Dark clouds in the Golden State
In a YouTube address released last Friday, California Governor Jerry Brown shocked his constituents with an announcement that the state’s projected revenue shortfall had increased to $16 billion. This followed very weak April state income tax collections, which deepened the budget hole from the $9 billion that Brown had originally forecast in January. The new deficit is a result of a reduced revenue outlook for California, higher school funding costs, and decisions by the federal government and courts to block certain budget cuts. New cuts that Brown floated yesterday will reduce General Fund spending as a share of California’s economy to its lowest level since 1972‑73.
The $92 billion budget that Brown had proposed in January for the fiscal year 2012-2013 (which starts on July 1) looked like this: With the new revenue shortfall, almost every area of the state budget has been targeted for cuts; education, which accounts for 53 percent of General Fund spending, is the only category that was spared. In his revised proposal, Brown substantially increased K‑14 spending (i.e., includes two years of community college or vocational training) and protected the University of California and California State University from further, deeper cuts. School spending is mandated by Proposition 98, which requires that California pass through a substantial portion of state revenues to local governments to fund education.
Overall, Brown proposed that half of the budget hole should be plugged with spending cuts, 35 percent with tax hikes and 15 percent with financial gimmicks. Brown’s preferred budget cuts (pages 5-7) total $8.3 billion and include a $1.2 billion reduction to California’s medicaid program (Medi-Cal), an $880 million reduction to welfare (Temporary Assistance to Needy Families payments) and a 7 percent reduction in hours to in-home supportive-care-services providers.
These monies are the lifeline that millions of Californians rely on. It’s hard to get a sense of the human side of this, but it’s enormous. And without additional revenues, deeper cuts will be required.
Reuters’ Jim Christie picks up the story here:
In California, where local property taxes are limited by law, and local services, including schools, are thus largely funded by the state, the most important source of government revenue by far is personal income taxes. Capital gains income from the state’s wealthy residents helps fill the state’s coffers in good times, but falls sharply in bad times.
California’s larger-than-expected deficit did not faze traders in the $3.7 trillion U.S. municipal debt market, said Gary Pollack, managing director at Deutsche Bank Private Wealth Management in New York.
“The market is taking it in stride for the time being,” he said.
California bonds have been trading a little better over the last few weeks, aided by rising prices and falling yields in the overall municipal market, Pollack said.
California, the muni market’s biggest borrower, has about $80 billion in outstanding obligation debt, compared with its $1.9 trillion in economic output.
Krugman’s argument for bloated government
Paul Krugman, Nobel Prize-winning economist and New York Times columnist, is once again banging the drum for federal aid for state and local governments. In theory, the federal government has the capacity to prop up states and municipalities by providing stimulus dollars to keep economic activity from stalling. However, this would require Congress to raise the debt limit and the Treasury to borrow from bond markets to get the money. Krugman contends that this would cost little and that the Obama administration is postponing the recovery by not fighting for more money from Congress:
The federal government has been pursuing what amount to contractionary policies as the last vestiges of the Obama stimulus fade out, but the big cuts have come at the state and local level. These state and local cuts have led to a sharp fall in both government employment and government spending on goods and services, exerting a powerful drag on the economy as a whole.
What Krugman’s analysis overlooks is that government at the state and local levels has been ballooning for decades and that a contraction may be necessary to purge the system of bureaucracy and outdated programs. Krugman’s borrowing plan would simply freeze budgets which, on their own, are basically unsustainable for state and local governments. As their costs increase, there is no more “fiscal space” in many state and local budgets to maintain the status quo without large tax increases. So after Krugman’s proposed federal stimulus expired, states and municipalities would likely have to raise revenues to support their expanded size.
Hoping that state and local government can provide a large number of jobs is unwise policy, since government employees have substantial attendant costs, notably generous pensions. Unlike private corporations, government cannot quickly add and reduce jobs as public budgets must go through the legislative process, which is infinitely more complex than corporate planning.
You can see the growth of government in the graph above, which plots state and local government employees per capita. In the early 1980s one government employee served 179 citizens. By 2002 one government employee served 155 citizens. This increase in employees either happened because governments took on more responsibilities, became less productive or padded the employee rolls as a result of political pressure (or a combination of all three).
