Amity Shlaes summarizes a report by Scott Moody (of the Public Choice Analytics) that compares the relatively free state of New Hampshire with less-free Maine.

FSU’s Bruce Benson makes the case for private security officers.

The Wall Street Journal takes note of a privatization trend across U.S. cities. This may be gated, so here is the punch-line:

California is looking to shed state office buildings. Milwaukee has proposed selling its water supply; in Chicago and New Haven, Conn., it’s parking meters. In Louisiana and Georgia, airports are up for grabs….About 35 deals now are in the pipeline in the U.S., according to research by Royal Bank of Scotland’s RBS Global Banking & Markets. 

Alan Blinder has an interesting article in today’s Wall Street Journal. 

In it, he says that the Obama Administration is on the right policy track in its attempt to extend unemployment benefits, create more fiscal stimulus, and permit the Bush tax cuts to expire for people earning more than $250,000. 

He makes a claim that has become increasingly popular: policies that tax the rich and redistribute to the poor are not only compassionate, they are stimulative. There was a time when those on the left talked about a tradeoff between redistribution and growth. But Blinder and others now argue that redistribution is, on net, stimulative; that it is possible to have one’s cake and eat it too. 

Blinder begins by conceding a point to the opponents of more generous unemployment insurance. He writes:  

[L]onger-lasting benefits dull the incentive to seek work, which in turn drives up unemployment. Economic research suggests they are right.

But, he says, “one shouldn’t exaggerate the magnitudes.” Furthermore, he sees reason to believe that unemployment benefits can be stimulative. The key to this reasoning is his assertion that the poor are more likely to spend a marginal dollar than the wealthy. That’s why we can tax the wealthy, redistribute to the poor, and see a net gain.

He writes:

[C]onsider three different ways to add a dollar to the budget deficit: increase unemployment benefits by $1, give a $1 tax cut to someone earning $50,000 a year, or give a $1 tax cut to someone earning $5 million a year.

While the immediate impacts on the budget are identical, the near-term spending impacts are not. The unemployed worker struggling to make ends meet will likely spend the entire dollar right away. The $50,000 earner probably will spend the lion’s share of it, saving just a bit—that’s what most Americans do. But the $5,000,000 earner probably will save most of the new-found dollar.

Blinder is referring to the “marginal propensity to consume.” Keynesians have long-argued that the poor have higher marginal propensities to consume than the wealthy. That is, Keynesians believe that if you tax a wealthy guy and redistribute the revenue to a poor guy, the economy will actually grow in the short run. Why? The wealthy guy wasn’t going to spend that money (or at least not much of it) anyway. He was just going to let it sit in his bank account (never mind that savings makes its way into aggregate demand as investment—buy Keynesians have other stories for why that doesn’t work). The poor person, however, is different. He will go out and spend that dollar right away, leading to a multiplier in terms of growth.

In my mind, this makes theoretical sense. The problem is: it doesn’t seem to be true. And President Bush’s Stimulus I provides the evidence. Economists Claudia Sahm, Matthew Shapiro and Joel Slemrod studied the way people spent the stimulus checks that were sent out in the first half 2008. Using data from the Reuters/University of Michigan Survey of Consumers, they found that spending patterns were “strongly at odds with the conventional wisdom.” It turns out that the poor were actually less likely to spend their 2008 stimulus checks than the wealthy. What’s more, analysis of the 2001 stimulus found much the same thing.

Now there may very well be humanitarian reasons for unemployment insurance (I’ll leave it to others to debate those). But is seems to me that the data are making it increasingly more difficult to argue that redistribution through unemployment benefits is both humanitarian and stimulative.

Here is an item I meant to blog on a while ago. In an article title “Local Governments Spend Millions Lobbying State,” the Pekin Daily Times reports that:  

Thirteen downstate bodies in 2009 together spent more than $194,000 on lobbying for an average of more than $16,000 each.

Now, $16,000 X 13 = $208,000. So, in the aggregate, these governments spent $194,000 in an attempt to gain a prize worth $208,000. 

