States In Crisis

Demos

States in Crisis

For decades, bad tax policies have undermined state governments.

As the recession starves state budgets, tax reforms— and more help from Washington—can regain public trust.

contents

A2 Public

Capacity and Public Trust

by dianne stewart and michael lipsky

A4 Loosening Fiscal Straitjackets

by iris j. lav and jon shure

A7 Digging Out, Planning Ahead

by nicholas johnson and michael leachman

A10 Transparency for What?

by mark schmitt

A12 A Tour of Six States A14 California in Crisis

by donald cohen and peter dreier

A17 Reform

Amid Fiscal Ruin

by greg anrig

A 20 State Fiscal Gimmicks: A Budgetary Balancing Act

by katherine barrett and richard greene

A 22 Buckeye

Budget Blues

by amy hanauer

Illustrations by Peter & Maria Hoey

this this special special report report was wasmade madepossible possiblethrough through the generous the generoussupport supportof ofthe the Charles Stewart Mott Foundation, Public Welfare Foundation, the the Ford Foundation, and Stoneman Family Foundation, The Annie E. Casey Foundation.

The Annie E. Casey Foundation, andbulk Thereprints, Cleveland Foundation.

For please contact Friedman For bulkDorian reprints, please at dfriedman@prospect.org. contact Adam Waxman at awaxman@prospect.org. publisher George W. Slowik Jr. publisher George W. Slowik special report editor MarkJr.Schmitt special report editors consulting editor Shelley Waters Boots Robert Kuttner and Mark Schmitt director of external relations subscription customer Dorian Friedman, (202)service 776-0730 x111 1-888-MUST-READ subscription customer(687-8732) service subscription rate $24.95 1-888-MUST-READ (687-8732) subscription rate $24.95

a2 march 2010

Public Capacity and Public Trust Can we reverse the vicious circle of frustrated citizens denying state government adequate resources—and then resenting the lack of state services?

By Dianne Stewart and Michael Lipsky

F

or 30 years we have witnessed a downward spiral of eroding public trust in government. While the federal government deals with the most momentous issues—national security, health reform, global climate change— state government has borne the brunt of a self-deepening tax revolt.

The fiscal noose imposed by tax and spending caps, now exacerbated by the recession, undermines states’ ability to raise necessary revenues. The process erodes state governments’ basic capacity to operate effectively—which further destroys public trust. This vicious circle diminishes the willingness of Americans to entrust government at any level with tackling challenges that call for decisive action or for planning and investment in the future.

As revenue collections decline due to the recession, states raise taxes or cut services to balance budgets. In hard times, reductions in public services are not only cruel but counterproductive— in a recession the economy requires not less but more public spending.

In the current crisis, government agencies cope by reducing staff, cutting hours of operation, closing local offices, increasing hurdles for service eligibility, and raising standards for what constitutes emergencies worthy of intervention. As they decimate university systems, health-care programs, publiceducation funding, and other essential services, the agencies reinforce the belief that states are incompetent.

The federal stimulus program enacted last year helped the states but made up only 30 percent to 40 percent of their budget shortfalls. A second round of federal support is far from certain. As this

special report demonstrates, without further federal assistance, the prospect for the states is grim. for the most part, states are where policies become visible and people experience public programs directly.

Frontline public services forge popular expectations of government. For example, state actions will determine the success of national health-care reform and will influence public opinion on the legitimacy of federal efforts to restore economic prosperity.

Yet few Americans grasp what state governments do, how they contribute to our country’s well-being, and how our federal system actually works. For instance, we educate our children through local governments required to meet state standards and aided with state and federal funds. If they attend college, most Americans receive higher education through state colleges and universities, which are financed with state funds; these costs are often supplemented through federal grants and student aid. Many of the critical programs that provide for people in need, particularly in hard times—Medicaid for low-income and disabled people, unemployment insurance, and the Temporary Assistance for Needy Families program—are state partnerships with the federal government.

Many might be surprised that the work force of state and local governments exceeds federal employment. At the last census (2002), 12.1 million people worked for the federal government, including military personnel and postoffice workers, but 15.6 million worked for state and local governments.

As our research at De¯mos reveals, too w w w. p ro s p ect. o rg

s tat e s i n c r i s i s many people now see government only as polarized politics or as an undifferentiated, ineffective bureaucracy. The public has lost touch with the ways the quality of life of communities depends on government. People have lost track of government’s role in long-term planning and as steward of schools, roads, police services, and other essential public facilities. Constructive responses to the fiscal crisis, if they are to emerge, will require reconstituting an understanding of the critical role of government and support for the public purposes it embodies.

The fiscal troubles of the states are unfolding in the context of a deeply embedded public distrust of government that has been engendered over decades by individuals actively hostile to government and by organizations that promote a small government, low-tax ideology. This past year the backlash against the bailout of financial institutions, the rejection of a public option in health-care reform, and the emergence of passionate “tea party” protests all bore witness to this distrust. At the state level, the manifestations were rampant. In the midst of the worst state fiscal crisis in decades, some state governors even found it politically expedient to refuse emergency federalassistance funds in perverse appeals to anti-government sentiment.

Public-opinion polling confirms that trust in state government is related to its ongoing capacity to manage state affairs.

According to the Gallup organization, in the 1990s, about two-thirds of Americans had at least a fair degree of confidence in their state’s ability to handle state problems. By the downturn of 2003, the last time states cut services drastically, this figure dipped to barely half. In 2009, public trust fell again, as all but two states experienced significant budget shortfalls this cycle of public distrust and government contraction can be broken. At stake is the viability of all levels of government in a time when effective and adequately resourced public structures are as crucial as ever. Over the last five years, De¯mos has sponsored research and engaged with state partners in extensive field work across the country to develop

strategies to break this cycle. This work suggests several steps that can begin to create a more constructive climate.

First, elected and appointed officials, as well as prominent civic and nonprofit leaders, need to promote a positive view of the mission and purpose of the public sector and offer a vision of the government to which we should aspire. For example, in his speech to Congress on health-insurance reform, President Barack Obama modeled a balanced approach that recognized government’s necessary role: “Our predecessors understood … that the danger of too much government is matched by the perils of too little; that without the leavening hand of wise policy, markets can crash, monopolies can stifle competition, the vulnerable can be exploited.” At every opportunity, we must make visible the essential roles that government is uniquely positioned to fulfill and which cannot be adequately undertaken by individuals or by private institutions.

Second, leaders can help citizens understand public systems and structures and the taxes that support them as necessary means to achieve the com-

Third, in seeking public support for government initiatives, we can rekindle Americans’ sense of citizenship and community. As a practical matter, this approach broadens the constituency for the initiative. In Wisconsin, advocates canvassing for a local tax measure realized in the midst of their campaign that they were not making headway and switched tactics to talk with voters about quality of life and the need to come together for the good of their community. In winning a surprising victory, they attributed success to the increased receptivity of voters to this new approach. Similar stories are told by leaders in other states, including those in Massachusetts and North Carolina.

Finally, it’s possible to cultivate public confidence that government can be a mechanism for pragmatic problem-solving to achieve a secure and prosperous future.

Our research indicates that when this image is evoked, Americans are much more likely to have a constructive view of government and are more inclined to support specific progressive policies. Candidates and organizations whose policy

Last year’s federal stimulus helped the states but made up only 30 percent to 40 percent of their budget shortfalls. More is needed. mon good. Years of conservative rhetoric have ingrained in our national psyche the idea that the public good is best served by the dogged pursuit of private interest and that taxes merely deprive individuals and companies of their own money.

While campaigning successfully to be governor of Massachusetts, Deval Patrick turned an opponent’s demand to “give back” taxpayers’ money into an appeal to people’s innate sense of community. “It is their money,” he declared during a debate, “but it’s also their broken road. And it’s their overcrowded school. It’s their broken neighborhood and broken neighbor. … It’s not this idea that people earn what they earn and have no responsibility for the Commonwealth. We have a responsibility, in addition to personal responsibility, to take charge of shared responsibility.”

goals require state revenues and depend upon effective government action should offer an aspirational picture of how adequately funded and competently managed public systems can serve people’s needs.

The state fiscal crisis is the front line of this struggle. State governments, no less than the banking system, are too important to fail. States’ ability to weather the fiscal storms, while also cultivating support for their public missions and the revenues necessary to fund them, will either help redeem the case for the role of government—or further undermine support for the public sector. tap Dianne Stewart is director of Public Works: the De¯mos Center for the Public Sector. Michael Lipsky is senior program director of De¯mos. the american prospect

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Loosening Fiscal Straitjackets Proponents say that caps on taxing and spending enhance democracy. In reality, they destroy accountable government—but that can be changed.

By Iris J. Lav and Jon Shure

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hen Justice Louis Brandeis famously called states “laboratories of democracy,” he might not have envisioned the out-of-control monstrosities that those laboratories sometimes produce. Case in point: caps or formula-based limits on revenues and spending that many states have adopted over the last three decades, which have undermined public services and stymied activist government.

These measures apply statutory or constitutional limits to how much the state or local governments in the state can collect in revenues and spend on services. They replace the normal giveand-take of legislative decision-making with simplistic formulas often designed to diminish the state’s ability to fund education, health care, and other services that help residents and the state prosper. Many of these limits require referenda before taxes can be approved or their terms can be changed. And once set in motion, these fiscal Frankenstein monsters are notoriously hard to stop.

Tax and spending limits exploit general public frustrations and lack of understanding of government; then, by defunding government, they reduce its ability to get the job done, and further heighten that distrust. They also perpetuate a cynical view of how government works, one that disconnects the need for services from how to pay for them.

The good news is that—with hard work and organization—these monsters can be slain. Most recently, in Maine and Washington state, voters rejected the formulaic approach, and progressive reform is possible elsewhere. Colorado provides an emblematic case. a4 march 2010

Initiatives for whom?

In Colorado, overriding constitutional spending restrictions is called “de-Brucing.” This odd term speaks to the influence brought to bear on the finances and politics of states where tax and spending limits can be placed on the ballot by petition. It also speaks to the harm such limits can cause to services essential to public well-being.

De-Brucing is named for Douglas Bruce, who lost a Democratic legislative primary in his native California 30 years ago. Bruce ended up becoming a Republican and moved to Colorado, where he wrote the so-called Taxpayer Bill of Rights or TABOR . Using the initiative system—which in 24 states puts proposed constitutional or statutory changes on the ballot for voter approval if supporters obtain enough signatures— Bruce engineered passage of TABOR in 1992, the third time he put it before voters. Proponents said TABOR would curb government excesses by giving the power to raise taxes to the citizenry rather than to their elected representatives, who couldn’t be trusted to rein in spending.

TABOR not only requires a public referendum to approve any tax increase but also limits the annual increase in revenues to a formula based on changes in the state’s population and cost of living; the state must return any revenues it receives above that limit to taxpayers. This approach created such a fiscal straitjacket that in 2005, Coloradans voted to suspend the TABOR formula and refunds for five years—but not before the state’s performance in areas such as education and health care had plummeted in national rankings. From 2001 to 2002, Colorado even had to stop requiring schoolchildren to be vaccinated because there wasn’t any money to

pay for it. TABOR is back on the Colorado ballot this year.

Bruce wasn’t the first activist to use the initiative system to go after state government. States have allowed voter initiatives ever since South Dakota adopted the process in 1898. Early in the 20th century, though, initiatives were a Progressive Era vehicle for average folks to challenge powerful corporations, which in many places were effectively ruling state governments.

The modern era of voter-mandated tax and spending limits began in 1978, when Proposition 13 in California changed that state’s landscape (planting the seeds of today’s budget megacrisis) and gave anti-tax forces in other states a game plan. Few people knew who Howard Jarvis was before his United Organization of Taxpayers got behind Proposition 13. But the 65 percent vote the measure won in June 1978 put Jarvis on the cover of Time magazine and helped propel Ronald Reagan to the White House.

