Note to State Governments

Flush with tobacco settlement cash, going on eight years of a rapidly growing economy, and in many cases with newly elected Republican governors, many states slashed taxes around 2000. The crisis is probably worst in California (Democrat), but Texas (R) and New York (R) are not doing much better. Missouri has adopted an innovative new measure:

…the governor of Missouri has ordered every third light bulb unscrewed to save money

. And in Oklahoma,

teachers are doubling as janitors in Oklahoma.

And in Oregon,

[teachers are] working two weeks without pay.

And in Nebraska,

Nebraska has dismissed two of its three state diagnostic veterinarians.

These state deficits are in at least one way more problematic than the federal deficit: states cannot run budget deficits from year to year. This means that if they slash taxes when times are good (as opposed to saving), then when times are bad they have to cut back on spending or increase taxes, which exacerbates the crises.

Some might argue that the need to help the states is another argument against Bush’s tax cut, but it’s not so clear cut. As a general argument against irresponsible tax cuts (say, ones that turn surpluses into $300 billion plus deficits), the states serve as a cautionary example. But making the case that the federal government should bail out the states instead of cutting taxes is somewhat risky because it dramatically reduces voters’ incentives to demand fiscal responsibility from their state government. If a state expects billions of dollars in federal aid whenever they cut taxes too much, then it is in that state’s economic interest to slash taxes (benefiting its residents) and then await a federal bailout (paid for by all citizens). This incentive towards irresponsibility is particularly strong in the less populous states (which were, coincidentally?, mostly red in 2000). Consider Montana, population 902,195. If bailing out Montana cost the federal government $1 billion dollars, then Montanans would pay roughly 0.3% of that cost, with the other states paying the balance. When every state reasons along these lines, fiscal affairs can go badly pretty quickly (if this sounds like a Prisoner’s Dilemma, it is). Even Californians only have to bear roughly 12% of the cost of any federal bailout of California, so the incentive is the same, but less strong than for Montana.