There has never been a tougher time to be a governor. Governors must deal with all the problems confronting our economy, but they lack the federal government's ability to run a deficit. With the $787 billion stimulus and sundry other bailout spending, President Obama and Congress have the rather pleasant task of printing gobs of money and throwing it toward favored sectors and projects.
Governors can only gaze on with envy. The numbers from the states are downright horrifying—and getting worse. The best estimate is that states, nearly all of which are constitutionally obligated to balance their budgets, collectively face deficits of about $350 billion over the next 30 months. That is about 20 percent of total state spending.
OK, you're saying, but didn't the federal stimulus package include money for the states? Sure, about $140 billion for all 50 states, enough to cover 40 percent of the shortfall. (AIG, by the way, has received about $183 billion, just about enough to cover its bonuses and Goldman Sachs' exposure.) So states still must make actual cuts of more than 10 percent.
But for governors, the news may be even worse. Unless the recovery outpaces all predictions, state revenues will continue to be paltry. Fourth quarter '08 numbers showed an inflation-adjusted decline of 5.6 percent from fourth quarter '07. The three major revenue streams for states—personal income tax, corporate income tax, and sales tax—all had declines, and the trend line suggests worse declines to come.
(All of this, by the way, does not even touch the problems of governments "below" the state level. With the dramatic collapse of property values and thus property-tax revenues, counties, towns, and villages are going to be struggling, begging for even more assistance from states, and seeking relief from mandated services and contributions to state programs.)
Unlike manufacturers, which can alter marginal costs, states cannot easily cut costs when revenues drop. Indeed, many think that state spending is and should be countercyclical since, in many respects, it becomes more important when the economy dips. So how on earth are governors going to manage this catastrophe?
First, consider state expenditures. The two largest sectors of state spending are education and Medicaid. More than 31 percent of state budgets, on average, is allocated to education (21 percent for elementary and secondary and 10.5 percent for higher education), an area where the pressure for better quality and, consequentially, more spending is overwhelming. Whether one believes that smaller classes, merit pay for teachers, expanded efforts on early literacy, extended hours, extended school years, more charter schools, or tougher standards and testing are the answer, none will come without more dollars. Significant reduction in this 31 percent of the budget is unrealistic.
The 21-plus percent allocated to Medicaid presents a similar conundrum. Demand for Medicaid services will probably spike as economic conditions decline, making more people eligible and desperate for Medicaid. Try as they might to control per-person Medicaid spending, the ineluctable rise of health care spending—driven by remarkable technology and remarkable inefficiencies—make this an area where real dollar saving are incredibly difficult. Absent fundamental federal overhaul, savings will be slim.
During my tenure as governor, we sought to restructure New York's $60 billion Medicaid program, per capita the most expensive in the nation, by creating a program focused more on community and preventive care, enrolling all eligible children, and shifting care away from expensive teaching hospitals and emergency rooms. It was the right step from both a health policy and budgetary perspective, and the plan was endorsed by thoughtful voices. As a political matter, it was Armageddon. After what can only be described as a political brawl, we had moderate success at a policy level, saving a bit more than 3 percent of the state dollar allocation to Medicaid. The opposition—all the major teaching hospitals and health care unions—spent about $10 million in negative TV advertising directed at me personally. Not surprisingly, other governors are not rushing to try similar programs.
With about 50 percent of all spending dedicated to these almost inviolate purposes, and another 20 percent or so allocated to debt service, corrections, transportation, and public assistance, it begins to become evident that finding cuts of 10 percent is easier to editorialize about than to effectuate.
Sure, we could eliminate all investment in needed water-treatment facilities, close libraries and parks, cut funding for law enforcement, DNA databases, and Innocence Projects, and abolish summer programs for kids. But that is not the government most of us want.
Compounding this misery, these state economies have for too long been based on an antiquated industrial model, which governors are trying desperately to retool. Whether in Michigan (disappearing auto jobs), California (shrinking high-tech sector), North Carolina (vanishing textile and furniture industry), or New York (cratering financial sector), governors are searching for a transformational fix to restart the job-creation engine. Yet this requires significant investment capital. The most promising ideas—increased higher education to foster the knowledge-based economy, high-speed rail to create efficient and environmentally sound transportation in our densest corridors, universal high-speed Internet access, and venture funds to create bio-tech startups—all require the one resource not available: money.
It is too bad the federal stimulus package did not require the sort of politically challenging yet necessary changes that would begin to alter the condition of state finances for the long term. The federal government could have used the opportunity to break the status quo over pension obligations, Medicaid structure, mandated services for health insurance programs, and teacher merit pay.
As the elected officials charged with paying for essential services using revenue sources that are directly correlated to economic cycles, governors have no easy remedies, and not even many hard ones.