Monthly Archives: October 2011

Illinoisans Are Becoming More Realistic About Dealing with the Budget Crisis

Although Illinois has become the quintessential example of a state with a broken budget process, a recent poll by the Paul Simon Public Policy Institute provides evidence suggesting that there may be some positive change occurring among Illinois voters.

Since 2008, the Simon Institute has conducted an annual survey of 1,000 voters in Illinois in order to examine how the general public thinks the state should deal with its budget problems. Specifically, the Simon institute has asked Illinois voters if they think the state’s budget deficit should be handled by: 1) bringing in more revenue, 2) cutting waste and inefficiency in government, or 3) a combination of budget cuts and revenue increases.

A majority of Illinoisans (57.7%) still believe that cutting waste and inefficiency will solve the state’s budget problems. Unfortunately, this is a non-serious way to cut – targeting inefficacy and waste is easy since there are no real constituencies for either. This is why it’s important to dig deeper and ask people about specific cuts.

Proposals for program cuts in the Institute’s poll include, among others, cutting spending on education, public safety, programs for poor people, and pension benefits for state workers. Not surprisingly, a majority of Illinoisans oppose cuts to each of these programs.

However, there has been a substantial increase in the number of people that favor cuts in Illinois’s pension system. In 2008, 24.1 percent of voters favored cutting spending on pension benefits for state workers. This number has increased by more than 20 percentage points over the past three years, to 45.5 percent.

There has also been a growing acceptance for various means of increasing revenues. This year’s results show that:

in 2011, for the first time, majorities approve of two of the revenue-raising measures in the poll: expanding legalized gambling (56.8%) and expanding the sales tax to cover services as well as goods (50.1%).

This is good news. It suggests that Illinoisans are becoming more realistic about dealing with the state’s budget crisis. Specifically, it suggests that Illinoisans are beginning to embrace the principle of generality in taxation – broadening the base will allow the state to potentially lower its tax rates. Additionally, a majority (74.1%) of Illinoisans oppose an increase in the state’s sales tax rate – highlighting the fact that voters are not just in favor of more taxes, but a broader tax base.

Ultimately, the results from this year’s Simon Institute poll indicate that Illinoisans are not only beginning to understand the severity of their state’s budget crisis but are also starting to accept some pragmatic avenues of reform. Politicians and policy makers in Illinois must act on this opportunity and focus on passing structural reform.

Trapped by Government Privilege

The right to operate two New York City taxi cabs has just been sold for $1 million apiece.

In order to operate a cab in New York City, the government requires drivers to affix little aluminum plates called medallions to the hoods of their cars. According to the article:

There are 13,237 medallions in the city; new ones, when issued, are sold at auction. But the medallion pool is rarely expanded, creating a scarcity that helps keep values high.

By restricting the supply of legal cabs, the policy effectively raises the price of a ride. It also leads to what Matt Yglesias calls “endemic taxi shortages in the outer boroughs.” As Felix Salmon notes, though, even if the city issued more medallions, fares wouldn’t go down since another city policy regulates those.

(Image courtesy of Stuart Miles / FreeDigitalPhotos.net)

Salmon then asserts that “utter chaos” would result if both policies were removed because riders would have to haggle with cabbies every time they rode. This seems like a rather absurd concern. Do you haggle with the local gas station operator every time you fill up? Is there utter chaos because magazine prices at newsstands are set by the market and not by regulation? Matt Yglesias adeptly dispatches with Samon’s concerns, writing:

In fact in Stockholm they’ve done what Salmon says can’t be done, and taxis are allowed to charge whatever price they like. The main solution to the problem he identifies is that most cabs are affiliated with one of a few large taxi companies that have posted fare schedules.

Let’s dig a little deeper into the economics of this. Both the price control and the medallion requirement seem to benefit cab companies at the expense of riders by raising prices above what the market would naturally bear. But as Gordon Tullock pointed out in a classic 1975 article called “The Transitional Gains Trap,” the cab operators really aren’t better off in the long run:

[T]he capital value of the monopoly profit has been fully taken into account in the industry. New entrants enter only by purchasing the medallion, with the result that they get only normal profits.

