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The Providence Business News, March, 1995

A great deal has been said of late about Rhode Island's current budget crisis. The common wisdom on this subject goes something like this: a faltering state economy has produced a precipitous decline in tax revenue, resulting in our well-publicized budget shortfall. This certainly sounds plausible enough. Tax revenue is definitely hurt when an economy slows. Ultimately, though, the validity of this line of reasoning rests on the dual assumptions that Rhode Island's economy has slowed noticeably of late, and, that tax revenue has also declined.

It is no secret that Rhode Island currently lags the nation in job growth. It has done so throughout this entire recovery. Two things must be kept in mind when discussing recent job performance. First, the cyclical gains Rhode Island has experienced since 1992 have been substantially offset by a host of negative structural changes, most notably defense cutbacks, corporate downsizing and health care consolidation. These have caused income gains and tax revenue growth to lag behind the levels they attained in past recoveries. While this pattern continued in 1994, it did not begin that year. The second point, which is an alien concept to many Rhode Islanders, is that we are not alone. Rhode Island is part of New England. While we as a region benefited enormously from the recovery of the 1980s, we are still paying for that success with sub-par performance in the 1990s.

The cyclical performance of the Rhode Island economy at present exceeds what the aggregate figures indicate, since those values net out the job loss caused by structural changes. Those aggregate figures themselves can be misleading. Payroll employment data for Rhode Island, which is partly based on survey results, indicates that our state's economy slowed at the end of 1994, as employment for the year increased by about one percent over the 1993 level. If we compare this "soft" data, based on a survey, with "hard," or non-survey-based state tax revenue data, a very different picture emerges. Sales tax receipts for 1994 rose by 5.3 percent over 1993 levels. State income tax withholding has grown at an annual trend rate of 5.4 percent in dollar terms throughout this recovery, and at a 2.6 percent real rate. I performed a statistical test, based on the common budget wisdom, to determine whether this trend changed in 1994 (presumably to a lower value). The results of that test indicate that this was not the case: it is valid to characterize the entire period of our present recovery with a single trend rate.

Thus, while the "soft" data indicate that Rhode Island slipped somewhat in 1994, the "hard" data indicate just the opposite, as neither sales tax receipts nor state income tax withholding dropped precipitously during 1994. This contradicts the prevailing budget crisis wisdom.

If Rhode Island's economy slowed a bit, but did not falter, and tax revenues have not dropped off significantly of late, what accounts for our budget problems? First and foremost is the combination of sluggish, but consistent, tax revenue growth (compared to past recoveries) and Rhode Island's large appetite for public goods. There is also another factor at work here. As the result of past crises and economic development decisions, during the next fiscal year, Rhode Island will be forced to spend about $42 million to pay for the after-effects of its 1991 banking crisis and another $21 million to support the Convention Center deficit. This debt repayment, while not substantially higher than it was last fiscal year, still curtails the amount of discretionary spending we can undertake, since our state's budget must be balanced each year. Can you imagine how different our budget situation and the perceptions of Rhode Islanders would be if we were able to allocate an additional $63 million dollars to finance our spending needs (assuming we would not have spent this sum on something else)? Those who believe that a weak economy produced our budget problems are partly right: it was the weakness caused by the banking crisis in 1991 that is in part responsible for our current budget woes. Our budget problems are, to a greater extent, the result of required expenditures than they are the product of declining tax revenues.

Believe it or not, this predicament makes Rhode Island a "laboratory" in the debate over federal budget deficits and future problems with the national debt. While that debate might have seemed to be abstract or its predictions unlikely to actually occur, the idea behind it is fairly simple. Current deficit spending decisions, which increase the national debt, result in larger interest payments in the future to finance that debt. Those payments can become large enough to seriously reduce future discretionary spending, resulting in hardship and difficult budget choices.

Does any of this sound familiar? Today, Rhode Island finds itself in the long-run for its short-run choices regarding DEPCO and the Convention Center. Servicing that debt reduces the amount of discretionary spending we can undertake each year. But, while our nation will never repay all of its debt, Rhode Island will eventually complete its DEPCO payments and (hopefully) have a Convention Center that is earning a profit.

by Leonard Lardaro


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