Denouement of budget diplomacy

Recent budget deliberations in several key states across the land have led to some inconclusive outcomes. A few states still do not have a formal budget. One has to think that part of the reason the budget finally passed in Illinois with an override of a veto was just due to sheer exhaustion after two years of deliberations and political posturing. At some point, the bills must be paid.

No taxpayer prefers to ponder the impacts of an approved tax increase. However, there are just times when there is no better alternative that leads to real revenue generation for the governmental entity. We have seen the ill effects of overestimating what will be anticipated in terms of collections and we also do not recommend that approach. We also clearly appreciate that a tax increase may have certain negative effects when it comes to fostering growth.

John Hallacy
John Hallacy, head of municipal research at Bank of America Merrill Lynch Global Research, listens at the Bloomberg State & Municipal Finance Conference in New York, U.S., on Wednesday, Nov. 2, 2011. During this year's budget season, states face more challenges than ever as they set financial priorities against the backdrop of lower property tax revenue, lower sales tax revenue and high unemployment. Photographer: Peter Foley/Bloomberg *** Local Caption *** John Hallacy

That is not to say that the expenditure side should not bear more scrutiny and that more adjustments and efficiencies should not be made in the wake of a tax increase. A tax increase should allow some time to make expenditure cuts with care and not with impunity.

Hearkening back to an earlier time in public finance, we witnessed many cases where taxes were raised with the full intent of rolling the increase back as soon as possible. This practice was adopted especially after recessions in the 1980’s and 1990’s whether or not the recession under consideration was mild or full in effect. In New York State in the early 1990’s a phased tax reduction had been approved over a multiyear period. The phased reductions were postponed after recession hit until revenues recovered over a couple of years. It was the smart and justifiable approach at the time.

California has certainly faced a fair number of budget imbalances over the years. There had been times when short term borrowing had reached new peaks out of necessity. Now with a great deal of budget discipline and a historic tax increase that was approved by the electorate, the state is thriving.

The rating establishment also has to appreciate how much political capital has to be expended to arrive at a better place in terms of budget balance. We do not think the time for a downgrade is after the taxes have been increased and other steps have been taken at great cost to avoid the budget crisis. We agree that the longer term problems will linger in the absence of any easy fixes. An extremely large pension burden is going to take more than one budget cycle to solve. The market reality is that regardless of the rating views that may not be all that favorable, spreads tighten when the budget passes. Investors and hedge funds win in this scenario.

Some of the budget and negotiating tactics are flowing down from the approaches we are experiencing as a spectator of the federal level. There appears to be no cessation of the partisan disagreements in approach. The calls for finding common ground largely go unheeded. Perhaps, a refreshed roster of legislators will attempt to take a less strict partisan approach when the integrity of the budget and the fostering of growth are at stake.

The reversal of the experiment in Kansas is instructive given services were increasingly at risk with the reduction in revenues from the tax reductions. Finding the appropriate balance given all of the updated and increasingly sophisticated tools is still subject to some trial and error in governing. De Toqueville observed that our process at best is messy. He was impressed with our commitment to liberty and equality.

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