Economists use the term “rent seeking” to refer to the expenditure of resources—time, money, and effort—in an attempt to redistribute existing wealth (which economists called a “rent”). Rent seeking is a wasteful activity. Instead of creating new wealth by finding new ways to satisfy consumer demand, people end up expending valuable resources chasing existing wealth. It is the difference between fighting over a piece of bread and baking a new loaf.  

Theory predicts and studies have confirmed that the losses associated with rent seeking vary as conditions vary (for example, it makes a difference if lobbying is subject to increasing or decreasing returns to scale). “Complete dissipation” is the term economists use to refer to a situation in which the rent seeking expenditures are equal to the entire size of the rent. In downstate Illinois, it appears that we have an unfortunate example of (nearly) complete dissipation.

Ezra Klein conjured up a fanciful reason why the stimulus spending hasn’t stimulated… anything. Matt and Eileen broke it down pretty thoroughly. Today, Mercatus Senior Research Fellow Veronique de Rugy has some visual evidence to rebut Ezra’s Keynsian dreams.

Klein is exactly wrong when he writes:

Uncertain about the future, [consumers] spend less now. The role of the government is to step up and keep the economy moving until consumer confidence returns.

Uncertainty isn’t a side-effect of a downturn, it’s a primary cause. In the recent bust, asset values were drastically skewed. If the government “keep[s] the economy moving,” confidence can’t ever return; everyone knows the old status quo was horribly flawed. Ezra, like Krugman, believes that government spending can drive an economy. Veronique’s chart neatly dispels the illusion that public spending can effectively supplement (or supplant) the private sector.

Yesterday I contra-posed Greg Mankiw’s view of stimulus spending against economic realities explained by Bruce Yandle. Last night I noticed this new video, from Reason.tv, in which Dr. Yandle explains in his own words the bootleggers and baptists theory, and talks about it in the context of other regulatory schemes.

The video shows both the depth and breadth of Dr. Yandle’s knowledge and insights, but also captures his gentle humility. It’s a privilege to work with him.

Greg Mankiw has a long article in National Affairs on the proper way to align incentives and stimulus spending:

Economists will no doubt long debate whether Cash for Clunkers passed a cost-benefit test. (Some early results, from Burton Abrams and George Parsons of the University of Delaware, suggest not.) But the fact that people responded to the incentive as they did — nearly 680,000 cars were purchased — suggests that a broader, more comprehensive program of incentives, such as an investment tax credit, might have stimulated spending even more.

Of course, not all tax cuts or credits are created equal, just as not all direct government spending is. One popular idea in recent years, for instance, has been a tax cut for businesses that make new hires. Indeed, the jobs bill signed by President Obama in March put in place a targeted payroll-tax exemption for some small businesses that hire people who have been unemployed for two months or more; several members of Congress have proposed broader tax cuts for businesses that hire new employees. The premise behind these policies is that, because unemployment is so high even as the economy begins to recover, we should create incentives for businesses to place unemployed workers into jobs.

There is a case to be made for a broad-based payroll-tax cut that might have this effect, but a narrower tax cut for new hires suffers from some major flaws. The basic problem is that we do not know how to properly define — or enforce a definition of — a “new hire.” Presumably we do not want a business to hire Peter by firing Paul and to then call Peter a new hire; this would cause a great deal of inefficient churning in the labor force (not to mention a great deal of unpleasantness for all the Pauls).

In this video from Mercatus’ Capitol Hill Campus, Dr. Bruce Yandle, Dean Emeritus at Clemson University’s College of Business and Behavioral Sciences, points out the faulty premise that stimulus spending increases demand. Instead, he shows that cash for clunkers and the recently expired first-time home-buyer credit simply shifted demand in time.

In short, for an incentive to actually stimulate an increase in demand, it would have to cost significantly more than the benefit created by increased economic activity. Mankiw himself explains that uncertainty is a recurring problem in economic planning:

The negative effects are even more challenging to trace. For example, if people observe the government issuing substantial debt (required to finance a stimulus), they may anticipate higher future taxes and therefore cut back on their current consumption. Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today. Obviously, recovery.gov has no way to take account of these consequences, either.

