July 21, 2011

States on Moody’s Credit Watch

Matthew D. Mitchell

Affiliated Senior Scholar

The consequences of a possible U.S. government credit downgrade recently struck closer to home for citizens of the five states that Moody’s warned may face a downgrade as well. Matt Mitchell, an economist at the Mercatus Center at George Mason University, foresees painful consequences for these states, including Maryland and Virginia, in the longer run.

“These states have done a great job of living at the expense of federal tax payers, but this can cut both ways,” Mitchell said. “In this case, those most dependent on federal funds and grants are most likely to be harmed.”

“For the citizens of these states, this will mean some combination of their taxes increasing or their state services decreasing, because a lower credit rating will make it more expensive for states to borrow money,” he said.

Among these states, Mitchell says it is interesting to note Virginia, which has a budget surplus this year, because it shows that even a well-managed state can go wrong.

“While no one state does it perfectly and no one state does it terribly, some are clearly better than others. New York State has managed to balance its budget with aggressive and reasonable budget cuts without raising taxes,” he said. “Over the long run, states that perform consistently better tend to be more economically free and have smaller budget gaps during recessions, and their spending has grown less rapidly over the last few decades.”