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The Providence Journal, Commentary Page
October 200

It is now mid-October. The run up to November’s elections appears to be proceeding well as a number of formal debates have already taken place and discussions of various issues occur every day. That’s what democracy is all about. Candidates have been discussing their positions on all of the major issues that will affect our state’s present and future course.

Or have they? I find it truly amazing that one of the most critical economic issues facing Rhode Island voters, if not the most important economic issue, in terms of its effect on our state’s future, has essentially been absent from any of this discussion. What issue am I referring to? The massive budget deficits that persons elected in November will have to confront starting on the first day of the next fiscal year. Estimates that I have seen place the total of deficits over the next two fiscal years at close to $250 million. That’s a quarter of a billion dollars! Not only is that a very large sum to have to eliminate, given our requirement of annually balanced budgets, it is so large that it will almost certainly slow our economy’s rate of growth as we move toward budget balance. That’s going to be a problem, since Rhode Island’s economy has been stuck in “first gear” for some time now, based on my Current Conditions Index. And, as the national economy slows in upcoming quarters, we may well move to a neutral or a slightly declining pace of economic activity in the months immediately preceding this fiscal crisis.

Most people will tell you there are basically two ways to eliminate a budget deficit: either taxes must be increased; or government spending must be reduced (or some combination of the two). Well, two out of three isn’t bad. There’s actually a third way – economic growth. Higher levels of income generated by growth automatically raise tax revenues, helping to reduce deficits. I think it’s safe to rule out too much reliance on the third alternative, given our lagging economic status, which promises to continue for some time to come. Note, however, that this “growth” effect is symmetrical: when economic growth slows, revenues tend to decline, making it more difficult to balance a budget. So, attempting to balance a budget requires dealing with a moving target.

So, how do candidates for public office, especially the gubernatorial candidates, plan to eliminate these large deficits? Which specific government spending programs should be affected? How much will we need to alter existing allocations to these programs? What about taxes? Should we attempt tax cuts at a time when we have large deficits? More critically, will Rhode Island be able to afford its move to a flat tax rate of around 5 percent in several years, or will progress toward this be ended or postponed as part of our budget balancing efforts? These are difficult questions that candidates have been able to avoid up to this point. I believe they have a responsibility to detail their positions on these critical issues in very specific terms. Absent this, how informed can our electorate be? We will be forced to stay tuned for a July surprise.

Fortunately, the economic gods have smiled on Rhode Island. At the present time, Rhode Island is far less cyclically sensitive than it has been in decades. The reasons for this are not very flattering, largely centering upon our failure to amass much of a “high tech” presence in the 1990s. Our ongoing major reliance on health services, tourism, and not-for-profits tends to cushion us from major declines in national economic activity (the last recession is evidence of this). So, during times of slowing national economic activity, Rhode Island’s relative economic status tends to improve. Think of changes in Rhode Island’s relative performance as you would a sector rotation in the stock market. We are the defensive sector (like consumer staples). When economic activity improves, cyclicals (i.e., states with far more growth potential) tend to outperform, and defensive sectors pull back (so our relative position deteriorates).

Since our deficits are very large, and a great deal of planning will be required to eliminate them, this is the perfect time for our leaders to make a meaningful break from the past. Fiscal policy in this state has been notoriously piecemeal over the years. Why is this? In analyzing it, I found it necessary to invent a word to describe our leaders: they are PAROPIC. Not only are they parochial, in that they tend to focus almost exclusively on Rhode Island, they are also myopic, devoting far too much effort to dealing with the here and now, and too little with the future. To evaluate fiscal policy, Rhode Island actually had to engage in its version of “Where’s Waldo”: years after numerous fiscal measures were passed, a Harvard economist was hired to see if any of these programs actually worked! Obviously, this has to end. Deficits of the magnitudes we are facing should be dealt with in a systematic way. In other words, this is the perfect time for Rhode Island to reinvent itself, and to redefine its economy. Since taxes are a major element in dealing with these deficits, we need to largely or completely overhaul our state’s tax and cost structure, making it more consistent with the realities of our status as a post-manufacturing economy. Should these efforts be successful at ending our lagging status, we will benefit from the added tax revenues they generate, which will make a number of spending programs more affordable than they have been during our tenure as a lagging economy. This will be very important in terms of one last area of concern – demographics. 

Is there anything fundamentally different about Rhode Island’s ability to eliminate its deficits at the present time? Yes, there is. A major structural event occurred over a year ago: Rhode Island’s total and working-age populations began to decline. Well, you might think, that’s not really such a big thing since this also occurred several times during the 1990s. While we were led to believe that such declines had in fact occurred, data revisions by the US Census Bureau indicate that these never took place. So, the current episode of declining total and working-age populations is the “real deal,” its first appearance here in decades. For Rhode Island, “the clock is ticking.” Add to this our above-average-age population, and it should be clear that Rhode Island can expect to experience the economic effects of retiring baby boomers before most other states.

Our lagging economic status coupled with a declining working-age population will make efforts to support state spending more challenging in the future. That’s not to say that it won’t be possible, just that it will be more challenging. Wouldn’t it be great if the political candidates here would actually discuss their positions on this issue?   

by Leonard Lardaro

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