discretion regarding when to withdraw and return money to the fund. Everything would have to be done according to a predetermined formula.
I would like to know what you think of this idea. If no good as presented do you think it could be massaged into something valid?
I am a firm believer in Keynesian theory so we are on the same page of the hymnbook. I once heard an interview with Milton Friedman in which he said that "Keynes was a socialist". I guess that means we are both socialists. Don't worry I wont tell anyone.
Sincerely,
Kent T. Ficarra
I just read your comment so this is off the top of my head. What about passing a law which links the state reserve fund to the Federal Governments Index of Leading Economic Indicators (LEI's). When the indicators predict an economic downturn, the state would start spending from the reserve. When the indicators predicted a rebound,
the state would start restoring the fund to its statutorily required level. The size of the fund would be revised each year to take into account inflation, population and economic growth and any other factors that experts would determine are relevant. In theory this would prevent politicians from raiding or otherwise misusing the fund since there would be no discretion regarding when to withdraw and return money to the fund. Everything would have to be done according to a predetermined formula.
I would like to know what you think of this idea. If no good as presented do you think it could be massaged into something valid?
I am a firm believer in Keynesian theory so we are on the same page of the hymnbook. I once heard an interview with Milton Friedman in which he said that "Keynes was a socialist". I guess that means we are both socialists. Don't worry I wont tell anyone.
Sincerely,
Kent T. Ficarra
Kent Ficarra has an interesting idea. I don’t know whether the LEIs are accurate enough predictors for this to work, but in any case, I think that a formula that eliminates (or at least minimizes ) discretion is an excellent idea.
The way we were thinking about it was after the fact rather than predictively: in other words, any year in which tax revenues grow by more than population and inflation growth, some money should be added to reserves, and any year in which revenues trail population plus inflation growth is a year when reserves can be drawn down.
Joel Kramer
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The way we were thinking about it was after the fact rather than predictively: in other words, any year in which tax revenues grow by more than population and inflation growth, some money should be added to reserves, and any year in which revenues trail population plus inflation growth is a year when reserves can be drawn down.
Joel Kramer
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