Dr. Yandle presents the counter-point that economic uncertainty is not just an unfortunate side-effect of directed planning and incentives. Uncertainty is a prime driver of economic stagnation, both fiscally and psychologically. When economic rules and incentives change rapidly, private investors and business owners have to question their entire rational decision-making process.

Suddenly, planning a business is like building a house on quicksand. The point of stimulus spending is to offset a drop in aggregate demand, and hope that economic growth offsets the cost of the spending.

However, aggregate demand drops, as it did in 2008, because asset values become skewed. Aggregate demand needs time to reset, while consumers and producers determine the appropriate level of supply and demand under new conditions. The market seeks to correct uncertainty. By introducing new rules and incentives, stimulus spending time-shifts this realignment, but doesn’t supplement it. It adds more uncertainty to an already infuriatingly complex puzzle. That’s why such massive spending hasn’t had any noticeable effect on unemployment; it’s probable that Washington, with the best of intentions, has made hiring people more difficult for a longer period of time. It’s the same reason cash-for-clunkers was such a dismal failure, and the home-buyer credit shows the same symptoms.

Far from being a momentary side-effect of stimulus spending, uncertainty is a systemic problem with interventionist economic policy. The poison is worse than the medicine.

The Louisiana Road Home program was established to provide up to $150,000 for homeowners rebuilding in the wake of Hurricane Katrina. Almost 5 years after the hurricane devastated the Gulf Coast, the Louisiana Recovery Authority estimates that one third of grant recipients have yet to rebuild and return home. Why? Garett Jones and Neighborhood Effects blogger Daniel Rothschild offered a few reasons last year in Forbes:

While initially designed to rapidly provide rebuilding assistance to residents, [the Road Home program] was loaded down with caveats and clauses meant to engineer a particular rebuilding plan, rather than allow the rebuilding to emerge spontaneously. Government rules became government direction, and private decision making was shoved into the back corner….

The biggest problem with Road Home was that it caused people to wait for promised federal help, and indeed, some people are still waiting. The initial promise of quick and easy government assistance combined with inept program administration and a 57-step application process mean that even [nearly five] years after Katrina, thousands of homeowners are still waiting for their checks…. So government action delayed private action and government plans crowded out local solutions.

Haiti — and the international commission that will direct its reconstruction — should heed lessons from the Gulf Coast recovery.

Yet development economist Jeffrey Sachs, like many other experts, advocates a centralized reconstruction strategy for the country. “There should be one overarching framework. There should be one major multi-donor bank account to finance the heavy outlays required for Haiti’s recovery. There should be a highly professional executive team co-ordinating the international support efforts.”

The Interim Haiti Recovery Commission grants Sach’s wish. It will determine which reconstruction projects deserve funding and then disperse the $9.9 billion pledged by donors. But it must beware entangling Haitians in obstacles that plagued Gulf Coast rebuilders — crowding out of local solutions, creating bureaucratic red tape that delays recovery, and unintentionally encouraging inaction as citizens wait for government or international panaceas.

Evidence from the Road Home program suggests that the federal government’s Katrina recovery strategy encouraged residents to battle for grants rather than innovate creative solutions to overcome their challenges. The international community’s reconstruction strategy in Haiti must avoid doing the same.

Alan Blinder has a thought-provoking article on Greece in the Wall Street Journal (with more Greek metaphors than Jason had Argonauts). His central claim is that governments should take their cues from St. Augustine, who asked God to make him chaste, but not yet. Because of the recession, the argument goes, we ought to run deficits as the “oracle” Keynes counseled.

But once things turn around, we should concentrate on balancing the books. The general strategy is: Run deficits in times of famine and surpluses in times of feast. This type of argument is quite popular now and was repeated ad infinitum at a gathering of left-of-center thinkers I attended last summer. It has also become a common argument for those who advocate tax increases rather than spending cuts to deal with state budget crunches.

