Parsing Pawlenty: A pollyanna turn on future state finances

In recent months, Gov. Tim Pawlenty has made some dire pronouncements about the future fiscal health of the federal government and state governments across the country [previous PIM item]. Just two weeks ago, in announcing that he wouldn’t seek a third term, he proclaimed (emphasis added), "The tax code in Minnesota is a relic of the 1960s and ’70s, and it’s a different world. In each of these categories–whether it’s taxes, whether it’s higher ed, whether it’s K-12, whether it’s human services–you can see the handwriting on the wall. You can see the demographics, you can see the technology, you can see the financial ability to sustain what we have. You can see the future.

"And you don’t have to look very far. Again, what is happening in California is going to foreshadow what happens, in my view, with the federal government and for many states for all the same reasons."

Yesterday, however, Pawlenty sounded quite a different note when the question of Minnesota’s future deficits came up, taking pains to imply that they might be much smaller than currently projected. Here’s a transcript of his relevant remarks:

"In four years, you don’t know what the economy’s going to be doing. This is a very speculative situation… a year out, much less three or four years out….

"For the [2012-13 biennium], a lot will change between now and then. There’s still going to be a remaining gap, but economic circumstances will undoubtedly change…. [As to] the state’s outlook, if you were to make decisions now based on what you think you may know about the economy four years from now, you would be thrashing about in ways that I think would be very reckless, because you cannot–we cannot–predict what that looks like. These forecasts change by billions from year to year. So we want to get it in a reasonable range, which this does….

"Anybody who can tell you what the economy’s going to do three or four years from now, and is consistently right about that–find me that person. I’ll buy you lunch if you can find me such an economist. To take one example out of dozens, what happens to inflation? If, as many economists are predicting, you see a return to double-digit inflation that isn’t accompanied by other negative economic consequences, that could potential turbo-charge revenues. Now it’s inflated revenues, but it turbo-charges revenues….

"There are some states that don’t even look beyond two years [in their budgeting forecasts]. I don’t know if it’s a majority or not. Many states budget year-to-year…. We budget for two years, and we’ve added this informal look-forward for two years beyond that. Most states, or many states, don’t even do that. So we don’t know. The short and simple answer is that it’s not credible to say you know what’s going to happen four years from now, other than in broad ranges. And if you made decisions, either on the spending side or the tax side, today to solve what you think is going to be the economic conditions four years out, you’d be making some very misguided decisions."

Two central rejoinders here. First, Pawlenty’s invocation of "double-digit inflation" as a possible wild card in projecting state finances is a non sequitur. Inflation helps to reduce the real cost of paying off standing debt burdens–such as the massive debts of U.S. households and companies, and the U.S. government–but it’s no help to state governments that have to balance their books in each budgeting period. For them, any revenue gains resulting from inflation are bound to be offset by inflated costs. More than offset, in fact, since the rate of health care cost inflation, which is consuming a growing share of state budgets, has consistently exceeded the general rate of inflation for many years.

Second, and more generally, there is hardly anyone in expert circles who believes that the economy, and government tax receipts, are going to rebound to pre-recession levels in the span of one or two years. Numerous factors–including the depth of the continuing global recession, the bleak expectations for employment recovery even once the recession officially ends, and the crippling debts that households, the financial sector and the federal government will spend years paying off or writing off–point to very slow growth at best for a period of years.

As I wrote here the other day, a recent study by Don Boyd of the Rockefeller Institute indicates that U.S. states are likely to face perennial fiscal crises into 2013 and beyond–crises sure to be worsened when the proceeds of the federal American Reinvestment and Recovery Act starting running out two years from now. Closer to home, Minnesota state economist Tom Stinson said in a PIM interview last week that current projections indicate that–absent any fresh tax increases–the state will not get back to the inflation-adjusted equivalent of its pre-recession 2008 revenues until sometime in 2013.

So when Pawlenty tries to suggest that future revenues may take care of themselves thanks to changing economic conditions, he’s not only having it both ways with respect to his own outlook. He’s flying in the face of what’s becoming a pretty formidable consensus that Minnesota and other states will continue to battle lagging revenues for a long time to come.