Commentary: States should save their surpluses, not spend them
By Karl W. Smith / Bloomberg review
It’s one of the few silver linings of the pandemic: State governments are awash with cash. Many spend it; on education, construction projects and tax cuts. They better save it for a rainy day.
There are two obvious rebuttals to this recommendation, both of which can best be expressed as questions. First: Isn’t it more fiscally responsible to use the money for long-term needs and short-term tax relief? And second: you mean it’s not raining now?
Both questions have the same answer: these are not normal times. That means the prudent fiscal path — Republican Maryland Gov. Larry Hogan’s plans for the state’s historic windfall, for example, include a mix of long-term infrastructure spending and short-term tax relief. – is not necessarily the wisest course. And what looks like rain to many consumers — inflation at its highest level in nearly four decades and a stubbornly persistent pandemic — looks very different from a fiscal standpoint.
The state’s current budget surpluses — Washington State projects an $8 billion surplus over the next four years — are driven by several factors. First, the pandemic has caused a shift in spending habits from services to goods. Most state sales taxes focus on goods, so this change has resulted in a significant expansion of the relative sales tax base.
It is highly unlikely that this change will be permanent. A simple rebalancing of consumer spending will lead to significant losses in government revenue. However, there is a possibility of overtaking. For example, spending on dental services fell by more than 20% in 2020, the latest year for which data is available. When the pandemic subsides completely, there will be a backlog of teeth waiting to be pulled.
Other services, from personal trainers to accountants, could see increased spending as consumers make up for all the things they’ve put off during covid. If and when that happens, states will face even bigger revenue shortfalls.
A second concern is inflation. Europe has seen much of the same shift in consumption patterns as the United States. But the trajectory of consumer spending in Europe is consistent with what it was before the pandemic. In the United States, it accelerated at a record pace. Thus, while inflation in Europe seems to mainly reflect transitory problems, that of the United States seems deeper.
This acceleration in spending and the associated rise in inflation are direct consequences of the much larger US government spending on pandemic relief. One way or another, these tendencies must correct themselves.
At least continued inflation will lead the Federal Reserve to raise interest rates. Some analysts expect seven rate hikes this year. In this case, consumer spending could be sharply reduced as the economy experiences a mini-recession similar to the one it experienced in 2015-2016; and states could see a sharp drop in revenue.
In a more favorable scenario, there would be fewer rate increases and a more gradual decline in overall consumer spending. There’s reason to believe it could still happen: Even with record consumption levels, Americans haven’t been able to spend all the relief money the government has handed out over the past two years. .
Savings rates have reached record highs, although they started to fall sharply at the end of 2021 and are expected to return to normal later in the year. When this happens, consumers may feel more hesitant about big purchases.
In this scenario, the blow to state finances would be less severe. Yet, it’s still hard to argue that now is not the right time for states to make deposits into their inclement weather funds. The cash position of their residents will almost certainly decline in the near future. It is therefore logical that States seize this opportunity to improve their own.
Karl W. Smith is a Bloomberg Opinion columnist. He was previously vice president for federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina.