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John Hood: Lawmakers should save budget, not spend, surplus

By John Hood

RALEIGH — Do governors and state legislators really have much to do with the performance of state economies? If governors and state legislators are to be believed, their policies are responsible for all good economic news — and rarely responsible for the bad news.

It’s easy to ridicule the self-importance of politicians. But the position on the opposite extreme, that state government has little effect on the economy, is also unwarranted. While everyone agrees that state policies can influence the growth of population, jobs and incomes in the long run, many analysts believe that state decisions don’t have much to do with economic fluctuations in the short run.

That’s mistaken. North Carolina’s experience during the Great Recession suggests otherwise. And a new academic study demonstrates that North Carolina’s experience was hardly a fluke.

The story begins back in early 2006, when then-Gov. Mike Easley and the General Assembly then controlled by Democrats were greeted with the news that North Carolina had a budget surplus of about $2.4 billion. After years of deficits or tight budgets during the early 2000s, it was a welcome relief.

But what should policymakers do with the surplus? Phil Berger, then minority leader of the State Senate, argued that the legislature shouldn’t go on a spending spree but should instead shore up the state’s reserves, pay down some debts, and roll back the Democratic tax increases that were partially responsible for the higher revenues. Other conservatives made similar arguments.

They were largely ignored. Although Easley and Democratic leaders did edge down the state’s sales and income tax rates, most of the surplus funded new expenditures. In fact, they increased state spending by 10 percent. Making matters worse, the 2006-07 budget contained hundreds of millions of dollars of recurring spending funded by one-time money.

This became a recipe for disaster when the Great Recession hit. By the 2009-11 budget biennium, new Gov. Bev Perdue and Democratic legislators faced billions of dollars in deficits. They were forced to cut back the very areas that got gigantic spending hikes in 2006-07. They also resorted to a new round of economically destructive tax increases.

Here’s where the new academic study I mentioned comes into the picture. Published in the Journal of Monetary Economics, it explored why some states fared far worse than others during the Great Recession. Co-authors Daniel Shoag of Harvard University and Stan Veuger of the American Enterprise Institute examined the role of policy uncertainty — the extent to which business leaders, investors and entrepreneurs had reason to believe some states were in better shape than others to ride out an economic storm without adverse fiscal shocks such as budget gaps and tax hikes.

Shoag and Veuger used an archive of news stories from 2006 to 2009 to construct an index measuring increases in “policy uncertainty.” They also looked at conditions that may well have produced or contributed to such uncertainty, such as state budget rules. The authors found that greater policy uncertainty among states was associated with larger increases in state unemployment rates. According to the study, North Carolina had the eighth-highest “policy uncertainty” score in the country in the run up to the Great Recession — people did actually take note of the fiscal recklessness of Easley and legislative Democrats — as well as the sixth-largest jump in unemployment.

But what caused what? Perhaps some states were destined to have horrible recessions and just experienced more policy uncertainty as a result. The authors used other techniques to test this explanation and found it unlikely. “Uncertainty is likely to be not merely a by-product of economic conditions, but an independent driver of outcomes,” they concluded.

The lesson for North Carolina’s current leaders should be obvious. Once again, we have a healthy revenue surplus this year. If used wisely — to build up savings, pay down liabilities and address other critical needs — it will make North Carolina a more attractive place to live, work, invest and create jobs. If squandered, that will create uncertainty about our fiscal future, with deleterious results.

John Hood is chairman of the John Locke Foundation.

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