May 20, 1991
"Perennially Strapped for Cash"
San Jose Mercury News
By Timothy Taylor
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WHEN THE government starts whining about how hard it is to make ends meet, it's natural to sneer and grab hold of your wallet.

But when almost every government body -- federal, state, county, city -- seems to be in a world of hurt, trapped between a shortage of revenue and a clamor for additional spending, a question arises. Why are all levels of government being squeezed at the same time?

One obvious answer is that when the gears of the economy start grinding, government balance sheets suffer. Recessions reduce the tax take and increase the need for unemployment insurance and welfare payments.

Recession
At the state level, for example, California's Department of Finance calculates that the recession has caused $7.8 billion of the state's $12.6 billion deficit, mainly by reducing income and sales, and thus reducing the amount of tax collected.

At the federal level, the Bush administration's February estimate that the budget would exceed $300 billion in 1991 was based on an economic forecast that GNP would grow 0.9 percent faster than inflation this year. To make that happen, an economic recovery will have to start this summer. If the recovery doesn't come, the budget forecasts that the federal deficit will be $40.4 billion larger.

But recession can't be the only reason governments are in financial straits. After all, money was tight even last summer, before the recession started. And the figures just cited imply that even without a recession, both federal and state government would still face substantial deficits.

Structural Problems
A second reason why government is strapped for cash is what the bookkeepers sometimes call a "structural" problem. What they mean is that certain government programs are designed in a way that makes large spending increases inevitable. Consider a couple of examples here in California. The number of prisoners in this state increased from 35,000 in 1983 to about 98,000 today. Naturally, the budget for building and running prisons has also shot up, and now stands at about $2.8 billion.

Similarly, the state of California now spends 18 percent more per child in grades K-12 than it did eight years ago, even after adjusting for recent cutbacks and inflation. Moreover, the number of school-age children is increasing. As a result, California spending on K-12 education has increased from $14 billion to $27 billion in eight years.

A structural issue at the federal level involves the elderly. Since 1970, while the U.S. population has increased by 21 percent, the number of people over the age of 65 has increased by 54 percent. At the same time, benefits for programs aimed at the elderly like Social Security and Medicare increased.

In 1991, the combination of Social Security and Medicare will total $373 billion, more than one-fourth of all federal spending and $75 billion higher than the defense budget.

Of course, there are good arguments for spending more on the elderly, on schools, on law enforcement. My point is not the merits of these programs, but the fact that they have a built- in tendency to expand, especially given trends toward more elderly people or more children or more prisoners.

'Cost Disease'
In fact, economists have put forward a reason why the costs of government are likely to expand faster than average; they call it the "cost disease of the service sector." The argument goes like this:

In industries that produce goods, productivity rises continually as technology creates new products and new methods of production. By comparison, productivity growth will be slow in many service industries.

There are limits to how fast accountants can go over the books; how fast barbers can cut hair; how fast lawyers can try cases; how fast teachers can instruct students, how fast programmers can write computer code. Sure, service industries can become more productive over time, but their productivity growth tends to lag behind manufacturing industries.

Over time, this difference in productivity translates into a difference in costs. Since 1970, inflation has pushed up the price of goods by 195 percent, but the price of services by 298 percent! The cost disease of the service sector means that prices for services rise about 1 1/2 times as fast as prices for goods.

Government Growth
Government does have a cost disease, but so do all organizations that mainly provide services, from hospitals to universities to law firms. Government is growing. In 1960, federal, state and local government spent 27 percent of GNP; in 1970, 31 percent; in 1980, 33 percent; in 1990, 35 percent. The visceral reaction to figures like these is to swear about bloat and inefficiency, corrupt and lily-livered politicians, back- room deals and pork-barrel politics.

But while these reasons appeal to the bile in my stomach, the rest of my gut instincts say that the structural and cost disease problems are more important causes of the government's fiscal crunch.

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