Category Archives: Federalism

The Ravitch Volker report: State Budget Crisis is Real

The recession of 2008 pulled the mask off of state budget pathologies that had been identified as institutional weaknesses in the decades leading to the crisis.

The “new normal” for state and local governments does not look like the booming 1980s and 1990s but in fact is riddled with many fiscal challenges.  Revenues aren’t what they were before 2008 though they are expected to reach pre-recession levels in FY 2013. The Medicaid and employee benefits bill is rising. The stimulus pushed forward budgetary reforms. These are some of the findings of the Ravitch-Volker Report, an effort of the State Budget Crisis Task Force which assembled in 2010-2012 to diagnose the major problems facing six states: California, Illinois, New Jersey, New York, Texas and Virginia.

Much of the analysis is non-controversial: Medicaid is eating up budgets, as are pensions costs and health care benefits.

Medicaid, currently at 24 percent of state spending, will continue to increase as enrollment, medical inflation and the increasing caseloads that come with higher unemployment increase costs. This is not a surprise. What is new is that the federal government is making it harder for cost-saving measure to be enacted, and “entrenched provider groups in each state resist reductions in Medicaid provider rates….”  I do not believe this is the intention of the authors of the report but the diagnosis of Medicaid’s future highlights the dysfunctional aspects of this federal-state pact which has led to the creation of special interests that benefit from inflating costs.

On the pension front the Ravitch-Volker report points to the the role discount rates have played in the pension funding problems facing the state and local governments, in particular in New Jersey. And they also note the reliance on budgetary gimmicks that may even result in a kind of budgetary “cynicism.” A point I have made in the past.

But the report also makes a few assumptions about the interplay of federal, state and local spending that I think could benefit from an expanded debate. The authors warn that cuts in federal discretionary spending will doom subsidiary governments. On the surface, that’s true. Cuts in aid mean less money in state coffers for education, transportation and other areas. But the larger question is what are the fiscal effects of grants-in-aid between governments? There is the public choice literature to consider on the role of fiscal illusion in finances. And further, does the current model of delivering these services actually work as intended?

Their recommendations are largely sound. Many of them have been made before: more transparent accounting, a tightening of rainy day fund rules (see our recent paper on Illinois), broad-based tax systems should replace narrow ones, the re-establishment of the Advisory Commission on Intergovernmental Relations (ACIR). Abolished in 1995 ACIR was concerned with evaluating the fiscal impact of federal policies in the states. Further the commission recommends the federal government work with the states to help control Medicaid costs, and the re-evaluation by states of their own local needs including municipal finances and infrastructure spending.

The report is timely, contains good information and brings many challenges to the fore. But this discussion can also benefit from a larger debate over the current federal-state-local spending model which dates largely to the middle of last century. This debate is not merely about how books are balanced but how citizens are governed in our federalist system. The Ravitch-Volker report is sober but cautious in this regard. The report sketches out the fiscal picture of the U.S. in broad strokes and offers general principles for states to follow and it is sure to create discussion among policymakers in the coming months.

 

 

 

 

 

Fiscal Tactics and the Columbia Pike Trolley

The Columbia Pike Trolley does not have a reputation for popularity among some local residents of Arlington County, VA. In a previous post, I noted the concerns voiced on local blogs and community boards that the $261 million trolley is several times more expensive than the alternatives. In addition, it is feared the trolley will not relieve congestion but will interrupt spontaneous economic development. The Green Party calls it, “the urban renewal trolley for the rich.” Part of the economic development plan involves demolishing older apartment buildings, raising rents.

How will officials try to finance the streetcar?  The plan requires the majority of funds come from local sources (seed money is being provided by a federal program). One possibility is they will dodge voter approval by raising revenue bonds instead of general obligation bonds (GO bonds). The reason is that in order to issue GO debt (which is backed by the full faith and credit of the government), the County would need to put the bond issue on the ballot. But they are worried about voters rejecting it. Revenue bonds don’t require voter approval since they are backed by an independent revenue stream; in this case, future revenues from the government’s surcharge on commercial real estate.

Locals may not have their chance to approve or reject the project, however. The Arlington Sun Gazettte reports that according to Virginia law Arlington as a county – not a city – government, “does not have the power to have a referendum on a topic or subject matter, like cities [do].” The decision to move forward or stop the project thus rests with the County Board.

Map of proposed Columbia Pike streetcar system

The plan is an example of what I define as “fiscal evasion.” These are maneuvers governments employ to defer or obscure the full costs of spending by evading rules or constructing loopholes. Not to be confused with venal gimmicks, fiscal evasion is often built into the rules. It is undertaken by, “circumventing statutory or constitutional budget rules, or through the weak design of such rules.”  In other words this approach is perfectly legal. Since revenue bonds don’t need voter approval revenue bonds present the “funding path of least resistance,” from the viewpoint of trolley advocates.

