A silver lining among the storm clouds

Recession drives better state budgeting practices

By Geoffrey Lawrence
  • Wednesday, March 9, 2011

They say there's a silver lining to every cloud. And Nevada currently faces a big cloud.

Nevada is suffering through its deepest economic recession in generations. Its unemployment rate lingers above 14 percent — highest in the nation. If you include discouraged and underemployed workers, as was the practice during the Great Depression, Nevada's effective unemployment rate is closer to 24 percent. Nevada also leads the nation in home-foreclosure rates, while more than two-thirds of homeowners are underwater on their mortgages as a result of the failure of the Fed-induced housing bubble.

Years of easy-money policies at the Federal Reserve acutely victimized Nevadans. Those policies led directly to over-valuation of real estate and illusory demand for the Silver State's flagship industries by infusing sham credit and equity into the holdings of private families. Mistaking this artificial credit for legitimate wealth, consumers believed they controlled more disposable income than was the case and spent themselves into disaster.

One major destination for this spending was Las Vegas, where the resort industry became so artificially profitable in the mid-2000s that workers were drawn to Nevada en masse to help build homes and resorts. As a result, growth in Nevada outpaced that of every other state.

Today, the Fed's bubble has burst and the illusory demand has dissipated, leaving many displaced workers in its wake. Nearly 67,000 jobs have been lost in Nevada's construction industry alone. Many lives were ruined in the wake of the economic downturn, which was fueled in part by the Fed's disastrous policies.

So what, if anything, can be the silver lining?

The market is correcting for the government's mistakes. Misdirected capital continues to be liquidated and reallocated in ways that reflect genuine market realities, rather than government-engineered distortions. As prices fall from their much-inflated peaks, businesses facing legitimate demand are moving into empty storefronts — a harbinger of job growth and prosperity to come.

It will be years, however, before surplus inventory on the housing market is liquidated and prices stabilize. Moreover, policy responses from Congress and the Fed in recent years have deliberately aimed to subvert the necessary market corrections.

Yet, though economic recovery is on a shaky and uncertain upswing, Nevadans can be thankful for one small, but important gleam of silver in the storm clouds overhead: the restructuring of state finances.

During the artificial boom, state and local government spending in Nevada grew without discipline. The only thing that outpaced tax collections during this period was politicians' lust for rewarding with tax dollars those who get them elected. State General Fund expenditures, on an inflation-adjusted, per capita basis, increased by more than 30 percent from FY03 to FY09 as lawmakers allocated money to programs like full-day kindergarten and class-size reduction. Such programs appease the unions that get lawmakers elected, but they do not boost student achievement.

Nevada's fiscal problems, however, go much further than the programs lawmakers created or expanded in response to record tax-revenue growth. The state has long used a flawed method of calculating budget projections, called "baseline budgeting." This method assumes that any program toward which lawmakers have ever allocated money should continue receiving funding into perpetuity, with annual increases for employee pay raises and inflation.

This method essentially excused lawmakers from performing their fiduciary responsibility to taxpayers — namely, evaluating whether state agencies achieved their goals, or even whether those goals remained relevant to the state's needs. Obsolete programs got a free ride, while adding to the burden on taxpayers.

Now, similarly to how misallocated capital is being redirected in the private sector, the economic downturn is pressuring Nevada government to rectify its own fiscal practices and liquidate unnecessary spending.

Gov. Brian Sandoval has introduced the state's first performance-based budget proposal, incorporating many of the principles advocated by the Nevada Policy Research Institute. The proposal distinguishes policy objectives in terms of priority and includes performance measures that will ensure accountability in the use of tax dollars.

Reforming state finances so that government is more responsive and cost-effective is a prerequisite to the broader economic recovery that every Nevadan desires.

Gov. Sandoval's Executive Budget is a first step in that direction — revealing a new silver lining over the Silver State.

Geoffrey Lawrence is deputy director of policy at the Nevada Policy Research Institute. For more information visit http://npri.org. This article first appeared in the March 2011 edition of Nevada Business.

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