Even if we conceded the Keynesian point that deficit spending is what the doctor ordered, and there are many who are not prepared to do so, what shall we make of the Keynesians’ view of politics? From my perspective, politicians simply don’t behave as the Keynesian model predicts. In the 74 years since Keynes wrote his General Theory, the U.S. has been in a recession just 17 percent of the time. Still, during those years, the Federal Government ran deficits 84 percent of the time. As Buchanan and Wagner argued several decades ago in Democracy in Deficit:

Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax.

Thankfully, at the state level, the politicians are not turned fully loose. This is because every state but Vermont has a balanced budget requirement. If, however, the new norm is for states to turn to the Federal Government for bailouts during a downturn, these balanced budget requirements will become increasinly meaningless. It is my guess that, like their federal counterparts, state politicians will fail to behave as the Keynesian model predicts.

I met a man last weekend who had built a house in Japan in the 1960s. He and his wife then returned to the US for a few years while he finished graduate school. He told me that he had left the house abandoned for two years and that they had been eager to get back to it.

“Why didn’t you try to rent it?” I asked. “The law was different there,” he said.

“If I had rented it, then it might not be easy to regain possession. Even if I had signed a lease with the tenants for a defined period, I might have had to sue them in order to get them out. And the judge might have looked at my salary and at that of the tenants, and he might have concluded that they needed the house more than I.”

Curious to see if this is still the case, I Googled Japanese landlord law. I found this site which seems to indicate things have changed.  Any readers out there with more context?

In the meantime, the story nicely illustrates a few points:

1. As first-year law students learn, property rights are best thought of as a “bundle.” One does not simply acquire all the rights to use a piece of property in any way one chooses. Instead, one acquires certain rights to use property under certain circumstances. In this framework, property rights configurations are best considered as a continuum: under some regimes, they are far more comprehensive than under others. In this case, the 1960s Japanese landlord doesn’t seem to enjoy the same level of rights as, say, a U.S. landlord today. On the other hand, I’m sure that he still retains some rights (presumably, squatters could not barge in and take over) and these were, no doubt, more comprehensive than those enjoyed by others elsewhere in the world.
2. My Googling found that Japanese law had previously been considered quite “pro-tenant.” But that’s a relatively simplistic way to think about it. No doubt, the laws were intended to help the tenants, but there were probably many potential renters who had to either pay higher rents or sleep on their friend’s couches because of it. Moreover, a great deal of property must have gone unused—just like my friend’s house—leading to widespread underutilization of resources throughout the economy.
3. Lastly, if I understand my friend correctly, it sounds like the judge had some level of discretion. This means that there was further waste as landlords and tenants duked it out in court to determine the use of the property. Notice that this (no pun intended) rent-seeking loss would not be present, if it were clear that property abandoned by the landlord always went to the tenant (no one would rent and no one would waste money on court battles). And those who have studied Tullock will also note that it would just be a transfer if bribing were legal and the judge were completely secure in his job. That is, the rent wouldn’t be dissipated because the litigants would just pay bribes equal to the expected value of winning the case and the value of the bribes would sum to the value of the economic rent.

Burlington, Vermont’s bond rating has been downgraded from Aa3 to A2 and placed on negative credit watch by Moody’s due to a high debt level. At Digital Society, George Ou places the blame on Burlington’s municipal fiber telecom:

In a city with approximately 20,000 homes and businesses, 4800 of which are municipal fiber subscribers, Burlington Telecom seems to have racked up a $50,000,000 debt.  That works out to about $10,417 per subscriber which is a huge tax payer subsidy for relatively affluent homes and businesses that can afford the relatively expensive fiber service.  Three out of four Burlington residents don’t subscribe to the municipal fiber service and it is likely that many of them can’t afford the service yet all of them are subsidizing the muni-fiber service with regressive local sales taxes.

Worst still, Burlington Telecom’s deficits and debt are rising which makes the prospect of financial stability more of a dream than reality.  This is likely due to the low 24% adoption rate and a dearth of premium high paying customers which makes it extremely difficult to recover the high costs of building out 100% of the residents and businesses.  There is even a criminal investigation to determine if millions of dollars have been misappropriated and a lawsuit to reclaim $17 million that Burlington Telecom took in 2008 from the treasury without notifying taxpayers.

