Our Spendthrift States Don't Need a Bailout

Last year at this time, many governors and state legislators were imploring Congress to let them spend more money by expanding the State Children's Health Insurance Program. Since the states share the cost of the program with Washington, the expansion would have allowed them to cover families with incomes up to 300% of the poverty level (more in some cases). It also would have meant hundreds of millions in additional state spending, and an estimated $24 billion in additional federal spending. President Bush vetoed the bill.

Today, governors and state legislators are singing a different tune. Unable to pay their bills as tax revenues shrink, they're imploring Washington to bail them out. California Gov. Arnold Schwarzenegger, who had been grappling with a $15 billion budget deficit, wrote to Congress on Oct. 21 applauding plans for $14 billion in aid for states in the latest proposed federal economic stimulus plan. New York Gov. David Paterson has twice traveled to Washington, most recently on Oct. 29, to ask for federal aid. The Empire State's budget deficit is now estimated at $12 billion over the next two years.

This zigzagging—beseeching the feds to let them spend more money one year, begging for a bailout the next—is what passes for long-term budgeting in many state capitals. From the end of the last recession in 2003 until this year, states collectively boosted general-fund budgets by an annual average of some 6.4%. In just 2006 and 2007 alone they added about $100 billion. During the period from 2003-2008, states also took on 38% more debt, increasing their collective indebtedness to $2.19 trillion.

Now it's cold-shower time. Earlier this year, in the spring, more than half of the states grappled with budget deficits amounting collectively to nearly $50 billion. Since then tax collections have fallen short of projections, producing further midyear budget holes in nearly two dozen states.

In California, Mr. Schwarzenegger tussled with the state legislature for months before passing a budget that largely "solved" the budget crisis through accounting gimmicks. Two months after the deal, state officials announced a new deficit of more than $10 billion because of rapidly declining tax collections.

Illinois has attempted to deal with a nearly $2 billion budget deficit in part by slowing down payment of its bills (its backlog of unpaid invoices was recently $1.8 billion) and hoping tax collections would revive. Instead, they are declining and the state's budget gap is widening. In Pennsylvania, Gov. Edward Rendell hoped a hiring freeze would help solve the state's budget woes. Just a few weeks after announcing the freeze on Sept. 16, the budget gap grew by nearly $300 million because of declining revenues.

This is not the first time states have been caught in this trap. One reason is because many fail to address their deep, structural budget problems during the good times, preferring to use booming tax revenues to start or expand politically popular (and often costly) programs. Another, deadlier issue is their failure to deal with huge and growing employee pension and benefits liabilities.

For years, state and local politicians have bought support from public sector unions by promising big benefits. Over time these promises exert severe pressure on their budgets. A study three years ago by the Employee Benefit Research Institute estimated that the average public sector worker earns 46% more in total compensation than his counterpart in the private sector, largely because government employers spend 60% more per worker on benefits than counterparts in the private sector.

States have collectively racked up some $731 billion in unfunded liabilities for pensions and other retirement benefits, according to a study published last December by the Pew Charitable Trusts' Center on the States. In particular, the states have been promising their employees rich nonpension benefits—such as retirement health and dental care—and paying for virtually none of it. According to Pew estimates, states have put aside a mere $11 billion to fund $381 billion in future nonpension benefits. Illinois, which has the largest percentage of unfunded pension liabilities among the states, actually cut its contributions to pension funds by $2.3 billion in the flush years of 2006 and 2007 as stock market returns were rising.

Taxpayers are often erroneously told that there's plenty of money to finance new perks. In the late 1990s, to take one example, California's legislature approved a series of pension enhancements which the California Public Employees' Retirement System predicted could be funded almost entirely out of stock market gains. Today, of course, major stock market indices are lower than they were in 1999. California state and local governments are paying some $12.8 billion a year to finance public employee pensions, up from $4.8 billion in 1999, according to the U.S. Census Bureau's survey of government expenditures.

States of course argue today, as they have countless times in the past, that they need federal aid to avoid cutting essential programs that hurt their most vulnerable citizens. But the blunt fact is that the money will only encourage them to keep doing business the same old way rather than seek innovative solutions.

For instance, many state officials want the federal government to boost infrastructure aid as part of a federal spending package, so that states can build more roads, bridges and mass transit. This is typically unimaginative: Around the world sits hundreds of billions of dollars of private capital looking to go to work financing infrastructure, which our states are largely ignoring.

Countries as different as France, Spain, China and Russia have tapped this money. In the U.S., only a few governments have even tried. Indiana Gov. Mitch Daniels privatized the state's major toll road for an upfront payment of $3.8 billion in 2006. He put the money in the state's transportation trust fund and increased investments in infrastructure. Other governors, like Mr. Rendell in Pennsylvania, have tried similar maneuvers. But they've been blocked by state legislators who want to keep these assets—and the public-sector jobs that usually are dedicated to running them—in government hands.

Still, the best argument for more aid is the obvious one. The federal government has already agreed to bail out many homeowners who knowingly made irresponsible bets on the housing market, as well as major financial institutions that loaded up on opaque, obscure and ultimately toxic investments.

Thus, when practically every day the federal government is defining downward the very notion of what constitutes fiscal responsibility, the states know they are hardly the most reckless supplicants in Washington. Unfortunately, more federal aid all but guarantees they won't use the current crisis as an opportunity to put their fiscal houses in order—setting the stage for worse problems to come.