In other words, those who want to charge monopoly prices must pay dearly for the privilege of doing so. And today the going rate is about $1,000,000. This is essentially the same story with any type of rent-seeking activity. If you want the government to give you a competitive advantage against your competitors, you can ask for a subsidy or a tax on your competitors, but expect to spend a lot of money lobbying for these favors. In fact, as Tullock argues, you should expect to spend so much money that in the end, you will only make a normal profit! Indeed, that’s why protected industries like autos, steel, agriculture, and green energy do not systematically make above-normal profits. (In pointing this out, David Friedman has opined that “the government can’t even give anything away.”)

But the story gets worse. Now let’s imagine that the government tries to do the efficient thing. Let’s imagine it listens to Matt Yglesias or me and deregulates the taxi cab industry. Well you can bet that the poor person who just paid $1,000,000 for the right to charge a monopoly fare is going to be more than a little resistant to any policy change which would make his fares go to the competitive level. In fact, the political resistance would be so great that Tullock called the entire policy a “trap” concluding:

The moral of this, on the whole, depressing tale is that we should try to avoid getting into this kind of trap in the future.

Think of this the next time you hear about a proposal that is likely to benefit one group at the expense of others.

House Promises not to Bailout State Pension Funds

With the appropriately foreboding headline, “The corruption you see; the doomsday you don’t,” The Chicago Tribune reports:

Every indication suggests that, once again, [House Speaker] Madigan and [Senate President] Cullerton will be waving from the curb as this situation grows even more disastrous. We see no evidence that Madigan and Cullerton will use the legislative veto session that opens Tuesday to reduce future pension earnings, while protecting benefits already earned, for current employees.

Yesterday, the House took up a bill aimed at preventing union leaders from collecting pensions based on salaries that they earned working for a public sector union rather than the state. While the issue of pension fund abuse has provoked media outrage, this reform would do little to help the funds’ overall solvency.

Legislators remain reticent to enact major reforms, despite the growing pressure of insolvency that state and municipal funds are facing. Part of the reason that policymakers may not believe that they have to make the difficult decisions involved in reform may be that recent federal bailouts for Wall Street, Detroit, and state governments have led to moral hazard. Under a system where legislators do not believe that their taxpayers and recipients will bear the full cost of bringing the fund back to solvency, they are not concerned with making reforms, instead perhaps assuming that the federal government will step in to bail out the ailing fund.

However, the political climate has changed markedly since 2008 when the federal government looked at bailouts as stimulus. Last week, U.S. House Republicans issued a letter stating that Congress would not step in to help state pension funds remain solvent. The Chicago Sun Times reports:

The letter bearing signatures from U.S. Rep. Peter Roskam (R-Ill.) and other members of the Illinois GOP delegation along with the influential chairmen of eight House committees, including U.S. Rep. Paul Ryan (R-Wis.), urged Springfield to “seize the opportunity to appropriately reform the state’s public pension systems to address their massive unfunded liabilities – and to do so by your own means” during the veto session.

While state leaders say they expect no help from the federal government, they also don’t seem to be in a hurry to accept the difficult sacrifices that will have to be made now that Illinois’ pensions have the lowest funding ratio of all states. As Eileen Norcross and Ben VanMetre found in a recent working paper, Illinois’s budget woes have reached this precipice because the state’s budget rules allow for overspending and permit today’s policymakers to push bills on to tomorrow’s voters. Changing these institution won’t be easy, but this is where policymakers need to start if they want real reform for Illinois.

Trust Me On This One

Think about how often you depend on the kindness trust of strangers. You can walk into a restaurant, order the most expensive item on the menu and leisurely eat it without offering up any sort of collateral. The restaurateur may not know you, but he trusts you. Similarly, you can walk into a New York City hotel, put down a credit card and spend a week in the lap of luxury. The hotel doesn’t know you, but they know your credit card and extend their trust in Visa to you.

