"[A] state may, if its citizens choose, serve as a laboratory; and try novel
social and economic experiments without risk to the rest of the
country."
- Justice Louis Brandeis, New State Ice Company v Liebmann, 285 U.S. 262 (1932)
By Brian Barry
The electoral map, the demographics
behind President Barack Obama’s re-election and the high-end tax
increases that were just wrung from the Republicans give
Democrats reason to believe that long-term political trends are
on their side in budget negotiations. This view, however,
ignores what is happening at the state level.
The fiscal outlook for many states is unsustainable. This
eventually may influence the politics of the national budget,
both directly (through battles over federal measures to help
troubled states) and indirectly (through voters’ attitudes
toward government).
It may take a decade or more for this dynamic to take hold,
but as leaders of both parties bargain over the debt ceiling and
assess their strategies for deficit talks during Obama’s second
term, they should also think about the path of state finances.
The prospects should unnerve Democrats, in particular: The 26
states that Obama carried in November tended overwhelmingly to
have lower credit ratings than the 24 where he lost.
The most obvious examples are California and Illinois, two
big states that are deep-blue politically and deep in the red
fiscally. The pattern holds much more broadly, however, across
the states that broke for Obama rather than the Republican
nominee, former Massachusetts Governor Mitt Romney. To see this,
imagine an electoral college in which each state’s worth, rather
than being dependent on its population, was instead determined
by the soundness of its Standard & Poor’s credit rating.
Credit Ratings
For easy comparison, the 50 states in this make-believe
electoral college (which would exclude the District of Columbia)
could be assigned a cumulative 538 points, equal to the total
number of votes in its real-world counterpart. The 13 states
with the highest rating, AAA, would get 15 points each, for
example; those with the next best rating (AA+) would get 12
points each, and so on.
Using this system, the states that Romney won would be
sufficient to give him a strong victory in this imaginary
electoral college: 278 to 260. A simpler system, which assigned
each state from zero to five points depending on which of six
S&P buckets it fell in, would also give a solid victory to
Romney, 94 to 88. It would appear, then, that Obama, who won
handily in both popular and electoral votes, did so largely by
carrying states that are more poorly governed fiscally.
To see the pattern another way, consider the type of state
where each candidate racked up points in the real Electoral
College. Romney got 73 percent of his electoral votes from 16
states that have either AAA or AA+ ratings from S&P; Obama
received only 39 percent of his electoral votes from states with
these two highest ratings, and those included swing states such
as Florida, Ohio and Virginia. Instead, the bulk of the
president’s electoral support -- 61 percent -- came from 14
financially weak states that he won handily. These states had
credit ratings of AA or below and he won 13 of the 14 by at
least five percentage points.
To be sure, a few states that consistently trend
Republican, such as Arizona and Kentucky, have lower credit
ratings, too. Governance has also been divided in some states:
as at the national level, voters will be treated to a debate in
these capitals about whether high-spending Democrats or low-
taxing Republicans are more to blame.
Still, it is likely that the bluest states will
disproportionately be the first to face serious fiscal stress
over the next few decades. It will also be hard for high-tax
states (the most Democratic ones) to solve the problem with
revenue, because higher taxes could drive away companies and
workers. And blaming the opposite party will be much tougher in
states than at the federal level, where divided government and
the swapping of party control in Congress and the White House
mean both parties’ fingerprints are on the national budget.
Permanent Majority
Democrats will probably bear the brunt politically,
therefore, as the public becomes increasingly concerned about
widespread fiscal problems in many states. The credit-strained
blue states thus represent a long-term threat to the permanent
national majority that many Democrats believe they see emerging
from the past two presidential elections. Both parties are
likely to clash over state-budget issues at the national level,
no matter what happens to federal taxes or health-care spending.
One potential battle, as with the federal budget, is over
how to measure the size of the mess. Many of these states have
gotten into trouble using flawed accounting for public-sector
pensions, a problem that Joshua Rauh, of Stanford University’s
business school, has highlighted. This gimmick has allowed state
politicians to make long-term promises to public-sector unions
without having to admit that they are taking on huge liabilities
through these spending commitments. Any federal effort to push
states to account for these liabilities correctly would entail a
political battle.
Debates over limiting federal income-tax deductions also
could involve state-budget politics, because taxpayers now get a
federal break for state and local taxes. A provision in the new
tax rules that Congress just passed reduces deductions for high-
income households. This affects top earners in high-tax states,
which tend to be Democratic, more than their counterparts in
low-tax states. Efforts to eliminate or further restrict the tax
break for states would also hurt the bluest ones
disproportionately.
Finally, because the most troubled states have unsustainable
budgets, they will eventually face sharp spending cuts and tax
increases if they don’t address their difficulties soon. This
long-term problem will await them even if their budgets begin to
look a little better in the short-term than they did at the
depth of the recession. In 2009, the states’ budget crunch was
so severe that the federal government chose to help them as part
of the stimulus package. If continuing state-budget neglect
leads to heavy austerity later on, the resulting economic pain
may create strong political pressure for some type of federal
bailout.
As Congress and the president clash over the nation’s
fiscal sustainability, they should be thinking clearly about how
wayward states will affect the long-term federal budget. Voters
could use a much better debate over state finances.
- Brian Barry is an economics professor and executive
director of the Initiative on Global Markets at the University
of Chicago Booth School of Business.
PS:
I am working on an updated map for the one above, which will help
explain why the Red State-Blue State argument on tax transfers is not as
clear cut as TPM would like to lead many to believe. While the figures
are fairly accurate above, the reason is not because of low taxation in
Red States and better business climates in Blue States.
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