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State government finances are in a bad way, and for an examination of why that is the case, see the latest edition of “Rich States, Poor States ^[2],” released this week by the American Legislative Exchange Council. The basic story, as anyone following state fiscal issues will surely know, is that too many states went on spending binges in the early part of the decade when revenue was rolling in, but didn’t leave enough in reserve to handle the collapse in revenues caused by the 2008-2009 recession. The ALEC volume is, as past editions have been, chock full of great information. For instance:

• Did you know that if states had just kept their spending growth the same as population growth plus inflation between 2002 and 2007, they could have maintained all their services and still provided a $500 billion tax cut?

• Why did states leave nothing in reserve? Political pressure, especially from government employee unions is a big part of the story. State legislatures, for instance, have lavishly enhanced pension benefits, but state employees should have little confidence that the states will ultimately make good on those promises. Only 9 percent of state pension plans have enough assets to be considered safe according to government standards.

• Many state legislatures, unwilling to take on the well-organized lobbies for government spending, have resorted to raising taxes on the rich. But that will only exacerbate the boom-and-bust budget cycles, as Maryland’s experience demonstrates:

Politicians in Annapolis created a millionaire tax bracket, raising the top marginal income-tax rate to 6.25 percent. … Already, Maryland has seen a one-third decline in tax returns from millionaire households. The rich have literally disappeared from the state tax collectors’ sights. Instead of the state coffers gaining the extra $107 million the politicians predicted, millionaires paid $257 million less in taxes than they did last year… . [Internal citations omitted.]

• Yes, taxpayers and businesses vote with their feet, because some states’ policies—e.g., lower taxes, less labor regulation—are better for the economy than others. Utah, Colorado, Arizona, South Dakota, and Florida are the top five ranking states in the ALEC-Laffer State Economic Competitiveness Index for 2010. The top ten states in that index have had population growth of 18.5 percent over the decade 1998-2008, while the ten lowest ranking states had population growth of only 5.2 percent over that period.

Cross-posted ^[3] at Insider Online ^[4].