Writing in today’s FT, investment-banking veteran (and former New York bailout-facilitator) Felix Rohatyn and ESC consulting-firm president Everett Ehlrich, pointing out that states still face $200 billion in operating deficits in the next three years, suggest a repeat of February’s economic stimulus.

Rohatyn and Ehlrich state that “the problem is not state profligacy but … a collapse in income tax revenues driven by cyclical economic conditions, for one, and the collapse of capital gains tax realisations.”

They suggest that Congress expand the February stimulus by $100 billion solely to “plug the states’ fiscal hole,” with “one-third to go directly to our largest localities.”

The team’s diagnosis is not quite correct, however.

In the states that face the biggest deficits, including New York and California, the main problem is that for years, unsustainable growth in tax revenues, much of it from the financial and real-estate sectors, fed unsustainable growth in operating spending, which far outpaced inflation.

The tax revenues have evaporated, yet the spending base remains.

This is an old story in New York and California.

In New York, the nation’s very largest locality — New York City — was happy to let spending keep pace with record tax revenues between 2003 and 2007. In the past eight years, city spending has outpaced inflation more than two-fold; adjusted for both inflation and population, it now surpasses Lindsay-era heights.

But even the traditionally low-tax, low-spending states that were home to the biggest real-estate bubbles ramped up their outlays during the boom years. They were flush with sales-tax revenues from tourists who had some money to spare after forking over their income taxes to California and New York.

To wit: Between 2000 and 2008, spending in Arizona grew by 41 percent after inflation, outpacing population growth by 12 percentage points.

In Nevada, spending grew by 70 percent, outpacing population growth by 40 percentage points.

Florida managed to keep general spending growth roughly in line with population, but only by using its state-guaranteed property-insurance program to subsidize torrid real-estate development in natural-disaster-prone areas, creating a huge, unfunded liability for the future.

Any new stimulus to plug state budget gaps would be dubious, because all it does is allow states (and cities) to maintain too-high spending levels that crowd out private-sector activity; New York has been sending its private-sector growth across its borders for years.

Further, if the next batch of state stimulus, like the last, mostly goes toward education and healthcare, it also would exacerbate existing imbalances that hurt the private sector, which badly needs better physical infrastructure rather than yet more spending in areas where the next dollar spent doesn’t equal a dollar’s worth of improvement.

Any suggestion for new stimulus money shouldn’t come unaccompanied by a strong suggestion that such stimulus come with real strings attached. The conditions for the money should be measurable, concrete, and permanent actions from state legislatures and local governments to rein in out-of-control pension, healthcare and other costs, the real culprits of many of the deficits.

In New York and California, such reform should also include efforts to make tax revenues less prone to severe swings, including lessening dependence on wealthy taxpayers’ highly volatile income.

California has at least made noise about such efforts; New York has not.

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