A more striking example of the expansion of government is spending on law enforcement. As seen in the graph below, spending (in constant dollars) for law enforcement went from $192 in 1982 to $344 in 2007, far outpacing population growth. After watching police in riot gear break up peaceful Occupy protests and swat teams being used for small-time drug arrests, we might ask if there are too many public resources dedicated to “peacekeeping” already.
The federal debt interest rate is literally below inflation, adding to the federal debt is currently not a problem.
The increased spending on police and education reflects the ramping up of education standards worldwide. I understand the need for reform, but cutting funding to education isn’t the solution. The same can be said for law enforcement.
In many ways, the idea of cutting government spending in a recession makes no sense. Programs like education and law enforcement a) directly pump money into the economy, raising employment and b) have overarching benefits for society, no matter where the economy is. If those programs are not worth our spending, I don’t know what is.
As for unsustainable local/state governments, there is definitely a problem there. I advocate a serious resturucturing on a state-by-state basis, but only AFTER unemployment reaches normal levels. There’s no point in sacraficing jobs for a balanced budget: there is no short-term benefit, and the long term benefits won’t be realized if we keep ourselves in this rut for too long.
For those who say “stop spending money we don’t have,” I say stop looking at marcoeconomic policy like you would a personal bank account. Large governments like the USFG can handle the debt burden. WWII proved that, an example classical economists would love to forget.
The soft side of federal spending
It’s not clear that Congress is capable of doing its job of managing the nation’s purse strings. Capitol Hill failed at identifying a combination of tax increases and reductions in spending that would have lowered our growing debt burden. Now every constituency that draws funds from the U.S. Treasury is angling to push others away from the trough. A perfect example is the internecine warfare to come over defense cuts. Here is a slick ad against funding for the military’s nuclear arsernal obviously coming from the traditional munitions and equipment makers:
The military players are well versed at battling over the spoils. But it’s the soft side of federal spending, where social support and services are funded, that is less equipped to fight over its share of decreased funding.
The automatic cuts that kick in due to the failure of the supercommittee are aimed at defense, Medicare and Social Security, and other discretionary social programs. The legislation spares cuts for Medicaid payments to states. It’s interesting that this area was protected when other major areas of the budget will have reductions. Medicaid cuts were the reductions that governors and county officials feared most because they consume an increasing amount of state and local budgets. Maybe governors were the real winners of the lobbying game when the Budget Control Act of 2011 was being written.
Politicians seem to be stuck in the blame game and hyperbole about who would or wouldn’t raise taxes on millionaires. We do need tax increases and we must cut everywhere as precisely and wisely as we can. Enough with the soundbites. It’s time to start talking hard numbers.
Don’t let the hawks win
The Supercommittee has failed. Their mandate to cut $1.5 trillion from the federal budget over 10 years was too great a hurdle for its members to climb. Now the automatic provisions of the Budget Control Act of 2011 will kick in. These require half of the $1.2 trillion in spending reductions to come from the Departments of Defense, Homeland Security, and Veterans Affairs; the National Nuclear Security Administration; some management functions of the intelligence community; and the international affairs budget from the State Department.
Already the fight over these required cuts is on. The war hawks in Congress are starting to circle in an effort to kill the automatic cuts to the military that are included in Budget Control Act. Reuters reports:
[T]he defense industry turns to lawmakers to undo the automatic cuts known as “sequestration.”
Top Republicans, including Senator John McCain, have already said they will pursue legislation to do just that, although President Barack Obama has said he would not support such a move
Republican Senator Jeff Sessions of Alabama, the ranking member of the Senate Budget Committee, says in the Bloomberg video above that across-the-board cuts would not apply to Social Security, Medicaid, Medicare beneficiaries, civil and military employee pay, or veterans. He says these areas need to equally share in budget cuts. There are certainly reductions that can be made in every area of the gargantuan federal budget. But I think we really need to dig deep when members of Congress fight to protect the U.S. military on grounds of global insecurity. In the case of Senator Sessions it’s useful to know a little about the dominance of military spending in his state. Bloomberg did a brilliant article last week that explained:
Overall defense spending in Madison County, [Alabama] jumped 76 percent over a decade to $15,889 a person, the sixth-highest in the country, based on data compiled by Bloomberg. In the six years since the nationwide base realignment, military contracts in the area have swelled 48 percent to $32 billion, bringing in 4,650 new government jobs.
