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%.

The headline reads, “State budget deal depends on borrowing, accounting tricks, and gimmickry.”

Which state is it?

In this case, California; the headline is from the Contra Costa Times. On Monday night the state made a deal to close its $26.3 billion deficit; the package includes $15 billion in spending cuts, and $11 million in accounting gimmicks, borrowing, and overly optimistic assumptions. These include:

• $2 billion borrowed from local governments’ property tax revenues (to be repaid with interest in 3 years),

• $2 billion in cuts to local transportation and redevelopment funds,

• $9 billion in payment deferrals to education, and

• Deferring state employee’s paychecks by one day – essentially putting $1 billion in salaries on next year’s ledger.

Here’s a rundown.

As you might guess, local governments’ reply to Sacramento’s, “Can you spot us some revenues, just ’til we get by?” isn’t positive. The Los Angeles Board of Supervisors voted to sue if the state pursues its plans to borrow their revenues. Other local governments are expected to follow.

As Leonard Gilroy at the Reason Foundation writes, when California borrows money — not lends, but borrows — there are strings, really serious ones. The state isn’t content to merely dip into the municipalities’ coffers; it would also like to help level its buildings.

Access to local redevelopment funds means, according to the Los Angeles Times:

Lawmakers will also be given the option to greenlight a controversial plan that would give some local redevelopment agencies broad new discretion to tear down and rebuild neighborhoods under their jurisdiction for decades to come, regardless of whether those areas are blighted.

Loan, unconstitutional revenue seizure, or license for destruction?

One casualty of the state budget crises is the low attendance of governors at their annual meeting in Mississippi. NPR reports that Governor Ed Rendell of Pennsylvania, chairman of the National Governors Association, opted to stay home to work out the state’s budget stalemate, and because, as of today, state employees are not being paid.

He was not the only governor who stayed home. Only about half showed up.

As NPR notes, with states facing a $200 billion revenue shortfall, this year’s budget crises are certain to continue into the next fiscal year.

Interestingly, of those in attendance, a few items seemed to bring consensus. First, there is “little appetite” for a second stimulus.

Governor Bill Richardson of Arizona is worried about the size of the national deficit. And Governor Haley Barbour of Mississippi cites Americans’ concern over the effect of this rate of spending on the value of the US dollar.

Also of great concern is national health care’s effects on state budgets.  The New York Times reports that governors know that the proposed national health care legislation represents a very large Medicaid bill for state governments, which shares the cost of providing the program with the federal government.

Vermont Governor Jim Douglas sums up the mood: “I think the governors would all agree that what we don’t want from the federal government is unfunded mandates. We can’t have the Congress impose requirements that we are forced to absorb beyond our capacity to do so.”

Residents in Point Pleasant Beach, New Jersey have resorted to a seldom-used method to protest their mayor’s proposal to raise taxes: they want him recalled from office. The recall petition containing 1,250 signatures was approved this week, giving Mayor Vincent Barella until July 22 to mount a challenge to the motion being placed on the ballot in November.

The movement to recall Mayor Barella began in the fall, after he asked the state government permission to levy local special options taxes on beach badges, paid parking lots, and alcohol — and more controversially, proposed parking fees on all neighborhood streets — to meet the $11.5 $1.5 million gap in the borough’s budget.

Republican state representatives don’t  like the idea. “We don’t support raising taxes, and [Barrella] doesn’t accept that response,” said state Sen. Andrew R. Ciesla (R-Ocean), referring to the all-Republican northern Ocean County delegation to the legislature. “He believes that it is appropriate to raise taxes in order to cure the financial ills of the borough on the backs of nonresidents and residents alike.”

And the Mayor’s Democratic rivals who initiated the petition also disapprove, claiming he has other options. Said one petitioner, “We have eight too many cops…. Manasquan has 6,500 people with 18 cops. We have 26 cops for 5,300 people.”

Residents’ motives seem clear — “No New Taxes!” — but the solutions aren’t as easy.

The Mayor argues that Point Pleasant Beach needs extra police and sanitation during the tourist season. Property tax hikes are off the table. And while hotels charge customers a 15 percent tax, the state takes 12 cents and the borough keeps three cents.

Therein lies one root cause: the dysfunctional fiscal relationship between the state of New Jersey and its 566 municipalities.

