Right now, the world is wondering if European leaders have the political will to save their economies from fiscal collapse. Defaulting on their debts would trigger a domino effect that threatens the continued existence of the European Union itself. Yet the entrenched interests of labor unions and government pensioners steadfastly refuse to accept cutbacks—even if it means taking their nations' economies down with them.
Could a similar scenario play out in the U.S.? That possibility is raised by a new study to be released Tuesday by the Republican staff of the Joint Economic Committee: Eurozone, U.S.A.—a close examination of the fiscal situation of state governments around the nation.
Its results are humbling. States that have followed Europe's economic policy model of unbridled spending are getting Europe's economic results: low growth and looming fiscal catastrophe.
Compared with the 10 U.S. states with the lowest rates of economic growth since 1990, the states with the highest rates of growth had smaller unfunded pension ratios (by 26%); lower debt ratios (by 18%); less tax revenue collected (by 22%); and lower welfare benefits (by 31%). Our report also shows that over the last decade, states with no income tax have much higher rates of job growth and population growth than states with the highest income taxes.
To their credit, many state policy makers have recognized the unsustainability of high-tax, high-regulation, welfare-state economics. But just as in Europe, many of the states in the deepest trouble seem the least interested in reform—either out of incompetence, ideological blindness, or a cynical expectation that when a crisis hits, someone else will bail them out.
The fuse on the U.S. debt bomb—which according to the National Bureau of Economic Research may be armed with as much as a $211 trillion fiscal shortfall—may prove to be the states' public-employee pension systems. Years of overly optimistic growth projections, underfunding and overpromising by politicians have rendered many of these public pension systems effective toxic assets on states' books. Some jurisdictions around the U.S. already spend more money on retired workers than on current employees, and more on retired teachers than on existing students and schools.
But this gathering storm is about more than just the pensions. It's about policy. In coming years, states with policies that grow their governments (rather than nourish private economies), whether through tax increases, regulation or cronyism, will drive away successful businesses and individuals, further draining their tax bases and exacerbating their fiscal crises. This process has already begun.
Higher taxes called for by California Gov. Jerry Brown to help pay for an "unexpected" 74% increase in the state's budget shortfall this year, and Illinois's recent income tax hikes of 67% on individuals and 30% on businesses, have done and will do nothing to stem the flood of people and businesses out of those states.
Meanwhile, states that confront their problems sooner rather than later, and without shifting the burden onto taxpayers, will be more likely to maintain and attract those same successful businesses and individuals and expand their own economies. In Wisconsin, ending collective bargaining for public-employee benefits in 2011 has helped eliminate the state's budget deficit, generated savings that prevented layoffs, and contributed to a reduction in property taxes. Similarly, pension reforms in Utah, New Jersey and Rhode Island have protected taxpayers from future pension costs.
Yet as big government-low growth states fall deeper into the fiscal hole, the question becomes whether Washington politicians will force taxpayers in more prudent states to bail them out. This cannot be allowed to happen. As the 2008 financial crisis proved, bailouts never solve anything. They only create more problems—moral outrage on one side, and moral hazard on the other.
It is becoming clear that the only way to force recalcitrant states to put fiscal reform on the table is for Congress to take state bailouts off of it. Recent experience on Wall Street and in Athens suggests that if decision makers in Illinois, New York, California or anywhere else believe Washington will bail them out of their fiscal mismanagement, we cannot expect any self-directed reform from them. As our report concludes, Congress must—in word and if necessary in law—make plain that the taxpayers will not protect these states from the consequences of their policies.