The Challenges of State and Municipal Debt

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Chairman Issa, Ranking Member Cummings, and Members of the Committee. Thank you for the opportunity to testify with regard to the financial and budgetary challenges facing state governments. My name is Andrew Biggs and I am a resident scholar at the American Enterprise Institute. However, the testimony I will deliver today is my own and does not reflect any institutional positions of AEI.

I will touch on three topics related to state government finances: pension financing; public employee pay; and state investment practices. All present challenges to state and municipal governments. But context is nevertheless required, as governments face different levels of challenges and have so far responded in different ways. Some states have maintained balanced or near-balanced budgets through the financial crisis, while others have run significant deficits. Some have responsibly funded their pensions even during difficult times, while others have fallen back on borrowing and accounting tricks. The differences arise from how hard different states were hit by the recession and how hard their elected officials worked to address their budget problems.

On average, the states currently borrow approximately 23 cents of each dollar they spend, equal to around 1 percent of GDP. To be fair, the states are models of fiscal rectitude relative to the federal government, which borrows 39 cents of each dollar it spends. But the states, which are governed by balanced budget rules and lack the ability to print money, are less able to run deficits with impunity.

Currently, New Jersey has the largest budget deficit of any state in the country at around 2 percent of state GDP. But within around 10 years, the Government Accountability Office predicts, states and local governments on average will face a structural deficit of around 2 percent of GDP, that is, deficits not driven by the business cycle but by the general mismatch between revenues and outlays.

Stabilizing state and local debt levels, the GAO found, would require an immediate and permanent 12.5 percent reduction in all state outlay or an equivalent increase in state revenues. For context, the CBO calculates that closing the federal fiscal gap over the same time period would require cutting spending by 25.8 percent, meaning that all sectors of government are facing the need for a significant fiscal consolidation. This implies that, should state and local governments encounter a true financial crisis, the federal government's capacity to help may be constrained.

While I remain hopeful that states can avoid any significant disruption, the world is a dangerous place and it is worrying that so many levels of our government remain financially vulnerable.

Andrew G. Biggs is a resident scholar at AEI.

 

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