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.

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.

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.

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.”

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).

Money doesn’t make graduates

Chart data

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.

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.

Why the little guys can be on top

Here is a brilliant map from the Tax Foundation (via 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.

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 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.

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