States are facing massive budget shortfalls; how are they responding, and what does that mean for our government and ourselves? How can we respond with both truth and compassion for all? Here’s an update.
1. Stone Age Government
A return to another era?
Small towns and counties, hit hard by the recession, have turned progress on its head and are turning paved roads into gravel roads, an action that would’ve been unthinkable not long ago. It costs about $75,000 per mile to re-pave an old asphalt road, versus about $2,600 per mile to convert it to gravel.
State and local government, like corporations and households, seems to have believed that the good times would last forever, and spent accordingly. Those freewheeling days are over now: state budget shortfalls are massive, much larger than the last recessionary period, adding up to $71 bil in 2009, $129 in 2010, and an estimated $144 bil in 2011, nearly 19% of the total budget for all the states, according to the CBPP.
Many states facing budget shortfalls have opted for accounting gimmicks that don’t solve the underlying problem, and delay hard decisions to next year. That’s probably why the total budget gap keeps growing from 2009-2011. Sooner or later, states will have to face the music, and cut spending, raise taxes, or some combination.
All the options are unpleasant for incumbents. Where I live, in Arizona, voters overwhelmingly approved (64% to 36%) a temporary increase in the state sales tax rate, taking it from 5.6% to 6.6%. In a brilliant example of the power of framing an issue, the sales tax was ubiquitously called ‘the penny tax’, making it seem small and trivial, when it would be more accurate mathematically to call it an 18% increase in the tax rate.
The problem is that, in the short term, increasing taxes is a reverse economic stimulus, and so is cutting government spending. The best strategy to deal with a debt-deleveraging recession is to cut spending and lower taxes. Recall that government spending, from a macroeconomic perspective, is consumption, not investment. Government spending takes a dollar from the economy in order to spend it (hopefully in a way that enhances the happiness of most people). Government never takes a dollar with a plan of how to turn it into $1.10. Not in this country, anyway. We’d call it socialism.
Increasing consumption spending is exactly the wrong direction in an economy that is suffering through the hangover of the largest debt-fueled consumption binge in history. What we need to do is increase savings, which will in turn increase investment. To do so requires less government spending, and lower taxes. But states are unlikely to do that because of the short term pain it causes. (It’s as if state lawmakers haven’t read my post on how pain is an opportunity for growth.)
2. A Pension Bomb
Well, how about some long-term pain?
Many states have balanced budget laws, which give lawmakers much less flexibility to run deficits during a recession. One way that states have sought to get around these restrictions is by borrowing from their pension funds. New York is borrowing $6 bil from its pension fund, which will probably cost the state an extra $1.85 bil in interest payments. Not exactly the wisest move for New York, taking such a gamble on future growth, but such is the attempt to put off the pain now in favor of more pain later.
Illinois has been borrowing from its pension fund in bad years, and underfunding it in good years, as the chart above shows, the state is among the worst offenders in the nation, with a total debt burden of $130 bil; the pension fund is unfunded by about $61 bil. The total debt adds up to $25,000 per household.
The total amount that public pension funds are short is somewhere between $1 and $3 tril. A truly staggering sum.
"I trust this week's pay is all here, Gentlemen?"
Balancing the budget can have its rewards, as Bell, CA City Manager Robert Rizzo has discovered. In his 17 years as the City Manager, he succeeded in balancing the small city’s budget and getting it out of debt, for which he rewarded himself handsomely, with a salary of $787,637 a year. The Assistant City Manager and the Police Chief were also on the gravy train, with salaries of $457,000 and $376,288. All three have now resigned amidst popular outcry. But it turns out firing these three isn’t much cheaper. Rizzo has a pension worth $650,000 a year for the rest of his life. Unfortunately, he’s not alone. There are 9,111 former public employees in California who have pensions of $100,000 a year or more.
Pension funds are particularly tricky, since they are based on contracts made with employees in the past. Honor and fairness demand that such contracts be honored. Yet at the same time, to honor Mr. Rizzo’s pension contract, as well as the thousands of others in CA alone that are in the same class, seems a crime, especially when we consider what will have to be cut to do so. During the boom, few people cared about such things. But with 9.5% unemployment, the political environment is far different than it was just a few years ago.
While the total liabilities are great, the problem is even larger than it appears, because nearly all the big pension funds assume a rate of return of 8%. That may have been reasonable during the 27-year period of stock market magic where the Dow went from 800 to over 14,000. But this is a new era. Returns of 8% a year will be harder and harder to come by as the market adjusts. At a minimum, pension funds will face the difficulty of returns failing to match their high expectations. What is far more likely is that funds will actually lose money, accelerating the crisis that is already brewing.
The twin forces discussed above will tend to weigh down economic growth. Taxes will either take the path of short term pain, slashing spending. Or they will raise taxes, probably sales and property taxes, to cover what are likely to be increased pension fund contributions, along with the already existing deficits.
Of course stagnant growth is the best scenario. If there is a major shock to the value of the dollar, a shock to the banking system, or increased downward pressure on stocks, then we’ll see GDP growth return to negative territory. Though states are running behind the times, as they often do, it’s a hopeful sign that households seem to have a good grasp on the new reality of frugality and saving. My feeling is that this will act as a much-needed counterweight to the excesses of the bubble years.
* * * * *
When people learn of the fiscal situation of the government, they tend to react with a loss of faith in the government. We see a backlash against incumbents, an sense of righteous indignation at the corruption and shortsightedness of the officials we elected and gave our trust.
We should be indignant. The situation is appalling. The greed and lack of concern for the future is maddening. But we must not retreat into cynicism. We must take responsibility for creating the situation. We allowed this to happen. We didn’t pay enough attention. Rather than lashing out in anger, I hope we take this an an opportunity to create something new that works better.
We have the same opportunity in our own lives to rediscover who we are, refine our personality, and move forward with hope and optimism.
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