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John Hood: Treat government aid as shock absorber

By John Hood

So far, the federal government has agreed to borrow some $4 billion and then transfer the money to North Carolina state and local governments to address the health, education, and economic consequences of the COVID-19 crisis.

More is probably coming. I can understand why. States and localities are facing yawning fiscal deficits, driven in large measure by revenues projected to fall about 15 percent short of original projections for the coming fiscal year.

But Washington is already broke. All new federal spending represents new federal borrowing. And North Carolina, like most states, must balance its operating budget with current revenues, not with debt. So must our cities and counties. I grant that state policymakers have violated the spirit of our balanced-budget requirement for years by using borrowed federal dollars to pay for Medicaid, education and other current operations. I’ve long been bothered by the practice. Now, with Congress talking about another large-scale relief package for states and localities, the potential for abuse is surging.

There is nothing wrong with public debt in moderation. When a government builds a long-lived capital asset — be it a sewage plant or a submarine — it can make sense to finance the project with debt to be repaid over the life of the asset, so that those taxpayers currently benefiting from its operation help to pay for it. Borrowing may also be needed during emergencies such as wars, natural disasters, and, as in this case, large-scale outbreaks of infectious disease.

So why do I worry about the next round of congressional relief for states and localities? Because I fear too much money will be squandered on low-priority expenses and politicized bailouts.

While nearly all states and localities will take a major fiscal hit from the COVID-19 crisis, some were better prepared than others to handle unforeseen shocks. Over the past decade, the North Carolina General Assembly wisely built up a rainy-day fund and other reserves while avoiding new and costly spending promises. And going back decades, North Carolina’s legislators, governors, and state treasurers have generally managed our public-employee pension funds with admirable diligence and restraint.

Although I can’t say the same about our poorly managed retiree-health benefit, it is still the case that the size of North Carolina’s total public obligations — both bonded debts and unfunded liabilities — compare favorably to those of most other states. If, somehow, those other states can use new COVID-19 funds to offset their pre-existing fiscal liabilities, that will have the effect of punishing prudent states like North Carolina.

It will, in short, reward budgetary recklessness and political irresponsibility. That will, in turn, produce more reckless budgets and irresponsible politicians in the future.

When considering how best to structure federal aid, I think the best image to keep in mind is a shock absorber. Washington should, indeed, allow states and localities to use federal funds to help cover immediate shortfalls in revenue. While they will still have to make cuts in some areas and hold the line in others, governments should try to protect core public services as much as possible — as well as the jobs and salaries of the public employees and private vendors who deliver them.

However, because money is fungible, a completely hands-off approach to federal COVID-19 relief would allow profligate states and localities to service preexisting debts at the expense of taxpayers in other places. So, I think as a condition for accepting any new round of federal funds, governments should be required to restate their unfunded liabilities using honest accounting and then submit a clear plan for discharging the debt.

If a government fails to submit such a plan, or to implement it consistently, Washington should then convert its COVID-19 relief from a grant to a loan — and at a punitive rate of interest.

After all, small businesses that don’t meet their commitments under the Paycheck Protection Program are going to have their grants converted into loans. Why should states and localities be treated more leniently?

Hood is chairman of the John Locke Foundation.

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