Prop. 13 sharply limited what home­ owners and businesses paid in yearly property-tax increases and imposed a constitutional requirement that twothirds of each house of the Legislature approve any tax increase. The following November, 15 states had anti-tax measures on the ballot. The right was now mobilized behind this newly adapted tool for taking the “elites” out of their traditional role of making tax policy.

Opponents of tax and spending limits were flummoxed. How could you be against democracy? President Jimmy Carter reacted to the California vote by calling it “an accurate expression of, first of all, the distrust of government.”

As Washington Post columnist David Broder observed in 2000, “The experiw w w. p ro s p ect. o rg

s tat e s i n c r i s i s ence with the initiative process at the state level in the last two decades is that wealthy individuals and special interests—the targets of the Populists and Progressives who brought us the initiative a century ago—have learned all too well how to subvert the process to their own purposes.”

In recent years several national antitax, anti-government organizations have come to view state policy, particularly ballot measures, as a promising way to achieve their aims. The biggest players include Grover Norquist’s Americans for Tax Reform, Dick Armey’s FreedomWorks, Americans for Prosperity, the Club for Growth, and FairTax.org. While Proposition 13 had a strong grass-roots aspect (California’s property taxes had been rising rapidly because of the Legislature’s failure to pursue tax reform during a period of inflation), these national organizations and their state affiliates have been the major force behind many of the more recent efforts to enact tax and spending limits. They have helped make the term “ TABOR” well-known across the country.

The perils of fiscal limits

While tax and spending limits vary from state to state, what draws the antigovernment right to Proposition 13 and TABOR–like measures is simply that they prevent government from doing its job effectively. This is a benefit for those who

The TABOR formula of linking revon autopilot; it’s dangerous for government to operate that way, too. enues to population growth and the cost The “one size fits all” nature of formula- of living might sound like a reasonable ­based limits can also cause distortions safeguard against runaway spending, and inequities. Proposition 13, for exam- but in reality it shrinks government to ple, sharply limits property taxes to a the point where it can no longer do its certain percentage of a home’s assessed value Supermajority Rule as long as the same States requiring legislative supermajority and voter approval owner occupies it, but to raise taxes, 2008 the house is reassessed as soon as it is sold. As a result, the owners of two identical houses sitting side by side can pay dramatically divergent property-tax bills depending on how long they’ve owned their house. Clearly, those who benefit from such distortions—or hope to do so in the future— Voter approval of taxes would not want the Legislative supermajority to raise some or all taxes policy changed. That Combination of supermajority and dy na mic , in tur n, voter approval source: conference of state legislatures, 2008 creates what political scientists call veto coalitions—groups with little in common job adequately. For one thing, not all but that together can block reform. segments of a state’s population increase Tax and spending limits can also have at the same rate. In states where groups unforeseen consequences over the long that require more services—such as term. For example, both Proposition the elderly or school-age children—are 13 and Massachusetts’ Proposition 2½ growing faster than the population as a (passed in 1980) aimed to shift some- whole, tying revenues to overall populawhat the responsibility for funding tion growth limits government’s capacity to meet needs.

The cost-of-living component of the TABOR formula also creates big problems. Often, designers of ballot measures choose a version of the Consumer Price Index that reflects the cost of a “market basket of goods” purchased by a typical schools and local government from local consumer. But state governments aren’t property taxes to state aid. It worked for typical consumers. The major items in a a while, but over the years neither state state’s basket of goods aren’t things like had the financial wherewithal to con- groceries but instead are health care, tinue large infusions of aid to schools education, and prescription drugs—all of and localities. As a result, California’s which tend to increase in price at much per-pupil school spending and student higher rates. performance now trail the national In tough economic times, TABOR’s average. And the two-thirds require- limits prove even more insidious because ment for legislative tax measures has they prevent the state from meeting the prevented California from solving its increased demand for such services current shortfalls. as job training, higher education, and

Voters may think they will gain control over government through such limits, but actually they will give up control—to a formula. want drastically limited government but is a nuisance for everyone else.

Inflexibility is a major drawback of fiscal limits imposed by initiatives. Voters may believe they will gain control over government through such limits, but actually they will give up control— to a formula. Representative government has the ability to adapt to new circumstances. A rigid formula cannot.

You probably wouldn’t want an airplane you’re in to fly through a massive storm

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medical assistance. The problems are compounded when a recession weakens revenues to the point where actual state spending in a given year falls below what the TABOR formula permits.

Because allowable spending growth (or revenue growth, depending on how a state’s restriction is worded) is tied to the prior year’s level, that lower-thanpermitted level then becomes the new base. As a result, TABOR permanently ratchets down services to their recession levels, preventing the state from recovering to previous levels when the economy improves. Public needs cannot be met that way.

That’s exactly what happened in Colorado. Revenues dropped in the recession of the early 2000s, and because of TABOR , the state couldn’t restore those revenues when the economy improved.

In 2005, voters permanently eliminated the part of the TABOR formula that created the ratchet effect.

Even in good economic times, TABOR tends to keep state spending each year

ic development. But in many other cases, such a campaign would be beyond the means of the people hurt most by limits on government taxation and spending.

Fighting back

For the anti-government right, of course, the difficulty of undoing fiscal limitations like TABOR s or Prop. 13 is a big part of their allure. Once in place, these measures will run on autopilot, feeding on voter resentment over government’s inability to function properly and spitting it back out in increasingly toxic form.

Supporters of ballot measures that limit spending and taxes had high hopes for the 2009 elections. Measures on the ballot in Maine and Washington state were given a good chance of passage following a summer of “tea party” rallies and growing frustration over the deepest recession in most people’s lifetime. Norquist, whose Americans for Tax Reform helps bankroll and guide state ballot questions, said, “I think the Maine TABOR will sort of be a spark to

Budget caps have helped bring together strange bedfellows to fight for budget processes that adequately fund the public sector.

1 percent to 2 percent below the level needed to maintain services. The impact of this persistent underfunding grows over time. Research shows that if every state had Colorado’s TABOR between 1990 and 2004, total spending in 2004 would have been 20 percent less than it was. That adds up to a lot of teachers, health-care workers, police, and fire personnel whom states simply wouldn’t have been able to afford.

Unfortunately, tax and spending limits tend to be very difficult and expensive to take off the books once voters realize the problems they cause. Doing so is beyond the purview of legislatures; another public vote is required. Colorado’s five-year suspension of the TABOR formula and refunds took an $11.3 million campaign, in this case largely paid for by the state business community that found TABOR was endangering economa6 march 2010

other states. … If Maine, a moderate Northeastern state, says, ‘Yes, let’s take a look at this,’ it then becomes a stronger sell in Arizona and Washington and Oregon and Florida.”

But the 2009 voting turned out not to be a reincarnation of the 1970s “tax revolt.” In both states the ballot measures lost convincingly. Were the antigovernment forces out-mobilized? (They were indeed outspent.) Did they overplay their hand? Is the public coming to more rational judgment about important issues affecting peoples’ lives?

It is certainly the case that TABOR forces public discussion about the economic and social benefits of public investments and brings new voices into that discussion. In both Maine and Washington, some business leaders helped in the fight against TABOR , realizing that reduced funding for education, infrastructure,

and other core government functions would harm their states’ competitiveness. This put them on the same side as public-sector unions, advocates for human services, local elected officials— Republicans and Democrats alike—and an array of other voices. If there is one good thing to say about TABOR , it’s that it has helped bring together strange bedfellows to fight for responsible budget processes that adequately fund the public sector.

But there is no reason for complacency. The prospect of pumping up voter turnout for the midterm congressional elections should make anti-government ballot initiatives appealing for the right in 2010. There is precedent for this stepped-up activity. During the last midterm elections, in 2006, well-funded right-wing efforts sought to put TABOR questions on the ballot in 16 states. Most of those efforts failed, though, and in the three states where TABOR reached the ballot (Maine, Nebraska, and Oregon) it was defeated.

This year, supporters are circulating petitions or working in the legislatures to put TABOR–like measures on the November ballot in Florida, Arizona, Missouri, Kansas, Minnesota, and Michigan. Also, supporters are pursuing ballot measures to roll back taxes or cap spending or revenues in Maine, Massachusetts, Colorado, Montana, Florida, North Dakota, and Arizona.

Their recent defeats notwithstanding, backers of state tax and spending restrictions cannot be ignored. Three decades after Proposition 13, anti-government activists are still trying—sometimes successfully—to impose limits they might not otherwise achieve through the normal legislative process. Their facile rhetoric about bloated government taking money from citizens that it can’t be trusted to spend effectively has the potential to be as mesmerizing as it is polarizing. tap Iris J. Lav is a senior adviser to the Center on Budget and Policy Priorities and former deputy director of the center. Jon Shure is deputy director of the State Fiscal Project at CBPP. w w w. p ro s p ect. o rg

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Digging Out, Planning Ahead The federal government needs to do more to help states survive this downturn— and plan for permanent anti-recession fiscal relief.

By Nicholas Johnson and Michael Leachman

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eb. 17, 2009, was a historic day for the economic relationship between the federal government and the states. The American Recovery and Reinvestment Act, signed into law that day, constituted an effort of unprecedented scope by the federal government to keep states and localities in the business of providing services and to prevent state budget cuts from dragging down the economy.

This step was needed because states and localities generally have to balance their operating budgets no matter what economic conditions prevail, while the federal government can and should run deficits during economic downturns.

The new law is sending hundreds of billions of dollars to cash-strapped states and localities. Some of the money is earmarked for very specific purposes, like highway spending or environmental investments. But much of it is relatively flexible aid to keep education, health care, public safety, and other key functions going. From sheriff’s deputies in Virginia to child-care providers in Arizona, hundreds of thousands of Americans whose work is financed with public dollars are staying on the job because of the Recovery Act. Thanks to the Recovery Act, not only have hundreds of thousands of jobs been saved, but millions of Americans have kept their health insurance and the economy is starting to recover. But the crisis has been so severe that the states’ fiscal trauma threatens to last longer than Washington’s help. The money will run out before state and local governments have fully recovered from the impact of the recession. In fact, as governors and legislatures recently began writing their budgets for next fiscal year—with projected revenues still far below needs—

the scheduled expiration of Recovery Act funds was their biggest concern.

More fundamentally, the approaching expiration of the Recovery Act’s state fiscal aid raises the question of whether the federal government is finally ready to begin treating states and localities like full partners in the business of serving the American people.

From Hurting States to Helping Them

To appreciate the change of direction that the Recovery Act represents, it’s worth a short trip down memory lane to the first half of the George W. Bush administration. Then, a somewhat milder recession was undercutting state revenues and core functions. Two-thirds of the states cut aid to school districts; 76,000 state employees lost their jobs.

But in the Bush era, Congress and the administration took several steps that actually made things worse. They terminated a seven-decade-old arrangement that allowed states to keep a portion of federal estate-tax revenues. They passed new corporate tax breaks that undermined state tax bases. They enacted a No Child Left Behind law that mandated major improvements to local schools but provided insufficient new funding. The major exception to the trend was a onetime, $20 billion dose of state fiscal relief in 2003, which (among other things) averted cuts in state health-care programs that would have cost over 1 million Americans their health coverage. That important step, however, was swamped by the others. All told, the actions and inactions of Congress and the administration cost states $175 billion between 2002 and 2005—three times as much as the states spend on higher education in a year. By 2008, federal grants to states

outside of Medicaid had fallen 9 percent in per-capita terms from their 2003 peak, after adjusting for inflation.

On the bright side, states’ own tax revenues were growing, thanks in large part to a real-estate boom—which turned out to be a bubble. When the bust came in 2007 and 2008, state revenues started tumbling.

