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States Face Fiscal Crunch after 1990s Spending Surge
by Chris Edwards, Stephen Moore, and Phil Kerpen
Chris Edwards is director of fiscal policy studies at the Cato Institute. Stephen Moore is a senior fellow at the Cato Instituteand president of the Club for Growth. Phil Kerpen is a policy analyst at the Club for Growth.
No. 80
Across the nation, large budget gaps are forc-ing state governments to make tough policychoices. While some states are trying to controlspending, others are turning to tax increases tobalance their budgets. Some state officials aretrying to pass the buck for their poor fiscal man-agement by pleading for a bailout fromWashington. But a bailout would encouragestates to continue overspending, which is thesource of the current fiscal mess.The states’ mistake was to allow rapid tax rev-enue growth during the 1990s to fuel an unsus-tainable expansion in spending. Between fiscalyears 1990 and 2001, state tax revenue grew 86percent—more than the 55 percent of inflationplus population growth. If states had limitedspending growth to that benchmark, budgetswould have been $93 billion smaller by FY01—representing savings roughly twice the size of today’s state budget gaps. If revenue growthhigher than the benchmark had been given back to taxpayers in permanent tax cuts and annualrebates, rebates could have been temporarilysuspended during FY02 and FY03 to provide acushion with which to balance state budgets.Current budget gaps provide policymakersan opportunity to weed out the budget excessesbuilt up during the past decade. Yet overall statespending continues to grow. After soaring 8.0percent in FY01, state general fund spendinghas not been cut in FY02 or FY03 even as largebudget gaps have appeared.States should impose tax and spending growthcaps to prevent budgets from growing too quicklyduring the next boom. Revenue growth above abenchmark would be given back in tax cuts and taxrebates. That would prevent spending from increas-ing too quickly and provide the option of suspend-ing rebates during slowdowns to close budget gapswithout the damage caused by tax rate increases.
February 12, 2003
 
Introduction
State policymakers are looking for ways toclose large budget gaps during their 2003 leg-islative sessions. Budget gap estimates arechanging all the time but have recentlyranged from about $17 billion to $50 billionfor the 50 states as a whole.
1
Unlike the fed-eral government, states have legal require-ments to balance their budgets. Thus, legisla-tors face tough fiscal tradeoffs.Some state lawmakers are pushing for fur-ther tax increases on the heels of an aggregatestate tax increase of more than $8 billion infiscal year 2002 (effective for FY03), whichwas the largest net increase in a decade.
2
Buttax hikes will not solve the overspendingproblem that prevailed in the states duringthe past decade. Groups such as the NationalGovernors Association and the NationalConference of State Legislatures have misdi-agnosed the cause of the states’ current trou-bles and pointed fingers everywhere but atstate lawmakers themselves. Those groupssay that the tidal wave of red ink is caused byexternal factors, such as federal mandatesand supposed “structural problems.” NGAexecutive director Raymond Scheppachargues that “structural problems states havein their tax base will continue to underminea recovery in state revenues.”
3
Some pundits are blaming the tax cuts of the 1990s for current state budget troubles.
4
Data from the National Association of StateBudget Officers show that net state tax cuts inthe late 1990s (FY95 to FY01) totaled $33 bil-lion.
5
But those cuts were not enough toreturn to taxpayers the $36 billion in net statetax increases that occurred during the early1990s (FY90 to FY94). With 2002’s $8 billionin state tax increases, and increases in FY03,taxpayers will be even further in the hole.State officials are blaming the federal gov-ernment for their budget woes and calling forgreater federal aid to the states.
6
The nation’sDemocratic governors are asking for a $50billion federal bailout.
7
The Bush adminis-tration has offered the states $3.6 billion.
