GOP and the blue state budget time bomb
Many economists and analysts are concerned that the next candidate for a federal bailout is not still-too-big-to-fail banks but financially irresponsible states. We have written about the threat that failed states such as California, Illinois, Connecticut, Maryland and New York pose to the fiscal health of the nation.
But the problem is bigger. In coming years, University of Chicago economics professor Brian Barry predicts, “Both parties are likely to clash over state-budget issues at the national level, no matter what happens to federal taxes or healthcare spending.”
Skyrocketing unfunded state pension liabilities, up to $4 trillion according to some estimates, are driving already financially troubled states down the path to insolvency, and there appears to be no political will to address the problem. States in the most dire fiscal situations are high-tax, left-leaning and Democratic-controlled, and according to Barry pose a “long-term threat to the permanent national majority that many Democrats believe they see emerging from the past two presidential elections.”
If the White House and Senate Democrats do decide to seek a bailout their buddies in the blue states, there are some reforms that Republicans could exact in exchange that could still improve the nation’s fiscal health and be a good deal for taxpayers.
It is clear that the House would justifiably have no interest in approving a bailout of fiscally reckless states. Two years ago forward-thinking members of Congress, including Representatives Devin Nunes (R-Calif.), Darrell Issa (R-Calif.) and Paul Ryan (R-Wis.), introduced a bill that would require states and cities to accurately lay out their pension liabilities, currently underreported by an estimated $2 trillion. The Public Employee Pension Transparency Act stipulates that Congress will not approve a bailout of failed states.
However, with the White House focused on finding ways to advance its agenda without congressional approval, such legislative safeguards are no longer sufficient to prevent a deadbeat-state bailout. Indeed, concern is growing that Democrats may pursue a backdoor monetary bailout of failed states by the Federal Reserve.
Joseph A. Grundfest, Mark A. Lemley and George G. Triantis – a trio of professors from Stanford Law School – recently described in The New York Times how it could work:
“Instead of a third round of so-called ‘quantitative easing,’ known in the financial markets as QE3, maybe it’s time for a QE-Muni. Here’s why. … State and municipal bonds help finance new infrastructure projects … as well as pay for some government salaries and services, by borrowing against future tax receipts. With about $3.7 trillion in debt outstanding, it’s a big and sprawling marketplace for bonds.”
Roosevelt Institute research fellow Mike Konczal, in a blog post, wondered if the Fed should buy up short-term state and local debt. He cited the union-backed advocacy group Change to Win’s claim that a Fed purchase of state and local debt could net $75 billion for state and local governments.
However, the Federal Reserve Act limits the Fed’s ability to purchase state and local bonds to those with a maturity of six months or less. The benefits predicted by Grundfest, Lemley and Triantis from a “QE-Muni” will not occur “unless the Fed is able to buy longer-dated muni paper” – which requires an act of Congress.
Now House Republicans are all but guaranteed to oppose a proposal to expand the Fed’s ability to purchase state and local debt – and they would be right to do so as a stand-alone bill. That’s not to say there isn’t anything Republicans could get in return that would make for a worthwhile deal.
If congressional Democrats would, for example, agree to block grant Medicaid and other means-tested entitlement programs to the states in exchange for allowing the Fed to buy longer-term state and local bonds, it would make for a deal that even the most conservative House member should seriously consider – and not be faulted for accepting.
Block-granting Medicaid would improve the fiscal condition of the federal government. As the Ryan budget explains, it would also help states by ending “the misguided one-size-fits-all approach that has tied the hands of so many state governments,” since states “will no longer be shackled by federally determined program requirements and enrollment criteria.”
Rather, they will have the freedom and flexibility to craft Medicaid programs to fit the needs of their unique constituencies. Rising Medicaid costs are now squeezing state budgets far more than any other program. Block-granting Medicaid, as was done in the House-passed FY 2012 budget, would reduce the growth in Medicaid spending by $800 billion over the next decade.
If all this sounds familiar, it should. In 1996 President Bill Clinton signed sweeping welfare reform, which block-granted that federal program to the states. Welfare rolls fell by 37 percent between 1995 and 1998, according to a study by the Heritage Foundation’s Robert Rector. By 2006, welfare caseloads had fallen by 56 percent since the reform’s enactment.
In fact, Clinton had vetoed earlier iterations of welfare reform twice before signing it in order to secure his re-election. The first version vetoed by Clinton would have block-granted Medicaid to the states.
Chicago Mayor Rahm Emanuel, the former White House chief of staff, famously advised President Barack Obama to never let serious a crisis go to waste. Unsustainable state and local budgeting is one of the most serious problems facing the U.S.’s economic outlook, and one that Congress will likely have to contend with sooner rather than later. Reform-minded lawmakers would do well to find ways to use this fiscal reality to advance long-sought and much-needed free-market reforms.
PHOTO (Top): California Governor Jerry Brown speaks at a news conference to announce the Public Employee Pension Reform Act of 2012 in Los Angeles, California August 28, 2012. REUTERS/Mario Anzuoni
PHOTO (Insert Middle): Federal Reserve Chairman Ben Bernanke during a news conference in Washington December 12, 2012. REUTERS/Kevin Lamarque
PHOTO (Insert Bottom): Representative Paul Ryan (R-Wis.) attends a campaign event in Mansfield, Ohio November 4, 2012. REUTERS/Eric Thayer