The nation's governors are moaning and groaning these days about their tough budget situations, as if they were the innocent victims of uncontrolled fiscal crises. Yet looking at Department of Commerce data, total state and local spending hit a peak 13 percent of the nation's economy last year, the highest in decades. If the states are short of money, it is because they are spending far too much.
The governors are blaming everything but their own reckless spending increases of the late 1990s for their budget woes. At the Cato Institute, we've calculated that if the states had kept their budget growth to a reasonable level of inflation and population growth in the 1990s, spending would have been $93 billion less today and the states would not be in a crisis.
The states are raising taxes to avert what they claim are Draconian budget cuts. But if you look at the latest data from the National Governors' Association, you see that overall state budgets are basically frozen but not being cut. It's true that some states are trimming spending – but why shouldn't they after years of rapid increases? Why shouldn't states be cutting when businesses and households have had to cut back as wages and profits have stagnated? Americans have less money for their own needs, let alone having extra to hand over to even bigger governments.
California is a great example of the 1990s state government boom and bust. California spending started to accelerate in 1996. General fund spending hit $67 billion in fiscal 2000, and then it leaped $11 billion to $78 billion in 2001. Now, two years in a row California has had to cut, but only by $2 billion. So the California budget is still far above the level it was as recently as 2001.
California is also a great lesson for why states should move away from volatile capital gains and corporate profits taxes. The California government boom of the late 1990s was fueled by $18 billion of capital gains and stock option tax revenue at its peak in 2001. That revenue has now plummeted to just $5 billion with the high-tech bust. To avoid the boom-bust cycle in the future, states should shift to more stable taxes, particularly sales taxes, to avoid fueling another overspending boom.
Also, states are in a different situation than local governments. Cities and counties are benefiting from a gusher of property tax revenue in recent years as property assessments keep rising across the country. The latest Department of Commerce data show that property tax revenues are up 5.5 percent in the first quarter this year over a year ago. So one place that state governments should cut to balance their budgets is their transfers to flush local budgets.
Unfortunately, we are looking at $17.5 billion in state tax hikes this year, even bigger than the previous record set in 1992, according to the NGA. But more than ever states are shooting themselves in the foot with tax hikes. Higher taxes have serious negative consequences. Entrepreneurs, skilled workers and businesses are more mobile than ever and will gravitate over time to low-tax states. Governments won't get the revenue they think they will get, and state growth and incomes will be reduced.
Not only that, but tax hikes on even the most demonized product, tobacco, have serious negative effects. Cigarette consumers have been the favorite target for state governments recently, but state government greed fuels higher cigarette smuggling and strengthens organized crime.
State governments should be treating the current slowdown as an opportunity to weed out the excesses and wasteful spending that were added in the 1990s. They should be looking for unneeded programs to terminate or privatize, and to provide the lean and efficient state governments that American taxpayers deserve.