Bernanke Warns Against Strict Budget Cuts

This article originally appeared on Crain’s New York Business

Federal Reserve Chairman Ben Bernanke dispensed budget planning advice for local and state governments Wednesday night at a dinner with the Citizens Budget Commission, a group that holds different views from his own.

                                                               Eliza Ronalds-Hannon







Federal Reserve Chairman Ben Bernanke said Wednesday that even in an era of extreme budget pressures, state and local governments must not neglect public services. He emphasized that the nation needs to keep spending on public education to better arm the U.S. economy in the long run.

“Cost-effective K-12 and post-secondary schooling are crucial to building a better work force,” Mr. Bernanke said. “The payoffs of early childhood programs can be especially high.”

Yet job cuts in the downturn have been especially pronounced at the local level, he noted, and nearly half of the local job loss has been in education. To counteract that damage and ease strain on the municipal bond market, he said governments must take measures to pad their financial reserves.

Mr. Bernanke spoke at the Citizens Budget Commission’s annual dinner in Manhattan on Wednesday, where he was the guest of honor. In his address, Mr. Bernanke steered clear of heftier topics like state bankruptcy and quantitative easing, which dominated his testimony to the House of Representatives Wednesday morning. He instead outlined the fiscal struggles facing local and state governments and offered advice on how to avoid budget cuts that could devastate local economies and slow the nation’s recovery.

Mr. Bernanke’s suggestions clashed somewhat with the beliefs of his host for the evening. The Citizens Budget Commission is one of the strongest voices in New York for cutting state spending—education included—because it believes the amount the government spends is hamstringing New York’s economy.

Here in New York, it seems, Mr. Bernanke’s fear of an economy that abandons education may be coming to fruition. This week Mayor Michael Bloomberg announced that the city budget for fiscal 2012 would cut $1.4 billion from the education system and eliminate 4,675 teachers unless the state provides more aid.

For their part, the Citizens Budget Commission believes that the state must cut its education budget, but that it can do so without sacrificing the quality of service.

“There do have to be some reductions in spending,” said Carol Kellerman, the Commission’s president, “but they should be made in a very targeted way.”

With focused cuts, the districts most reliant on state funding should be able to maintain that funding, while wealthy districts with high property values absorb the cuts, Ms. Kellerman said.

Mr. Bernanke gave fairly vague advice for New York specifically, and didn’t take a stand on whether he believes tax hikes or added fees are appropriate measures for the state at this point. Mr. Bernanke did generally seem to favor tax reforms over fees, though, and said that those reforms should aim to provide countercyclical stimulation for the economy.

One important strategy for the future, Mr. Bernanke said, is for governments to generate heftier “rainy day” funds.

“Building an adequate reserve fund during good times may not be politically popular, but doing so can pay off during bad times, as well as lessen the tendency to overspend when times are good,” he said.

Raising taxes and fees is another way to address budget shortfalls, Mr. Bernanke said, noting that New York, California and Illinois have already done so. More states may soon follow suit, especially as federal stimulus grants start to wind down this year. He said the key to this strategy is to raise the taxes that are less subject to variance, such as necessity goods, for which demand remains stable, and property taxes, which lag behind the economy enough to remain a strong source of revenue in a downturn.

Embracing these strategies to address fiscal shortfalls will help calm the choppy municipal bond market, which has been shaken lately by fear of strained budgets, he said.

Mr. Bernanke presented these strategies as an exploration into what can be done to reduce state and local budgets’ sensitivity to the business cycle, which he said has increased over time, making government revenues too closely linked to the economy. That sensitivity impedes long-term budget planning and puts the screws to governments when they are most vulnerable. The chairman was careful to emphasize that he does not advocate eliminating balanced-budget rules, although he believes other factors must take precedence.

“Budget balance and budget stability are important fiscal issues,” Mr. Bernanke said. “In the long run, though, the most important fiscal issue is whether the structure and composition of the government budget best serves the public interest.”

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