8
But the federal government has its own $200billion or more deficit problem, and, of course, the taxpayers who pay the federal billsare the same ones who live in the 50 statesand pay state taxes.Nonetheless, there is a drumbeat for a fed-eral taxpayer bailout. Bob Herbert of the
 NewYork Times
has called for a revenue-sharingplan between the federal government and thestates, which would mean that citizens of fis-cally responsible states would have to sup-port the mismanaged budgets of states suchas California.
9
The
Washington Post 
’s DavidBroder has also called for increased federalaid to states, claiming that “the problem isnot that states are profligate spenders.”
10
In fact, rapid state spending growth isexactly the problem, as shown in Figure 1.While inflation averaged just 2.8 percentannually from FY90 to FY01, state generalfund spending grew at an average rate of 5.7percent, according to NASBO. Total stategeneral fund spending grew particularlyrapidly at the end of the 1990s, with growthof 7.0 percent in FY99, 6.6 percent in FY2000,and 8.0 percent in FY01.
11
Even as economicgrowth slowed and budget gaps appeared,state spending still increased 1.1 percent inFY02, and it is expected to increase further inFY03.
12
Despite the word “crisis” beingthrown around by state officials, Figure 1does not suggest a crisis in state spending atall; it simply suggests a slowdown from priorrapid growth rates.This paper reviews state budget growthduring the 1990s, provides a state-by-statecalculation of excess budget growth, andexamines the inverse relationship betweentaxes and economic growth. The authorsconclude that states should turn currentbudget problems into opportunities to weedout the excessive spending that was addedduring the boom years of the 1990s.Spending cuts would allow states to avoid taxincreases that would delay economic recov-ery. In the longer term, states should enactcaps on budget growth to avoid repeating theexcesses of the 1990s during the next eco-nomic growth cycle.
2
State generalfund spendinggrew 7.0 percentin FY99, 6.6 per-cent in FY2000,and 8.0 percent inFY01.
 
Revenue “Shortfalls” orSpending Excesses?
Few governors or state legislators seem tohave learned the lessons from the economicrecession a decade ago. In the boom of the1980s, the states added many costly new pro-grams, and when the economy went intorecession in the early 1990s states foundthemselves in financial trouble.
13
Then-gov-ernor Mario Cuomo of New York declared,“We’re broke to the marrow of the bone.”
14
Today, governors are using similar hyperboleas state revenues stagnate and politicaldemands to meet new spending commit-ments rise.State government officials proclaimthemselves innocent victims of revenue“shortfalls.” But are states suffering from rev-enue shortfalls or spending excesses?Consider that the budget gaps being report-ed are partly fictions created by prior budgetforecasts that were far too optimistic—sort of like sales growth forecasts for telecom com-panies in the 1990s. Suppose that a fictitiousGovernor Spendthrift had planned for a 6percent rise in her state budget, but GovernorFrugal planned for an increase of 3 percent.Then suppose that actual revenue growth inboth states turned out to be 3 percent. Thatwould be no problem for Frugal. ButSpendthrift would describe her situation as a3 percent “shortfall.” Yet Spendthrift’s actualproblem is a “spending excess” caused by anoverly optimistic budget plan.Another variation on the shortfall themeis the supposed identification of “structuralshortfalls.” Several states have used thisbogeyman as an excuse to push for broad-based tax increases. It is said, for example,that Internet sales are eating away at statesales tax bases. Yet U.S. Department of Commerce data show that Internet sales arestill only about 1 percent of all U.S. retailsales, thus hardly posing a current threat.
15
Supposed structural shortfalls are
3
Are states suffer-ing from revenueshortfalls orspendingexcesses?
274.7302.4312.0331.4352.3371.2388.4410.4439.1468.2505.6511.1518.0289.1
$150$200$250$300$350$400$450$500$550
90 91 92 93 94 95 96 97 98 99 00 01 02 03
Figure 1General Fund Spending in the 50 States, FY90–03
Source: NASBO, “Fiscal Survey of the States,” November 2002 and prior issues. FY02 and FY03 are preliminary.
   $   B   i   l   l   i  o  n  s
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