Job losses in every state reduced income-tax collections. Hard-hit consumers cut their spending, causing salestax revenues to plummet. Declining home values depressed local propertytax collections. Total state tax revenues in 2009 were between 10 percent and 15 percent below levels in the previous year and even further below the level needed to maintain current services adjusting for inflation and population growth.

Faced with collapsing revenues, rising demand for services, and the legal requirement that they balance their operating budgets, states had few good options. They first turned to their “rainy day” reserve funds, which states had built up to record levels during the expansion, but this was far from enough.

By early 2009, governors and legislators were exchanging their budget scalpels for hatchets. Half the states announced cutbacks in health care, two-thirds cut higher education, and three-fourths cut back on their work forces.

These cuts didn’t just weaken core public services. They also cost jobs.

When states cut spending, they lay off workers, cancel contracts, and reduce purchases—setting off a ripple effect that further weakens demand. As much as possible, for the good of the economy, the country needed state and local governments to keep operating as normal.

So when Congress and the Obama administration put together the Recovthe american prospect

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ery Act, they included a healthy dose of temporary funding to help support ongoing state spending. This included more federal Medicaid funding and additional funding for education and other services in the form of a new State Fiscal Stabilization Fund.

By July, less than five months after the bill’s enactment, states already had spent about $30 billion in fiscal aid. The money not only saved the jobs of teachers and police officers but also supported the earnings of nonprofit service providers, businesses that sell to government, and private-sector health-care professionals whose employers depend on government spending. Without it, last summer states would have laid off more workers and cut even more spending to vendors and others, further damaging the still-weak economy.

Combined with other elements of the act, this infusion of state fiscal aid worked as intended to boost consumer and government spending quickly, helping save the economy from free fall and carrying it through to a fragile recovery.

The nonpartisan Congressional Budget Office estimates that the Recovery Act saved as many as 1.6 million jobs by September 2009. Leading private-sector economic forecasters agree that the recession would have been significantly worse without the act.

However, the federal money only closed about one-third of states’ budget shortfalls. So states still are cutting jobs and services—just not as fast as they otherwise would have. The nonpartisan Government Accountability Office surveyed school districts and found that 32 percent were planning to cut jobs, though not as deeply as most would have without the federal aid.

Unfinished Business

The states’ fiscal crisis will not be easily dispatched. Due to falling tax revenues, states faced $110 billion in operating budget gaps for fiscal year 2009, which they addressed with a combination of spending cuts, reserve-fund drawdowns, some tax measures, and the first $30 billion or so in Recovery Act dollars.

The gaps for the current fiscal year have a8 march 2010

been even larger, approaching $200 bil- California raised tuition by a third and lion; even after taking into account the cut enrollment by thousands. Alabama, increased federal aid, the gap is nearly Florida, and Massachusetts have cut $125 billion, the largest ever recorded. back home-based services for seniors.

State revenues won’t return to normal The cuts will only get deeper. until after the job market recovers, which Meanwhile, many states will also could take years. At the same time, the raise fees, excise taxes, and other revneed for health care, food stamps, and enues that hit low- and middle-income other state assistance remains high. In families the hardest. Over 30 states have some parts of Texas, people needing food already raised taxes. Responsible state stamps have had to wait as long as three policy-makers will balance spending months to schedule application interviews, The Recovery Act Falls Short even though federal State budget deficits in billions, fiscal years 2009–2012 law says benefits must be processed in 30 FY2009 FY2010 FY2011 FY2012 0 days. Plus, more peo–$2 –$31 ple across much of the –$38 –25 –$68 country are enrolling in –50 community colleges to –$118 improve their job skills –$79 –75 because so few jobs are –100 now available, increas–$142 –$110 ing higher-education –125 –$120 –$125 costs. For all these –150 reasons, state budget shortfalls next fiscal –175 year could reach $180 –$180 –200 –$193 billion, almost as much as in the current year.

■ Budget gaps offset by Recovery Act A nd federal aid ■ Remaining budget gaps after Recovery Act will soon run out. The source: center on budget and policy priorities; congressional budget office expanded Medicaid support is scheduled to disappear at the end of December, cuts with tax increases weighted toward right in the middle of most states’ fiscal the wealthiest households. Though year. Many states also will have spent spending cuts and tax increases both most of their extra federal education reduce economic demand, tax increasfunding by that time. State legislatures es targeted to the rich have less of an are considering spending cuts that could impact because much of the revenue hit the brakes on the national recovery, they generate would have been saved based on whether they think Congress rather than spent. And certainly the will allow the Recovery Act assistance wealthiest Americans can afford to pay to end as scheduled or phase it out more somewhat higher taxes, given the explogradually. Without more aid, there will sion of income they’ve enjoyed over the be more cuts. last two decades. Still, the budget gaps States have already slashed their that states now face are going to be spending in sometimes severe and too large to close with progressive tax shocking ways, often harming those increases alone.

Especially to the extent that they rely already left vulnerable by the recession.

Tennessee has stopped signing up new heavily on spending cuts, state budget kids in its Children’s Health Insurance actions could cause big problems for Program. Hawaii public schools are the nascent economic recovery. Indeed, cancelled on most Fridays this year due investment bank Goldman Sachs cites to teacher furloughs. The University of states’ responses to their revenue probw w w. p ro s p ect. o rg

s tat e s i n c r i s i s lems as a key reason why it expects the economy to slow in 2010.

Unfortunately, it won’t be easy to convince Congress to extend federal recovery funding, for several reasons.

The unemployment rate, only starting to surge when the Recovery Act was enacted, continued to rise in subsequent months, a fact that opponents have used effectively to mislead the public about the act’s effectiveness. This will make it harder for Congress to spend even more federal money to follow a course that is working but that many Americans mistakenly believe isn’t.

A number of policy-makers have also expressed concerns about the Recovery Act’s impact on the deficit. Certainly the act has driven up the deficit in the short term, but its impact on the longer-term deficit is negligible because the measure is temporary. Almost the entire projected deficit over the next 10 years is attributable to three causes: the economic downturn, tax cuts enacted and not paid for under the Bush administration, and the wars in Iraq and Afghanistan. The entire $787 billion Recovery Act accounts for just 3 percent of the long-term deficit.

Another challenge is that many who normally would favor dramatic government action on behalf of the economy and state and local services have done little to defend the Recovery Act, particularly its state aid provisions. Some liberal organizations have focused on the act’s shortcomings rather than all the good the stimulus has been doing. Striving for perfection has been the enemy of the good here.

A Permanent State-Federal Partnership

Politics aside, the debate over extending Recovery Act funding needs to take place in a larger context. This nation needs a permanent partnership between the states and the federal government that kicks in automatically when the economy begins to decline.

As noted, states are required by their constitutions to balance their operating budgets; they can’t print money. At the same time, they have to deal with the cruel irony that in bad economic times,

the need for what they provide goes up at the same time that available resources go down. The cost of “countercyclical” aid that states provide to struggling families, like emergency income assistance, food assistance, shelter, and health care to the newly unemployed, is designed to increase during downturns. Other state services, like education and transportation, remain important investments for states’ long-term economic well-being and are problematic to curtail. Asking states to do the most at times when they have the least isn’t good for anyone.

In this recession, the aid to states was enacted about a year after states began to experience serious revenue shortfalls and fiscal problems. In the previous recession, at the beginning of the decade, a much smaller amount of assistance wasn’t enacted until nearly two years after the recession had officially ended. Although the need for federal

roughly intact. Such strategies would protect jobs and services and would have a stabilizing effect on the economy.

And as the economy continues what will likely prove a long, slow march to full recovery, the federal government can take other steps to help state education, health, transportation, and public-safety investments recover. For instance, Congress could change federal law on the taxation of Internet sales, so that states could receive billions of dollars in revenue that are owed in principle but not collected.

States themselves have a role to play here, too. They could stockpile even bigger rainy-day funds and other reserves during expansions, and they need to be a lot more cautious about enacting big tax cuts like those of the 1990s that turned out to be unaffordable. Some states also need to address structural problems in their budget processes such as formula-

Despite anxiety over deficit spending, the entire $787 billion Recovery Act accounts for just 3 percent of the long-term deficit. assistance to states during an economic downturn is evident, a lot of political considerations can get in the way of actually providing that assistance.

A better way would be to guarantee states a boost in federal aid when the economy turns down. No more haggling in Washington while the economy sinks and joblessness rises. For instance, the federal share of Medicaid costs could adjust automatically to reflect changes in unemployment so that when joblessness rises, the federal government picks up a bigger share of the cost—as long as states maintain the program at roughly current levels. Since Medicaid is now the third largest revenue source for states— just behind sales and income taxes—this change alone could make a significant difference in how states weather downturns. Federal grant formulas for education and human services also could be adjusted to increase during recessions, with a quid pro quo that states use the money to keep overall expenditure levels

based revenue limits, caps on rainy-day funds, and an absence of multi-year budgets, all of which hinder state planning for downturns. Such reforms could make it harder for Congress to withhold help in a future recession by claiming that states caused their own problems.

Throughout American history, crises have prompted institutional changes designed to keep them from happening again or to minimize the harm if they do. As bad as this recession has been, it would have been much, much worse without timely federal action. Now, with troubled times still fresh in mind, we should put in place a system that recognizes the importance of maintaining state services in a crisis—so we’re ready next time. tap Nicholas Johnson is director of the State Fiscal Project at the Center on Budget and Policy Priorities. Michael Leachman is senior policy analyst at the center. the american prospect

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Transparency for What?

The left, right, and center agree that they want more state budget data.

But not all data improves policy.

By Mark Schmitt

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ransparency” was probably the word of the year for 2009, at least in policy circles. At the federal level, President Barack Obama’s memo on his first day in office promised “an unprecedented level of openness in Government ... transparency, public participation, and collaboration. Openness will strengthen our democracy and promote efficiency and effectiveness in Government.” Justice Louis Brandeis’ line that sunlight is the best disinfectant went from insight to cliché and beyond in a short time.

The Web site recovery.gov has become the centerpiece of the government’s effort to make every knowable bit of information about spending under the American Recovery and Reinvestment Act (the economic stimulus) available to the public and will be the centerpiece of Obama’s transparency agenda. Other sites, such as data.gov, are opening up the vast amount of information the government has held for years. Transparency involves not just making information available, however; it also involves using the Internet, database technology, and graphic interfaces to make information accessible and useable for citizens to do their own research and make their own judgments.

The “transparency movement” encompasses far more than government spending and the data governments collect. Political reformers were among the first to push for total transparency of campaign contributions and spending; “report cards” on schools, doctors, and bank lending practices have been important mechanisms to further public goals without additional regulation. The push for transparency extends to the private sector as well, especially in the wake of the financial crisis— after all, the context of Brandeis’ original line referred to a proposal requiring disclosure of investment bankers’ fees. a 10 m a r c h 2 0 1 0

The transparency movement may also be one of the few initiatives in recent American political culture that is thoroughly bipartisan, or more accurately, cross-ideological. Because it challenges those in power who often control access to information, it has appeal on both ends of the ideological spectrum as well as to more centrist good-government activists and advocates for consumer protection. The basic theory of the transparency movement is Brandeis’: “Publicity” prevents the corruption that is almost inevitable in closed processes (especially when money is involved); information allows citizens to participate in democratic decision­m aking; and this knowledge makes people better “consumers” of both public and private goods and allows voters more effectively to hold politicians accountable.

From these forces, it is assumed, better public policies will emerge.

However, as we’ll see below, as long as people differ about what they consider better public policies, they will give priority to different aspects of the transparency agenda. this cross-ideological alliance has been particularly inf luential when it comes to transparency in state budgetary decisions. While the federal government has always provided fairly robust budget information—albeit not at the granular level of recovery.org—which think tanks and advocacy groups aggregate and make accessible, state data is often obscure, even from legislators themselves. The notorious “three men in a room” who make budget decisions in New York state (the governor and leaders of the legislative bodies), the predawn votes in California and other states, and the provisions hidden in off-budget categories not only make it impossible for citizens to participate in

government; they severely limit the ability of even elected officials to do their jobs and to create a broad constituency for better data. And the traditional means of obtaining and distributing information about state budget choices—newspapers— have been disappearing from the field at a rapid rate. An April 2009 study by the American Journalism Review found that the number of reporters covering state government declined by 32 percent over the previous six years.

