The Reality of Donor States

We have all seen the stories of economic distress out of Europe in the past couple years. The European Union has been severely strained by the fiscal crises in the Mediterranean countries and the unwillingness of northern European governments to bail them out. In Spain, the region of Catalonia is considering seeking independence because they believe they are paying an enormous amount of tax to the central government of Spain and not getting much in return, while other Spanish states benefit form generous federal programs.

On a continental level, Germany (the largest EU economy and population) has been reluctant to bail out deeply indebted countries like Greece, Ireland, Portugal, Spain and Italy. While these countries make the headlines, other EU members states are struggling to handle growing debt burdens such as France, Belgium and Cyprus.

Germany is not alone in their animosity toward countries that did not take care of their fiscal health over the years. The Scandinavian countries, Estonia, Bulgaria, Luxembourg, The Netherlands, Austria and a few smaller Eastern European countries have expressed dismay about having to pitch in to save the EU project due to irresponsible budgeting from other members.

Here in the United States, we have a similar problem. However, ours has a unique twist.

Just as in Europe, there are donor states and recipient states. Many large states including California, Illinois, New York and New Jersey pay far more income taxes to the federal government then they receive in federal expenditures and grants. Meanwhile, places like the Dakotas, Gulf Coast states, Virgina, New Mexico and Maryland received more in federal expenditures than they pay in income taxes.  Thus in terms of the nation's federal expenditures, Illinois is a donor state and our neighbors in Indiana are receivers.

Since wealthy people pay the bulk of the income taxes in the USA it is not surprising to see New York, California and Illinois among the top donor states because those states contain large financial centers (New York City, Los Angeles, the Bay Area, San Diego, Chicago) where wealthy investors, entrepreneurs, bankers and lawyers tend to gravitate for professional reasons. These wealthy Americans pay huge quantities of income taxes to the federal Treasury. Meanwhile, North Dakota and Kentucky are not known for their vast cities, full of millionaires. These lower income states tend to pay less in income tax for the simple reason that their population earns lower incomes on average.

There are a variety of reasons for federal disparity in the distribution of federal funds. Large agricultural states received massive subsidies. Coastal states have large military bases and rural western states have research facilities that soak up huge amounts of money. States with older populations have many more people on Medicare, disability and prescription drug subsidies.

Occasionally you will hear a governor or Congressman gripe about this disparity. Texas politicians are probably the most vocal in their anger about being a donor state. Receiver state politicians avoid the topic. Many of these smaller, poorer states are represented by Republicans. They are the first in line to call for lower taxes, but last in line to give up their state's subsidies or federal benefit surpluses.

On the surface, it would seem that the United States and European Union have identical problems of donor states and welfare states. California and Germany would seem to have a lot in common. They are both the largest economies in their respective unions and donate large amounts of money to subsidize smaller members states. Illinois would take the role of France and Puerto Rico would seem to be our Greece.

Go below the surface and you will see there is an important difference. In Europe, most of the donor states have reasonable debt levels and budgets that are in a range of balanced. In the United States, donor states tend to be the ones with the most debt, worst credit ratings and most unbalanced budgets based on future obligations.

In terms of debt to GDP, Massachusetts, Rhode Island, New Hampshire, Vermont and New Jersey take the top 5 spots. New York is in the top 10 and Illinois in the top 15.

If you combine state and local debt, New York state is king and Illinois is number 6.

Underfunded pensions are spread around the nation just as unfunded social spending is spread across Europe. Illinois, a donor state, is the worst pension offender; but, Mississippi, one of the bigger recipient states, isn't much better.

The point is that in the United States, many of the large donor states are also fiscally irresponsible with their budgets while the recipient states tend to be more balanced. In Europe the opposite is true.

So what does this mean for the United States? First of all, no one will seek a breakup of the country the way the EU has openly talked about a break-up of their union. While Texas might be excited about the prospect, most large states would not want to go it alone with the massive debt burdens they currently carry. Small states wouldn't want lose the subsidies and welfare they receive.

Secondly, the big donor states may start seeking bailouts of their pension and health care debt. They will use the excuse that their fiscal irresponsibility is not to blame for their plight and that recipient states owe them for their generosity over the years.

Finally, most big donor states who are in a fiscal crisis are represented by Democrats which means they fully support more debt-financed spending on social programs and construction projects in their state. Expect to see big city Democrats in Congress to start proposing massive new spending for unnecessary projects in their districts.

Over the next few years, you will hear more and more about "donor states." When you do, just remember that most of them don't act responsibly with their own budgets. Remember that many of those states are experiencing significant out-migration from working age adults and families escaping terrible policies that are harming their quality of life.

Before donor states start griping, they need to get control of their self inflicted fiscal and economic distress.

In the meantime, recipient state governments should start looking for ways to generate more revenue from commerce because the gravy train won't last forever.

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