Just last year, Burlington was crowing about its Aa3 bond rating and its fiscal prudence, predicting that Burlington Telecom would become self-sustaining in the near term. What a difference a year makes.

Via the Twitter feed of Cord Blomquist.

Ohio’s Buckeye Institute for Public Policy Solutions recently released their new State of the State report. From the press release:

In nineteen years, Ohio’s job market only created a net 176,100 new jobs, or just over 9,000 jobs per year. That weak job growth means limited opportunities for you, your family, and your friends. Limited opportunity makes it hard for you to get ahead and attain the American Dream.

As the job market weakened, the taxes and fees you pay to government at all levels rose making your state and local tax burden the 7th highest in the United States. The tax climate for businesses in Ohio is the 47th worst in America.

[...]

The only way to spur robust job creation and lower our taxes is to eliminate Ohio’s anti-business job policies and to reduce the cost of government. These actions will not be easy but failure to make fundamental reforms will render Ohio even less competitive with other states in both job creation and taxes.

The executive summary adds:

If Ohio wants a vibrant job market, our elected officials must stop nibbling on the margins and put in place policies that allow businesses of all sizes and industries to grow and create jobs. By making hard choices that defang entrenched interests, our government can send a clear message that unequivocally tells Ohioans and the business community across America that Ohio is a place where businesses and their employees will face low tax burdens and effective, cost-contained government.

Click here to download the entire 11.6 MB PDF file.

Is there any other kind? I have an op-ed up at AOL News on the looming crisis in state pension funds. The New York Times article I reference is here, and the Pew study is here.

If you’d like to read more on this coming pension tsunami, we recommend this. Eileen and I have forthcoming issue of Mercatus on Policy on the issue, and will have a longer paper in the future.

Today, Slate’s Explainer column tackles the question: Can California declare bankruptcy?

No:

Chapter 9 of the U.S. bankruptcy code allows individuals and municipalities (cities, towns, villages, etc.) to declare bankruptcy. But that doesn’t include states. (The statute defines “municipality” as a “political subdivision or public agency or instrumentality of a State”—that is, not a state itself.) For one thing, states are said to have sovereign immunity, as protected by the 11^th Amendment, which means they can’t be sued. In other words, they don’t need any protection from angry creditors who would take them to court for failing to pay their debts. As a result, states can simply borrow money ad infinitum.

California Senate candidate Carly Fiorina mooted the idea last month.

In November, voters in Colorado Springs voted against a measure that would triple the city’s property taxes, and as a result, local government has begun to issue many painful cuts in services. The city was the birthplace of the nation’s most restrictive Tax and Expenditure Limit, so it is no surprise that residents were not in favor of the steep increase.

Colorado’s Tax Payer’s Bill of Rights (TABOR) prevents the state and municipalities from raising taxes without voter consent. The issue of whether state-level TELs should limit home rule by constraining local spending is controversial, but as the law stands it undeniably gives voters control of budgeting.

The official reaction to this vote has been ugly. Budget officials seem to be punishing their constituents for their fiscal preferences by shooting the cocker spaniel, as their Boston counterparts threatened.  The expression refers to politicians who generally threaten to take away valued services, but in this case they are following through. Colorado Springs politicians are choosing to make the necessary budget cuts by turning off street lights, cutting park budgets, and even removing city trash cans, in what seems to be an effort to anger residents rather than make the most efficient cuts possible.

Marketplace’s Kai Ryssdal interviews a resident on the issue:

“They’re going for the things that are easy to cut rather than the things that are hard to cut. And the things that are hard to cut deal with human beings and personnel.”

Fowler says the city needs to look much harder at pay-cuts and lay-offs. But city officials have decided that its employees shouldn’t take pay cuts just because residents want to keep taxes low. So instead, Parks and Recreation took a big hit. That department’s budget was recently slashed by 75 percent.

