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Wall Street Journal.

Memo to Rookie Governors: Cut, Cut, Cut.
November 6, 2002

By William D. Eggers

Yesterday's elections produced the largest turnover of new governors in years. But after they finish celebrating, many of them might want to crawl into bed and pull down the shades. By the time they take office, the cumulative 2003 state budget shortfall will be over $50 billion, and the question will be whether 2002's bumper crop of freshman governors will yield 2006's largest group of former governors.

Making their task unenviable is the way their predecessors looked this year's $40 billion collective deficit square in the face -- and punted. The full accounting makeover was deployed in an attempt to pass off a corpse as a diva. Rookie governors are left with only two choices: deep spending cuts or broad-based tax increases.

The early 1990s, the last time so many governors faced large budget shortfalls, showed that voters are much more likely to accept tough budget cuts than a tax increase. Nearly all the governors who came out of the last crisis in good political shape -- John Engler, William Weld, George Pataki, Frank Keating, Zell Miller and Christie Whitman -- not only refused to raise taxes, but actually cut them, using fiscal crisis as an opportunity for reforms. All of them were re-elected three years later. This year's freshman class can do the same if it follows these budget-balancing strategies.

  • Reduce work-force costs: With revenues in free fall, states will find it impossible to balance budgets without reducing government work-force costs. Employment caps, hiring freezes, furloughs, cutbacks in government positions, work-rule changes, incentives for early retirement and higher premiums for retiree health care costs: all must be on the negotiating table.
  • Reform Medicaid: Medicaid, which now accounts for a fifth of state expenditure, is one of the main causes of the current state fiscal crisis. Long-term, fixing Medicaid means changing its perverse "defined benefits" structure. Near term, states can reduce drug costs through private pharmacy contracts, co-payments and buying pools; curb long-term care costs by promoting home- and community-based alternatives to institutional care; and rein in medical costs by contracting for specialized services and eliminating coverage of optional services.
  • Streamline education services: In most states, only 50 cents of every dollar spent on education ever makes it into the classroom. One culprit: the exorbitant per capita costs experienced by small school districts that provide their own IT, finance, bus, food and security services. Economies of scale could be gleaned from consolidating these support functions into regional service centers serving multiple districts.
  • Turn capital assets into financial assets: By selling or leasing state enterprises and assets, governments can turn dormant physical capital into financial capital, which can be used for deficit relief. State governments also benefit financially by putting assets on the tax rolls.
  • Cut redundant/poorly performing programs: In the '90s, many states put in place performance-based budgeting systems. The goal was laudable: fund outcomes, not inputs. The problem: most of these systems had no teeth. The new governors now have a chance to bite back. Programs that don't work should be eliminated or rolled into programs that do. In 2000, Texas eliminated one of two state job training programs with overlapping responsibilities. Why? One program achieved much better results than the other. Rather than expend taxpayer resources trying to "fix" the poor performer, the legislature simply shut it down. Savings: $25 million per year. And it was a signal to programs that failure carries a fiscal death penalty.
  • Use technology to cut costs: The private sector is starting to see cost savings and productivity increases from IT investments. Such savings typically represent permanent reductions in the cost of doing business. Government is next in line for technology-driven efficiencies.

To deal with what they see as "structural imbalances" in state budgets, some governors have been talking about the need for comprehensive tax restructuring (read: tax increases). But before even contemplating this, they need to address the equation's expenditure side. The strategies outlined above can help not only cut costs but transform state government. The question now is: Which freshman governor will be the first to embrace this second-term strategy?

Mr. Eggers is a senior fellow at the Manhattan Institute and director at Deloitte Research.

©2002 Wall Street Journal

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