by James A. Bacon
Virginians take great pride in their status as a state with a AAA credit rating. But if you put any credence in a set of projections made by Jeffrey Miron with the Mercatus Center, increasing indebtedness could start to unravel the commonwealth’s fiscal integrity by 2034… if not long before. We have 23 years before we reach the point of no return.
What happens in 2034? That’s when Virginia’s indebtedness-to-GDP ratio reaches 90%, the point at which, research has shown, sovereign states reach a tipping point at which indebtedness slows economic growth and a fiscal crisis becomes nearly inevitable. So argues Miron in a new paper, “The Fiscal Health of U.S. States.”
The paper draws five broad conclusions about the fiscal condition of the 50 states:
First, state government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound. Second, the key driver of increasing state and local expenditures is health-care costs, especially Medicaid and subsidies for health-insurance exchanges under the Patient Protection and Affordable Care Act of 2009. Third, states have large implicit debts for unfunded pension liabilities, making their net debt positions substantially worse than official debt statistics indicate. Fourth, if spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to GDP within 20 to 30 years. Fifth, states differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.
Underlying his projections, Miron makes a number of assumptions, which he insists are biased, if anything, toward more optimistic outcomes. He expects that state spending will continue to increase at a rate comparable to the average growth rate of the 1962-2008 time frame. Future expenditure growth will be hard to restrain, he contends, because it will be dominated by Medicaid and other health-care spending. He assumes that interest rates on government debt will remain stable, despite a significant risk that it could run higher, and that economic growth will continue at historical rates despite some evidence that it might be slower. But, critically, he also assumes that tax revenues as a percentage of the economy will not increase as a percentage of the GDP. Political pressures will prevent politicians from raising taxes, so legislators will resort to budgetary gimmickry and off-balance sheet borrowing to make ends meet.
If you find those assumptions to be reasonable, or even somewhat optimistic, then you should be very worried. One very important assumption Miron does not make is that the federal government experiences a fiscal crisis between now and then, cutting back on federal aid to states and localities and crippling the national economy. If you believe that a Boomergeddon-style scenario will occur within the next 15 to 20 years, as I do, then the day of reckoning for the states will come all the sooner.
Virginia is in better condition than the average state, though that will buy it a reprieve of only a few years. The commonwealth’s adjusted debt-to-GDP ratio in 2008 was 7.5%, compared to 11.2% nationally. While states with weaker finances will reach the dreaded 90% debt-to-GDP ratio by as early as 2023, it will take Virginia until 2034. If Virginia manages to reduce expenditure growth by 0.5% less than historical averages, it will delay Doomsday until 2041. By eking out a growth rate 0.5% faster than historical averages, it can delay crunch time until 2042. (Miron does not consider a scenario of a slower rate of spending growth and a higher rate of economic growth.)
As with all such long-term projections, these assume that past trends continue indefinitely as before, which, of course, they won’t. What I fear most is a global investor revolt against sovereign debt, triggered most likely by a default by Spain, Italy and other European Union countries, which drives up risk premiums for sovereign debt in all advanced democratic societies. The contagion could easily spread to California, Illinois, New Jersey and New York. If one of those states defaulted, all states would wind up paying higher interest rates on their debt. States don’t use long-term debt to finance day-to-day government operations, but they do use it to fund critical educational and infrastructure investments needed for economic growth.
I see no evidence that state leaders are on the same wavelength as Miron: They persist in thinking of the commonwealth’s sterling credit rating as unshakable. We still have time to enact fundamental deep-structure reforms to transportation, land use, health care delivery and education that would bring costs in line with revenues, but not as much as we think. The requisite sense of urgency does not exist. Unless the public temperament changes soon, Boomergeddon will not spare Virginia.
