June 7, 2016

When Conservatives Save the Welfare State

The welfare state is a global problem, slowly bringing the entire Western world to an economic standstill. There are two reasons why this is happening. First, lack of long-sightedness among economists and other social scientists, leaving the long-term trends in our economy unexplored; there is no analysis of long-term causal trends. Since the decline in growth and stagnation of prosperity in the Western world is a long-term phenomenon, very few people pay attention to it. 

Secondly, Even when there is some insight into the problem, the welfare state prevails. In Europe, this is due entirely to destructive ideological attachment to our modern systems of redistributive entitlements. In the United States, this ideological impairment of analytical thought only accounts for part of the reason why the welfare state persists. A more likely explanation why there are no major movements to reform away our big entitlement programs is that we simply have not yet suffered an urgent fiscal-panic style crisis. 

So, how would America's conservatives - who adamantly state that they are for limited government and against the big redistributive state - react when faced with a real fiscal-panic situation? Be aware: the answer may shock you.

Unlike the welfare states in most European countries, the American welfare state is fairly decentralized. With the exception of Social Security and Medicare our entitlement programs fall under the jurisdictional responsibility of the states. Therefore, when states run into fiscal problems they become public-policy laboratories for how politicians may respond to similar fiscal circumstances at the federal level.

Previously we have seen fiscal crises in states like California, New York and Illinois, all dominated by liberals with unwavering commitment to big government. Therefore, it is not a surprise that the legislative reaction to the crisis in those states was to do everything in their power to preserve the welfare state: higher taxes, more dependency on federal funds, and spending cuts for one purpose only, namely to slim-fit government into a narrower tax base.

At no point do welfare statists want to reduce the size of their government for any other reason than to give it a better chance to survive in the long run.

So far it has been difficult to find any meaningful examples of how conservatives respond to similar circumstances. Now, though, we have two states that offer excellent laboratory conditions for conservative fiscal-panic reactions.

The first state is Alaska. Since oil prices began tumbling two years ago, Alaska has been on a track to big budget problems. However, the state's fiscal problems are not just the work of declining tax revenue from oil production. During the long oil boom that began in the 1980s and is now coming to an end, the state government has become so used to the severance taxes that legislators never even think twice about what would happen if there were a structural change to the global oil market. 

In fairness, it is easy to get used to such a convenient revenue stream. People with inherited wealth never think twice about what would happen if their invested fortune were wiped out by a financial calamity. By the same token, Alaska legislators have never thought of the possibility that oil revenue would decline - and decline permanently.

Yet that is precisely what has happened. The decline is due to the American expansion of oil production, compounded by global economic stagnation (Europe, Japan) and decline (China). As our economy continues to drag its feet (2-2.5 percent growth at best) our own economy adds insult to injury to the Alaskans.

That said, though, there have been signs of a turn for the worse in Alaska oil production for a long time. The peak of production on the North Slope, where the bulk of the oil is found, was passed many years ago; the long-term trend was already pointing slowly downward when the dramatic price fall began. Furthermore, there is enough analytical capacity at the Division of Oil and Gas under the state of Alaska to tell legislators exactly where the oil market is heading - and what consequences it would have for the state's severance tax revenue. 

In other words, if the conservative, limited-government lawmakers in Juneau had not been so comfortable with getting more or less free tax revenue, they would not be in a situation today where they have to deal with a budget deficit equal to 75 percent of the state's general fund. 

But now that they wake up - how do they respond? A piece in the Anchorage Daily News sums it up well:
Alaskans want deeper cuts to state spending. More than any option, including new taxes or tapping into Permanent Fund earnings – more even than a combination of taxes and cuts – voters want a state government that Alaska can afford. And they are correct in wanting this. Efforts in Juneau this year are focused predominantly on "new revenue;" fees, cutting industry incentives, new taxes, and increases to existing taxes. But while debates over these catch-what-we-can revenue initiatives are dominating discussion, they fail to address the budget crisis. Using the fiscal notes from the Office of Management and Budget, all new revenue measures combined generate $855 million. That's enough money to fund state government for a little over a month.
It is invigorating to see that voters, practical as they are with their own personal finances, see that they cannot afford higher taxes. Governor Bill Walker, also a practical man, has announced that without spending cuts the state will need an income tax where people pay the state about six percent of what they owe the federal government. (In other words, if you owe Uncle Sam $100 in income taxes you pay the state $6 on top of the $100.) Alaskans look at this, as well as all Walker's other proposed tax increases, and realize that their personal finances will be ruined. Alas, they demand spending cuts and a state government they can afford. 

