August 17, 2010

State Spending Restraint

An Analysis of the Path Not Taken

State and local government spending has grown at a remarkable clip over the last half-century. Since the close of World War II, aggregate state and local spending grew 34 percent faster than the private sector and 37 percent faster than federal government spending. In recent years, the difference in growth rates has widened. From 2000 to 2009, state and local government spending grew nearly twice as fast as the private sector (while over the same period, the federal government grew even faster). Spending growth has not been uniform across spending categories, and Medicaid spending is by far the fastest-growing component of state expenditures. In this paper, I review some of these trends and then estimate what would have happened under an alternate scenario in which spending growth had been restrained. I look at the ten states with the largest FY2009 budget gaps and the ten states with the largest FY2010 budget gaps. Because six states make both lists, I analyze fourteen states in total. For each, I estimate what its FY2009 spending level would have been had its budget grown at the pace of population growth and inflation, beginning in two periods: 1987 and 1995. In twelve of the fourteen states, the entire FY2009 budget gap would have been avoided had the state kept spending at real 1995 per capita levels. In thirteen of the fourteen states, the budget gap would have been avoided had the state kept spending at real 1987 per capita levels. I conclude by reviewing some state-level institutional reforms that may be able to restrain the growth of state governments. But given the prominent role that Medicaid plays in state spending growth and given the fact that the program is financed jointly by the states and the federal government, reform may need to be addressed at the federal level as well.

The first version of this working paper contained a mathematical error in two charts. The updated version corrects this error and expands the discussion of the growth in Medicaid spending.