Government

ECONOMIC ANALYSIS: Scoring political points can cost state in long run

May 28, 2007

Perhaps the best thing that can be said about economic cycles-the boombust patterns of everything from housing to commodity prices-is that they keep economists and forecasters gainfully employed. John D. Rockefeller tried to eliminate them by controlling production and distribution. Franklin Roosevelt tried to cut them short by using the federal government checkbook. And Alan Greenspan, and now Ben Bernanke, keep trying to talk and cajole financial markets in the direction they think they should go.

It hasn't worked. Or, perhaps more accurately, it hasn't ended the ups and downs that can wreak havoc on job security, personal net worth, and government finances. At some point in every economic expansion, it seems, we collectively forget about economic history, and start acting as if growth will go on forever. And when some of the bets we place go sour, a recession is the usual outcome.

That presents a problem for state governments, including Indiana's, which are obligated to provide public services of all kinds through boom and bust alike. Most of the revenue streams used to pay for government services go up and down with economic activity, which can result in surpluses in good times and deficits in bad. At the low point in the aftermath of the 2001 recession, the 50 states had a combined $250 billion shortfall between their spending commitments and the cash on hand to pay them.

That's why we've had a rainy day fund in Indiana since 1985. Not only does setting aside excess revenue in good times make it easier to weather the downturns that produce budget shortfalls, but it can reduce state borrowing costs as well. In fact, Indiana's fund is one of the better-conceived such funds of any state, with law requiring deposits to be made anytime personal income growth exceeds 2 percent.

But the recent calls to suspend the state's sales tax on gasoline remind us of the pressures always out there. We love our democracy, and those elected representatives lucky enough to serve when tax coffers are full-or even just starting to fill-often like to return those sentiments in the form of tax cuts and rebates. Which never hurts at election time, of course.

In fact, the electorates in some states don't trust the Legislature to do the job right. Oregon passed a constitutional amendment that requires the state to return all surplus revenue to the taxpayers-in the form of a check-anytime collections exceed forecasts by 2 percent or more over a fiscal year.

In these battles between these populist sentiments and prudent fiscal management, the side with the votes often has the upper hand. But in the case of Indiana's sales tax on gasoline, a move to suspend the tax would have some especially bad repercussions.

In fact, one of those already has manifested itself. Because the O'Bannon administration made that move in the midst of what proved to be a successful gubernatorial campaign, the precedent has been set, and calls on future governors to suspend the tax-perhaps until it is permanent-can be expected. Not only does that hurt tax revenue-not a bad thing, in the eyes of many-but it makes the base of the sales tax narrower and more volatile than it is today. Which makes revenue even harder to predict.

But the larger precedent is more ominous. The everyday invocation of "emergency" situations is exactly the kind of gimmickry that allows Congress in Washington to ignore every balanced budget resolution it has ever passed. Those who rate the state's borrowing capacity, and issue ratings on state-backed municipal bonds, must now regard as less certain the tax revenue streams that ultimately back our promises to repay.

But if the costs of these actions lie in the future, the benefits and political returns of what are unmistakably popular actions to cut-however negligibly-high gasoline prices can be had with the stroke of a pen. And time will tell us which side prevails.



Barkey is a research economist at Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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