The Great Deformation (110 page)

In the aftermath of the financial crisis, however, there was a far more consequential equity issue; namely, that the Obama money drop was inherently anti-progressive. It wasted the state's now radically diminished balance sheet capacity. In truth, the era of chronic deficit finance triggered by the Reagan Revolution thirty years earlier had taken the national debt from 30 percent to 100 percent of GDP.

Accordingly, it was no longer prudent to borrow in order to fund expensive money drops because there was very little runway left on Uncle Sam's balance sheet. Indeed, the very real risk of a runaway debt service spiral loomed just over the horizon. So Washington faced an unyielding requirement to eliminate current deficits and to target scare federal dollars tightly and unfailingly on the truly needy.

That was the objective reality, but the “progressives” in the Obama White House never got around to discovering it. Petrified by the Bernanke depression call and badly advised by its cadre of antiquated Keynesian professors, it hastily embraced the greatest money dump ever concocted on the banks of the Potomac. The party which claimed to champion the down-and-out and which advised itself to “never let a good crisis go to waste” failed on both counts.

FISCAL FOLLY FROM THE VICAR'S NAPKIN

On the surface, the $160 billion in grants for Medicaid and education programs appeared to be better aligned with needs-based transfers. Yet the fact that these funds might support low income households through classroom instruction or outpatient medical services was only incidental. They still amounted to a deficit-financed money dump in the form of a temporary funding bridge to state and local governments.

The actual objective at hand, once again, was the Keynesian project of borrowing money on Uncle Sam's credit card and pumping “demand” into the American economy. And like most of the stimulus package, this misdirected
purpose was taken hostage by powerful special interest groups, thereby immeasurably deepening the nation's fiscal crisis.

The flaw was embodied in the White House's overall predicate; namely, that the Obama stimulus would generate a conventional cyclical rebound. This, in turn, would cause recession-swollen expenditures to decline and the state and local revenues to recover. The $160 billion funding bridge for Medicaid and education would thus be self-liquidating.

This predicate was not remotely accurate or plausible, however. The Medicaid and education funding crisis was structural and permanent, not a transitory artifact of recession. If these expenditures were vitally necessary as a social policy matter they needed to be funded out of taxes, not deficits. By going the latter route, the stimulus package was merely setting up yet another fiscal booby trap that would be lurking a few years down the road.

What happened during the bubble years was that state and local budgets were flattered by windfall revenues from swollen incomes, sales, and property values, and from one-time fees and taxes scalped from bubble hot spots such as new shopping centers and subdivisions. Accordingly, between 1990 and 2008, state and local revenues from their own sources (i.e., not federal grants) more than tripled from $700 billion to nearly $1.9 trillion, thereby raising their revenue take from 12.2 percent to 13.6 percent of GDP.

This gain in the revenue take (percentage) from GDP amounted to $200 billion, but as it happened the education and public welfare spending (mostly Medicaid) burden relative to GDP increased even more. During the same eighteen years, state and local spending for these purposes rose from 6.8 percent of GDP to 8.6 percent. This translated into $250 billion in incremental spending by the bubble peak in 2008, and meant that state and local governments had used up their entire revenue windfall, and then some, just on these items.

It was in this context that the Keynesian vicar in the White House handed Nancy Pelosi and Harry Reid a piece of paper on which was scribbled the simple term “$800 billion.” Professor Summers' writ thus rivaled the Laffer napkin as the kind of foolish macroeconomic nostrum that could only incite politicians to spectacular feats of abuse. In this instance, the education lobbies, the nursing home operators, home health agencies, and legions more lined up outside the Speaker's office volunteering to help fill in the blank on Summers' napkin.

As indicated, this $160 billion exercise in filling in the vicar's stimulus target created a giant fiscal trap. On the one hand, a significant portion of the revenue gain from the bubble era has evaporated during the Great Recession.
By 2010, for example, the state and local revenue windfall had shrunk by half, to $100 billion.

At the same time, total spending for education and public welfare has continued to rise dramatically, fueled by both growing need and the temporary federal money drop. State and local spending for these functions thus reached 9 percent of GDP by 2010, meaning that the expenditure burden gain relative to the 1990 GDP benchmark was now $300 billion per year.

Needless to say, the resulting gap will generate excruciating pressure for new Washington bailouts and fiscal transfers; that is, for relief of the state and local fiscal gap that was recklessly widened by the Obama stimulus. The original “good crisis” was thus wasted. Facing the evaporation of their bubble-era revenues, state and local governments should have been forced to make hard choices; namely, to raise new taxes to pay for these swollen programs or to enact deep program reforms and spending cuts.

Along the periphery, in fact, some modest instances of that occurred. During 2010, for example, Arizona drastically cut nonclassroom education funding while also approving by statewide referendum a sales tax increase earmarked for education. So doing, it proved that voters were willing to face the music if presented with honest choices.

But that was the great exception. In the main, the vast money drop stemming from the vicar's $800 billion napkin permitted state and local officials to simply kick the can to Washington. They were thereby enabled to avoid the wrath of their own voters or, better still, the need to face down the real culprits behind their fiscal squeeze: the teachers and other municipal unions and the legions of crony capitalist health care providers who feast off the Medicaid program.

Bernanke's spurious depression call thus cast a long shadow of fiscal mayhem. It created a twenty-two-day sprint to fashion a stimulus bill in the new Obama White House that amounted to policy by pandemonium. In that context, the vicar was empowered to launch the giant Keynesian experiment that his Uncles'
*
textbooks had only pined for decades back.