To replace this loss, and to open the obscure and often closed process to public understanding, state budget groups such as the Massachusetts Budget and Policy Center, which are associated with the generally progressive, authoritative Center on Budget and Policy Priorities, have been leading the push for budget transparency for some years, setting out guidelines and best practices to make the information useful to citizens. In 2007, conservative anti-tax advocate and organizer Grover Norquist joined forces with Ralph Nader on a campaign to ask states to make all expenditures public on a single Web site, an effort sometimes referred to as Government 2.0.

So far, 19 states have responded with some expansion of the budget information they make available.

The differences between the NorquistNader proposal and the best practices put forward by groups like the Massachusetts Budget and Policy Center are revealing of the differences in approach behind the unified facade of the transparency movement. Norquist and Nader’s approach might be called microtransparency: Their model legislation calls on states to dump every bit of data possible onto the Web. This includes, to quote the Oregon bill as introduced, having “each state agency … maintain a w w w. p ro s p ect. o rg

s tat e s i n c r i s i s copy of each monthly statement for all its credit cards” used by employees and requiring each month’s statement to be made available on the Internet within 30 days after it was paid, with only the credit-card number deleted.

The language its sponsors used on introducing the bill reveals the assumptions behind such an approach: “Transparency is important because, in the end, there is no such thing as government money; it’s only taxpayer money in government hands,” said Gene Whisnant, an Oregon state representative.

This brand of micro-transparency is based on an assumption of corruption and waste. A blizzard of tiny data points, without context, does not improve government or help citizens make decisions.

It can generate newspaper stories about small items of wasteful spending, but as Charles Sheketoff of the Oregon Center for Public Policy points out, “If the media could find $1 million of waste every day, it would still be less than 1 percent of the state budget.” At a time of economic and fiscal crisis, when states have to make bigger decisions about spending cuts

rated many of the practices intended to increase understanding, not just data, including a requirement that the Web site created “should teach users about how state government works and provide users with the opportunity to learn something about how state government raises and spends revenue.” putting the budget in perspective also means focusing on more than spending— in most states, tax expenditures, or spending through the tax code, rival other forms of spending and often aren’t fully reported, even in the most general terms. While the U.S. Treasury has reported tax expenditures since 1974, most states only recently developed taxexpenditure reports, nine states don’t publish them at all, and as the Center on Budget and Policy Priorities (CBPP) points out, most of those that do omit crucial information, such as how many households or businesses benefit.

Tax expenditures are a perfectly legitimate tool of public policy, but at both the federal and state level, they receive far less scrutiny than direct spending does.

A blizzard of tiny data points, without context, does not improve government or help citizens make better decisions. and tax increases, a focus on small items, along with the assumption that government is wasteful and corrupt, hardly increases citizens’ ability to think about the choices ahead.

Advocates like Sheketoff tend to focus both on that bigger picture and on a different set of details than credit-card bills, such as complex tax provisions.

Sheketoff says the goal of transparency should be to help citizens, advocates, and legislators put the budget “in perspective.” He says he practices “social math” when he speaks to citizens’ groups, asking them to make sure they know the largest source of state revenue and the largest spending categories and understand the difference between a million and a billion. The transparency legislation as enacted in Oregon incorpo-

At the state level, almost all spending is determined by annual appropriations, forcing constant review of decisions.

But tax expenditures usually become a permanent part of the state’s tax code: Georgia, for example, spends $4 million a year on a sales-tax exemption for videotape rentals that has never been reviewed. And because of their complexity, tax expenditures can run out of control or help hidden beneficiaries without public scrutiny—Sheketoff cites an alternative-energy tax credit passed in Oregon that benefited Wal-Mart, which got an $11 million tax credit in return for a $7 million investment. A similar tax credit in Arizona, for alternative-fuel vehicles, cost $680 million in its first year, although when passed it was estimated to cost $3 million to $6 million.

The Nader-Norquist model bill doesn’t even mention tax expenditures.

A more nuanced and useful approach to transparency would open up these often-neglected areas of budgeting, ensuring that citizens and legislators at least know about these arrangements.

The best practices recommended by the CBPP–linked groups also try to put all spending, direct and through the tax code, in perspective: The Massachusetts group’s recommendations, for example, ask the state to differentiate between permanent and onetime costs, to show historical information on each budget category, and to show whether budget changes represent the amounts needed to continue current services or a real increase or decrease in services.

The information produced by these initiatives has in turn helped feed a new medium for citizen access to information, in the form of state-level blogs that cover politics and government. Some, such as MinnPost, were founded by journalists and have a specifically journalistic purpose; others are more ideological in nature.

The combination of state-government transparency initiatives, state-level think tanks that can make sense of the information, and the network of blogs and other outlets hold the promise of replacing, and perhaps even surpassing, the work traditionally done by journalists.

Earlier this year, Lawrence Lessig— a legal scholar and recently a political reform advocate—wrote an important article called “Against Transparency” in The New Republic. Lessig argued that much of the transparency movement in all its forms was more focused on “naked transparency” that was “not going to inspire change. It will simply push any faith in our political system over the cliff.”

Much transparency encourages cynicism, invades privacy, or actually obscures important facts in a sea of data points— such as state employees’ credit-card bills. The distinction between that form of naked transparency and the kind of transparency that encourages real understanding, civic participation, trustworthy government, and better policy, is illustrated by the unfolding debate over making state budgets more accessible. tap the american prospect

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A Tour of Six States

north carolina’s fiscal crisis isn’t unique,

indiana’s fiscal crisis was slow to boil

but in a region where tax increases have long been political poison, the way state officials are dealing with it is.

The numbers are intimidating: The 2009– 2011 budget showed a $4.6 billion difference each year between the revenues needed to maintain reasonable levels of service and the state’s ability to raise those revenues. All told, that is about 25 percent of the state’s general fund. In comparison, the state’s previous worst shortfall during the 2001 recession was only 10.8 percent. Fierce cuts to public spending were widely anticipated.

“We’ve never had a shortfall of that size in our state,” says Meg Gray Wiehe, public-policy analyst for the North Carolina Justice Center.

“But the cuts could have been much, much worse than what ultimately ended up happening.”

That’s because North Carolina’s Democratcontrolled Legislature decided against getting slash-happy. Instead it balanced the budget through three roughly equal measures: stimulus funds, cuts (Medicaid reimbursement rates and classroom size for fourth-grade through 12th-grade both suffered), and a temporary tax package.

The temporary taxes are spread widely across the population. Progressive measures are included, namely a 3 percent surtax on corporate income, a 2 percent surcharge on individual incomes of $100,000 to $250,000, and a 3 percent surtax on $250,000 or more. A regressive item was included, too: The sales tax was increased by 1 percentage point, a cost which falls disproportionately on low-income Carolinians.

Beyond the immediate crisis, the temporary tax increases have opened up the political space for a broader reform of North Carolina’s tax system, which relies on taxes that weigh heaviest on the poor. The budget includes language requiring the financial committees of both houses to meet during the off session to come up with recommendations for reforming the state’s outmoded tax system, which largely dates back to the 1930s.

“It’s a conversation we’ve been having for 50 years,” Wiehe says. “Now more than ever the political will to change it seems to be there.” —jake blumgart

over. While five years ago the state was facing near bankruptcy, in July 2009 it passed a budget increasing K-12 educational spending while preserving a $1.3 billion surplus. There were no state employee layoffs, and in September, Gov. Mitch Daniels took to The Wall Street Journal to boast of his state’s relative solvency.

Yet even then, taxes were falling below revenue projections. Every month since the middle of 2008, tax receipts fell short of expectations. In early December, Daniels announced a $150 million decrease in higher-education funding. He froze state-worker salaries and turned down a $9,000 raise, continuing to earn a comparatively modest $95,000 a year. Thirty-three workers were laid off that month. Daniels called upon state agencies to cut spending more than once in 2009, forcing them to operate on budgets that were 20 percent lower than in the previous fiscal year.

There was hope that the belt tightening, which was to save the state between $300 million and $400 million, would be sufficient. Instead the governor had to announce a $300 million cut in public-school funding after a December bipartisan audit revealed Indiana’s revenue for fiscal years 2010 and 2011 would haul in nearly $1.85 billion less than previously predicted. Fortunately, the state has a rainy-day fund for just such circumstances.

As a backdrop to the fiscal situation, Indiana is one of the most economically unequal states in the nation. Nearly 19 percent of Hoosiers rely on some form of welfare, and the state’s rich out-earn the poor by a margin of 7 to 1. While income representing the wealthiest fifth of the state has risen nearly 38 percent between 1987 and 2006, the lowest fifth witnessed a far more modest increase of 9 percent. —mikhail zinshteyn

The Pew Center on the States ranks arizona’s budget woes as second only to California’s. In the prebust era, when the state was flush with cash, lawmakers cut taxes and increased government spending.

Now, hit hard by the housing bust (the state has one of the highest rates of foreclosures), Arizona is faced with a $2 billion deficit—a shortfall that’s expected to soar to $3.4 billion in the coming fiscal year. Aided by the state’s supermajority requirement to pass tax increases, the doctrinaire Republicans who control the Legislature have left devastating cuts to social services and education as the only recourse.

Legislators and the governor have already slashed funding for K-12 education by $144 million and knocked out $155 million from the state’s Department of Economic Security, but this barely makes a dent in the problem. Earlier in the year, Gov. Jan Brewer—a moderate Republican— vetoed proposed cuts in the hope of forcing the Legislature to pass a 1 percent sales-tax increase. But as the year came to a close and it became clear the Legislature wasn’t going to budge, she looked at cutting costs elsewhere. Brewer is now asking the federal government to take over detaining undocumented immigrants and has proposed setting up a wait list for the state’s Children’s Health Insurance Program. The state is also playing with the idea of shortening the school week to four days.

“We face a state fiscal crisis of unparalleled dimension, one that is going to sweep over every single person … as well as every business, every family, every Arizonan,” Brewer says. With the state’s political forces gridlocked, little hope remains of narrowing the scope of the impact. —gabriel arana

Exacerbated by the national recession and collapse of nearby Wall Street, new jersey has dealt with a soaring deficit and tax problems for years. By borrowing money to balance its budget, New Jersey accrued an extraordinary $44 billion debt. Payments on those bonds, in turn, have limited spending in the already-scant budgets. Republican administrations in the 1990s cut taxes and made the problem even worse. Lastly, spending is limited by a tax-rebate plan; half the current budget is dedicated to rebates, which are meant to offset sky-high property taxes.

This year, New Jersey racked up a budget shortfall of $4.3 billion, which is projected to hit $8.3 billion in 2010. Since October 2008, unemployment has shot up from 6 percent to 9.7 percent.

With state revenues decreasing and budget goals consistently unmet, New Jersey has made record budget cuts, slashing funding to localities and eliminating 2,000 state jobs. Without the stimulus money infused into the 2010 budget, education would have been cut by 12.2 percent ($1.4 billion), and health and senior services would have faced cuts up to 27.3 percent.

On Nov. 3, 2009, Gov. Jon Corzine became the first Democratic casualty of the economic crisis. “There are 48 governors glad they didn’t run for re-election in 2009,” says Jon Shure of the Center on Budget and Policy Priorities. “It was a climate tailormade for a challenger.” To make up for falling revenue, Corzine raised taxes rather than cut services; he lost to Republican challenger Chris Christie who promised to cut taxes and spending.

November’s election threatens New Jersey’s recovery. For years, the state has deferred payments to its pension fund; keeping the program solvent means diverting large funds from other forms of spending in the future. Without new revenue, the deficit will continue to take precedent over services.

