Very Serious
Very Serious with Josh Barro
David Schleicher on the Fiscal Whipsaw in State Governments
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David Schleicher on the Fiscal Whipsaw in State Governments

COVID filled state government coffers; now, fiscal deficits abound. What should state and local officials do?

Dear readers,

I’ve written a lot over the last year about the federal budget and how different the federal fiscal situation is than it had been over the 25 years leading up to COVID. The excessively large federal budget deficit is the subject of intense political fighting, but it’s also a significant substantive problem for the economy in a way that hasn’t been true since I was in elementary school. Inflation is elevated, interest rates have had to rise to contain inflation, and that means both that government borrowing is increasingly expensive, and that it crowds out private sector economic activity.

The picture in state governments is related, but different.

While COVID ballooned the federal budget deficit, it was actually a fiscal windfall for states, which enjoyed generous federal aid and surprisingly strong tax collections. Federal aid to individuals and businesses propped up consumer spending (and sales tax receipts), while rising asset prices strengthened the property tax base and generated strong income tax receipts from capital gains. In 2021, state governments were flush — and sometimes, they even made responsible choices, making deposits into their pension funds and building up their rainy-day funds to extremely high levels. The labor shortage has also, perversely, strengthened state and local government finances — as public-sector wage increases failed to keep pace with the private sector, and many jobs at schools, police departments and other agencies went unfilled, the quality of state and local government services deteriorated. But those governments also saved quite a bit of money on payroll.

But states and localities have also experienced a whipsaw. The strong capital gains tax receipts of 2021 were not so strong at all in 2022. Federal COVID aid tapered off. Government workers are belatedly getting the raises that are needed for hiring and retention. Many governments that just two years ago were figuring out how to spend big surpluses are now addressing large deficits. If they largely socked that money away, they’re well positioned; if they used it to establish new government programs and good taxes, not so much.

To talk about how the states are managing all of that, I invited Yale Law School professor David Schleicher for an episode of the Very Serious podcast. David is an expert on state and local government finance, and I had a wide-ranging conversation with David about how states have (and have not) learned the lessons of their budget crises from the Great Recession, and how they’re adjusting to once-again lean times.

For the most part, what states are experiencing now is a problem, rather than a crisis. We do not expect near-term insolvencies in states or major municipalities. But in the longer run, some places — especially in the Midwest — face the risk of a vicious cycle: relative economic decline, which weakens the tax base, which requires higher tax rates or reduced public services, which further reduces economic competitiveness, which weakens the tax base, and so on until it’s no longer clear why anyone wants to live or do business in Chicago.

To break that cycle, governments need to find ways to do more with less. A silver lining of the fact that a lot of American local government is inefficient — especially when it comes to infrastructure delivery — is that there really are opportunities to save taxpayers’ money while improving the quality of government. But if those reforms were easy, they would have been done already.

I hope you enjoy the episode and I invite you to post questions or responses in the comments.

Very seriously,

Josh

Click here for a transcript of this episode.

Discussion about this podcast

I hope Chicago can figure it out. I lived there for two years, and absolutely loved it, even with the harsh winter. I think it is one of the most unique and beautiful cities in America (in the world), and it would be very depressing for it to go downhill and end up like a Saint Louis or Detroit. It's gonna take good governance and perhaps a check on the Democrats' grip on power in the state and cities, much like California, I think. Josh, do you think if moderate Republicans can make inroads in the state, it would help the politics and help with fiscal responsibility?

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As someone who has lived in the far suburbs of Chicago for the last 15 years, sad to say Chicago has already started heading downhill, with no real plan to fix it. The new mayor is a puppet of the Chicago Teachers' Union, who took loans out (with future union dues as collateral!) to get him elected. Their agenda (and therefore his) is about as far to the left as you can get. Unfortunately, if moderate Republicans (and moderate Democrats) were able to tip the scales, Paul Vallas would have been elected instead of Brandon Johnson. More and more people from the suburbs refuse to go downtown any more due to crime (regardless of the actual odds of crime happening to them, it's all about perception), overall commercial real estate vacancy rates are around 20%, with downtown retail space even higher, and no one is even pretending that fiscal responsibility is a priority. It's a sad state of affairs for a wonderful, unique city.

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Yeah, I'm sure a lot of folks are pessimistic about the state of affairs. The one silver lining is Vallas came close, which means maybe with a few adjustments (perhaps a person of color running who is a moderate Dem or Republican), changes can be made. I'm hoping for the best, as it really is a wonderful city.

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This was a really entertaining and well-produced episode.

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The question is

How do you become the company?

That state and local governments

Identify

And then take out loans

In order to pay you

To do stuff

...

Municipal bonds yo

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Very Serious
Very Serious with Josh Barro
Very Serious is a weekly conversation with top political commentators, columnists and policymakers, focused on how events in the news relate to major, long-standing controversies in politics, economics and culture. Host Josh Barro is joined by a rotating set of regular guests to work out the ideas behind the arguments on topics serious and not-so-serious. It’s a great conversation across ideological lines that will leave you entertained, enlightened, and maybe even persuaded.