The United States spent approximately $700 billion, or 4.7 percent of GDP in 2010, on the military. China, a much bigger nation, spent $114B, or 2.2 percent of their GDP.
Irene damage estimated at 0.214% of GDP
Irene has come and gone. She was a big girl but fortunately she didn’t cost a lot in terms of economic damages. The biggest toll was the 25 lives she claimed. I mourn those deaths and know their loss is incalculable to their families.
Local, county and state officials responded to the disaster admirably. Local newspapers and television stations are full of stories of families evacuated and emergency measures taken. New Jersey and New York City preemptively evacuated millions of people and shut down mass transit and other infrastructure systems. Given the scale of potential damage the losses have not been that great.
The economic loss of Hurricane Irene has been estimated at approximately $3 – 4 billion. Measured against a gross domestic product of $14 trillion Irene will ding the economy for about 0.214% of its annual output. Some have suggested that this will give the construction industry a boost, but it’s not significant. Irene’s damage, on its own, is not a substantial blow to the U.S. economy, but nine other “weather disasters” have caused more than $35 billion in damages this year, according to the National Climatic Data Center at the U.S. Department of Commerce (hat tip Empty Wheel).
The federal agencies which man the front lines during disasters are facing funding pressures in this time of budget austerity. The Hill reports that the disaster relief funds of the Federal Emergency Management Agency have dipped below a crucial threshold that keeps them from initiatives broader than debris clean-up. The Huffington Post explains that the National Oceanic and Atmospheric Administration will have trouble launching the replacements of current weather-tracking satellites on schedule due to budget reductions.
All levels of government are restraining their expenditures, but ensuring the safety of the people is the primary responsibility of every level of government. I’d like to suggest to members of Congress that there are plenty of areas in the military budget that can be reduced to ensure that all necessary funds for domestic protection efforts are covered. The events of this weekend show that it is vital that FEMA and the NOAA are fully funded.
“The economic loss of Hurricane Irene has been estimated at approximately $3 – 4 billion.”
Where did you get that estimate? The lowest one I was seeing on Monday was $7B, and that’s probably higher now, given the week of VT.
Money doesn’t make graduates
It is hard to make comparisons between different states’ data on public schooling because each one is faced with unique conditions. That said, the data above is pretty striking. The graph shows the public school dropout rate — the percentage of students dropping out annually — and the amount of public money spent per student per year, in thousands of dollars. You can see that there is not a lot of correlation spending and the dropout rate. Spending more doesn’t educate more students.
Of course this data only speaks to the dropout rate rather than educational achievement. So we can’t see the upside to higher spending. It’s always helpful to have bigger budgets but public schools, like all parts of muniland, will need to dig deeper and achieve more with less money. I’m confident that we can improve our educational system in the face of budget tightening.
I’m interested in all comments and references on the topic please leave them below.
Further:
US Department of Education: Public high school graduates and dropouts: 2007-08
For all the money and thought and resources we’ve poured into schools in impoverished neighborhoods, we’ve done little to raise the trajectory of those growing up in these communities. Brill believes that’s because of racalcitrant teachers’ unions. I believe it’s considerably more complicated than that.
http://blogs.reuters.com/great-debate/20 11/08/24/should-we-really-expect-schools -to-cure-poverty/
It’s the military, stupid
The U.S. Chamber of Commerce has published a letter to Congress’s new Joint Select Committee, aka the supercommittee, with the changes they would like to see made to the budget and tax code. The supercommittee’s brief is pretty broad; it will be looking at ways to balance the federal budget by raising taxes and/or reducing expenditures.