And Governor-elect Christie’s promises to cut spending and taxes will further worsen the state’s economic prospects. —pema levy

In some ways, colorado is luckier than its regional neighbors like Nevada and Arizona, states that bought into the housing bubble in a huge way and are now suffering accordingly. On the other hand, those states never had to deal with Colorado’s 1992 Taxpayer Bill of Rights (TABOR) law, which forced state legislators to restrict spending increases to the rate of inflation and population growth and made them return revenues raised over that limit.

“We’ve seen significant reductions in rates of revenue collection [beginning] in the late 1990s and early 2000s, primarily because the TABOR law wouldn’t allow the state to save or invest,” says Carol Hedges, senior fiscal analyst for the Colorado Fiscal Policy Institute. “We went into the recession with some of the lowest rates of tax collection and public revenue available for public investment, of any state in the country.”

Thirteen years of TABOR (which was put on hold in 2005) have ensured emaciated state budgets. These severely constrained circumstances made it particularly painful for lawmakers to trim the fat. Fiscal year 2009–2010 required $1.5 billion in “budgetbalancing decisions” from Gov. Bill Ritter, a Democrat. He paid for what he could with stimulus funds. The rest was made up of cuts from Medicaid, higher education, food stamps, and most other state programs.

Now with fiscal year 2010–2011 looming, Ritter has proposed an additional $1 billion in cuts, and it looks like the school system will have to absorb most of it.

“K through 12 seems like the only option left as we move into the 2010–2011 cycle,” Hedges says.

The only bright side is that these grievous wounds to state services could further discredit TABOR in the eyes of Coloradan voters, possibly spurring them to extend the legislative sanctions passed against the law in 2005. Hedges expects TABOR reform to emerge on the ballot as soon as 2011. —j.b.

nevada’s deficit may not be as large as its neighbors to the east and west, but given the state’s reliance on gambling and tourism revenue, which have declined sharply with the economy, the $1.2 billion shortfall for fiscal year 2010 will be tough to close. But state legislators on both sides of the aisle have shown a remarkable ability to work together: A mixture of cost-cutting and tax increases have already shrunk the budget deficit from $3 billion to $64 million—and Republicans in the Legislature seem open to straying from the party line.

Unlike Arizona, Nevada’s government isn’t controlled by hard-line Republicans; the House has a solid Democratic majority, and Republicans have shown themselves to be amenable to increasing taxes. In May, legislators in the House and Senate prevented an all-out budget crisis by overriding the governor’s veto of a $781 million sales-tax increase. The plan, however, also included a $1 billion reduction in funding for social services—and included a salary cut for government workers.

To deal with the rest, Gov. Jim Gibbons continues his one-sided approach. He has asked state agencies, public schools, and universities to prepare for budget reductions as large as 10 percent.

But there are less ascetic solutions.

Nevada could revise its regressive tax structure, in which the top 1 percent of the population contributes 1.8 percent of its income to the state budget and the bottom 20 percent pays 9 percent.

The state could also borrow money from municipalities—a $160 million stopgap—that could keep the state afloat until the economy recovers. —g.a.

California in Crisis With a dysfunctional state government unable to act, the universities, schools, and roads that were once the model for the nation are crumbling—if not collapsing.

By Donald Cohen and Peter Dreier

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alifornia is broken—and broke. Its K-12 public schools, roads, levies, aqueducts, parks, and bridges; its health-care system; home health care for the elderly and disabled; and even its onceenvied public universities are all crumbling from long-term neglect and underfunding.

State employees have been forced to take three unpaid furlough days per month— equal to a 14 percent pay cut.

Every public service and every community across the state has taken a hit.

Emily Merchant, 27, saw the number of students in her San Diego kindergarten classroom double in one year. “I love teaching, but now I’m looking at other options,” she laments. “It’s too exhausting to do this forever and do my best for the students.” In Sacramento, the municipal fire department has slashed $2.1 million from its budget by shutting down some water-bearing trucks, a decision that could put lives and property at risk.

The state adopted a budget in July that cut 585,000 children from the popular Healthy Families program. Gov. Arnold Schwarzenegger is even considering releasing 20,000 inmates from California’s overcrowded prison system.

California isn’t alone. Thanks to the deep recession, virtually every state is projecting a deficit for the 2010 and 2011 budget cycles as demand for public services increases while revenues decline.

The National Association of State Budget Officers projects combined gaps of all state budgets of at least $250 billion over the next two fiscal years. Unable by law to run deficits, state governments have little choice but to slash public programs and eliminate thousands of public-sector jobs, which only further extends the downturn.

In fact, state and local governments are shedding employees faster than the federal stimulus program can restore the cuts, a 14 m a r c h 2 0 1 0

exacerbating the nation’s jobless figures.

California, though, is in a league of its own. According to the state’s chief budget analyst, Mac Taylor, personal income and business activity hit hard by the recession have caused state tax collections to plummet further and faster than at any time since the Great Depression. State legislators and the governor made $45.9 billion in spending cuts for the 2009–2010 budget year—$30.3 billion during an extraordinary midyear special legislative session last February and another $15.6 billion during the yearly July budget agreement.

California actually has three overlapping budget problems. The first—declining revenues resulting from a long, deep recession—is shared with every other state.

The second is the result of its own irresponsible fiscal policies, which Steve Levy, head of the Center for the Continuing Study of the California Economy, calls “our special hell.” In the late 1990s when the dot-com boom boosted California’s economy, state lawmakers increased spending by about $10 billion, mostly to play catch-up on K-12 education and to expand health and social services. But they also foolishly cut taxes by about $10 billion. When the boom busted, revenues fell, but Sacramento neither rolled back the tax cuts nor repealed the spending increases. Desperate for revenues, Gov. Gray Davis, a Democrat, in 2003 tripled the vehicle license fee, which generated $4 billion a year by boosting fees by $130 on a typical car. Schwarzenegger, a Republican, swept into office that same year in part by promising to roll back the unpopular increase in the “car tax.”

He kept his pledge and plunged the state into an even deeper budget crisis.

The third and most important budget problem is the fiscal straitjacket created

by Proposition 13, the original tax-revolt ballot proposition that voters approved in 1978, which capped property taxes and made it extremely difficult to raise revenues. As a result, even before the recession, California had steadily disinvested in its once world-class education system and physical infrastructure.

California now ranks at or near the bottom in many state comparisons. In 2006, the most recent year for which figures are available, it ranked 46th among states in per-student spending for public schools.

Not surprisingly, its eighth-graders came in next to last (just above Mississippi) in reading and ranked 45th (tied with West Virginia) in math. The state ranks 30th in the percentage of ninth-graders who graduate from high school.

Those who do graduate from high school now face shrinking opportunities.

California’s three-tiered higher education system—the 10 campuses of the University of California, the 23 California State University institutions, and the 109 two-year community colleges—was once a model of high quality and low fees. Now it is imploding—both hiking its fees and turning away tens of thousands of students.

In September, University of California President Mark Yudof announced a plan to raise tuition and fees by 32 percent by next September, increasing the annual cost of tuition alone to over $10,300, more than double the amount just five years ago. To close a $535 million budget gap, the system laid off 1,900 workers, imposed faculty furloughs, and reduced class offerings. The CSU campuses hiked tuition and fees by 32 percent but still must reduce enrollment by a total of 40,000 students over two years.

All of this isn’t because California can’t afford to provide these essential public services. Its gross domestic w w w. p ro s p ect. o rg

s tat e s i n c r i s i s product—$1.9 trillion in 2008—would make it the world’s eighth-largest economy. Its per-capita income—$41,571— ranked seventh among the states in 2007. The state has some of the country’s most productive, innovative, and profitable industries—high-tech, agriculture, tourism, entertainment, aerospace, and transportation—as well as three major ports, including the nation’s largest (the Los Angeles/Long Beach), which unloads almost half of the goods entering the United States. According to the Milken Institute, a pro-business think tank, California “remains the world’s center for venture capital and has the largest number of high-tech start-ups in the country” as well as a booming life-sciences sector. politics, not plummeting prosperity, are at the root of California’s dysfunction. And there is plenty of blame to go around.

Proposition 13, crafted by right-wing political operatives Howard Jarvis and Paul Gann, did more than simply limit property taxes. It created a constitutional requirement that all tax increases pass the Legislature by a two-thirds majority. (The state already had a two-thirds requirement to pass the annual budget, dating back to 1933.)

Jarvis and Gann meant to put the state in a fiscal straitjacket. They succeeded.

Now, three decades later, this change has made California virtually ungovernable.

Though the Democrats now have a 51-to-28 majority in the Assembly and a 25-to-14 majority in the Senate, it isn’t enough to raise taxes and pass a budget. They need three Republicans in the Assembly and two in the Senate to cooperate. Unfortunately, the GOP has lost virtually all of its moderates and is dominated by rabidly anti-tax, anti-government conservatives—giving a small minority veto power over the budget.

California is the only state that requires a supermajority for both tax increases and budget approval. As a result, each year the leaders of both parties get together and play chicken with the state budget, daring each other to bring the state to the brink of fiscal collapse. In the last two budget cycles, while the governor and the Legislature were

negotiating to pass a budget, the state was forced to hand out IOUs instead of cash payments to contractors, state workers, and aid recipients.

Eventually, enough Republicans (mostly those in swing districts) agreed on a package of tax increases and spending cuts in order to pass a budget, but they have paid a political price for doing so. Senate Minority Leader Dave Cogdill was ousted from GOP leadership after supporting the budget agreement. This year, a recall was launched against freshman Republican Anthony Adams, an ardent conservative assemblyman from Hesperia, after he voted for the package. The recall failed, but Republican true believers quickly readied primary challenges against Adams—who has announced he won’t run for reelection— and other GOP “turncoats.”

Another obstacle the state confronts is the unintended consequences of century-­old democratic reforms. In 1911, California Progressives created the state initiative process to put government directly into the hands of the people.

Since then, 331 initiatives have made it to the ballot. Ironically, collecting sig-

ing on public universities declined by 12 percent.

California has also been prey to faux reforms. In 1990 voters approved a ballot initiative that imposed three two-year term limits for members of the Assembly and two four-year limits for the Senate, while cutting legislative staffing budgets.

The high turnover means that lawmakers have to leave just as they are learning the ropes and developing some expertise.

The shortage of policy staff means that Sacramento policy-making is dominated by the “permanent government” of professional lobbyists, who disproportionately represent business interests.

A further obstacle to restoring the state’s viability is the allegation that it is anti-business. The state’s Republicans, powerful business lobbies, corporatebacked think tanks, and corporatefriendly economists like the media-savvy Jack Kyser (of the Los Angeles County Economic Development Corporation) constantly complain that California’s regulations and business taxes create an “unfriendly” business climate that drives away jobs and private investment.

In reality, this “crying wolf ” lobby is

California is the only state in the union that requires a supermajority for both tax increases and budget approval. natures and then waging a statewide initiative campaign now costs millions of dollars, limiting the process to interest groups with deep pockets.

Direct democracy has tied lawmakers’ hands in crafting a budget. In 1988, for example, the California Teachers Association sponsored Proposition 98, which committed the state to spend 40 percent of its annual budget on K-12 education.

In 2004, Californians passed a ballot initiative to increase funding for mental health by imposing a 1 percent tax on personal income over $1 million.

In 1994, Proposition 184 mandated “three strikes and you’re out” sentencing requirements. From 1984 to 2008, percapita spending on prisons increased by 126 percent, while per-capita spend-

wrong on all fronts. According to the California Budget Project, the state’s tax burden is only slightly above the national average. A Public Policy Institute of California study of business relocations concluded that “the number of California jobs moving to other states due to business relocation is relatively inconsequential.” A subsequent PPIC study confirmed that “rhetoric aside, California loses very few jobs to other states.”

