Watching
the States
Three
years of sluggish economic growth and a bear market for stock prices have taken
their toll on the nation’s states. In fiscal 2003, states struggled with a
combined budget shortfall of $50 billion. Forecasts for 2004 show deficits
growing to between $60 billion and $85 billion.1
The magnitude of these discrepancies has attracted a stream of negative attention
from the media. But even though being “in the red” is never ideal, some
experts argue that state budget problems could actually help improve the
nation’s economy in the long run.
Alexander Hamilton, one of the framers of the U.S. Constitution, once said, “A
national debt, if it is not excessive, will be to us a national blessing.”2
Hamilton believed that carrying a debt burden would encourage federal
legislators to spend more responsibly, streamlining services and eliminating
unnecessary expenses. This same sentiment may also apply to the states.
During the 1990s, most states saw their coffers balloon as income and
consumption-related tax revenues grew. Many responded by expanding state
programs and reducing unpopular taxes, sometimes to excess. For example, between
1995 and 2001, the Indiana state budget grew 48% while inflation rose only 16%.3
When the economy slowed in 2001, oversized state budgets led to huge deficits.
Idaho went from its biggest-ever budget surplus to its biggest-ever budget
deficit in a single year.4
Because
states are required to balance their budgets every one or two years, many have
already taken measures to cut millions of dollars in spending. Though this may
mean fewer services in the short term, it could result in increased
productivity, lower taxes, and faster growth down the road.
Budget shortfalls could also benefit municipal bondholders. Last year, Standard
& Poor’s downgraded the bond rating on at least three states and lowered
its outlook on at least nine others as a result of reduced revenues and
shrinking cash reserves.5 Many states wishing
to issue debt must now pay higher interest to bondholders.6
Though painful in the short term, state budget deficits may not be entirely
negative. You may want to learn more about how the legislators in your state are
using the current budget crisis to set the stage for the future.
1) Center on Budget and
Policy Priorities, December 2002
2) QuotationsPage.com, 2002
3–5) The Wall Street Journal, December 23, 2002
6) The principal value of bonds may fluctuate due to market conditions. If
redeemed prior to maturity, bonds may be worth more or less than their original
cost. Note that in some states you will have to pay income taxes if you buy
shares of a municipal bond fund that invests in bonds issued by other states.
Although some municipal bonds in the fund may not be subject to regular income
taxes, they may be subject to federal, state, or local alternative minimum tax.
If you sell a tax-exempt bond fund at a profit, there are capital gains taxes to
consider.
© 2003
Emerald Publications