The Chamber, which represents business interests, strongly insists that the supercommittee slash entitlements and reform the tax code by lowering tax rates. From the Chamber letter:
The Chamber urges you to consider how the current tax laws act as an impediment to worldwide competitiveness, a deterrent to saving and investment, and an obstacle to innovation and entrepreneurship. Accordingly, the Chamber believes that the current code needs a comprehensive reform to lower overall marginal tax rates, to encourage saving and investment, to foster global competitiveness, increase capital accumulation, attract foreign investment, and drive job creation.
The problem with the Chamber’s argument about lowering tax rates to increase our global competitiveness is that the United States already has some of the lowest corporate tax rates in the western world. Here are corporate taxes as a percentage of GDP from the OECD. (Countries in dark green collect the lowest amount of taxes, countries in red collect the highest) In the Western Hemisphere only South American countries have lower corporate tax rates than the U.S.
Taxes on corporate income as a percentage of country GDP.
The fact is that the U.S. collects a lower amount of total taxes as a percentage of GDP than most of the western world. We are clearly competitive already on the basis of tax rates. Data source: OECD.
Unfortunately, Mr. Buffett largely ignores the flaws, loopholes and complexity of the U.S. tax code, all of which are far more responsible for the imbalances he seeks to correct. This brings me back to the connection my (astute) friend drew to the story about G.E.’s taxes. Even though the corporate tax rate is an infamous 35%, G.E. paid far less than that last year to the IRS (the exact amount was still being debated the last time I checked, but most estimates still put it well below even 20%). The problem is not necessarily that the U.S. government needs to raise tax rates , it’s that it needs to raise taxes . We need to close the loopholes that allow companies, and individuals, to avoid paying for their fair share of the government services and security that are vital to the health of our nation. There are, essentially, two tracks to take here: addressing the methods (secrecy) and addressing the motivations (big rewards, low to no consequences).
On the methods side, policy makers should enact legislation that would require banks to collect the beneficial ownership information for all account holders. Tax information should also be exchanged automatically between all countries on each other’s citizens. Both of these strategies would significantly inhibit the ability of individuals and corporations to hide the true nature of their tax obligations to the U.S.—and to other governments.
Another set of changes to the rules should focus on the motivations, or cost-benefit ratio, of evading taxes. Making tax evasion a predicate crime for anti-money laundering would subject those prosecuted to much steeper (jail) sentences, which raises the risk to their reputation and their lifestyle for engaging in such behavior. Requiring reporting by MNCs of all profits and taxes paid on a country-by-country basis would also raise the reputational risk for using overly aggressive tax planning. (Investors would also benefit from knowing exactly where a company is making money and where it is losing money—helping them gauge the strategic risks the company faces.) Finally, international commerce laws should be updated to require personal signatures that the prices of goods and services have not been altered for the purpose of evading taxes or customs duties in a given cross border transaction. No rational employee is going to want to risk jail time for herself or himself in order to save the company some money.
http://www.financialtaskforce.org/2011/0 8/19/oracle-of-omaha-sees-big-picture-mi sses-loopholes/
Why the little guys can be on top
Here is a brilliant map from the Tax Foundation (via WPRI.com). The percentages on the map indicate the amount of each state’s annual budget that goes to pay off interest on their debt. Massachusetts leads the pack in this statistic with 9.58% of their budget going towards interest payments, much higher than the average. It’s important to note that this is not a map of relative ranking of debt loads as that would look quite a bit different and have California in the lead.
After seeing this map, S&P’s announcement that cities and states can keep their AAA rating despite the U.S.’s downgrade makes more sense. The National League of Cities said the following in response to Standard & Poors’ statement:
Standard & Poor’s announcement that cities and states may keep their AAA bond ratings despite the recent downgrade of the U.S. federal government demonstrates the difference between U.S. federal debt and the municipal bond market.
Unlike the federal government, municipal debt is typically not used to finance day-to-day operations. Local and state governments use municipal bonds to finance infrastructure projects. Nearly all local and state borrowing is longer-term (20 or 30 years) and debt service payments are predictable (usually the same amount each year). Additionally, local and state debt levels are low, about 16 percent of GDP, and usually representing a relatively small portion of local and state budgets, about 5 percent on average.
