Opinionated @ CFE

Balanced Budget Pitfalls

May
20

Since long before I was on this earth, politicos of all stripes have frequently talked about balanced budgets, both at the state and federal levels. Many states have adopted laws or even constitutional amendments to ensure that, unlike the feds, expenditures do not exceed revenues. In many cases, these help keep states from going gorging on debt spending. There are, however, a number of pitfalls lurking just around the corner that can thwart the intention of such laws and even serve as an impediment to sound government finances.

Let us consider what a responsibly budgeted household looks like. Ideally, we would be spending less than we make, especially during the good times. We often hear the advice to save up a full year’s worth of expenses just in case and to save up for large purchases rather than use credit. I’ve also heard the sound advice to never buy anything on credit if the debt will outlast the purchase. When the lean years come, there’s no debt to pay off and plenty of savings to help us get through it. Now compare this to how the state of Utah does its budgeting. In good years, the state will finance lots of programs and tax cuts. In lean years, budgets are slashed and taxes rarely go back up. Why all of the volatility? There’s two reasons behind this.

The first is that the state, by law, can only establish a reserve fund equal to 6% of general fund and education fund expenditures. If the state were a family earning $50,000 per year, that would equate to putting away a scant $3,000, less than a month’s worth. Because the reserve is so small and dips in a single year will often entirely exceed this amount, it doesn’t do much to smooth over rough patches in the economy. We instead get a roller coaster budget and lots of fiscal uncertainty.

The second problem is that state and local governments, instead of saving up for large planned construction projects, will issue bonds for the projects. Over the lifetime of the bonds, this can double or triple the actual cost of what was originally being paid for. So why do it? Because it kicks the can for increased taxes down the road. Saving up for these projects requires a higher tax rate now even though it costs a lot less down the road. Combined with various restrictions on government expenditures from the state level and a general distrust at any temporary taxes going back down (which is often well-founded), we end up acting in an irrational and emotional manner that’s quite expensive.

Another proposal I’ve seen on the table is to restrict budget growth to the rate of inflation and population growth. This sounds like a good idea, but there’s still a lot of problems with it. Transportation, for instance, would take a huge hit under such a model. Vehicle miles driven outpace the rate of population growth significantly and nobody has the guts to raise the gas tax, which has stayed flat for 14 years, to compensate for it. Eduction also poses a challenge as we get an increasing influx of students for whom English is a second language. These students are often much more expensive to education and, again, it has no bearing on either inflation or population growth. These are just two examples of how these restrictions don’t line up with realities.

In the end, I don’t think any law on how budgets are made is likely to enforce the same kind of fiscal discipline we expect from individual households. If anything, they are likely to make us worse off, especially as creative politicians figure out how to game them. Do you want fiscal responsibility? Then let’s start changing our “business as usual” ways.

2 Responses to Balanced Budget Pitfalls

  1. Ronald D. Hunt

    I have kinda figured that the biggest problem with taxation is the politicisation of the taxation. I almost think that the only true way to have a balanced budget that actually works is to infact remove the rate setting authority from the legislature(both state and federal) and have it adjusted yearly based on spending needs.

    Changes in the rate could be weighted over a 3-5 year period to make changes occur gradually.

    Along with a larger reserve fund as you mention above and perhaps things would work better.

  2. You obviously haven’t done your homework on this.

    First, a small point. The education reserve fund can be funded up to 7% of education fund appropriations, not 6%. See page 107 of http://finance.utah.gov/reporting/documents/10UTCAFR_000.pdf

    Second and more importantly, the state also has an unofficial second rainy day fund when it uses ongoing cash instead of bonding for capital projects. During good times (like FY 2007), Utah does a lot of this. In addition to preventing this cash from being used for ongoing operations (like salaries), this method allows the state to dip into this stream when revenues decrease. When revenues decrease, the state then takes the cash from roads and buildings and uses it to balance the operations side of the budget. To make up for the cash shortfall on the capital side, the state either bonds or delays the capital projects.

    The following comes from page 6 of http://www.governor.utah.gov/budget/Budget/Budget%20Summaries/2008BudgetSummary.pdf

    Infrastructure funded with cash in FY2007
    Higher education buildings $72 million
    Other buildings $118 million
    Capital improvements $73 million
    Highways $489 million
    Total $752 million

    In short, you are wrong when you suggest that we just bond for roads and you are wrong to not point out that using cash for capital projects is a second rainy day fund.

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