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Challenging Challenges

Last month, Bob McDonnell won a landslide victory in his bid for the Virginia governor’s mansion. But by sometime early next year, he may well begin to wish things had turned out differently. The reason? He is inheriting what is probably the worst budget crisisin living memory. In January, the General Assembly will take up consideration of Virginia’s 2010-12 biennial budget. According to current guesstimates, balancing that budget will requireclosing a $3.5 billion gap between expenditures and revenues.

 

How did this happen? Between September 2008 and September 2009, Virginia’s economy contracted by 114,900 jobs, and ourstatewide unemployment rate went from 4.1 percent to 6.3 percent (peaking along the way at 7.3 percent in June 2009). Thatprecipitous economic declinehad areciprocal impact on state tax revenue. In September 2009, sales tax collections were down 6.6 percent from the year before, personal income tax 6.8 percent and corporate income tax 10.6 percent.

 

 

Although many economists, such as Richmond Federal Reserve President Jeffrey Lacker, have recently concluded that modest improvements in housing, construction and consumer spending indicate that the economy has started to improve, it is important to realize that employment, and therefore state tax revenue, traditionally lag behind other economic indicators. As a result, the worst of our fiscal challenges still lay before us.

 

 

Addressing those challenges will not be easy. The main reason for that is all of the “easy” fixes have already been made.In respondingto the most recent $1.5 billion deficit in the state’s 2008-10 biennial budget, Governor Kaine relied heavily on federal stimulus funds and other one-time funding sources (e.g., expending almost half of the raining day fund and delaying state contributions to the Virginia Retirement System). With the easy fixes exhausted, only the more difficult ones remain (e.g., the ones that involve not only goring someone’s ox, but barbecuing it as well).

 

 

But, as we look farther out we may well benefit from the fact that necessity is, or at least can be, the mother of invention. Among the policies that Virginia could pursue to better prepare for the inevitable next economic downturn, I humbly suggest the following:

·Accept that Keynes is dead. It is an inside joke among economists that President Nixon’s announcement that, “we are all Keynesians now,” corresponded perfectly with the general debunking of Keynesian economicsin the academic literature. The main reason that the $787 billion “stimulus” bill has not been very stimulating is that it has largely been used as a slush fund to protect government jobs. Those jobs were on the chopping block because tax revenues from the private sector declined as the economy declined.  Siphoning off future tax dollars from the private sector to protect government jobs does almost nothing to generate private sector jobs, and therefore almost nothing to solve the underlying problem.

·Bust the ratchet.Politicians are rewarded for handing out goodies, not withholding them. As a result, there is always an accretion of new government programs in every expansion that we have no way to pay for when the economy goes south. The options for fixing that problem range from the simplistic – like Colorado’s TABOR legislation thatconstrains growth in government spending to growth in population and inflation – to the sophisticated – like Virginia’s own Performance Budgeting Project which provides tools that policy makers (and Joe Citizen) can use to evaluate precisely what specific government programs accomplish and at precisely what cost.

·Realize that public goods don’t have to be publicly produced.Virginia was an early leader in the privatization of certain government functions (e.g., interstate highway maintenance) and is one of only three states that maintain a central body to manage government efficiency initiatives (i.e., the Commonwealth Competition Council). Privatization has a proven track record at reducing government costs and other states are starting to catch on. In 2009 alone, Arizona, California, Illinois, Louisiana and New York either proposed or enacted major privatization initiatives.

·Don’t be afraid to ask questions.The General Fund (tax funded) portion of Virginia’s annual budget increased from $12.3 billion in FY 2001 to $16.2 billion in FY 2009. The bulk of that $3.9 billion increase (approximately four-fifths) occurred in twoareas – Medicaid and K-12 education.Where growth in the Medicaid budget is largely a function of ever expanding federal mandates (including $34 billion in unfunded mandates in the currently proposed health care reform legislation), growth in the K-12 budget is largely a function of the state’s Standards of Quality (SOQ) funding formula. The SOQs have been described in some quarters as a “black box.” And given that an 8.0 percent increase in K-12 enrollment between FY 2001 and FY 2009 was somehow sufficient to drive a 42.2 percent increase in the state’s K-12 budget, it may be time to take a look inside that black box.

 

Reprinted with permission from Richmond BizSense

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