In New Jersey, localities can only levy property taxes. The state levies all other taxes (including taxes that used to be levied by local governments), and redistributes a good portion of those revenues back to the municipal governments. The result is not property tax relief for localities, but years of fiscal illusion. State aid to local government is treated like money from above, and many lead local governments to systematically spend more than they would if the locality had to raise those revenues directly.

And then there’s the state’s incentives to consider.

In the case of Point Pleasant Beach, the town doesn’t get back much of what it puts into the state’s common revenue pool. The mayor argues, “The state derives a lot of benefit in sales and income taxes, but how much does the state put into it? We pay all the costs and they get all the revenues.” Taxes levied on Point Pleasant Beach’s motels don’t go to the town’s boardwalk repairs, they go to Trenton.

The Mayor’s other options including reducing the police force (he proposed laying off one officer), went down in flames this fall. And without budget cuts, the mayor won’t meet the state-imposed tax cap on local property tax rates.

Point Pleasant Beach could ask the state for more aid, but this plays right into the claims of Trenton. Small towns (Point Pleasant has under 5,300 residents) have long been targeted by the state government for municipal consolidation on the theory they are, by definition, inefficient.  This claim is hard to prove, considering the inefficiencies and bad incentives built into the state’s revenue/aid system.

An excellent solution comes from Stanley Fischer, one of the petition’s authors. The beaches and boardwalks belong to the bars, amusement parks and pavilions. To deal with the summer partygoer crowd,  let the boardwalk businesses hire additional police. Good idea, and it can be taken further. Point Pleasant need only look to neighboring Seaside Heights’ Business Improvement District. There are already about 80 Special Improvement Districts in the state.

The concept is simple: businesses establish a geographical boundary, a board of directors, and agree to a municipal tax. In exchange, the revenues are funneled back to the district to provide needed services: sanitation, street cleaning, boardwalk repairs, security, and marketing.

For more, read this paper by Robert Nelson, Kyle McKenzie and myself.

Syndicated columnist Neal Pierce has been writing about state and local affairs since at lease the 1970s. In a recent column, he asks, “Are State Governments Obsolete?” It might have been more appropriate to ask whether state governments actually exist — at least in the traditional constitutional sense. Blessed by the Supreme Court and other judicial rulings, state governments have become administrative appendages of the federal government.

In one area after another in the twentieth century — matters of transportation, public health, land use control, education, wildlife management, etc. — the federal government assumed powers that had traditionally been reserved to the states. States might still have an administrative role, but they are now working under a very tight federal leash.

The sweeping environmental laws of the 1970s shifted control over clean air and water to the federal government. The states were, to be sure, left to administer air and water pollution laws day to day but under federally approved programs, leaving real control in federal hands. The Endangered Species Act not only federalized significant parts of wildlife management but also asserted federal authority over large areas of state and local land use. No Child Left Behind moved a large step towards the full federalization of education in the United States.

The federal government has not limited its takeovers to economic and environmental areas, where spillover effects do sometimes create difficulties for states whose  boundaries are awkwardly configured. As the Supreme Court declared in 2005 in the Raich case (with Justice Scalia surprisingly abandoning his previous federalism principles to support the decision), federal marijuana laws trump state and local laws. Federal power over the states now even extends bizarrely to the minimum drinking age for alcoholic beverages, an area explicitly reserved constitutionally to the states. (Like many others, the Supreme Court justified this federal undermining of state authority on the grounds that the states “voluntarily” accepted it — in order to protect their federal transportation funding.)

It is not the states but the U.S. Senate that is obsolete. When the United States was founded, the ratio of the largest state in population to the smallest (Virginia to Delaware) was 13 to 1. Now it is 71 to 1 (California to Wyoming). The U.S. Congress makes most of its decisions by forging compromises that bring together large enough coalitions of winners to pass a bill. Senators from Wyoming and other sparsely populated states sell their disproportionately large voting rights for disproportionately large federal moneys (relative to population). That is a main reason farm subsidies have been impossible to curb: states like North Dakota and South Dakota trade Senate votes for this abundant source of federal money.

In many cases small states actually want the federal government taking responsibility because then federal money pays. This dynamic is apparent in the Rocky Mountain states where 50 percent of the land is federal — and, even if it were offered to them, states would refuse to take financial and administrative responsibility.