Perhaps the most damaging fallout of California’s chronic budget gridlock may be public mistrust of government. A statewide survey conducted in September concluded, according to PPIC director Mark Baldassare, that the public “has now lost confidence in their leadership, and we are seeing record levels of distrust in state the american prospect

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government.” The poll found that 73 percent of all Californians—and 79 percent of frequent voters—said state government was run for the benefit of the few.

And most troubling of all for those who recognize the need for additional revenues, the PPIC polls discovered that three out of five Californians believe that state government wastes “a lot” of the money they pay in taxes. Only 5 percent said there was little waste. In fact, there is little “fat” in the state budget. California’s ratio of state employees to population is the third

the people and issues they care about. A growing number of business leaders, once opposed to any new taxes, now express concerns that the lack of investment in physical infrastructure, the future work force, and the social safety net is causing long-term damage to California’s economic health and competitiveness.

Two moderate business organizations (the Bay Area Council and Joint Ventures Silicon Valley) and the centrist Los Angeles Times editorial board are calling for a state constitutional convention to

Polls show that Californians favor raising taxes on rich industries and individuals over cutting education and health programs. lowest, behind only Nevada and Illinois, and is far below the national average.

Despite hostile attitudes toward state government, voters are nevertheless willing to raise local taxes to pay for the services they want. In the November 2008 election, in the depths of a worsening recession, voters in 23 local jurisdictions (including El Cajon, a solidly Republican suburb in San Diego County) adopted sales-tax increases to support local services, and in 17 school districts they passed parcel taxes—all by more than the required two-thirds margin. california has had some of the nation’s most progressive legislative leaders.

The previous Assembly speaker, Fabian Nunez, had served as political director of the Los Angeles County AFL-CIO. The most recent speaker, Karen Bass, is a former community organizer from South Central Los Angeles. Her recently elected successor, John Perez, is a former union organizer. But the combination of supermajority vote requirements and term limits (which lead legislators to constantly maneuver to seek the next office) thwarts progressive solutions.

California’s dysfunctional governance and chronic fiscal crisis have triggered a wave of blue-ribbon studies and policy proposals sponsored by various interest groups, each worried that California’s budget battles are having a negative impact on a 16 m a r c h 2 0 1 0

rewrite the document all at once rather than do it piecemeal. The Bay Area Council’s new coalition, Repair California, got approval from the attorney general to gather signatures to put two measures on November’s ballot—one calling for a constitutional convention and one setting rules for it. They intend to make “holistic changes to our state government and wrestle our state back from special interests.” But others are concerned that randomly selected citizen delegates at a constitutional convention would be no better than inexperienced term-limited legislators at fixing California’s broken political system and fiscal policies.

Convention madness aside, progressive unions, consumer groups, and moderate business leaders can probably reach agreement on a set of incremental reforms that could repair the tax and budget fiascos. The solutions fall into three general categories—generating new revenues, eliminating structural gridlock, and increasing federal responsibility.

Any solution to balance revenues and expenses necessarily means tax increases.

Polls show that most Californians prefer increasing taxes on profitable industries and high-income Californians over cutting education and health-care programs.

California think tanks and advocates have identified billions of dollars in potential new revenue sources. Restoring Schwarzenegger’s repeal of the vehi-

cle license fee would generate $6 billion annually. A small increase in the tax rate for high-income earners would generate $5 billion annually. Broadening the sales tax to include services (ranging from legal and engineering services to haircuts) could generate up to $8 billion per year, according to the Board of Equalization, a state tax agency. Progressives also point out that California is the only oil-producing state that doesn’t tax oil at the well—a potential source of $1 billion per year in additional revenues.

Jean Ross, executive director of the California Budget Project, argues that lawmakers should “start by repealing recent tax cuts given to some of the biggest and most profitable corporations.”

The September 2008 and February 2009 budget agreements included $2.5 billion in corporate tax breaks that only apply to a handful of the largest California firms. State law prohibits disclosing which companies benefit, but Apple, Intel, Paramount Pictures, and Walt Disney are among the large firms that supported these tax cuts.

To chip away at Proposition 13’s property-­tax limits, unions, consumer and community groups, and even some businesses, advocate a “split roll” system that would increase property taxes on business but maintain the current limits on residential taxes. Because Proposition 13 locks in property-tax rates at the time of purchase, the current system typically taxes new commercial property at a much higher rate than it does older firms, putting new businesses at a competitive disadvantage. Since residential properties are sold more frequently than commercial properties, the share of state revenue from residential property taxes has steadily increased, while the proportion from commercial properties has steadily declined. In 1994–1995, business property was assessed at 87 percent of its full market value, but by 2006–2007, the rate was down to 60 percent.

In Los Angeles County, in patterns typical of a whole state, single-family residences accounted for 39.9 percent of the tax roll in 1975, before Proposition 13.

This year their share is 55.8 percent. In the same period, commercial-industrial w w w. p ro s p ect. o rg

s tat e s i n c r i s i s property has gone from 46.6 percent of the county’s tax roll to 30.9 percent.

Disneyland—which has never changed hands—pays a nickel per square foot in property taxes, while a typical home pays over $2 per square foot. The splitroll change would generate $7.5 billion in annual revenue to the state.

Every progressive and now some business organizations agree the state can’t generate new revenue without structural reform that loosens the Proposition 13 straitjacket. An outright repeal of the law isn’t politically possible. Instead, the most talked about incremental steps would be, first, allowing a simple legislative majority to pass a state budget and to raise taxes and, second, eliminating the supermajority requirement for raising local taxes and bonds (for schools, libraries, and other public services), since voters are more likely to support a new tax when they can see local services or construction that it finances.

California Forward, an alliance of business moderates, labor and community leaders, and former elected officials, chaired by centrist Democrat Robert Hertzberg, a former Assembly speaker, is promoting a package of reforms starting with two 2010 ballot measures. The “Best Practices Budget Accountability Act” would lower the vote requirement for adopting the state budget to a simple majority and require “pay as you go” rules for new programs or tax reductions. But revising the supermajority requirement for the budget without doing so for raising taxes makes little sense given the state’s recent history of fiscal chaos. As well, adopting a pay-asyou-go plan in the depths of recession may lock in wholly inadequate levels of funding for essential programs.

In October, the Los Angeles County AFL-CIO and the Los Angeles Chamber of Commerce formed Californians for a Fresh Start. It introduced a ballot measure to modify term limits to allow legislators to serve a total of 12 years in either the Senate or Assembly. The sponsors’ hope is that a more stable Legislature will develop the political and legislative maturity to earn public trust to pave the way for fiscal reform.

Even with these changes, Levy, Ross,

and other experts agree that California can’t entirely tax itself out of the current budget crisis. According to Ross, given the depth of the recession, “no combination of spending cuts or tax increases is sufficient on its own to remedy the current shortfall without inflicting significant harm to the poor and the state’s economy.”

In short, solving California’s problems, like solving those of nearly every other state, requires federal help. “States can’t borrow the same way the federal government can,” Levy observes. In the short term, “massive federal investment to the states would be the best bang for the buck to create jobs and to stimulate economic recovery.” Without significantly more federal relief, the ensuing waves of state and local employee layoffs will hamper the nation’s economic recovery.

Levy warns that debates over specific

taxes or rules won’t resonate with voters unless they are part of a broader vision of California’s future. “It’s about a social contract,” Levy says. “It’s about whether we want great schools, and if we want every high school student to be able to go on to pursue higher education, and whether we should be building an infrastructure to secure our energy, water, and mobility needs.”

“It’s not about adding a penny or two to the tax rate,” he adds. “It’s about whether we want California to be a great place to live.” tap Donald Cohen is the co-founder and president of the Center on Policy Initiatives. Peter Dreier is professor of politics and director of the Urban & Environmental Policy program at Occidental College in Los Angeles.

Reform Amid Fiscal Ruin In some states, progressive leadership and grass-roots activism have turned crisis into opportunity for long-deferred tax reform.

By Greg Anrig

I

n October 2007, two months before the onset of the worst U.S. recession since the Great Depression, Maryland’s Democratic governor, Martin O’Malley, convened a special session of his state’s Democrat-controlled General Assembly in a high-stakes effort to close an unexpectedly large $1.7 billion budgetary shortfall. A central component of O’Malley’s proposal was converting the state’s flat income tax of 4.75 percent to a progressive system with higher brackets of 6 percent and 6.5 percent for upperincome households. At the same time, he advocated a combination of tax hikes on corporate income, sales, tobacco, and vehicle titles, along with reductions in taxes on property and the incomes of lower earners.

The progressivity of O’Malley’s plan

was somewhat weakened as the negotiating process unfolded, largely through the interventions of legislators representing Montgomery County and its influential minority of multimillionaires. Nonetheless, the final budget reduced income taxes for lower- and middle-income taxpayers while adding three new rates ranging from 5 percent to 5.5 percent on incomes from $150,000 to $1 million for single individuals and $200,000 to $1 million for married couples. In addition to those permanent changes, incomes over $1 million would be taxed at 6.25 percent for three years, beginning in 2008. At the same time, the newly balanced budget actually provided more funding to extend health-care coverage to 100,000 lowerincome residents, build public schools, clean up the Chesapeake Bay, and invest the american prospect

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in transportation infrastructure. The liberal columnist E.J. Dionne Jr., in a Washington Post column titled “A Governor Unafraid of Government,” wrote, “The sound you are hearing not only in Maryland but in state capitals across the nation is the crashing and crumbling of ideology, specifically a right-wing ideology that demonizes taxes and government while preaching that the public interest depends upon solicitude toward the comfortable and the privileged.”

Dionne’s pronouncement describes only a minority of states, but the experience of Maryland and several other states does suggest that a progressive fiscal politics is indeed possible as states face a deepening budget crisis. as the recession unfolded, with state tax receipts plummeting at the steepest rate on record, at least six other states entirely or predominantly under Democratic control followed O’Malley’s leadership and soaked the rich to help close budget gaps while minimizing cuts to basic public services. Unfortunately, the downturn has been so severe that even the most progressive state governments have been unable to completely avoid painful spending reductions and tax hikes on average citizens, notwithstanding federal stimulus support that modestly helped to soften those blows. Still, the efforts in those seven states to recalibrate their tax systems during the ongoing crisis are an important and welcome change.

Prior to O’Malley’s initiative in Maryland, the only other states to institute higher income-tax rates on upper-income residents were New York in 2003 and California and New Jersey in 2004. In general, the financing of state governments has always been highly regressive, loaded most heavily on the backs of low- and middle-income families through sales, sin, and flat income taxes, supplemented by lottery and other gambling revenues.

In addition to promoting fairness by shifting the burden onto high earners who prospered most during this era of rising inequality, taxing the wealthy is the least economically damaging way for states to meet their legal obligation to keep their budgets in balance during a recession. Not a 18 m a r c h 2 0 1 0

surprisingly, a regressive tax structure feeds the climate of revolt against taxes.

Altering that psychology requires taxation based on the ability to pay.

Beyond Maryland, the story so far in the six other states that added new incometax brackets for high earners, in brief: Wisconsin. In late June, the state’s Democratic governor, Jim Doyle, signed a budget that closed a $6.6 billion, twoyear shortfall in part by creating a 7.75 percent income-tax bracket on earnings over $300,000 for married couples and $225,000 for individuals. In addition, he cut in half the tax exemption on capitalgains income, which almost entirely affects upper-income households. Together those changes were expected to raise $529 million over the two-year budget window.

in its neighbor to the south, Oregon’s response to its own huge deficit and one of the highest unemployment rates in the country was indeed a stark contrast to the Golden State’s actions. But like California, Oregon is unusually reliant on voter referenda, and the $733 million in tax hikes are subject to public approval on Jan. 26.