Once he had scribbled “$800 billion” on the napkin, it meant that the nation's check-writing pen would be handed off to Speaker Nancy Pelosi and Harry Reid. Not surprisingly, they used it to pay off the National Education Association (NEA), the school superintendent's lobby, the textbook publishers, the school construction industry, the special education complex, the preschool providers, and dozens more. For good measure, they
threw in another $16 billion so that millions of middle-class college students could get their Pell Grant handouts topped up by about $1,000 each. And these money drops only constituted the $100 billion education piece of the bounty.

To be sure, apologists for the Obama stimulus who are of the “progressive” persuasion would undoubtedly insist that even if the NEA and Head Start lobbies have offices on “K Street,” they do not belong in the same camp as the mortgage bankers, oil and gas drillers, or private-jet leasing companies. Yet, whether they were doing God's work or lining their own pockets, as the case may be, the NEA's impact on fiscal governance is of the same character as the notorious business lobbies that raid the tax code.

In fact, the Obama stimulus was insidious precisely because it mobilized scores of organized special interest groups that happened to be in the social uplift business to lean hard on Washington for debt-financed fiscal subventions. Whether the $1.22 trillion that state and local governments had spent on education and public welfare in 2008 was squeaky clean and not amenable to reduction, or riddled with excesses and waste and therefore capable of deep cuts was actually not the question at hand.

The truth was that the massive fiscal due bill at issue had been built up over two decades of faux prosperity. The issue in February 2009, therefore, was how the federal system of governance would face up to cutting these programs or raising new taxes to fund them or some combination of both. The overwhelming bulk of these outlays went to permanent programs and clients: school budgets and nursing home patients, not recession-induced caseloads. Accordingly, there was simply no justification for deficit finance of the fiscal gap which emerged when bubble-era revenues fell away.

Yet that's exactly what happened. The $160 billion health and education package was simply an end-run around fifty state constitutions which prohibit deficit finance of ongoing operating budgets. So four years have been lost and the fiscal gap is now greater than ever owing to Washington's endless game of shuffling the fiscal pea from one pod to the next.

But the giant state and local fiscal gap that the Obama stimulus temporarily alleviated is a menacing overhang which will continuously impinge upon the already paralyzed machinery of fiscal governance in Washington. The K Street lobbies mobilized by the vicar's napkin will never stop coming back for second and third helpings.

This is implicit in the truly shocking bottom-line fiscal equation for state and local budgets during 2010, when the Obama stimulus was having its maximum impact. Own-source tax revenue amounted to $1.27 trillion. This was 8.7 percent of GDP, meaning that the state and local tax claim on
GDP had lapsed all the way back to its pre-bubble-era level recorded in 1990.

At the same time, total general government spending (excluding pensions and insurance funds) reached a record level of $2.54 trillion, representing 17.5 percent of GDP. This was a dramatic gain from 1990 when state and local spending had been only 14.3 percent of GDP. So after the two-decade bubble finally collapsed, the state and local tax take had not budged at all, while the overall spending claim had soared by 3.2 percent of GDP—a staggering $475 billion gain.

The point had now been reached where state and local governments were only funding half of their general budgets with broad-based local taxes on income, sales, and property. Half of the balance, or $625 billion, was coming from Washington; that is, from grants and transfers that were drastically swollen by the Obama stimulus.

Furthermore, the balance was being obtained by a mushrooming array of user fees, service charges, permits, licenses, and especially soaring tuition charges at state colleges and universities. In theory, these user-based revenue sources are the preferred way to finance local government services, but they also measure the level of fiscal desperation and instability now embedded in state and local finances.

At the end of the day, the vicar planted a fiscal time bomb. It is evident that state and local officials are failing miserably at the task of raising general tax revenues commensurate with their massive spending commitments, and may be reaching the limits of their political capacity to extract fees and charges. So the pressure on Washington to continue to fill this cavernous fiscal gap will be overwhelming—until the next recession ensues, and then there will be a fiscal catastrophe.

 

*
Summers' uncles were Paul Samuelson, who won the Nobel Memorial Prize in Economics in 1970, and Kenneth Arrow, who won the Nobel in 1972.

CHAPTER 29

 

T
HE FISCAL NOAH'S ARK ERECTED ON CAPITOL HILL DURING THE
first twenty-two days of the Obama administration contained upward of $60 billion for green energy and was additive to about $30 billion of loan guarantee authority already in place. Yet every dime involved an unnecessary and inappropriate fleecing of American taxpayers and constituted a warning sign of the nation's true fiscal peril. Indeed, corporate welfare this egregious, sponsored by a purportedly left-wing White House and promoted by famous venture investors like John Doerr, virtually proves that free market capitalism has been abandoned in the United States.

GREEN ENERGY:

CRONY CAPITALIST LARCENY IN PLAIN SIGHT

Wholly apart from the technological virtues and economic prospects of the various flavors of green energy—solar, wind, electric-battery cars and biofuels—that landed a berth on the Obama stimulus ark, there exists an underlying truth that literally shuts down the debate. The evidence that the private market is providing prodigious amounts of risk capital to both develop and commercialize new energy technologies is overwhelming. The “market failure” meme mainly comes from promoters of perpetual “science projects” and from scofflaws peddling technology and entrepreneurial failures.

Indeed, the Obama green energy extravaganza implicates a stunning case of taking coals to Newcastle. Financialization has done vast harm to the American economy, but that it has produced the greatest class of speculators and fortune seekers that the world has ever known cannot be gainsaid. What has been true at least since the early 1990s is that there is no
speculative project in any field of commercial endeavor—internet advertising, mobile telecom, social media, online services, conventional retailing, software-based gadgets, and countless more—that cannot attract capital and even a large crowd of momentum-chasing speculators if it is even remotely meritorious or viable.