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Harry Moroz

Cutting Costs Before We Know What Cuts Cost

The economic downturn has been with us for quite a while now. We are familiar with its more salient features: high unemployment, sunken home prices, less money in the bank. At least at the state and local level, we have even grown accustomed to government doing less, not because there is less demand or need for its services or because it is providing those services poorly, but simply because budget deficits have arisen as the economic downturn has driven down tax revenue.

New York City’s new Deputy Mayor Stephen Goldsmith plays on this idea in a new article for Governing in which he calls for the creation of a “culture of cost savings” in state and local governments. He argues that the cost cutting that is now necessary must be deep and must be a constant, long-term project.

Goldsmith’s ideas for how to cut costs effectively are sensible: cut costs early and often but also keep an eye out for big savings; empower a single individual (a deputy mayor perhaps?) to own the task of cutting costs; incentivize cost cutting among bureaucratic staff; and explain the consequences of a failure to cut.

In fact, Goldsmith presents cost cutting as an end in and of itself, explaining that in Indianapolis he established the goal of saving the city $1 million a month. In other words, the goal was not necessarily improving efficiency or doing more with less, but taking $1 million off the city’s books. This is also evident when he calls for a “bias for action” in cost-cutting, something that emphasizes cutting over what is being cut.

Goldsmith argues that a laser focus on cost cutting is necessary because “city, county, and state executives confront the ‘new normal’ of lower revenue…” The implication is that state and local governments are stuck with a miserable revenue outlook and so the only way to reconcile budget deficits is through deep and sustained cost cutting.

Indeed, the fiscal outlook for state and local governments is grim. This graph shows long-term state and local operating balances dipping continuously and severely into deeper deficit between 2010 and 2060 until they reach more than 5 percent of GDP.

State and Local Deficit.JPG

The picture is not pretty. However, it turns out that there is a very familiar explanation for these increasing deficits: rising health care costs.

The GAO writes that:

The primary driver of fiscal challenges for the state and local government sector continues to be the growth in health-related costs. Specifically, state and local expenditures on Medicaid and the cost of health insurance for state and local retirees and employees are projected to grow more than GDP.

In fact, the GAO contradicts Goldsmith’s prediction of a “new normal” of declining revenue, explaining that:

revenue growth, excluding Medicaid grants from the federal government, is projected to be relatively flat as a percentage of GDP.
As a percentage of GDP, health expenditures by state and local governments will rise quickly while non-health expenditures will actually fall.

Health and Non Health Expenditures.JPG

To the extent that he implies that long-term, deep cost cutting is necessitated by a “new normal” of lower state and local government revenues, Goldsmith's suggestion is inaccurate. It is true that the revenue outlook for states and localities will be bleak until the economy recovers (though New York City, for example, expects revenue increases in each of the next five years). But the longer term fiscal challenges faced by cities are a product of rising health care costs, not lower revenue.

This means that an across-the-board emphasis on cutting costs – no matter what they are – will be unhelpful in addressing the long-term fiscal challenges faced by states and cities. The recently passed health reform bill holds in it potential measures for “bending the cost curve” of health care costs, and more must certainly be done to hold down costs. But in the case of state and local budgets, not all costs are created equal.

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Posted at 7:36 PM, May 12, 2010 in Cities
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