 

 

Monday morning links

Demographic shifts in American metropolitan areas since 1950 via Demographia

Public Sector Inc post: The consequences of investment risk in public sector plans

Woonsocket, Rhode Island and talks of bankruptcy 

New federal school lunch rules: students must buy fruit and vegetables (even if they throw it in the trash)

The True Cost of the Columbia Pike Trolley: Priceless

A proposal to build a trolley car system on Columbia Pike in Arlington, Virginia continues to provoke strong reactions from residents. The County Board estimates it will cost between $214 million and $261 million to build and between $19.5 million and $25 million to operate and maintain.

As the PikeSpotter calculates, that’s $200 million more to build than the next best option: an enhanced bus line. Why the County Board’s push for a $50 million per mile streetcar system?

According to advocates, the Pike Transit proposal will relieve area congestion, spur economic activity and promote environmental sustainability.

However, residents from all sides of the political spectrum appear to disagree with the County Board. Arlington Yupette says the Pike Transit plans are “elitist” and intended to drive out middle class and working class residents by driving up rents. The end result: the “Clarendonization” of South Arlington. Some point to the need for resources to be directed to the overcrowding in county schools. And still others highlight the high likelihood of such projects becoming boondoggles.

Given the anecdotal lack of popular support expressed by area residents, why are officials persisting? Public finance holds a key. Should the county go ahead and commit to build a rail line here is how it will be financed. Thirty percent of funds will come from the  New Starts/Small Starts federal grant program and 14 percent from the state of Virginia. The remainder is to be provided by Arlington and Fairfax Counties.

Is this fiscal illusion at play? The Small Starts Program will provide up to $75 million if the local government provides a match. County Board officials are confident that Arlington and Fairfax can foot $140 million (Arlington will pay 80 percent of that) with the state of Virginia kicking in a further $35 million. Because a chunk of the cost of building the rail line can be externalized, that is, passed on to state and federal taxpayers, it looks like a bargain…at least for a fleeting moment. It’s still about $170 million dollars more than what it would cost to add more buses.

And there are more complications that arise from mingling federal, state and local dollars as noted by the Sun-Gazette. Virginia is a right to work state. Are union employees required to work on the rail line since the project will receive federal dollars? If yes then the increased labor costs will make the project even more costly to the county. (Lieutenant Governor Bolling believes Virginia state law trumps federal law in the matter.)

While new estimates continue to push the costs higher, at least one Arlington County Board member is undeterred by fiscal considerations, “This is a project that has the most potential to help us achieve our environmental goals and livability goals. We think it will have a very high return.”

That is, the costs of building the streetcar line are concrete, and the returns are mired in the counterfactual.

 

 

 

Don’t Bailout the States

Last week the Illinois House adopted HR 0720 which was part of a growing effort to remove the possibility of a federal bailout for the states. The synopsis of the House Resolution reads:

Urges the federal government to take no action to redeem, assume, or guarantee State debt; and the Secretary of the Treasury should report to Congress negotiations to engage in actions that would result in an outlay of Federal funds on behalf of creditors to a State.

Senior Director of Government Affairs at the Illinois Policy Institute, Collin Hitt, offered committee testimony on the resolution. While writing about his testimony, Collin correctly argues that

Illinois’ problems are its own. Illinois has the tools to fix its finances. The state is seeing record reviews. Pension reform and Medicaid reform are possible, and there are concrete ideas to fix these debt-ridden programs. The prospect of a federal bailout only forestalls those solutions. If a federal bailout is considered imminent – or even possible – then the urgency to actually solve our problems ourselves is diminished. This resolution sends a message throughout state government that a bailout is not a solution that the State of Illinois can plan on.

That last part is absolutely essential, as it gets at a serious issue currently taking place in Illinois and other troubled states across the U.S. When politicians and law makers are dealing with a state that is on the brink of fiscal collapse they have two options: 1) make lasting intuitional and structural reform or 2) avoid significant reform and hope that most of the issues fix themselves. As a federal bailout becomes more likely, however, avoiding reform becomes politically easier. This, therefore, becomes a race to the bottom scenario where the states that end up in the worst fiscal shape are “rewarded” with a federal bailout… A very bad incentive structure and a scary road to head down.

Hopefully HR 0720 gains more traction and Illinois and begins to change the growing federal bailout expectations. If it is successful, other states should surely follow.