Perhaps these extreme, if inefficient, measures in Colorado Springs will lead voters to pass a tax increase in the next election. Or these budget-cutting tactics could end the careers of incumbent politicians.

Chris Papagianis of E21 asks the question: Can the Greek crisis happen in the United States? Papagianis suggests that the problem lies not on the federal level, but at the state level:

Obviously, states – like the Eurozone members – don’t have their own individual currencies to devalue during a budget crisis. It’s also not simply whether California, Nevada, or Arizona’s deficit and gross debt compare with those of Greece, but how financial markets would deal with a state default and to what extent the political culture in these state capitols can be counted on to avert such an outcome.

[...]

However the Greek situation is resolved, it is a reminder that financial panics are not just about specific debt-to-income ratios, but investor sentiment and the financial system’s ability to absorb a default. As more investors become aware of their exposure to the unthinkable, they take actions to hedge that risk. This leads to greater awareness of the risks, an erosion of confidence among counterparties, and the potential for the kind of “run on the bank” that ultimately did in Bear Stearns and Lehman Brothers.

Whole thing here. Niall Ferguson wrote about this prospect earlier this week in the Financial Times. Here’s an easy backgrounder on the Greek crisis.

A new study from the Tax Foundation looks at how local governments are attempting to change the way they calculate hotel occupancy taxes, from the amount paid to the hotel to the amount paid by the consumer to online travel services like Expedia and Priceline:

Local governments’ efforts to collect discriminatory taxes from online travel services amount to a revenue grab from out-of-staters and ultimately harm interstate commerce, according to a new Tax Foundation report.

City officials in 22 states have, with limited success, sought to reinterpret hotel occupancy taxes to apply to amounts paid by consumers for online travel booking services (such as Expedia, Orbitz and Priceline).

“Hotel taxes are attractive to local politicians because they are a way to shift the tax burden to ‘outsiders,’” said Joseph Henchman, the Tax Foundation’s Tax Counsel and Director of State Projects, who authored the report. “But because every U.S. city has a hotel tax, we’re all somebody else’s ‘outsider.’ And that means everyone is paying high hotel taxes everywhere.”

This study compares combined lodging tax rates across different cities. Las Vegas has the lowest rate and San Francisco the highest; four of the five highest-tax cities are in California. When rental car and meal taxes are factored in, Chicago, Nashville, Charlotte, Seattle, and Houston are the most taxed cities for visitors. (It’s not unusual in my experience when renting cars in Houston to pay more in taxes, fees, and assessments than the base rental price of the vehicle.)

This book chapter looks at the efficiency and incidence of tourist taxes. An article from USA Today shows how fiffering practices between web sites have made comparison shopping tricky.

Mercatus Senior Fellow and Neighborhood Effects leading lady Eileen Norcross appeared on Fox Business this afternoon, discussing her recent article in Reason. She discussed the fiscal situation in New Jersey, and how it got so bad. From the Abbot court cases to public sector unions, she covers a lot of ground. Watch the interview here.

In the Reason article she dives into the union stranglehold on state finance in more depth:

Since 1990 local governments have added 45,500 new jobs. Nearly all of them are represented by one of a dozen unions, which have helped secure some of the plushest public sector jobs in the nation. It’s easy to see how property taxes have grown at twice the rate of inflation over the past decade. A government worker in New Jersey earns an average of $58,963, a police officer averages $84,223 (the second highest in the nation), and six-figure public sector salaries are commonplace. Compare this to neighboring Philadelphia, where the average police salary is $49,000. According to one estimate, of the $23 billion New Jersey raised in property taxes in 2008, $18 billion was spent on police, municipal, and teacher salaries.The tab for public workers doesn’t end there. Factor in the state’s pension plan, currently under-funded by $34 billion. The New Jersey Taxpayers’ Association calculates pension payouts for the average teacher range from $1.6 million to $2.5 million, per retiree. For the average police officer, that range totals between $3.2 million and $6 million, per retiree.