We may be coming to a point where we should revisit the whole U.S. constitutional scheme. The usurpation of state authority is only one of many examples of current federal dysfunction. The U.S. fiscal situation seems dangerously close to veering out of control (see this recent Robert Samuelson column). Many of these problems have to do with the structure of Congress, starting with the Senate.

Another major problem is the assumption of far ranging policy making responsibility in the courts (the reason Supreme Court nominations now consume so much of the nation’s attention). Big changes are needed in both areas.

It is a very large subject. Obviously, nothing radical is likely to happen any time soon. But just to put out some ideas for discussion, I recently speculated on a brand new constitutional arrangement for the United States.

Recommendation No. 1 – abolish the U.S. Senate.

The cover story of this week’s Economist discusses Rich States, Poor States, the report published earlier this year by the American Legislative Exchange Council.  The subject of an earlier post, the book attributes Texas’ rapidly growing domestic-born population to low tax rates and favorable business conditions and suggests that California’s loss of domestic population is due to a state government that has grown unsustainably large.

The article points out that in addition to increasing numbers of native-born Americans, Texas along with many other states is experiencing large increases in its population of immigrants from Mexico and Central and South America.  While these large numbers are presenting some challenges to the state’s healthcare and education systems, another piece points out:

Texas has proved far better than the other border states (California, New Mexico, and Arizona) at adapting to the new, peaceful reconquista. In California, Proposition 187, which cracked down hard on illegal immigration, was heartily backed by the then Republican governor and passed in a referendum in 1994, though it was later struck down by a federal court. This kind of thing has only ever been attempted in Texas at local level, and even then only very rarely.

For the most part, Texans seem to see immigrants as adding to the diverse skills in the labor market, increasing the size of the economic pie for all of the state’s residents, rather than acting as a drain on fixed resources.

As previously discussed, recessionary budget difficulties may allow states to learn from one another’s successes and failures in fiscal policy.  This same principle holds true in states’ policies in immigration, education, and all other fluid policy issues. The Economist concludes:

Texas still lacks California’s great universities and lags in terms of culture. California could adopt not just Texas’s leaner state, but also its more bipartisan approach to politics and its more welcoming attitude towards Mexico. There is no perfect model of government: it is America’s genius to have 50 public-policy laboratories competing to find out what works best—just as it is the relentless competition of clever new firms from Portland to Pittsburgh that will pull the country out of its current gloom.

It’s called “shooting the cocker spaniel.” When governments must choose between unpopular tax hikes, or government spending cuts, a trade-off is announced: “If we make program cuts, they will be very, very, painful.”

In other words, “Don’t make us shoot this dog.”

That appears to be the strategy of both the Franklin Park  Zoo and the Stonehman Zoo in Boston. They have announced that the state’s budget cuts (from $6.5 million to $2.5 million in annual state funding) will force it to lay off 165 workers and find new homes for 1,000 animals.

According to the zoo’s director, “Not all the animals in the collection will be able to be placed at other facilities. The Commonwealth would then be forced to either continue to maintain the animals in the closed facilities or euthanize them.”

Governor Deval Patrick has rightly stated that the Zoo’s threat to kill up to 200 of the potentially homeless animals is nothing more than an inflammatory scare tactic. According to the governor’s spokesman, “In the midst of an economic crisis like this one, when families and businesses alike are making sacrifices, we would all do well to remain level-headed and focus on solutions.”

Apparently, it’s not the first time the zoo has threatened to euthanize the animals in its care. The Stoneham Zoo tried it in the early 1990s in the face of budget cuts, to no avail. The animals were actually moved temporarily to the Franklin Zoo.

I cannot help but be a  little alarmed. Are these partially-government-subsidized employees caring zookeepers, or are they holding the animals hostage to their demands?

One can’t help but be reminded of Crazy Ernie from Weird Al Yankovich’s 1989 film UHF. This is how low the discourse on state finances seems to have sunk.

Addendum: Crazy Ernie was beat the the punch by National Lampoon.

A Wall Street Journal editorial discusses the severity of the budget crises in three states: California, New Jersey, and New York.  While all states are suffering decreased revenues this fiscal year, the problems in these states have been especially severe, resulting in possible downgrades for California’s bonds which are already the lowest-rated in the country.

