When a Surplus is Really a Deficit

Jun 3, 2013Elizabeth Pearson

States are showing budget surpluses, but that doesn't mean that everything has been fixed post-recession.

News of surging income-tax revenues and surprise budget surpluses has brightened statehouses over the past few weeks, but it’s worth asking whether we should be thinking of these revised fiscal projections as surpluses at all. After all, current state surpluses are the product of deep cuts to higher education, delayed repair to basic infrastructure, and unfunded pension liabilities — in fact, these surpluses are better viewed as evidence of serious, structural budget deficits.

For one thing, welcome news from the states comes with the disclaimer that much of the revenue surge prompting headlines is due to one-time revenues caused by taxpayers with capital gains and other types of non-withheld income accelerating income into the 2012 tax year as they anticipated higher federal income-tax rates in 2013.

But the larger cause of current budget surpluses is the deep cuts state governments imposed during the recent recession. For instance, states are now spending 28 percent less per student on higher education compared to when the recession began in 2008. The recession also produced more dramatic losses in state government jobs than in any other downturn over the past fifty years. State-government spending cuts and job losses have dragged down the economy, slowing recovery and prolonging the jobs crisis.

States (with the exception of Vermont) have legal requirements to balance their budgets each fiscal year, and therefore do not have recourse to deficit spending. One reason recent cuts were so deep is that states relied disproportionately on spending cuts rather than revenue increases to balance their budgets during the recession — and because federal recovery aid to states expired in mid-2011 even as states struggled to cope with increased obligations due to the economic collapse.

As states cut to the bone to survive the recession, prolonged under-investment eventually produces misleading surpluses. Meanwhile, it is perversely harder to actually see the budget gaps that states grapple with each year. At the federal level, recessions produce annual deficits and increase the size of the federal debt, prompting political wrangling over sustainable solutions. As ideologically charged as these debates can be, they at least engage a visible target: no matter whether the federal books balance in any given year, we still confront the costs of past wars and economic downturns in arguments over the size of the public debt.

But, because states don’t have the option of deficit spending, budget gaps at the state level are effectively internalized through cutting services, laying off employees, and delaying improvements. Each year’s painful shortfalls are solved through cuts that swiftly and quietly become a “new normal.” With no mounting debt to remind us of these structural imbalances, past years’ debts seem to disappear — but in fact they are leaving lasting impacts on states’ abilities to underwrite economic growth in the long term.

Hollow as they are, today’s surpluses are being cited in states like Wisconsin to call for permanent tax cuts that will start the austerity cycle anew by generating future shortfalls that can then be “solved” by new cuts. Such efforts come on the heels of attempts in several states to abolish income taxes during the past legislative session — and fly in the face of the simple fact that, while state tax revenues now have three years of growth under their belt, they still have not surpassed their pre-recession levels. Advocating tax cuts when state revenue remains below pre-recession levels would be laughable if it were not so dangerous. This recession has impacted state tax collections far worse than in past recessions, and even if current revenue growth rates continue it could take years for revenues to catch up to pre-recession levels, adjusted for population growth and inflation.

More responsible discussion of revenue increases and “surpluses” has revolved around whether funds should be set aside in state rainy-day funds or used now to restore services. These are important conversations to pursue. But we must also consider a broader conversation about state budgets as a reflection of our public priorities. As states rebuild in the wake of the recession, which public investments will support economic growth and meet fundamental needs for safe infrastructure, quality education, and services for vulnerable citizens? Viewed in this light, today’s improving bottom line is a step in the right direction but still falls far short of both pre-recession goals and our broader common priorities. In other words, we are still faced with severe deficits.

Seizing on recent changes in state tax collection is the wrong place to focus these broader discussions. Instead, we need to be talking about revenue increases and much-need tax-system modernization like extending the sales tax to services and digital goods. Revenue increases have always been part of the state government toolkit when it comes to balancing budgets — Republican and Democratic policymakers alike recognized this fact as recently as the 1960s and 1970s when they repeatedly adopted major new taxes to invest in their states. Remembering this bipartisan legacy can be an important part of making the case for responsible tax reform at the state level.

When surpluses are the result of dramatic cuts to services and unprecedented job losses, they shouldn’t be considered surpluses at all. We can cheer the good news of growing state tax collections while pursuing broader measures of fiscal health, most notably a budget that balances with our priorities.

Elizabeth Pearson is a Roosevelt Institute | Pipeline Fellow and a PhD candidate at UC Berkeley.

 

Money in vise image via Shutterstock.com

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