Monday, July 28, 2003

State governors and legislators believe that after all of their hard work and painful actions they’ve taken in the past year, their governments are now “doing more with less.” The evidence, however, suggests just the opposite: States are doing less with more. The cost of state and local government services is rising along with spending in such a manner that inflation-adjusted state services are declining, but the states and localities are absorbing an increasing portion of our total output.

Conventional wisdom says state tax revenues are stagnant or falling. The Medicaid cost explosion, unmet educational needs, depleted rainy day funds and other factors have forced states to rein in expenses and increase taxes. A new study from the American Legislative Exchange Council (ALEC) shows that in 2002, taxes were raised by 20 states, and the number to date for 2003 exceeds that with some states, especially California, still contemplating their options.

In reality, the fiscal problems of the states are mainly a consequence of a spending explosion in the 1990s extending into this decade — not revenue shortfalls. But the thing that is leading quite literally to states doing less with more is the inflation in the cost or price of state and local governmental services.

The keeper of our national income accounts, the Bureau of Economic Analysis of the Department of Commerce, computes price indices in calculating real gross domestic product (GDP). The graph shows that from 1996 to the first quarter of 2003, prices in the whole economy rose 11.9 percent, but they rose significantly more, 19.21 percent, for state and local government consumption. All other major components of the GDP price deflator (index) rose less than that, and some, such as the import index, actually fell.

This has important consequences. For example, from the first quarter of 2002 to the first quarter of 2003, state and local government spending rose 3.9 percent in nominal dollar terms, slightly more than total GDP. The spending explosion at the state and local level continued, albeit at somewhat less frenetic levels than a few years ago. Adjusting for price changes and for population growth, real GDP grew about 1 percent, but because of rising costs, real state and local government spending actually fell about 1/2 percent. Those governments are absorbing a larger proportion of our growing output — but actually giving us less per person in services. This is literally “doing less with more.”

Why is this occurring? These governments largely produce services, and the price of services has risen relative to the price of goods in recent years. But this is not the whole answer. The federal government produces services too, and its inflation rate, although high, is lower than for state and local governments. I suspect the remaining explanation can be found in two words: productivity and rent-seeking.

State and local governments typically are monopolies providing their services in a non-market environment, and they are slow to innovate. For example, they have dragged their feet in terms of moving to more efficient modes of delivering educational services. It takes far more resources to educate a kid at a public university today than a generation ago, for example, yet there is very little evidence the students are learning more. The same is doubly true of students in public schools. Technology, rather than lowering costs by reducing labor, is actually increasing them, by adding more capital to existing labor. With the possible exception of prostitution, teaching is probably the only profession where there has been absolutely no productivity advance in the 2,400 years since Socrates taught the youth of Athens.

Similar problems exist for a whole variety of other services. Medicaid costs soar because we refuse to imbue the system with more market discipline. In some states, it costs more to house a prisoner than send a student to Harvard, and little cost-benefit analysis is being done to test whether alternative arrangements might be more cost-effective for non-violent felons.

Rent-seeking refers using the power of government to redistribute income to a group that provides nothing new in return. A good example: government employee unions use their political clout and campaign contributions to get large pay increases. Government employee average pay exceeds that of private sector workers, and in the last year for which data are available, 2001, the gap widened. Add to that the more generous fringe benefits, greater time off and enhanced job security, government employees command a major earnings advantage — one that is helping drive up costs.

Is it no wonder that state and local governments are doing less with more?

Richard Vedder is an adjunct scholar at the American Legislative Exchange Council and a visiting scholar at the American Enterprise Institute.

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