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Sacramento Bee Columnist Daniel Weintraub

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July 28, 2003

State spending cuts aren't "dragging down" the economy

The New York Times on Monday had a big story saying California’s budget crisis – and budget cutting – had, along with similar events in other states, “stripped the nation of a source of economic growth” and begun to “drag down the national economy.” With all due respect, I think this is nonsense. And, because it’s becoming part of the conventional wisdom, it needs to be stopped, now.

First of all, The Times swallows whole the notion that California’s emerging budget deal will cut $8 billion in current spending, and says the state will see $12 billion in cuts over two years. I don’t know where they got the $12 billion – it’s not attributed – but even on paper, state general fund spending will shrink only from a high of $78.1 billion last year to $70.8 billion next year, a drop of $7.3 billion.

And even that is an accounting fiction. Actual spending won’t drop by nearly that much, if at all. More than half of the reported spending reduction is actually a tax increase -- the $4 billion tripling of the car tax. State bookkeepers count that as a cut because the car tax is a local revenue source, and when it was reduced several years ago, the state started reimbursing the cities and counties for their loss of revenue. Now that the tax is going back up, the locals will get their money directly from motorists, so the state reimbursement is no longer needed. The state books that as a budget cut, but the government will still be spending exactly the same amount of money. Other items booked as cuts include a $1 billion accounting shift in Medi-Cal that will have no effect on actual spending, and a $2 billion infusion of federal money that will relieve the state of some of its obligations in health and welfare programs. When you add all these and other measures together, it’s possible that actual government outlays in California will rise, not fall, in the year ahead.

But even if all the assumptions in the Times story were true, I still don’t think state spending cuts would hurt the economy. One could argue that they would actually help it. After all, the states, unlike the federal government, cannot print money. Everything they do is pretty much a zero-sum game. If they spend more, they must tax more. If they spend less, they tax less. This means that the only thing at issue is who spends the money: the government or private individuals and businesses. If the state cuts spending on health care by $1 billion, that’s $1 billion that remains in the private economy.

The net effects of this transfer are open to debate. Some would argue that state spending will produce more bang for the buck because it tends to go to low-income people who then put it all back into the economy, while private holders of wealth might keep it stowed in the bank or in investments. Others would say that leaving the money in private hands is better for the economy because those investments create jobs and boost productivity. I would stake out some middle ground by pointing out that even state spending often winds up in private corporate hands, or in the pockets of wealthy individuals, as when the state pays hospitals or doctors for medical care for the poor. That money can be socked away – or invested – as easily as money that’s simply left in private hands. Which is why the Republican complaint that state tax increases hurt the economy, while logical, is difficult to prove, because all the money the state takes in taxes comes back to the economy anyway, just in different places.

But the Times ignores that debate and all of these subtleties in favor of a simple explanation implying that every dollar the state “cuts” from spending is a dollar somehow removed from the economy. It’s just not so. Every dollar cut from state spending is a dollar left in the economy. There is a huge difference.

Find the Times story here. Signon/password required but use mine: californiainsider/insider

UPDATE: A reader notes that the Times' analysis is more credible if one considers the effects of state deficit spending on the economy. When states borrow, it allows them to spend money that they haven't yet taken from their citizens in taxes, thus stimulating the economy. This is true. But California isn't giving up on deficit spending. The budget deal pending today includes plans for a $10.7 billion bond to pay for services rendered last year. That's the biggest borrowing of its kind in the history of the state.