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Friday, April 10, 2020

Preparing States for Fiscal Panic

We have a big structural-deficit problem in the federal budget. The coronavirus stimulus has not changed that for the better. There is a bill to be paid here, and without the right measures in place, it won't be a pretty experience.


The Trump administration has taken the first steps toward turning around the regulatory disruption of the economy. In addition to the CDC relaxing some of its social-distancing guidelines, Attorney General William Barr has called for an end to the "draconian" lockdown of the economy. These are both parts of a concerted strategy to slowly walk back the regulatory invasion of the economy.

When the walk-back takes effect, we can all get back to business as usual. However, there are repercussions to come from this, especially in terms of government finances. We are going to have to deal with a major increase in the federal debt, at a time when the federal government still suffers from the credit downgrades early under the Obama administration. 

We should also keep in mind that before this disruption happened the federal government operated a $1 trillion deficit at a time when unemployment was at 3.6 percent. This is a bad sign of a big structural deficit in the federal budget. 

Structural deficits do not go away with economic growth. You also cannot reduce them with tax hikes: the only way to deal with a structural deficit is to structurally downsize government. 

A structural reform is something entirely different than just reducing spending in the state or local government budget. You do not structurally reduce spending by simply slicing a few dollars off the top of a spending program; a structural reform means changing the parameters that make spending grow in the first place. For example, a comprehensive school-choice program introduces new methods for providing K-12 education, methods that weaken cost drivers such as large administrative overhead (a notorious problem in public schools in Wyoming) and encourage more cost-efficient forms of education, including home-schooling networks.

Another example is Medicaid reform, including thoughtful choice measures such as the ones Senators Harkin and Specter brought forward, and Harkin's idea of backpacking Medicaid funding with the patient. I have also proposed a set of reforms that would allow for Medicaid funding reforms under the same choice-oriented banner.

Education and health care are the big cost drivers in state and local-government budgets. Table 1 gives us an overview of how government spending is distributed across the states in our region. The first panel reports the share of total expenditures for, respectively, education, health care and social services, transportation and public safety. The second and third panels break down to the state and local levels, respectively:

Table 1: Major components of government spending
Source of raw data: Census Bureau
State and local

It is interesting to note how relatively consistent the spending distribution is across these states. States have taken a greater responsibility for health care, while local governments have concentrated on education. There are two different reasons for this:

  • Primary and secondary education has historically been a local-government matter; in a state like Wyoming, where the state constitution imposes often-debated mandates for government education spending, local governments spend more than 45 cents of every dollar on public schools;
  • Government health-care spending increased dramatically in the latter half of the 20th century, courtesy of the federally created and part-funded Medicaid program.

In other words, any reform agenda for either of these two spending programs would have to recognize where the program is historically and fiscally rooted. This is good news for education reform, where school choice in line with, e.g., the Arizona Education Savings Account model or the Wisconsin voucher program could bring substantial cost savings to local governments across our region.

At the same time, the prospect of Medicaid reform is not quite as good. On the contrary, in the wake of the current, drastic increase in federal borrowing it would be a good idea for states to expect substantial cost-cutting in Medicaid in the coming years. This, in turn, will likely bring changes to the Medicaid program that restrict patient choice and hurt the finances of Medicaid providers. 

To counter this, states need to be proactive on reforming Medicaid. A later article will take a more detailed look at what reforms would be needed by state; for now, let us take a closer look at the government finances across the Mountains region to get a better idea of the impact of such reforms - and of what we can expect if we don't do anything.

Medicaid, again, is funded as a joint venture between the federal government and the states. Technically, the states run the program, but the federal government has kept a solid hand on the program by maintaining its regulatory jurisdiction, and by providing more or less half its funding. This has led to a blurred line of jurisdiction between states and local government in terms of who can do what to reform the program. 

To further complicate reforms, there is also a split in what government level is responsible for actually dispensing appropriated dollars. For example, in Montana the state spends 41.7 percent of all the tax dollars going into hospitals, with local governments doling out 58.3 percent. (This, of course, does not count private funding of hospitals, only the government share.) The costs for funding health care - in other words not hospitals themselves - are split between the state and local governments by a somewhat different balance: 56.3 percent for the state and 43.7 percent for local governments.

It may come as a surprise that local governments are responsible for a big share of health-care spending - in fact the majority in Colorado and Utah - but there is a likely explanation in how Medicaid is organized within the state. Long-term case spending can be decentralized all the way down to counties:

Table 2: Distribution of health care spending
Source of raw data: Census Bureau
HospitalsHealth care
CO State36.9%49.4%
ID State7.8%55.5%
MT State41.7%56.3%
NE State18.6%80.4%
ND State98.2%82.3%
SD State17.9%77.7%
UT State86.0%49.8%
WY State0.3%89.5%

In effect, this means that three levels of government are involved in Medicaid: federal, state and local. So long as the funding faucet is wide open and tax revenue is abundantly available, this does not create much of a problem. The trouble begins when the belt starts tightening, as was recently exemplified in New York, where back in January Governor Andrew Cuomo presented a plan
to reduce the state's looming $6.1 billion deficit by forcing New York City and other local governments to rein in their Medicaid spending - or pay for it on their own.
In our part of the country, from a fiscal viewpoint North Dakota is in the best shape for comprehensive reforms. The state has almost the entire jurisdiction over tax dollars going into health care and hospitals. By contrast, Wyoming is in a difficult situation with split responsibilities: the state pays for almost all of Medicaid but tax-funding of hospitals is a local matter. 

In other words, different states will have to take different approaches to reforming government involvement in health care. What is not different across state lines is the need to get started on reforms; with the traditional political inertia in Congress, we can expect them to do nothing until panic knocks on the door. By that time, there is no longer any room for thoughtful, proactive reform. All that remains at that point is for Congress a slash-and-burn strategy for reducing spending. 

States that have started proactive reforms ahead of Congressional panic cuts will be much better prepared to keep their health care systems resilient, adaptive, liquid and responsive to patient needs and provider innovation.

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