In other words, it looks like the legislators in the Frontier State, most of whom will speak passionately about their conservatism, are more attached to the welfare state than their voters. There is, however, an explanation for this. So far the budget cuts necessary to downsize the state government enough to close the budget gap have not even reached the conceptual stage. The opinion polls in Alaska will be completely different when voters realize the reality of spending cuts equal to 75 percent of the state's general fund. 

At that point, defenders of the welfare state will once again prevail over those who want long-term reforms. The reason is not that welfare statists are correct - they are not - but instead that the kind of reforms needed to reduce and eventually eliminate the welfare state are complicated, take time to implement and must be carefully executed. 

Fiscal panic is not the right time to try such reforms. As a default solution, then, conservative legislators stick to the path of least resistance: try save the welfare state at all cost.

The other state that offers a good "conservative laboratory" is Wyoming. So far the budget crisis in the Cowboy State has not reached Alaskan proportions, but as this chart explains it is well on its way there:

So far, there are no concerted efforts by the legislature to cut spending. Therefore, the best outlook for spending is that it stays flat through the forecast period. As for revenue, for at least the past year the state's economic analysis group, the Consensus Revenue Estimating Group (CREG), has consistently predicted that, after a decline for approximately two years, revenue will flatten out. CREG has never presented any analytical motivation for this forecast, making it seem like a “conventional wisdom” forecast more than anything else. 

At this present time, the combination of flat spending and flat revenue is the best-possible outlook based on currently available information. This means that even under the most favorable, possible conditions the budget deficit will not go away.

It is important, however, to keep in mind that the constant spending-revenue outlook is not the most likely outlook. That would be a continuous increase. 

Since CREG has no analytical base for its prediction that revenue will flatten out in a couple of years, the more realistic outlook is that revenue will continue to decline. The combination of declining revenue and increasing spending is the worst-case outlook for the Wyoming state budget. Given current legislation, and given what seems to be the prevailing legislative mindset, this worst-case outlook is also the most realistic one. It can lead to a budget deficit of $1 billion in FY2020.

A deficit of $1bn would be almost one third of the General Fund. That is still a far cry from the gone-mad situation in Alaska, but it is serious enough to wake up the state's slumbering legislature. At the same time, since that legislature is dominated by self-proclaimed fiscal conservatives it will be very interesting to see how they handle this situation. 

So far, all they have mustered to do is tap into savings to avoid spending cuts and tax increases. This is unfortunately an indicator that when push comes to shove, they may very well prefer to save the welfare state over saving the rest of the economy.

If that is the case - and knowing Wyoming politics I find this to be a disturbingly likely scenario - then Wyoming is destined to go down the same path as Alaska. Up in Juneau desperate legislators have spent down the Constitutional Budget Reserve to a point where remaining funds will pay for one more year's worth of deficit, at best, and now they are trying to change the rules for the state's Permanent Fund so they can get their hands on even more savings. 

The state of Wyoming has something to the effect of three years' worth of spending in the bank (given no drop in federal funds). Under the worst-case scenario above that money will evaporate fast. 

With conservatives in both Alaska and Wyoming reacting like die-hard welfare statists to their fiscal crises, there are reasons for concern regarding the federal level. How will the otherwise very active Congressional conservatives respond to a fiscal crisis? Granted, the federal government does not rely on severance taxes for its revenue, but instead depends to 80 percent on personal income taxes. But this does not mean they cannot be pushed up against the wall by runaway deficits, credit downgrades and rapidly rising interest rates. 

Will they take preemptive action and start long-term reforms of spending programs? Or will they, like their peers in Juneau and Cheyenne, punt on the deficit, deny the true nature of the crisis and... wait for the inevitable?

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