Reuters: Some munis can have higher ratings than US – S&P
Bond Buyer: S&P Report Says States, Locals Can Be Rated AAA
Bloomberg: S&P Plans No Added Muni-Rating Cuts Until U.S. Budget Details Are Complete
Top Ten States (highest debt) Voted for Obama
Bottom Ten States (lowest debt) – Voted for McCain
Muniland likely resilient to U.S. downgrade
It’s a little frustrating to hear commentators outside of muniland bash all municipal bonds as though they were a homogenous asset class. AOL’s Daily Finance ran a quote from the top regulator at the Municipal Securities Rulemaking Board, who is pushing back on this idea:
“It is important to remember that only four to six [defaults] make headlines, but 45,000 others are doing OK,” Lynnette Kelly Hotchkiss, executive director of the Municipal Securities Regulation Board, tells DailyFinance. “Remember that every issuer is unique and needs to be analyzed on its own merit.”
Reuters is running with the meme that the municipal bond market will likely be resilient in the face of Standard & Poor’s downgrade of the United States. Bloomberg is sailing in the opposite direction with a gloomy view of the prospect of downgrades for munis after S&P’s action. The Bond Buyer reports that low expected issuance should help buoy yields. And the Wall Street Journal details how muniland has passed a critical threshhold in the second quarter as municipalities were able to renew and renegotiate their bank backstop agreements:
The municipal-bond market passed a critical test in the second quarter, as states, cities and other municipal issuers readily replaced billions of dollars of expiring credit agreements with banks.
In the three-month period, Moody’s Investors Service Inc. said the vast majority of municipal issuers renewed, replaced or refinanced most of the $26 billion of expiring letter-of-credit agreements and other backstops that the ratings firm tracks.
According to Moody’s, about three quarters of the expiring credit agreements backing variable-rate bonds were either renewed or replaced by a different bank.
The real story is the long-term flow of funds
Standard & Poor’s will likely downgrade thousands of municpal bonds that are linked to the U.S. government today. This won’t pose much of a problem for these credits, except to raise their borrowing cost slightly. But the real story for muniland is how much federal funding to state and local governments will be cut in deficit-reduction talks. From the Bond Buyer:
The federal government’s largess
The states rely on the federal government for 1 out of every 3 dollars they spend. States are rightly worried that the new “super committee” established by the debt ceiling deal in Congress will be looking at these monies to reduce spending. I thought it would be useful to look at the federal budget and get a sense of the size and composition of these expenditures.
I got a large table of data from the Government Printing Office (GPO) that shows the Congressionally authorized grants to the states. About half these monies are administered by states and flow through their budgets (see especially Medicaid and education funding) and the balance are distributed as federal programs. Here are the main programs administered by the states in this pie chart. Federal unemployment assistance is not included in this area of the budget.
Medicaid has always been the biggest cash transfer program to the states. It requires matching funds from state and county governments. Although it escaped mandatory reductions in the first phase of deficit reduction it’s the area that has governors and legislators most concerned. Medicaid is the poor cousin to other health insurance programs and it generally pays the lowest reimbursement rates. Some creative thinking is needed for this widely used health insurance program.
The other interesting observation I had looking at these numbers was the comparison of spending on special education to career and vocational training. Spending on special ed was over five times higher than spending on job training. I’m not advocating reducing special education but we must commit more resources to training unemployed Americans for higher skilled jobs.
Dig into the data a little. Where we spend our treasure is a big factor in America’s future. There will be less federal largess. Let’s spend it wisely.
(Federal budget via GPO. Data in $ millions)
United We Stand…… Divided We Fall……. Anyone remember that?
Extreme Partisan Politics are running and ruining this country, and has been for a long time, and far too long at that.
Maybe the American People should Unite and stand up for what is Right and Just, and get these Career Politicians and Lobbyist/ PAC Thugs out of Washington, and see how they like it on “Welfare”
Current Politics = Legalized Mafia.
The government is not For the People, and by the People anymore.
It is not a Democracy as it was meant to be.
It is for the Super Wealthy, The Poorest or Laziest of the Poor, Big Business, and Big Banks.
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Resident Muniland expert
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