Backed by business lobbies and antitax groups, the ballot measures would abrogate the transformation of Oregon’s income tax from a flat 9 percent to one that adds brackets of 10.8 percent for married couples earning between $250,000 and $500,000, and 11 percent for couples earning over $500,000.

(After 2011, the top rate would drop to 9.9 percent.) Largely because of federal stim-

The wreckage of Colorado’s public services provided compelling evidence against rigid strictures on state fiscal policies.

Thanks as well to $2.2 billion in federal stimulus aid, Doyle and his Democratcontrolled Legislature were able to avoid deep reductions in school funding while still reducing state spending by more than $3 billion through steps like across-theboard cuts to state agencies. Although Wisconsin’s unemployment rate soared from 4.7 percent in September 2008 to 8.3 percent a year later due mainly to a surge in manufacturing job losses, the bleeding appears to have stopped at a level well below the national average—at least for the moment. Doyle announced that he won’t be seeking a third term, saying that he doesn’t believe elected executives should serve more than two terms: “I know that I will regret this decision many times over the coming year, but I am not going to pull a Brett Favre on you.”

Oregon. “I will be the first to tell you I do not think Oregon is California,” said Gov. Ted Kulongoski, a Democrat, as he signed a budget that included higher tax brackets on upper-income households and increases in corporate taxes. By efficiently approving legislation that largely avoided the stalemates and draconian cuts to public services implemented

ulus aid that has been spent more rapidly and effectively than in other states, Oregon’s unemployment rate dropped from a peak of 12 percent to a still-high 11.1 percent. The state’s term-limit law prevents Kulongoski from running for a third consecutive tour of duty, but the January vote will be a revealing test of progressive taxation’s popularity.

North Carolina. In this once stalwart conservative state, Gov. Bev Perdue, a Democrat, and the two Democrat­controlled chambers of the state Legislature jousted for more than a month beyond the July 1 fiscal year deadline to settle on a budget that received no Republican votes. Their agreement added a tax surcharge of 2 percent for married couples with incomes between $100,000 and $250,000 and single filers with incomes between $60,000 and $150,000. The additional rate is 3 percent above those thresholds, with the surcharges applying only for 2009 and 2010. A 1-cent increase in the sales tax was also approved. The main sticking points between Perdue and the Legislature related to her preference for higher taxes in exchange for more support for education and other public w w w. p ro s p ect. o rg

s tat e s i n c r i s i s services. Perdue, who was elected last year, quickly lost popularity as layoffs in the state’s manufacturing sector knocked the unemployment rate up to the 11 percent range. But one poll after the budget agreement was reached showed her approval rating bouncing up 14 points to 43 percent.

Connecticut. This state’s Democratcontrolled Legislature ultimately carried the day against popular Gov. M. Jodi Rell, a Republican, after the longest budget battle in the state’s history, which dragged on for two months into the new fiscal year. In addition to a dollar increase in the cigarette tax, the new budget included an increase in the top bracket from 5 percent to 6.5 percent for individuals with incomes over $500,000 and married couples filing jointly in excess of $1 million. The Legislature fended off most of the deep cuts to a wide range of programs that Rell had sought, but the budget also included many accounting maneuvers that may come home to roost before long. Soon after the budget became law without her signature, Rell announced that she would not be running for re-election in 2010 even though her approval ratings remain well above 50 percent. Democrat William Curry, who lost the governor’s race in 2002, told the Hartford Courant, “She may have won the prize for least ideological Republican of her generation, and that went over big in Connecticut.”

Even still, she steadfastly opposed the millionaire’s tax and tried unsuccessfully to repeal the state’s estate tax.

New York. Although it’s difficult to find reason to applaud the Empire State’s notoriously dysfunctional and sometimes clownish Legislature, its Democratic leadership deserves credit for pushing through new top brackets for high earners that are scheduled to remain in place for three years. The rate was raised from 6.85 percent to 7.85 percent for individuals with income between $200,000 and $500,000, and for married couples filing jointly with income between $300,000 and $500,000. Regardless of filing status, the new rate on income above $500,000 is 8.97 percent. Since that budget was approved in March, the state’s fiscal con-

dition has continued to deteriorate along another piece of good news related to with the state’s economy. At this point, state taxes during this otherwise disthe unpopular Democratic governor, mal economic period was the defeat David Paterson, who resisted the higher in both Maine and Washington of the upper-income tax rates, is acting more tax and spending limitation of the soresponsibly by trying to push a recalci- called Taxpayer’s Bill of Rights [See Iris trant state Senate to address a deficit J. Lav and Jon Shure, “Loosening Fisthat’s already back up to $3.2 billion. cal Straitjackets,” page A4]—a referHawaii. The Aloha State’s heavily Dem- endum that Grover Norquist and other ocratic Legislature overrode Republican anti-government zealots have pushed Gov. Linda Lingle’s veto of tax increas- onto state ballots over the years. Largely es, which included the imposition of because TABOR proved to be so disasthe highest state-level income-tax rate trous in Colorado, the one state where it in the country. The top rate was raised was fully in effect for an extended perifrom 8.25 percent to 9 percent for married State Tax Increases couples with income Over half of all states have raised taxes in the current between $300,000 recession (2008–2009). and $350,000; 10 percent for income between $350,000 and $400,000; and 11 percent for income above $400,000. In addition, the state’s standard deduction and the personal exemption were increased by 10 percent, reducing the taxes owed by low- and moderateincome families. As Between 0% and 1% in most other states, Between 1% and 5% new budget gaps have More than 5% quickly emerged since source: center on budget and policy priorities the deal for the current fiscal year was reached.

In Hawaii, where declining tourism has od, none of the 20 states that have conpushed the unemployment rate to 7 per- sidered TABOR constraints since 2004 cent, Lingle recently vowed again to draw have adopted them. The wreckage that the line against additional tax increases. became of Colorado’s public services and New Jersey. Gov. Jon Corzine’s defeat fiscal condition has proved to be comin November to Republican Chris Chris- pelling evidence against TABOR’s rigid tie can be blamed on a lot of factors, strictures on state fiscal policies. (Maine foremost among them the state’s weak also deserves credit for overhauling its economy and hostility toward high prop- tax system in ways that make it more erty taxes. Relatively low on the list was equitable and progressive.) the increase in upper-income tax brackReform depends on the presence of ets that the Democrat-controlled Leg- courageous state officials and on-theislature approved and Corzine signed ground advocacy groups to contest the in June as part of their budget agree- permanent influence of business lobbies. ment. For one year only, income-tax In these recent reform efforts, progresrates on households with incomes above sive policy and grass-roots groups worked $400,000 will rise, with the top level closely with legislative allies and conon earnings above $1 million increasing ducted sophisticated public-education from 8.97 percent to 10.75 percent. and outreach campaigns. the american prospect

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In Wisconsin, a broad-based coalition led by groups like the Wisconsin Council on Children and Families and the Institute for Wisconsin’s Future created a catalog of revenue options that it advocated to the governor and legislative leaders.

The coalition held forums statewide to advance these proposals and directed advocacy efforts in key legislative districts. Further, it held rallies at the state Capitol to show support for the efforts.

In Maryland, at the request of legislative leadership, the Maryland Budget and Tax Policy Institute, the Maryland Council of Nonprofits, and other organizing groups conducted analysis and delivered testimony to legislative committees on the need to advance revenue proposals. They worked with members who were on the fence to make the case for revenues.

In Oregon, progressive groups conducted extensive polling to gauge public attitudes relative to revenue options.

They used this information to help craft messaging and guide policy options that were ultimately advanced by the Legislature. The coalition Our Oregon is resisting the repeal campaign, making the case to the public that these measures are a necessary and reasonable part of a balanced solution to the state’s budget crisis.

Elsewhere, coalitions like Together for North Carolina, the Better Choices campaign in New Jersey, and New Yorkers for Fiscal Fairness came together to advance revenue proposals. They directed sophisticated, targeted campaigns that included placing letters to the editor, phone banking, coordinating local constituent meetings with legislators, and organizing rallies at states’ capitols. Ultimately, these public-education efforts were very successful. In many cases the revenue proposals promoted by the coalitions came from members of the State Fiscal Analysis Initiative, like the Fiscal Policy Institute in New York, New Jersey Policy Perspective, and the North Carolina Budget and Tax Center.

Although the worst of the recession is winding down, populous states are expected to confront an ongoing budget squeeze for years to come. State and a 20 m a r c h 2 0 1 0

local tax revenues are likely to remain meager, the share of the population relying on state and local services will be high, health-care and educational costs will continue to soar, state pension plans will remain badly underfunded, and the federal stimulus money that staved off disaster will run out unless Congress passes bolder emergency aid. In that climate, governors and state legislatures can’t on their own fix a system of federalism that is rapidly breaking down. But,

as demonstrated during the immediate crisis, they can act to shift the burden of financing state government more toward residents who are best able to afford higher taxes. In a small but meaningful way, that’s progress. tap Greg Anrig is vice president of policy and programs at The Century Foundation and the author of The Conservatives Have No Clothes: Why Right-Wing Ideas Keep Failing.

State Fiscal Gimmicks: A Budgetary Balancing Act Phony budget accounting defers the day of reckoning— but raises costs.

By Katherine Barrett and Richard Greene

W

hen state legislators and governors talk about the care with which they keep their states fiscally sound, they frequently refer to the mandate that they pass a balanced budget­—a requirement in all states except Vermont. Every dollar spent is presumably balanced against a dollar coming in. This sounds pretty good in theory. Who could get into fiscal troubles with a system like that?

Almost everybody, it turns out. When revenues fall, budgets are often balanced with gimmicks that can cost states, localities, and taxpayers more money in the long run. To be sure, the day the budget passes, projected revenues equal anticipated expenses. But the gimmicks only defer the day of reckoning. Within weeks or months, revenues come in low, expenses come in high, and it’s time to turn to further fiscal magic to get through the year.

Consider Arizona. That state has decided to sell a passel of state buildings and then lease them back so the state can continue to use them. That could raise around $737 million for gen-

eral operations in the near term—but it means that the state will have to cough up rent year after year after year. Cut through the complexities of the deal, and it becomes clear that Arizona is really borrowing that money—sidestepping the constitutional requirement forbidding deficit spending and with no real plans for paying the annual costs that go out decades into the future.

In a remarkable segment on Jon Stewart’s The Daily Show, correspondent Jason Jones interviewed an Arizona state senator, Linda Lopez, who reacted with great discomfort when asked, repeatedly, how the state was going to come up with the rent in future years, after spending the $737 million in 2010.

Jones’ last question in the interview: “OK. I gotta say again. Next year, what are you gonna do?”

Lopez’s answer: “Oh my goodness.

You’re killing me here. You’re absolutely killing me.”

This is not the kind of answer designed to give citizens comfort. And Arizona is hardly alone. “Many states have historically used a whole array of gimmicks to w w w. p ro s p ect. o rg

s tat e s i n c r i s i s begun nipping at money supposedly dedicated to telecommunications for general government purposes and that New York and Rhode Island have been doing so for years.

Sometimes, states simply delay paying their bills. Minnesota faced a $2.7 billion budget gap that remained at the end of the 2009 legislative session. Gov. Tim Pawlenty has been dead set against new some states shortchange their public- taxes. So, according to Christina Wessector pension plans, even though they’ll sel, the budget project deputy director of eventually have to find those payments the Minnesota Council of Nonprofits, he instead simply delayed $1.8 billion in school payments. “Normally, schools get paid 90 percent of their funding in one year,” she explains, “then [they] get a 10 percent followup payment in the next year. That small delay in payments allows for the state to adjust the actual amount paid to schools to account for Arizona will be paying rent for its use of once-public changes in enrollment, buildings, like the State House of Representatives (right). etcetera. But the gover-

ross d. fr anklin / ap images

hide the fact that their budgets aren’t really balanced,” says Don Kettl, dean of the school of public policy at the University of Maryland. “Today’s fiscal nightmare has put pressure on many to dig even deeper into their bag of tricks.

