Fate of the States: The New Geography of American Prosperity (5 page)

Even for those who are not underwater on their mortgages, access to credit has been severely impinged on. Since the peak, almost $2 trillion in available credit-card and home-equity lines have been cut from the system.
³⁸
With so much credit taken out of the system, consumer spending has declined. The steady erosion of basic social services at the state level is creating more out-of-pocket expenses for middle- and low-end consumers who must compensate for reduced public services such as transportation, health care, and education.

Owning a home would become a core component of the American experience, and by the second half of the twentieth century, both business and the government were intent upon turning more Americans into homeowners—whether they could ultimately afford it or not. For a while, it was good business. An economy and a country with a high homeownership rate enjoy an economic multiplier effect. Very little related to home buying or home ownership can be outsourced to India or China. The vast majority of costs associated with building homes are labor related, and people who broker, build, fix, and clean homes are always local. When a family buys a home, they pay a real-estate agent and a home inspector. They buy furniture for the home and perhaps hire a contractor or handyman to upgrade the kitchen before moving in. And if they were city dwellers before relocating to the burbs, maybe they even buy a new car. The government figured out that promoting housing promoted both jobs and consumption, boosting the overall economy. If company towns used to be built around industries, the government discovered that it could create “housing towns” simply by loosening the rules around owning a home and qualifying for a mortgage. What the government failed to appreciate, however, was that this housing boom was built on mortgages too many buyers simply could not afford. And as my grandfather used to tell me, the more debt you take on, the smaller the margin of error you leave yourself should anything go wrong.

States Gone Wild

Almost all states are required to have balanced budgets. Almost all have caps on how much municipal bond debt they can issue. Yet over the past few decades, elected officials have figured out ways around these well-intended restrictions. Gaming the system wasn’t even particularly hard, and it was impossible for the average person to track what was happening because information and disclosure were all but nonexistent. But all of this changed in 2009 when states were forced to open their proverbial kimonos and disclose the magnitude of unfunded pension and health-insurance obligations tied to state workers and retirees—as was now required under new Governmental Accounting Standards Board rules.
¹
And 2012 disclosure requirements were even greater, further breaking down the entrenched system of opaque and misleading state and local financial disclosure. The problem essentially boils down to rich promises made to state and local government employees that governments could never afford.

Since 1960, state and local workforces have grown one and a half times faster than the private sector. Current taxpayers fund the rising salary costs associated with all of those new hires, and future taxpayers are also on the hook for the retirement benefits of all of those hires. Add this to the amount of debt owed by the federal government and the amount of debt the average American has amassed over the past decade, and the obvious question arises: “Who’s going to pay for all of this?”

Cities and states never questioned where the money was going to come from to pay for the new sports stadiums or generous union contracts. Local spending decisions were based on assumptions that property-tax revenues would keep on rising. State expenditures assumed ever-increasing income from sales and income taxes. And if the tax revenue wasn’t there? Cities just assumed that their states would be there to bail them out, just as the states figured that the federal government would be their fiscal safety net.

The U.S. government system was designed so that the federal government takes responsibility for national issues like defense and immigration. Generally, it is up to the state and local governments to provide the public services that we rely on at an everyday level. How safe is the drinking water? How often is the trash collected? How good are the public schools? How safe are the streets? This is what defines the quality of life in our communities. The deal we make with our states and municipalities is a straightforward one: They provide us with basic services and a social safety net, and we pay for those services—either with current tax dollars or with future ones we’ll owe to repay principal and interest payments to bondholders. The cost of services rendered is supposed to align with the revenues collected.

That’s the idea, anyway. Because forty-nine states have constitutional requirements to balance their budgets every year or two, whenever tax revenues fall short of expectations, states are supposed to either hike tax rates or attack expenses by cutting spending and programs. Thirty-six states have already raised taxes, layering on special levies or one-time taxes, causing a brief uptick in tax receipts.
²
But receipts have since leveled off, and in many states they’re trending down. The outcome is inevitable: more budget cuts. Since 2008 Nevada has cut $80 million from mental-health programs. New York State has cut $1 billion from its state college and university system. And Washington State has cut $2.6 billion from K-12 funding.
³

The reality is that over the past decade, states haven’t had the money to pay for all of their programs, projects, and promises, forcing them to seek significant spending cuts. Over the past five years, states have cut over a quarter of a trillion dollars out of their budgets—the equivalent of 13 percent of 2010 total spending and 17 percent of 2010 tax receipts.
⁴
Education and public safety have been frequent targets for cutbacks at the state level, but state aid to cities and counties has suffered most. Local governments traditionally rely on state transfers for over 40 percent of their funding, but with state budgets now being slashed, there is less money trickling down.
⁵
After decades of expanding social services, refurbishing schools, doling out generous raises to cops and teachers, and building new parks and sporting venues, the local-government machine has had to pull back dramatically and begin a long and seemingly endless series of cuts to programs and services.