The Journal states:

A decade ago all three states were among America’s most prosperous. California was the unrivaled technology center of the globe. New York was its financial capital. New Jersey is the third wealthiest state in the nation after Connecticut and Massachusetts. All three are now suffering from devastating budget deficits as the bills for years of tax-and-spend governance come due.

During booms in the business cycle, high tax rates accompanied by an increased level of government services are palatable to taxpayers, but as these three cases exhibit, high-tax policies can quickly become unsustainable as incomes fall.

Eileen’s last post explains that state and municipal policy makers including Rudolph Giuliani are currently discussing reforms toward greater fiscal responsibility in order to promote prosperity in their localities, but these reforms are going to be difficult to enact for states that are already deeply indebted.

A great asset of the American federal system is that policy variation across the states allows citizens and law makers to observe how various fiscal policies function in the real world.  As described by the authors of the newly published 2009 edition of Rich States, Poor States, constituents do in fact “vote with their feet” by moving to states with policies that fit their desires.  This year’s index demonstrates that states in the South and West are generally gaining domestic population from the Northeast where taxes and government involvement in the economy are generally higher.

Unfortunately, the same experimentation at the federal level carries much greater costs.  Until now, federal aid has allowed for irresponsible fiscal policies to continue at the state level, but this policy may be coming to an end.  If the federal debt and deficit approach the unsustainable levels that states such as California, New Jersey, and New York have reached, no entity will be able to bail it out.  Additionally, economic policies at the federal level do not provide the same sort of natural experiment within the country and carry a higher risk of severe negative consequences.

The article continues:

At least Americans have the ability to flee these ill-governed states for places that still welcome wealth creators. The debate in Washington now is whether to spread this antigrowth model across the entire country.

While government systems can never incorporate the feedback mechanisms of the market, the federalist system allows for a sort of competition between states and localities in which competition allows successful programs to thrive and spread. However, this system only works when unsuccessful local policies are not subsidized by the federal government and when authority is sufficiently devolved to allow states to differentiate their policies from one another’s.

Even as General Motors is undergoing bankruptcy proceedings in hopes of reinventing itself with a viable business model and saving the jobs of its Detroit employees, analysts remain skeptical about the corporation’s future success.

A Detroit News editorial wisely advises that Michigan should move forward from this difficult time rather than attempting to preserve GM workers’ jobs for as long as possible while the company continues its likely slow decline:

Michigan’s entire focus must be on creating a business climate that makes the state attractive for job creators in a wide range of industries. It can’t afford to focus on any one segment in hopes of finding the next Big Three. Its future will depend on making itself irresistible to investors across the spectrum.

This perspective is grounded in historical evidence, according to a recent series in The Economist called “Business in America.” In the past, recessions have offered an opportunity for entrepreneurial innovation:

Firms founded during tough times have to be tough. Although more firms typically start up in fat years, Paul Kedrosky of the Kauffman Foundation found that each bad year in America since the second world war produced just as many firms that have subsequently grown large enough to list their shares. He concludes that firms that begin in bad times are more likely to turn out to become economically important: think of Microsoft, Apple, and Krispy Kreme doughnuts.

If Detroit and Michigan can succeed in creating an attractive business climate through maintaining a favorable regulatory climate and lowering corporate tax rates, the area could foster new industries that may profit from some of the capital that becomes available from the auto industry, the current low rental rates, and the environment of creative destruction.

By supporting the common belief that GM is too big to fail, the federal government is probably just slowing the company’s eminent disappearance. At present, this policy appears favorable to Detroit constituents who are supporting federal assistance to auto makers. If instead, however, the city were allowed to organically develop a variety of new businesses to take the former auto giant’s place, opportunities for future growth would be permitted, and business people could take advantage of a situation that has potential to be favorable to new start-ups.

USA Today reports that the federal government has overtaken sales, property, and income taxes to be the largest source of revenue for state and local governments:

The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations.

The sales tax had been the No. 1 source of state and local revenue since the mid-1970s, according to the Bureau of Economic Analysis. Before that, property taxes were the primary source. That changed in the first three months of 2009.

Federal grants — early stimulus money plus conventional federal aid — soared 15% in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2%.

Here’s Len Gilroy on this story. Here are data from the Tax Policy Center on state revenues by category (albeit from 2006). Here are Eileen Norcross and Frederic Sautet on the longer-term ramifications of increasing intergovernmental transfers.