Federal Medicaid Proposal Could Help State Budgets

Representative Todd Rokita (R-IA) has proposed a new bill, the State Health Flexibility Act that could vastly improve incentives in state Medicaid administration. The bill would convert Medicaid and the Children’s Health Insurance Program (CHIP) into a block grant program under which states would have the freedom to shape the program as they see fit. Additionally, up to 30% of the block grant could be transferred into the state general fund if state lawmakers could administer the program for less than the grant amount.

Currently, Medicaid operates a little bit differently in each state, but most states receive matching funds from the federal government at levels between 50% and 74% of what they spend out of the state budget. This set up encourages states to overspend on this program because the federal government pays them to increase spending.

This program would bring all states in line with reforms already implemented in Rhode Island and Washington. In a recent podcast, Scott Beaulier discusses some of the benefits that these states have acheived through reform, both in their budgets and in their healthcare outcomes.

The State Health Flexibility Act would save money for taxpayers at the state and federal levels by capping federal spending at its current nominal amount. Both inflation and GDP growth would serve to reduce real Medicaid spending at the federal level. By removing the incentive for states to increase Medicaid spending to receive federal dollars, the bill would also reduce spending at the state level. Furthermore, states would enjoy freedom to determine Medicaid and CHIP spending for themselves, better tailoring the program to meet their citizens’ specific needs.

Despite reducing Medicaid spending, this reform bill would provide better incentives for improved outcomes by shifting state focus from matching funds to better healthcare. In Rhode Island and Washington, Beaulier found that states used cost saving measures such as not allowing Medicaid patients to use emergency rooms for non-emergency care and encouraging preventative care, improving healthcare while saving money.

Current Medicaid spending patterns are unsustainable. The State Health Flexibility Act provides an opportunity to save taxpayers money, put state budgets on a saner trajectory, and improve health outcomes for benefit recipients.

 

New Medicaid Case Study Highlights the Role of Politics in Policy

Last week, Scott Beaulier and Brandon Pizzola released new research on Medicaid, conducting case studies of five states that have implemented reform measures designed to control program costs. They find that the political climate is essential to the success of reforms.

Medicaid is a cost driver in state budgets for several reasons, but an important factor is that most states have designed the program so that a formula determines the amount of federal money they receive based on state-level Medicaid spending. Reforms which move to essentially a block grant program, as implemented in Rhode Island and Washington, have so far successfully reduced Medicaid spending by eliminating this incentive. These two states have moved to a system where the federal government pledges a fixed yearly amount toward their Medicaid spending. If the full amount is not spent, the remainder can be transferred to the general fund. This reverses the incentive from spending as much as possible to searching for cost savings. Both states have also introduced measures of individual patient responsibility, requiring, for example, that Medicaid recipients do not rely on emergency rooms for routine care. While it is too soon to tell if Rhode Island and Washington will manage to control costs in the long run, both states appear to have achieved improved incentive structures for doing so.

These states passed reform bills not by making a gradual transition to new policies, but by moving decisively. In contrast, Florida lawmakers attempted to test reforms in two counties before expanding them to apply to the rest of the state. This time lag served as an opportunity for interest groups to block further changes. Rhode Island and Washington developed support from these interest groups by framing the issue as the state against the federal government rather than one of winners and losers within the state. In Tennessee reform has not been successful because key interest groups like the Tennessee Medical Association did not get behind proposed reforms, making them unworkable in practice.

Despite the apparent successes in Rhode Island and Washington, the federalism research that Ben and Eileen explored last week reveals that block grants are not a panacea. Block grants, like all intergovernmental spending, carry with them fiscal illusion. This obfuscates program costs to taxpayers by spreading the funding across multiple layers of government. While moving from a matching funds formula to a block grant is an improvement in transparency, total spending is still obscured. Furthermore, while neither state has failed to keep spending within the the budgeted block grant so far, it’s hardly inconceivable that program costs will outpace grants at some point, leading states to seek bailouts after implementing reforms.

The demonstrated reasons to be pessimistic about the viability of programs whose costs are shared across state and federal governments leave reason to question whether or not block grants are successful tools for curbing costs in the long run. However, Rhode Island and Washington have chosen a path that is at least more sustainable than other states, which face incentives to increase Medicaid spending with no limit in sight.

Harrisburg’s downward spiral

ReasonTV has a revealing report on what happens when municipal governments forget their core functions (public safety, schools) and pursue white elephants and boondoggles. The incinerator fiasco is only a piece of the story. For a period of decades the mayor embarked on several plans to make Harrisburg a tourist destination, buying a hotel, acquiring Old West art and objects for a never-opened museum, sinking millions into a Civil War museum and other flights of fancy. In the meantime, Harrisburg’s crime rate soared and education rankings plummeted (they upgraded the facilities to no great effect).