% Change in State Expenditures from 2000 to 2010

SOURCES: BEA, U.S. CENSUS, AND MWAG

From 2000 to 2010, state spending grew by 72 percent in California, 98 percent in Texas, and 114 percent in Nevada. That new spending totaled $107 billion, $59 billion, and $7 billion respectively. State and local government spending as a percentage of each state’s gross domestic product (GDP) also rose dramatically. In 2009 it accounted for over 25 percent of Michigan’s GDP; the figure for California was 25.3 percent, for New York over 28.1 percent. California alone spent $431 billion in 2009, according to the U.S. Census Bureau. Add together New York’s expenditures of $276 billion and Michigan’s $86 billion, and the sum exceeds Turkey’s entire GDP, which is the eighteenth largest in the world. Many states have essentially become dependent on their own spending to prop up their economies. There is, of course, great discrepancy from state to state. In 2009 Texas government spending accounted for a relatively low 9.7 percent of GDP. But it’s not that Texas has been frugal. In fact, its expenses have been growing at a fairly torrid pace—up 98 percent from 2000 to 2010—but it has a larger revenue stream due to the thriving oil and gas industries.
⁶

Budgets are bloated with pet projects of lawmakers wanting to pump money into their districts and into constituents’ pockets. Taken individually, many of these projects seem well intentioned, reasonable, and even beneficial—the Boys & Girls Club facility in the Lacoochee section of Tampa Bay receiving $1 million out of Florida’s $70 billion budget or the Government House in St. Johns County, Florida, receiving $2.5 million to create an “Interpretive Film & Exhibit and Government Museum.”
⁷
But the cumulative effect is devastating. Padding of budgets with fluff spending has been going on for so long that it has become a difficult habit to break.

For years nobody seemed particularly worried. For the same reason so many people believed home prices could never decline, states never foresaw a decline in tax receipts—and certainly never foresaw a prolonged one. They spent as if the good times would never end and made big promises to state and local government employees based upon the deliberate bet that they wouldn’t. Total state tax collections peaked in the second quarter of 2008 at around $241 billion, according to the U.S. Census Bureau. Individual tax receipts collected by the states topped out in the same quarter at $99 billion.
⁸

Then came the bust. Within a year, the bottom fell out of real estate and states were caught shorthanded. Those states with the greatest exposure were left with the largest budget gaps. Foreclosures skyrocketed, and states and cities saw their tax rolls shrink at a time when they needed more cash, not less, to pay for the expensive benefits, pensions, and infrastructure and other projects (which invariably run over budget) they had just approved. The school district in Newton, Massachusetts, for example, spent $197 million on a new, bond-financed high school—a veritable superschool boasting an Olympic-size pool, indoor track, climbing wall, dance studio, arts wing, and electronic music center. Construction costs ran $50 million over budget, and when the new high school finally opened in 2010, the district was suddenly faced with a $6 million budget gap—which it closed by laying off teachers, increasing class size (one Advanced Placement math class had forty-six students), and eliminating classes in Latin and Russian.
⁹
Of course, Newton wasn’t alone in its foolish excess: Many states and municipalities borrowed billions, willfully deluding themselves that the money would materialize from ever-increasing property-tax revenues.

