Budget Cuts Make Hard Times Harder

Some argue that cutting services in a time when people need services more than ever is destructive. Instead, responsible leaders would balance cuts with targeted tax and fee increases.

Others argue that the last thing government should do in tough times is attempt to raise revenue. Instead, leaders of this persuasion would slash services and lay off front-line workers before ever attempting to raise a dime in extra revenue.

The drop in state tax collections is the "sharpest on record" according to the Nelson A. Rockefeller Institute of Government. To deal with this drop that created an almost $7 billion deficit, Wisconsin state leaders chose the first path, balancing cuts with increased revenue from closing tax loopholes. And, according to a new report from the Center on Budget and Policy Priorities, Wisconsin was not alone in this approach.

“With the recession continuing to widen the gap between shrinking revenues and residents’ increasing need for services, a growing number of states are adopting a balanced approach to their budgets that includes revenue increase as well as spending cuts. Since Jan. 1, 30 states have raised taxes and another seven states are considering doing so,” according to the report Tax Measures Help Balance State Budgets.

While most states are using tax measures as part of the solution to their problems, local governments in Wisconsin are less inclined to seek revenue solutions. One reason is that local governments in Wisconsin have fewer revenue raising options. And state-imposed caps limit how much they can raise through their primary revenue source, the property tax. But even in communities that are below their revenue caps, there is considerable philosophical resistance to seeking additional revenue.

There does not seem to be the same resistance, however, to balancing budgets on the backs of public employees, either by taking pay and benefits away from workers or simply eliminating jobs and services. The Center on Budget and Policy Priorities report outlines why a strategy that relies exclusively on cuts is a losing strategy in a bad economy. Contrary to anti-tax rhetoric, tax increases are better for the economy than spending cuts.

Here is an excerpt from the report:

During recent deliberations in New York over how to close a growing budget gap, Governor Paterson and the legislature received a letter from 120 economists in the state. Citing “economic theory and historical experience,” the letter observed that “raising taxes during a downturn — particularly taxes that affect only higher-income families — is generally better for a state’s economy, and better for its citizens, than sharp budget cuts.” The letter went on: “The reasons are simple. Almost every dollar that states and localities spend on aid for the needy, salaries of public employees, and other vital services enters the local economy immediately.

So if states cut their spending in these areas, overall demand suffers at a time when demand is already too low and support services are most needed. "The alternative — raising taxes — also reduces spending, but by less than budget cuts of comparable size. And by targeting these taxes appropriately, their negative effects can be minimized.

For example, high-income households typically spend only a fraction of their income and save the rest. As a result, each $1 increase on taxes on high-income households will reduce their spending by much less than $1.” The letter echoed the conclusions of a paper written during the last recession by Columbia University professor and Nobel Prize winner Joseph Stiglitz and Peter Orszag, now director of the U.S. Office of Management and Budget, asserting that spending cuts can be more harmful for a state’s economy in a recession than tax increases.

The report also points out that it is during recessions that families have the have the hardest tie paying for necessities, and many families lose or can no longer afford health coverage. States, if they raise sufficient revenue, can step in to make sure people most hurt by the recession do not face even more difficulties because of cuts in government programs that specifically help people in need. Unfortunately, these programs are often the first to be cut in a revenue shortfall.

Despite anti-tax orthodoxy that suggests increasing taxes hurt the economy, the report found no evidence that states that increased taxes in response to the recession of 2001 were any faster or slower to recover from that recession than states that did not raise taxes.

"States that raised taxes were just as fast to rebound from the recession as states that did not, even though they were typically climbing out of a deeper hole," according to the report. "States that had enacted significant tax increases (more than 1 percent of revenues) in the 2002-04 period saw growth rates in personal income, employment, and the median wage from 2004 to 2007 that closely matched national averages. Furthermore, a number of states that enacted significant tax increases during the early 2000s subsequently experienced above-average growth in these key economic indicators...

"On the other hand, a number of states that did not raise taxes, or cut them, during the last recession subsequently saw slower-than-average economic growth. Among them are Iowa, Kentucky, Minnesota, Missouri, New Hampshire, and Wisconsin.

Those states’ decision to avoid tax increases (and, in some cases, to enact large cuts in services) failed to protect them from below-average growth in both personal income and employment during the subsequent period. "In short, neither economic theory nor experience supports the idea that states should shy away from raising taxes in a recession for fear of harming their economic performance," the report states.

While the report looks at states, and states have more tools than local communities, the lesson still applies. Fighting joblessness by eliminating jobs and services that put money directly into the local economy doesn't help the local economy.

Working creatively to maintain services is not only more humane to people in need, it makes economic sense. For more on this report and to look at the extensive documentation that goes with it, check out the Center for Budget and Policy Priorities web site at: www.cbpp.org. Look under the "Areas of Research" header for "State Budget and Tax."