Overview
As the Senate prepares for its budget debate, a central question will be whether to approve a budget that relies primarily on spending cuts to close the state’s $5 billion budget gap, or whether to adopt a budget plan that includes tax increases as well as spending cuts. The budget proposal from the Senate Committee on Ways and Means (SWM) includes close to $3 billion in spending cuts, reliance on about $1.5 billion in temporary federal stimulus aid, close to $400 million drawn from reserves, and more than $200 million in new fees. This Budget Monitor describes the spending reductions proposed by the SWM budget by program area, and the services that would be reduced or eliminated as a result of those cuts.
As the budget is developed, it is important to consider the long-term effects on the state economy and the residents of the Commonwealth of cuts in funding for education, for health care, for public safety or for other services. But, in addition to long-term concerns, there is a more immediate question. What would be less damaging to the economy in the short term: spending cuts or tax increases? Nobel Prize-winning economist Joseph Stiglitz and Peter Orszag, who is now President Obama’s director of the Office of Management and Budget, examined this question in an important paper. After noting that there are negative effects of both spending cuts and tax increases, they explain:
[E]conomic analysis suggests that tax increases would not in general be more harmful to the economy than spending reductions. Indeed, in the short run (which is the period of concern during a downturn), the adverse impact of a tax increase on the economy may, if anything, be smaller than the adverse impact of a spending reduction. . . . [I]f taxes increase by $1, consumption may fall by 90 cents and saving may fall by 10 cents. Since a tax increase does not reduce consumption on a dollar-for-dollar basis, its negative impact on the economy is attenuated in the short run. Some types of spending reductions, however, would reduce demand in the economy on a dollar-for-dollar basis and therefore would be more harmful to the economy than a tax increase.1
Economists across the country who have considered these issues have echoed this basic conclusion, noting that, given the balanced budget requirements at the state level, tax increases, particularly if they are progressive, are generally less harmful than budget cuts.2
As the nation endures the most severe recession since the great Depression, states are facing extraordinary fiscal challenges.3 Massachusetts is no exception. The $3.5 billion dollar budget gap faced by the Governor and the House forced extremely difficult choices. Because of continuing deterioration in the national economy, tax revenue is now expected to be $1.5 billion less in FY 2010 than estimated at the time of those budget proposals. The Senate’s job is now even more difficult. Their challenge is to craft a budget that meets the state’s fiscal obligations but that also creates a strong foundation for economic growth so that the Commonwealth will be able to move forward again when the recession ends.
Staff