The severity of the recessionary storm was fully revealed in 2009, when second-quarter tax receipts plunged by $40 billion—a record 16.4 percent decline from the previous year.
¹⁰
Thirty-six states posted double-digit revenue losses, the largest declines in history. The slump continued quarter after quarter with only modest gains, prompting Lucy Dadayan, a senior policy analyst at the Rockefeller Institute of Government, to warn that “state tax revenues will continue to be insufficient to support current spending commitments” and that more spending cuts and tax increases were most likely on the way for many states.
¹¹

In fiscal year 2013, which began in July 2012, the Center on Budget and Policy Priorities (CBPP) expected 350,000 more K-12 students in our public schools and another 1.7 million college and university students, many of whom receive state aid. With more employers doing away with health coverage and an increase in the number of unemployed workers lacking any benefits, the CBPP projected that 5.6 million more people would seek Medicaid coverage, which is jointly financed by states and the federal government.
¹²
Where will the additional funds needed to meet these obligations come from? Many states have already made deep cuts in health and education spending. Florida, for instance, slashed assistance to state colleges, and North Carolina took an ax to education spending, lopping $2.6 billion from its fiscal 2013 budget. That comes on top of the nearly $1.5 billion North Carolina schools have been forced to give back to the state in so-called discretionary reductions.
¹³
In other words, faced with its own shortfall, North Carolina took back monies it had already appropriated to counties, cities, and school districts. But this is what happens when states put together budgets based on overly rosy revenue projections.

The state of California has been the worst transgressor when it comes to foolish government spending. The state was in relatively good fiscal shape until 2000, when it fell victim to the implosion of the dot-com boom. With revenues shrinking and cost-of-living increases mandated for current and retired state employees, a budget gap opened; as the downturn dragged on, the gap widened into a chasm and then an abyss. One of the key reasons for the record deficits was that during the good years public sector unions negotiated some astoundingly rich contracts. In 2011 the
Wall Street Journal
cheekily advised young people seeking high-paying jobs to forgo Harvard and become California prison guards. Training, the piece pointed out, took four months instead of four years, and the state paid you while you learned, with starting salaries that ranged from $45,000 to $65,000 and went up—way up—from there. In 2010 one sergeant with a base salary of $81,683 collected $114,334 in overtime and $8,648 in bonuses. And he was eligible for an annual $1,560 “fitness” bonus for getting a checkup. The capper: He could retire at fifty-five with 85 percent of his salary and medical care for life.
¹⁴
Thus the prison guard with thirty years of service, whose highest level of compensation was $100,000 a year, would be eligible to retire at age fifty-five with an $85,000 annual pension. According to the annuity calculator on CNNMoney.com, a fifty-five-year-old male employed in the private sector would need $1.63 million in retirement savings in order to purchase an annuity with a comparable yield.
¹⁵

The city of Stockton, in California’s Central Valley, offers another example. Stockton is flat broke and in 2012 became the largest U.S. city to ever go bankrupt. City officials admit they approved outsized benefits for city workers without having any understanding of the eventual cost. Writing in the
Wall Street Journal,
Steven Malanga, a senior fellow at the Manhattan Institute, quoted the city manager likening Stockton’s fiscal history to a Ponzi scheme in which employees were promised “huge—and unfunded—salaries and benefits,” whose costs the city didn’t calculate and couldn’t afford. Citing “a lack of transparency” as Stockton’s biggest problem, officials now admit that the union contracts allowed for the insertion of hidden costs—a hundred different ways in which employees could quietly boost their pay. One egregious example: Stipends for a fire captain’s uniform, needed or not, could add $35,000 to a $101,000 base salary.
¹⁶

Even before the housing collapse in 2007, Stockton couldn’t afford its generous benefits, so it turned to risky investments. Using $125 million of borrowed funds, it invested in the California Public Employees’ Retirement System (CalPERS), California’s pension fund, hoping to earn returns higher than the interest rates it was paying on its debt. Instead, the city lost nearly a quarter of its original investment—money that it had borrowed in the first place!
¹⁷
As Stockton’s fiscal situation deteriorates, residents are paying the penalty. There are now 25 percent fewer police officers, which translates into dangerously long waits for emergency assistance. If a house is burglarized and no one is hurt, chances are the police won’t show up at all. California municipalities like Stockton find themselves boxed in fiscally by a constitutional amendment California passed in 1978 called Proposition 13. Prop 13 capped property-tax assessments at the 1975 value of residents’ homes, limited rate increases, and, for good measure, required a two-thirds vote of the state legislature to increase income taxes (which now makes it harder for politicians to make up for lost property-tax revenues).
¹⁸
No reassessments were allowed under this law unless properties changed ownership. So in spite of California more than doubling its home values during the better part of the last decade, little new revenue was collected from properties that hadn’t changed hands.