Unfortunately, this kind of chicanery almost inevitably leaves them in worse shape in years to come.”

in order to make good on promises to retirees. In 2003, 2004, and 2005, Oklahoma’s payments to its Public Employees Retirement System covered less than 60 percent of the actuarially required contribution. Between 2000 and 2006, New Jersey’s contributions to its pensions never exceeded 30 percent of the required amount. Others use money that was borrowed for capital expenses, like buildings, to pay for operating expenses, like payroll.

A number of states play the shift-andslide game, in which money collected for one purpose winds up being used for another. In Wisconsin, for instance, a 75-cents-a-month fee on cell phones was originally earmarked for improvements in its 911 emergency-response services, but the state diverted $100 million, over fiscal years 2010 and 2011, to local governments in the hope of reducing the pressure to hike property taxes. The Associated Press reported in July 2009 that Oregon, Delaware, and Hawaii have

areas that are not likely to have reserved stocks of cash—having to reduce program outlays and resort to layoffs.

Illinois legislators, meanwhile, came to the end of their last fiscal year around $4 billion in the red. What to do? Legislators decided to just pay the money sometime in the new fiscal year. This is bad news for vendors, large and small, who generally anticipate that a state is probably going to pay its bills on time. It’s also potentially bad news for the state in a variety of ways. Vendors may well add a premium—which could be more than 5 percent—to compensate themselves for not getting paid in a timely way. Not only is there no such thing as a free lunch in this case but the state winds up paying for the lunch with interest. california, not surprisingly, may take the prize for using the most gimmicks in recent years. Consider this partial list: California borrowed at least half a billion (as reported in the February and July budget packages) from various specialfund accounts, recorded $1 billion in revenues by assuming that parts of the State Compensation Insurance Fund could

Arizona is selling state buildings and then leasing them back so the state can continue to use them—a disguised public debt. nor changed that percentage to 73 percent up front and 27 percent in the next year.

This is a huge burden to schools that now need to front more money themselves—so they may need to turn to reserves or shortterm borrowing to cover that gap.”

Short-term borrowing can be an expensive proposition. Who pays? The same citizens whom the governor saved from increased taxes.

In New York, Gov. David Patterson in mid-December announced that he intended to hold back some $750 million in payments scheduled to go to schools and local governments. When will the state make good on its promise to fully fund schools and localities? Nobody seems to know the answer, which leaves schools—particularly those in poorer

be sold, and redirected at least $1.6 billion in transportation funds. The state also borrowed some $2 billion from its localities, picked up another $2.3 billion by speeding up tax collections, and raised $1 billion by shifting the last payday of the fiscal year into the next year.

Few in the state may notice if paychecks are delayed by a single day. But when those 24 hours let the checks slide over into a new fiscal year, it can mean huge artificial savings for the state. They’re artificial, of course, because the money still has to be paid—and these gimmicks produce no new money.

Ultimately, all these actions are taken in order to avoid the hard decisions that can truly put states on firm financial footing: tax increases, service cuts, and the american prospect

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genuine gains in efficiency. But the first two tend to put off voters, and the third is elusive at best.

Still, “there’s just no alternative to stepping up and facing the megaissues,” Kettl says. “Sooner or later they all stare us in the face. It might seem easier to wait them out, but when they come back in the future they never get any easier to solve—and they often present all sorts of nasty new twists that make resolving them even more painful.”

“It can seem more politically expedient to let future leaders take the heat,” Kettl adds. “But that isn’t what leadership is all about.” tap Katherine Barrett and Richard Greene, principals of Barrett and Greene, Inc., are correspondents and columnists for Governing magazine, founding authors of the B&G Report, and consultants to the Pew Center on the States.

Buckeye Budget Blues Ohio has all the reform elements in place— except political will.

By Amy Hanauer

I

n Ohio, decades of deindustrialization, a tax-cut strategy pursued with nearly equal zeal by both parties, and the deep recession combine to create a severe fiscal nightmare. There are some promising glimpses of momentum building for a smarter, more progressive approach. But despite a swing toward the Democrats in recent years, fundamental reform has yet to materialize.

Ohio faced a budget shortfall of $2.6 billion in fiscal year 2009 and a shortfall of $3.3 billion in fiscal year 2010.

Last summer Gov. Ted Strickland and Ohio legislators cobbled together a deal that relied on much-needed federal fiscal relief to states, more than $2 billion in excruciating budget cuts, and a scheme to allow video slot machines at horse-racing tracks in this traditionally anti-gambling state. However, the Ohio Supreme Court said the gambling extension required voter approval through referendum, forcing lawmakers to play another hand.

Ohio Democrats, who took over the governorship in 2007 and the Ohio House in 2009, have mostly hewed to an antitax rhetoric and policy approach nearly as extreme as the Republican brand. a 22 m a r c h 2 0 1 0

Democrats have continued to phase in a Republican-passed tax-slashing plan that includes across-the-board incometax cuts and replacement of two major business taxes, including our corporate income tax, with a system designed to bring in much less (which then failed to generate even that lower forecast). The new system relies on a commercial activity tax, which was supposed to bring in about half the revenue that the corporate franchise tax and the tangible personal property tax, both eliminated, had generated. There is now no general business tax in Ohio, and the new system is not bringing in the revenue its supporters had promised.

Before the recession hit, the initial cuts did not immediately prevent some important new investments—expanding preschool; holding higher-education tuition costs down; and broadening lowincome children’s eligibility for health insurance. But as revenues spiraled downward, from both the recession and the tax changes, it became clear that the budget tightrope could not be walked without decimating services or restoring needed revenue.

In a bipartisan fashion, the governor

and lawmakers began deeply hacking at basic public infrastructure with cuts both shortsighted and cruel. “I downsized this government almost 5,000 fewer employees now than when I became governor,” Strickland boasted in a December 2009 interview in The Columbus Dispatch. “I’ve done what Republicans have claimed they’re going to do for decades and have failed to do.”

Mental-health treatment and outreach to the homeless were cut. Elderly protective services, prescription assistance for the poorest and sickest, public transit, after-school programming, environmental inspections of coal mines, need-based college aid, and a program that had helped 14,000 kids prepare for kindergarten were also among the casualties.

This type of slashing might defer some costs, but the piper will be paid later and larger in higher costs for remedial education, pollution and its cleanup, juvenile justice, nursing homes, and more.

The budget cuts dramatically weaken the bridge out of poverty and into the middle class. In some corners of the state, suicide rates have doubled. Counties have cut nurse visits to the severely disabled, dental care for the poorest children, and even indigent burial assistance. Until federal stimulus money was identified to rescue them, Lorain County had announced complete elimination of bus routes, leaving 300,000 residents with no ability to get around without a car.

Ohio has a dwindling force of socialservice professionals, just as the frayed safety net is being stretched ever thinner to catch the increased number of families needing help. In Lucas County, home to Toledo, the Job and Family Services Department’s staff plunged from 625 to 375 over a decade, while in the last year alone, claims for Medicaid, cash assistance, and food stamps have spiked—the last by 14,000 cases. In rural Van Wert County, a 50 percent jump in food-stamp eligibility clashes with 25 percent drops in staffing.

In December, Democrats and a few Republicans found the courage to oppose further budget cuts, temporarily halting the last phase of a scheduled income-tax cut. The move filled an $850 million hole w w w. p ro s p ect. o rg

s tat e s i n c r i s i s in the budget. But even its advocates presented it as just a delay, failing to seize the moment to defend the value of the public sector.

Without additional federal fiscal aid next year, analysts predict a $7 billion or $8 billion fissure out of about $51 billion in the two-year budget covering fiscal years 2011 and 2012, just to maintain current services. This approximate 15 percent shortfall mirrors the gap in many states. but maybe ohio can point to a better way. A small caucus in the Legislature has worked with the Progressive States Network to outline an approach that would better meet people’s needs and make the state budget and economy more sustainable. Two progressive caucus leaders have introduced a bill to restore the sensible 7.5 percent tax bracket that once applied to income over $200,000 and to create a new half-millionaire’s bracket of 8.5 percent for income over $500,000. Caucus members have also gotten behind investments in renewable energy, higher building-efficiency standards, moratoriums on home foreclosures, expansions in health-insurance coverage, stronger regulation of credit cards, more renter protection, and other innovations that invest in our economy and foster economic justice.

Additionally, a promising urban task force, co-chaired by Clevelandarea state Reps. Mike Foley and Sandra Williams, has issued a report that calls for fewer tax abatements, better intercommunity collaboration on business attraction, foreclosure remediation, more mass transit, home weatherization, and improved adult-worker retraining.

These efforts could begin to revitalize Ohio’s beleaguered cities. Both the progressive caucus initiatives and the urban task force recommendations are mostly in the proposal stage, but they represent green shoots for a progressivism that has been dormant in recent years.

While organized labor is weaker than it once was in this industrial state, unions can still unite people around equity, as they demonstrated in a successful 2006 minimum-wage campaign. Community organizing is enjoying a modest resur-

gence with groups like the Mahoning Valley Organizing Collaborative effectively mobilizing citizens to push for equity. A state budget-advocacy coalition, the Campaign to Protect Ohio’s Future, successfully repelled a 2005 attempt to amend Ohio’s Constitution to limit state and local government spending. After the dismal 2010–2011 budget, this group has new members, new energy, and a new resolve.

Leaders, who include many of the state’s social-service providers, have vowed to reconstitute a revenue-raising effort for future budgets. If progressives join forces, backed by good research, the politics of tax-cutting and service-slashing might begin to look different. further federal fiscal relief is an essential part of the solution. Without the aid received so far, even Ohio’s relatively miserly 2010–2011 budget wouldn’t have been possible. Help from Washington is essential to prevent layoffs, halt a further downturn, relieve need, and buoy private investment and spending. But states also need to bring their own tax systems back into alignment after years when a slashing mentality held sway.

While federal fiscal relief and more balanced state tax policy are critical, they alone will not end the high­unemployment economy. And as long as unemployment is elevated, tax receipts will be too low. To restore employment, we need a muscular federal jobs program. The Economic Policy Institute has called for spending an additional $120 billion over the next three years for hiring unemployed Americans to fix and enhance our communities. This would create over a million jobs, raising family incomes and unleashing an army of us to help revive the economy.

A mix of these public jobs and other solutions could make America more energy efficient. The national Apollo Alliance sketches out the blueprint beautifully. Among the pieces: upgrading our outdated electrical grid, weatherizing public buildings, lending for and publicly funding weatherization for homes and commercial buildings—what President Barack Obama and others have dubbed “Cash for Caulkers.” We also need more support for mass transit, which could promote a made-in-America supply chain in renewable-energy equipment

While federal fiscal relief and more balanced state tax policy are critical, they alone will not end the high-unemployment economy.

In Ohio, that means reversing the unsustainable income-tax cuts passed in 2005 and putting in place the new top brackets described above. Together, these would generate more than $950 million a year, most paid by the very richest sliver of Ohioans. The previously mentioned changes in our corporate tax structure are costing Ohio about $1.6 billion a year, according to the Ohio Department of Taxation. We should adjust the rate of our business taxes so that they bring in as much inflationadjusted revenue as our previous system did in 2005. This would provide significant revenue for the state, while still being (perhaps overly) generous to business, which already paid a smaller share in 2005 than it did a generation ago.

and help factories retool for the cleanenergy economy. And a more generous policy of need-based financial aid for learning beyond high school could pull other young, often unemployed workers out of the labor market until it recovers.

This great recession is killing state budgets, most cruelly in places like Ohio where the fiscal effects of the downturn are most extreme. Better policy could help Ohio and kindred states step back from the abyss—not only with our budgets in better balance and our public services intact but with a new approach that leaves us far more prepared for the challenges of tomorrow. tap Amy Hanauer is executive director of Policy Matters Ohio. the american prospect

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