The debate about the role of the Community Reinvestment Act in the current mortgage morass — and its effects on neighborhoods — continues with this article from Edward Pinto in City Journal. Pinto writes:

Whatever the precise magnitude of the CRA’s role, there is no question that as the government pursued affordable-housing goals—with the CRA providing approximately half of Fannie’s and Freddie’s affordable-housing purchases—trillions of dollars in high-risk lending flooded the real-estate market, with disastrous consequences. Over the last 20 years, the percentage of conventional home-purchase mortgages made with the borrower putting 5 percent or less down more than tripled, from 8 percent in 1990 to 29 percent in 2007. Adding to the default risk: of these loans with 5 percent or less down, the average down payment declined from 5 percent to 3 percent of the loan’s value.

As for Fannie and Freddie, most of the loans with 5 percent or less down that they had acquired by 2005 had down payments of 3 percent or even no down payment at all. From 1992 to 2007, the two entities acquired over $3.1 trillion in low-down-payment or credit-impaired loans and private securities backed by credit-impaired loans—and these are performing horribly: the delinquency rate on Fannie’s and Freddie’s remaining $1.1 trillion in such high-risk loans is 15.5 percent as of this past June 30, about 6.5 times the rate on the entities’ traditionally underwritten loans. All this risky lending, of course, drove the nation’s homeownership rate up and inflated a housing-price bubble.

Last year, Tyler Cowen disagreed. Here is Randy Kroszner’s take. Russ Roberts wrote about it in the Wall Street Journal last year.

On October 15, Puerto Rico’s public sector labor unions promise “the most massive movement” in their history.  Yesterday union leaders clashed with riot police outside La Fortaleza, the governor’s mansion in San Juan.

A general strike is being called in response to Governor Luis Fortuño’s decision to layoff 17,000 government workers in order to avoid a budgetary crisis. Puerto Rico faces a budget deficit of $3.2 billion.

It’s a bold move, considering that 25 percent of all those employed in Puerto Rico work in the government sector. The move is part of a larger plan to deal with Puerto Rico’s poor economic growth, growing public sector, and the lowest credit rating in the U.S. (now at BBB-).

While the unions argue that layoffs will drive up the unemployment rate, what is striking about Puerto Rico is the long-running anemia of its private sector. Stephen Davis and Luis Rivera-Batiz find in a 2005 study that employment rates in Puerto Rico are 55 to 65 percent of US employment rates. The employment shortfall is concentrated in the private sector, in particular for labor-intensive jobs.The authors cite several causes:

• High minimum wage requirements,
• Tax incentives for capital-intensive activities,
• Regulatory barriers, and
• A business climate that rests on being able to secure favors from the government.

In other words, economic policy — heavily reliant on government transfers — has discouraged private sector growth making the government sector a leading provider of jobs.

The cuts are, in a sense, unavoidable. Public sector employment is a main driver of the commonwealth’s budgetary crisis: nearly 70 percent of Puerto Rico’s budget is for payroll.

How will state governments recover from the catastrophic collapse in revenues? According to Indiana Governor Mitch Daniels, that all depends on whether states want to face up to the caus — the happy (and now unsupportable) spending binge of the 1990s, when states increased spending an average of 6% a year.

Writing in today’s Wall Street Journal, Governor Daniels estimates it will take GDP growth twice the historical average of 3.49% to return state tax revenues to their previous long-run trend line by 2012.

And even then, revenue recovery may not happen. Consumer spending is down. Americans may have moved into a renewed era of saving. That means less sales tax revenues for states.

The choice before states: more taxes, or less spending, and permanently smaller government.

State governments will continue to face hard choices: slash services, union benefits, or privatize what the state cannot support.

The Journal also reports on what one-day employee furloughs look like in the states: A 3 hour wait for drivers license renewals in California, no birth certificates available in Wisconsin, the shutdown of shooting ranges and visitor centers in Michigan, no food stamp applications filed in Maine, and fewer traffic patrols on Maryland highways.

There is a bright spot in this exercise: furloughs force efficiencies. When California began DMV furloughs in January, 473,000 people chose to renew online, an increase of 32%.