Like money, trust lubricates the wheels of commerce. It allows us to do business with people we’ve never met, expanding the “extent of the market,” and our standard of living. Indeed, as Steve Knack, senior economist at the World Bank, sees it: “If you take a broad enough definition of trust, then it would explain basically all the difference between the per capita income of the United States and Somalia.”

Why is it that strangers in the United States are so much more willing to trust one another compared with strangers in Somalia? More importantly: how can we build trust in places where it is lacking? Studies have found that humans have some rather ugly rules of thumb when it comes to trust. They are more likely to trust others if they are perceived as high status or if they are of the same race. That doesn’t offer much in the way of helpful policy advice for building trust.

But new research by Omar Al-Ubaydli, Daniel Houser, John V. Nye, Maria Pia Paganelli and Xiaofei Pan points to another trust-builder: experience with markets. They write:

In randomized control laboratory experiments, we find that those primed to think about markets exhibit more trusting behavior. We randomly and unconsciously prime experimental participants to think about markets and trade. We then ask them to play a trust game involving an anonymous stranger. We compare the behavior of these individuals with that of a group who are not primed to think about anything in particular. Priming for market participation affects positively the beliefs about the trustworthiness of anonymous strangers, increasing trust.

Progress depends on the extent of the market, the extent of the market depends on trust, and trust can be facilitated with familiarity with markets.

Welcome, Emily. Congratulations, Tate

You may have noticed a familiar name in the Neighborhood Effects cue. When she was working on her MA in economics here at Mercatus, Emily Washington used to contribute to this blog. We are pleased that after a stint in commercial real estate, Emily is now back at Mercatus. As the new Associate Director of State Outreach, she will help connect state policy makers with Mercatus scholars and their research. Luckily, she has also agreed to resume writing on this blog.

And speaking of transitions, another great writer and Mercatus alum, Tate Watkins, is now blogging over at Reason.com. His post on the Internet Tax is my favorite (but read them all).

The USPS: A Business or a Welfare Organization?

In our oped in the Chicago Tribune yesterday, Maurice McTigue and I argue that Congress needs to decide if it wants the USPS to be an independent business or a taxpayer-supported welfare organization.

Currently Congress wants to have its cake and eat it too – it wants to maintain the government controlled quasi-monopoly over postal delivery but it also wants USPS to operate as a profitable competitive organization. Striving to have the USPS operate in this sort of middle ground will simply not work.

From our oped:

In order for the USPS to operate as a business and become profitable, Congress needs to allow it to make the same decisions every private-sector business makes, which includes choosing the location of its assets, closing post offices, laying off workers and competitively pricing its services. This also means the USPS should not be allowed to borrow from the government or receive written guarantees.

Given the current fiscal problems stemming from the already overcommitted welfare system in the United States, creating another one is simply not an option. If instead, Congress were to remove the barriers to postal delivery, it would allow the USPS to restructure itself into a 21^st century organization – an organization that could provide an improved quality of service at competitive prices.

New Jersey judge rules her pension benefits can’t be cut

From John Bury’s pension blog:

Judge Linda Feinberg, sitting in Trenton, ruled the increased health benefits and pension contributions that Governor Chris Christie and Democratic legislative leaders put into effect on June 28, are unconstitutional as it applies to judges, in particular Judge Paul DePascale, because it amounts to a reduction in their salaries. The ruling does not affect state and local public employees, including teachers, police and firefighters, who are now paying the increased costs.

As Mr. Bury notes, why can other employees have their benefits reduced, but not judges?

Will The States Really Increase Net Spending If We Send Them More Money?

Ezra Klein writes:

[N]ot all “temporary stimulus spending” is the same. The theory behind a temporary payroll tax cut, for instance, is that it gives Americans a bit more money to spend. But that only gets the economy moving in a significant way if Americans are sufficiently interested in spending that money. The argument against a temporary tax cut is that Americans know it’s temporary and they know that they will eventually have to pay for this sort of spending and so they save the tax cut rather than spend it.

In contrast, Klein believes a new proposal by Senator Reid would lead to more net spending. That’s because instead of channeling the money to taxpayers who might save it, the Reid proposal would channel it to state and local governments who will surely spend it.

