Getting the States Into Fighting Shape

As David Frum notes,  a lot of states face severe fiscal challenges for many years to come.  Many of the biggest budget items for states—Medicaid, bond payments, pension obligations to retirees—are virtually impossible to reduce. Big , broad-based tax increases, although difficult to avoid under many states’ balanced budget laws, will simply discourage investment and growth. Without indulging into liberal (“tax the evil corporations”), moderate (“run government like a business”), and conservative (“cut taxes to increase revenue”/”privatize all education”) fantasies, states looking to balance their budgets aren’t totally out of luck.  At least six steps—none of them easy but all of them within the realm of possibility—seem wise and likely to accomplish good social goals with a minimum of pain to citizens.

1. Eliminate special tax abatements and business “relocation/retention” grants.

In efforts to attract new enterprises, revitalize decrepit areas, boost politically favored types of business, nearly all states run massive corporate welfare programs including “enterprise zones,” “TIF (tax increment financing) districts,” “job retention tax credits,” state “HUB (historically underutilized business) zones.”  Although a few states simply give grants to private businesses, most of these programs involve issuing bonds, building infrastructure, or granting tax credits that benefit only a particular business or development. The practice produces headlines for politicians but largely serves to let political leaders decide on the location of development that would happen anyway.  These business subsidies tend to feed on themselves: cities like Chicago and Syracuse, New York have made such widespread use of them that almost all new development requires some sort of tax abatement or other assistance since unabated tax rates are so high as a result. Although it appears almost certain to cause some short-term pain, many states would almost certainly increase revenue while cutting base tax rates if they simply quit the abatement drug cold turkey. Certain areas, many of them in need of help, probably would lose out. But, in the end, the free market would make better decisions about business locations than central government planners ever could.

2. Cut operating aid to all but the poorest local school districts.

Most school districts in most states get a large majority of their budgets from local property taxes.  Although other funding mechanisms that rely on aid collected through income and other statewide taxes seem fairer and even better on paper since property tax revenues are very volatile and unevenly distributed, they haven’t worked in practice and tend to hurt good school districts while doing nothing to improve bad ones.  Over the years, however, the creation of state lotteries, statewide school infrastructure funds, special initiatives to reduce class sizes, and the like have caused the state aid to creep up even for very wealthy school districts.  For example, Fairfax County, Virginia, America’s wealthiest large jurisdiction (median household income tops $100,000), gets almost 20 percent of its schools budget from the state government. While truly poor school districts in inner cities simply couldn’t operate without state aid, well-off localities would still be able to spend above-average sums of money on education even if they didn’t receive a penny in assistance from the state.

3. Repeal mandatory minimum sentencing laws, reduce prison construction, and focus on community corrections.

As crime rates soared out of control between the 1950s and early 1990s, states desperate to do something about crime invested heavily in prison infrastructure and police while stiffening penalties on wrongdoers.  Mandatory minimum sentencing laws and the abolition of conventional parole (in favor of “time off for good behavior”) played a major role in driving this expansion. As a result, corrections’ percentage of state budgets doubled from about 2 percent on average in the 1970s to a little less than four percent today. Crime has fallen pretty consistently since the mid-1990s as a result. But in addition to being expensive, this program has negative social consequences: Roughly 2 million Americans are in prison today and most prisons do nothing to prevent them from returning to their same behavior as soon as they leave.  States like Michigan and Texas, however, have realized continued crime reductions and saved lots of money by restoring judges’ ability to set sentences and slowing the rate of prison construction.  This needs to be done with care: Simply “letting ‘em loose” probably does more harm than good. But when some of the savings from reduced prison spending goes to pay for more intense and rigorous parole and probation efforts, states can simultaneously save money and continue to be tough on crime.

4. Require significant private or local participation in all infrastructure projects outside of statewide capital plans. (And some within them.)

Nearly all states maintain separate capital budgets specifying investment plans for roads, schools, parks and other infrastructure.  These plans, produced through technocratic, rigorous evaluation of priorities, costs, demands and benefits typically provide decent roadmaps for state investments. But states that don’t simply allow legislators to rewrite them outright follow them only in the breach and instead fund whatever projects gather the most political support. This practice isn’t all bad since the technocrats who write the plans in the first place aren’t all-knowing, but when combined with the official capital plans, it results in haphazard, uncoordinated, badly planned roads, bridges, and train lines.  While many states might be best either dropping the capital budgets altogether or refusing to fund anything outside of them, neither option could ever garner enough support to become law. A middle ground, however, appears quite practical.  States could give the most significant funds only to projects that pass a rigorous series of cost/benefit tests (and then only when there’s actually money to pay for them) but encourage private sector and local entities to issue their own bonds, levy tolls, form special taxing districts, and otherwise find money to pay for desired projects that don’t pass every test or simply don’t have funding.  Actually enforcing this sort of infrastructure discipline would require constitutional amendments in many states, but it could improve infrastructure investments while saving money and seems difficult to argue with. Of course, the same practices could also save taxpayer money if implemented within the capital budgets as well.

5. Reform state employee pensions (particularly for “public safety” workers)

Even as private sector firms replace “defined benefit” pensions with “defined contribution” (401(k)-type) plans, most public entities continue to stick with traditional pensions. Out of social respect for the work they do and a need to compete with generous military pensions, furthermore, fire and police officers typically have gotten the most generous pensions and been able to retire at the earliest ages. The pension systems have grown out of control and now impose enormous fiscal risks on most states.

Although every state has slightly different pension problems, at least two steps seem in order if states want to fix their pension mess. First, states should simply find ways to scale back their obligations.  In many cases, switching to defined contribution pensions makes a lot of sense.  Basing pensions on average pay over the course of a career rather than that in the workers’ few top-earning years and limiting workers’ ability to “buy” larger pensions can also have good consequences. Second, states should limit the reach of public safety pensions. Over the years many groups outside of fire and police services (prison guards, security guards, and sanitation workers) have weaseled their way into the public  safety systems.  If they exist at all, states should limit generous public safety pensions to workers that actually spend most of their careers running into burning buildings or fighting crime.

6. Legalize stuff (No, not drugs)

States looking for easy revenue windfalls should look for things they can deregulate, legalize and, yes, tax. (Let’s put drugs aside:  despite some claims to the contrary, marijuana legalization seems unlikely to boost any industry besides pizza sales.) While everyone knows about Nevada’s gaming Mecca and Delaware’s corporate headquarters center, dozens of other states have found lucrative niches through deregulation. Vermont, for example, is a haven for “captive” insurers while South Dakota has an enormous credit card industry.  All of these deregulatory measures have enormous first-mover advantages: the states listed above are all places where forward-looking legislators passed the first law of its type and buttoned up a large part of an industry before other states could act.

A few ideas seem pretty obvious. A state that passed a law clearly legalizing and regulating Internet gambling (which currently exists in a gray area) would attract an overnight stampede of business and tax revenue. Likewise, a legislature that replaced absurd beauty school requirements for cosmetologists with short safety and hygiene courses would probably become the beauty equivalent of Hollywood overnight.  The very best ideas, however, are probably ones that nobody has thought of yet or involve industries like space travel that may take a very long time to grow. With enough creative thinking, however, states can begin to solve their fiscal ills.