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States of Crisis

Jan 24, 2011, Vol. 16, No. 18 • By MATTHEW CONTINETTI
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As if Congress didn’t have enough to worry about, the states are on the verge of a fiscal meltdown. From Albany to Springfield to Sacramento, the bill for decades of profligacy has suddenly come due. A gimpy economy brings in lower revenues for state comptrollers. The bond vigilantes have caught the scent of the states’ massive unfunded liabilities. The federal stimulus money that some states used to cover expenses is about to run out. And worst of all, Mitch Daniels can’t be cloned.

States of Crisis

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The good news is that, thanks to recent elections, a slew of pro-business budget hawks now occupy governors’ mansions across the country. What’s more, even some liberals recognize the magnitude of the crisis. There must be something in the water of the Hudson, because New York Democrat Andrew Cuomo is starting to sound like New Jersey Republican Chris Christie. Cuomo recently delivered a state of the state address that ought to be required reading in every capital. He railed against an out-of-control government, dismissed any tax hike, and extolled the virtues of the private sector. Ronald Reagan would have been proud.

No one wants his state to end up like Illinois, which massively increased personal and business taxes last week to cover a fiscal gap the size of the Olduvai Gorge. But the governors won’t easily avoid that fate on their own. State budgets are so dependent on federal dollars that Congress has a role to play as well. What the governors need are federal policies that allow the states maximum discretion to economize and innovate. It’s lucky for everyone involved that the governors’ interests dovetail with those of the House Republicans.

One of the biggest drivers of state deficits, for example, is Medicaid, the health insurance program for the poor. Medicaid is funded through a combination of state and federal dollars; the poorer your state, the larger the federal subsidy. But those subsidies come with strings attached. The federal government, in the form of “maintenance of effort” requirements, dictates where and how the states must spend Medicaid funds.

Such requirements tie governors’ hands when it comes to writing budgets. They also force governors into uncomfortable situations, since the offer of federal money is often predicated on additional spending by the state. As a group of 33 governors put it in a January 7 letter to the president and Congress, “Efforts by the United States Department of Health and Human Services (HHS) to regulate state operations impose greater uncertainty on our budgets for oncoming years and create a perfect storm when coupled with the current state of the economy.”

Even absent a crisis in the states, the GOP House would be wise to reexamine Medicaid. So why not begin by suspending or eliminating the maintenance of effort requirements? This would allow the governors greater latitude in shaping their budgets. Congress could also turn Medicaid into a block-grant program along the lines of welfare. That way each state would know in advance how much money it would receive in a given year. A block grant would force state governments to spend the money more responsibly. Feckless legislators and governors would no longer be able to drink from an endless spigot of money originating in Washington.

The federal government doesn’t restrict its meddling to health care. There are all sorts of mandates with education and transportation spending as well. Putting fewer conditions on the money the federal government sends to the states would not only help the governors. It would also advance House Republicans’ deregulatory agenda. Anything that allows the states to experiment and compete is worth trying. The Davis-Bacon Act, for example, requires states to pay the “prevailing wage” in contracting. In the real world, this forces the states to contract with unions at the taxpayers’ expense. Repealing Davis-Bacon would enable the states to save money—or build more highway projects at the same price. It’s a good deal either way.

There are also things the federal government can do to make states better bookkeepers. Congressman Devin Nunes of California proposes shining a light on state and local governments’ defined-benefit pension plans. His Public Employee Pension Transparency Act would give us a sense of the true cost and disposition of pension funds. Municipalities would have to reveal their (currently hard to find) financial data and disclose their actuarial assumptions. And since state pension fund accounting makes Enron look like a paragon of fiduciary responsibility, the bill would discourage further binges.

Republicans in Congress might also want to revisit the way the federal government subsidizes state borrowing through the tax deduction for municipal bond interest. And Congress could take up the state bankruptcy law proposed by University of Pennsylvania law professor David Skeel in these pages last year. As always, the best solution to debt crises is robust economic growth, so conservative tax, spending, and regulatory policy will help the states too. The opportunities for imaginative and constructive policy are endless. Time to get to work.

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