Saturday, November 08, 2008

Need for fiscal reform at the state and local level

The current economic episode is highlighting the urgent need for reform of the fiscal management of state and local governments. In theory, "the government", which includes state and local governments, should lend a hand and help out when the economy struggles and goes into recession. Unfortunately, we are seeing that not only are state and local governments not helping, but they are in fact making the problem MUCH worse by cutting spending, services, and jobs. They are in fact doing the exact OPPOSITE of what they should be doing. Somehow, state and local governments picked up on Wall Street's "disease" and revamped their fiscal policies to exploit and leverage for "boom" times and to be completely unprepared and in fact wrong-footed for "lean" times. Now, state and local governments want (and do need) the Federal government to "bail" them out. Sure, the Federal government should in fact lend a hand and bail them out, but only after extracting promises to reform the fiscal policies of state and local governments that led to the need for a bailout.

What is needed is a credit facility that would issue debt secured by the U.S. Treasury and loan money to any state or local government that requests it. That federal guarantee would make the debt as good as "normal" Treasury debt, so it should trade easily in the debt market. The interest rate for the loans should be at least 5% to assure that the Federal government will earn a profit and that the state and local governments feel at least a little pain for their fiscal misbehavior and encourage the loans to be paid off ASAP.

The reform that is needed should have two components: 1) state and local governments must agree to be net savers in boom times, so that they can self-fund from their own deep reserves in lean times, and 2) state or local constitutional balanced-budget requirements need to be set aside in "extraordinary times" such as recessions when tax receipts fall sharply enough that even savings from boom times are insufficient to cover the shortfall.

There is simply no good excuse for the current situation where the response to economic weakness and a temporary shortfall of tax receipts is a significant cut in spending, services, and jobs. It is precisely in times such as these that state and local government spending, services, and jobs are most needed and should in fact be expanded rather than contracted.

Although I encourage balanced budgets, I would be cautious about increasing taxes. If taxes need to be increased, do it in boom times to raise reserves for lean times. But raising taxes in lean times is a particularly wrong-headed approach, probably driven by balanced-budget restrictions, and will simply lead to making the problem (economic  weakness) worse by taking even more money out of the pockets of consumers and businesses.

-- Jack Krupansky


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