Balanced budget rules in the US

Background institutions

The budgetary status of state governments in the US can be seen as currently being shaped by four main factors. These are, the evolving characteristics of US state finances, state balanced budget legislation, the economic crisis and the American Recovery and Reinvestment Act. Each of these factors, stemming from past or current policy, is equally important in analysing the current budgetary crisis in the US states, and will each be introduced in this section.

The changing nature of US State finances

Ward and Dadayan (2009) summarize that,

“In recent decades, the scope of state and local governments’ budgetary commitments has expanded significantly due to a combination of policy decisions at all levels of government and sharply rising costs in one area, health care. At the same time, states and localities are confronted by challenges in their revenue systems, including heightened voter resistance to tax increases and tax structures that fail to capture growth in important sectors of the economy. Meanwhile, states’ finances—long intertwined with those of localities—have become increasingly influenced by federal programs and policies.

State and local expenditures have not only grown sharply, but have changed qualitatively in important ways over the last three to four decades. Just as the federal budget is increasingly dominated by entitlement spending programs, state/local expenditures have taken on ‘‘entitlement’’ characteristics as well. Such expenditures have become more difficult to adjust when economic and revenue conditions deteriorate, largely because of growing costs for health care.

Government and academic researchers, and the agencies that set financial reporting standards for states and localities, are increasingly focusing attention on ‘‘fiscal sustainability.’’ This is a broad and longer-range concept that has been defined in varying ways to represent the ability of governments (whether at the national, state or local level) to meet existing program commitments with existing resources not only in current terms but into the future.”

Indeed, the changing nature of state expenditures, particularly due to an increasing share of entitlement, the increasing importance of Medicaid in total spending and a limited ability to raise taxes has significantly dampened the ability of states to be fiscally sustainable. As seen in the table 1.1, while total state and local expenditures grew by 32% from 2001 to 2006, Medicaid vendor payments and Public Welfare expenses grew by 56 and 44 percent respectively. When comparing these growth rates to those from 1996-2001, this table shows how the relative growth in Medicaid and Public Welfare spending has accelerated in recent years.

Table 1.1

Increases in selected state/local expenditures, 1996-2006

Source: Census Bureau data; Rockefeller Institute of Government calculations

The growth of such entitlement programs and the expansion of state and local roles can only but aggravate the fiscal stress on State Budget officers. Even without the increased pressure from the economic crisis, public pressure to keep taxes low and local budget laws combined with the growing program pressures are making balanced budgets very difficult in practice for state budget officers. We explain some of these other pressures below.

Balanced budget rules in the US

All the states except for Vermont have a legal requirement of a balanced budget. Some are constitutional, some are statutory, and some have been derived by judicial decision from constitutional provisions about state indebtedness that do not however, at face value, call for a balanced budget.[7] While the rules regarding balanced budget requirements vary from state to state including at what stage the budget must be balanced and if post enactment modifications have to be made, in general, state officials take balanced budget requirements seriously and they are widely respected throughout the US. For a summary of the balanced budget legislation by state, see Table A-1 in the appendix.

The idea behind balanced budget rules is that they serve as a tool to limit government spending because, in order to raise spending, governments must increase taxes, which is unpopular.[8] Primo (2007) explains that while this is in fact the goal of budget rules, their actual effect on spending levels is debatable. Whatever their intentions, balanced budget rules have a substantial effect on the budget process in the U.S states and lead to many intended and unintended consequences. The rules have also been shown to increase budget surpluses and decrease deficits (Bohn and Iman 1996), but perhaps, most unintentionally, the rules have also increased the volatility of State finances with respect to the business cycle as States are required to adjust their budgets accordingly. Bayoumi and Eichengreen (1995) show, using an index on state fiscal controls developed by Anderson and ACIR (1987), that moving from no fiscal restraints to the most stringent restraints lowered the fiscal offset to income fluctuations in the U.S. states by around 40 percent. Clearly balanced budget rules have a big effect on the degree to which states are able to provide fiscal stimulus, and relative to other federations (see US Canada comparison) these rules are very strict in the US.

Date: 2016-04-22; view: 548