The problem is that John Taylor and John Cogan have convincingly shown that in the last stimulus, despite Keynesian hopes, the state and local governments didn’t use the extra money to increase their net spending. Instead, they used it to decrease borrowing.

In other words, the federal government borrowed and transferred hundreds of billions of dollars to the states which used the money to reduce their own borrowing, largely offsetting the federal increase in borrowing. In the end, little if any new purchasing power was created or advanced through time.

It isn’t clear to me why we should expect anything different this time around.

New Tax Foundation Study on Unemployment Insurance across the States

On Monday, the Tax Foundation released a new study by Joe Henchman on Unemployment Insurance policies in the 50 states. The study highlights that while the federal-state program is supposed to be counter-cyclical, in reality states do not use periods of high growth to prepare their unemployment trust funds for recessions. At the beginning of 2008, most states were prepared to pay less than one year’s worth of high unemployment benefits, leading to quick insolvency for many states’ funds in recession.

In order to provide benefits, states have had to borrow from the federal government. Henchman explains:

Beginning on September 30, 2011, states must pay approximately $1.3 billion in interest on those outstanding balances; in many cases, businesses and employees in those states will also face increases in federal unemployment insurance tax rates as a result of those federal loan balances. These new interest obligations and tax increases, if they ultimately occur, come at a time when private sector hiring is already at a low level and states are under significant fiscal pressure. These unemployment insurance fiscal policies may exacerbate negative job growth and tax trends, instead of operating countercyclically as the program was intended.

The study also provides analysis of the different taxes and benefits across the states. The compilation of the variation of tax rates, duration of benefits, funding gaps, and other policy factors makes this paper an excellent jumping off point to look at state level reforms based on states that have performed relatively well in this program compared to the neighbors.

In a more ambitious policy proposal, Henchman recommends Individual Unemployment Benefit Accounts as an option for reform. These accounts, which Chile adopted in 2002, provide a measure of income stability during periods of unemployment. Unlike state-administered UI programs, though, private accounts do not carry the perverse incentives that may dissuade people from finding work while they are receiving these benefits because money which goes unused during unemployment can be accessed upon retirement. In 2010 Eileen Norcross and I did a brief analysis of the incentives that the current UI program provides and came to the same general policy recommendation.

Tightening Municipal Bankruptcy Laws

There have been 629 municipal bankruptcies in the US since 1937. Some of the most recent include: Vallejo California, Central Falls Rhode Island, Boise County Idaho, and as of last week, Harrisburg Pennsylvania.

As a result of these recent filings, municipal bankruptcy, or Chapter 9 of the U.S. Bankruptcy Code, has become an increasingly important topic in the policy community and a few states have taken action towards tightening up and/or clarifying their municipal bankruptcy laws.

Rhode Island passed legislation earlier this year that:

takes the decision to file for receivership out of the hands of the community and gives it to the state Department of Revenue. It also replaces the existing state budget review commission system, set up in the 1990s, with a new three-step process of increasing oversight

Just last week, California Governor Jerry Brown signed legislation that changes how cities file for bankruptcy:

After the law takes effect in 90 days, municipalities in the most-populous state will have to submit to a neutral review of their finances, or demonstrate a fiscal emergency, before seeking Chapter 9 bankruptcy protection in federal court.

Given that future municipal bankruptcies are imminent, legislative actions aimed at tightening up and clarifying the current bankruptcy laws may be beneficial. However, Chapter 9 should not be seen as the solution or as an easy way out of a tough situation. As Michael Viscount and Josh Klein rightly argue:

Chapter 9 is a tool for a municipality to restructure its finances in an orderly fashion — but it is not a substitute for political will, which is required to tackle the difficult fiscal problems surrounding us…. Municipal bankruptcy will not eliminate any of the hard choices that must be made to restructure governmental obligations successfully.

Waiting until a municipality is on the brink of bankruptcy is fiscally irresponsible. Politicians and policy makers need to stop waiting until it is too late and begin taking the necessary steps towards creating policy environments that promote fiscal stability.