Check out the video here.

Hamilton’s Paradox

I recently finished reading Jonathan Rodden’s 2006 book Hamilton’s Paradox: The Promise and Peril of Fiscal Federalism. The book provides a fascinating analysis of fiscal federalism that combines theory, qualitative and quantitative analysis, and contemporary case studies.

Rodden begins by detailing the potential promises and perils of fiscal federalism. He states that the promise of federalism is straightforward: “decentralized, multitiered systems of government are likely to give citizens more of what they want from government at lower cost than more centralized alternatives.” The perils of federalism, although less examined in the literature, are rooted in the idea that “In decentralized federations, politically fragmented central governments may find it difficult to solve coordination problems and provide federation-wide collective goods. As in the private sector, public institutions only produce desirable outcomes when incentives are properly structured” (p. 5).

In Chapter 3 Rodden provides a very interesting history of federalism and federal bailouts in the U.S. Specifically, he discusses the federal assumption of state debt that took place in 1790, the rapid growth in state borrowing in the early 1800s, the nine states that defaulted in 1841 and 1842 (Maryland, Pennsylvania, Arkansas, Florida, Illinois, Indiana, Louisiana, Michigan, and Mississippi), and the constitutional debt limitations that many states adopted in the 1840s and 1850s.

Most interesting is the game theory model Rodden develops in the second half of Chapter 3. Specifically, it’s a dynamic game of incomplete information that takes place between the central government and a single subnational government. Information is incomplete because subnational governments don’t know exactly how the central government will behave in the event of fiscal crisis. That is, the central government will either allow the subnational government to default (resolute type) or will provide a bailout (irresolute type).

The fist move of the game occurs when a subnational government experiences a fiscal shock with lasting effects (i.e. recession). In response to the fiscal shock it can either adjust immediately or refuse to deal with the shock by borrowing, with the long term hope of receiving a bailout. The path that the subnational government takes is a function of, among other things, the expected probability of the central government being resolute or irresolute (the complete game is much more detailed than the brief description provided here).

Rodden utilizes this game as he develops each of the case studies provided later in the book. The case studies involve comparing and contrasting the events that have taken place in Germany and Brazil. In the 1990’s two states in Germany received formal bailouts by the federal government (the Bund). During the same time, however, bailouts were distributed to virtually every state in Brazil. In Chapters 7 and 8 Rodden carefully details the structures of government in these two countries and outlines the reasons their outcomes were so different.

Two of the many important conclusions that Rodden makes in this book are (1)

when free to borrow, growing transfer dependence is associated with increasing deficits, both among federated units and local governments (p. 116)

and (2)

The central government must not only allow subnational governments significant tax autonomy and disentangle its books from those of the subnational governments, but it must demonstrate through costly action that it will not assume subnational liabilities when times get tough (p. 267)

This brief review of Hamilton’s Paradox only covered a few of the many important topics that the Rodden details in the book. I strongly recommend this book for anyone interested in fiscal federalism.

Twenty states face bill for Unemployment Benefits

The Center on Budget and Policy Priorities has a new analysis highlighting the $35 billion bill that 20 states owe to the federal government for covering benefit extensions. The report points to one of the design problems with the current program. The joint federal-state unemployment insurance program (UI) is financed via a payroll tax. States have kept the tax too low and thus did not build up enough reserves in the UI fund to weather the recession. This isn’t the first time UI has run into this problem, in fact it’s a perennial issue. Alan Krueger of Princeton provides a summary of some of the structural weakness in UI, a program unchanged since the New Deal.

While it is widely recognized that UI is structurally broken, solutions vary considerably. In a paper for The Brookings Institute, Rosen and Kletzer suggest “strengthening the federal role” in UI that would require states to harmonize eligibility criteria and benefit levels, increased eligibility and benefits financed by a higher FUTA tax. In addition Rosen and Kletzer propose a wageloss insurance program for those who become employed at a lower wage than their previous job; and lastly private accounts for the self-employed.

The Tax Foundation proposes another set of fixes. These include loosening up restrictions in the program to allow states to experiment with alternative programs, as well as the establishment of individual accounts.

In September the Obama Administration proposed a ‘sweeping reform’ of the current program. Included was the wageloss subsidy for the employed. In last week’s SOTU the president stressed transforming UI into an employment program via job training services. But these new appendages avoid the problem that UI was created to address: how to smooth private consumption during times of temporary and involuntary unemployment?

What about a private insurance model? Trooper Sanders makes the case at The Huffington Post.