Category Archives: State Policy

Austerity measures lead to unrest in Greece

In anticipation of €26 billion ($37.4 billion) in spending cuts and tax increases to reduce Greece’s deficit over the next five years, unions called for strikes. Affected services included public transportation, schools, hospitals, and media. In addition student demonstrations in Athens turned violent as protesters hurled bottles and firecrackers at police.

The austerity measures are in return for last year’s €110 billion EU/IMF debt bailout. A good portion of the proposed cuts will be to public sector salaries, defense and health care spending.

Was the bailout enough to keep Greece afloat? According to the Wall Street Journal’s scorecard they could have used about €151 billion, which means they should borrow about €40 billion more to plug last year’s hole. The tab has grown in the interim and markets are demanding 15 percent to lend to Greece. S&P rates Greek bonds “in deep junk territory.”

Charles Forelle at Brussels Blog offers four possible solutions: 1) Modify the current measures by extending the time horizon to pay back the bailout, “plow ahead with privatization”, and restructure the terms of the bailout loans 2) Give Greece more bailout money, 3) Delay paying creditors in exchange for new bonds that are paid off later, and 4) Tell lenders to take a “haircut” today.

Each of these comes with its own set of  repercussions: political, economic and fiscal.  The choice will depend on which fallout Greece’s government want to face. Markets have already reacted to yesterday’s strikes in Athens (and S&P’s warning to Portugal’s banks). A round of  euro selling was touched off by investors concerned that Greece is likely to default again.

The tax-free break on municipal bonds under scrutiny….again

Eliminating the tax-favored treatment of municipal bonds is again being considered by Congress. The Wall Street Journal reports it’s been proposed 125 times since 1918. This time the odds are higher that the tax break on interest income is eliminated given the urgency of reducing the debt. According to one analyst getting rid of the tax break on munis may beneficial to the market since, “many public-private partnerships are prohibited by the private activity bond restrictions that come with tax-exempt bonds.”

Some believe that a substitute needs to be offered to state and local governments. One proposal is to revive the Build American Bonds (BABs) program in which the federal government subsidizes the issuer paying 35 percent of interest costs. Investors  get a higher but taxable yield on bonds. BABs have a constituency among infrastructure groups and mayors and a majority of mayor’s want BABs included in the upcoming highway bill.



Easterly on Poor Economics

William Easterly has a thought-provoking book review in the Wall Street Journal of Poor Economics by Abhijit Banerjee and Ester Duflo. The authors’ case studies into how the effectiveness of aid programs shows that what appears to be “irrational behavior” can be explained with deeper investigation. For example, a flower-seller in India is in constant debt. Rather than pay off her loans she admits she would rather not take more money home because her husband drinks the profits. That is, it’s better to pay the moneylender than enable a drunk spouse.

Another take-away by Easterly – beware of drawing overly-general policy lessons from context-specific field work.

The Odyssey to Xanadu

In previous posts I have covered the trials of the Xanadu shopping center/entertainment complex in the New Jersey Meadowlands. Beset by bad timing, financing troubles, negative public reaction the facility is an example of the perils of government-induced investment.

A new developer will invest $1 billion, and the state of New Jersey has agreed to throw in $200 million in tax breaks to complete the project. To date the development has received $900 million in subsidies and tax breaks. The new owner has changed Xanadu’s name to “The American Dream” and plans to install a water park. The new opening date is scheduled for the fall of 2013.

Illinois Gov. Quinn’s plan to borrow more money

Governor Quinn suggested that he might suspend $1 million in aid to local governments unless he gets approval to borrow over $4 billion to finance state spending. Illinois has an $8 billion budget gap. About $2 billion of the gap is for Medicaid and health insurance which must be paid for the state to continue getting a 57 percent match rate from the federal government.

Illinois’ debt position is one of the worst in the country. The state is ranked in the top five with the highest debt and pension funding needs, currently at $6,692 per capita. Illinois’ general obligation bonds were rated A1 with a negative outlook by Moody’s in January, the lowest rating in the nation.

Pew Center’s new report on state pension funding

The Pew Center Center on the States has released an updated report on the status of pension and health care funding in the states. Since last year the total unfunded liability for these two employee benefits combined has increased 26% to $1.26 trillion. The unfunded pension gap represents $660 billion of the total. About 31 states are funded below 80 percent based on this measure of the liability.

The Pew Center’s study relies on the discount rates as reported by the states to determine the size of the liability which means if applying the risk-adjusted rate the liability is significantly higher. They estimate when applying the risk-adjusted rate the unfunded liability for pensions alone amounts to between $1.8 and $2.4 trillion.

What explains the “Widening Gap”? According to Pew revenue declines in 2009 made it more difficult for states to make their contributions, which given future revenue projections may remain the case for awhile. The second reason is investment losses that occurred in 2009, and is due to the practice of recognizing asset losses over a period, rather than all at once. In FY 2010, preliminary data show some asset recovery.

On the health care front the picture is even more serious. Retiree health benefits were only 5 percent funded in 2009 with 19 states setting aside no funds for health benefits.

Keynes vs. Hayek, Round II

Many readers of this blog are probably already familiar with Fear the Boom and Bust. It is a YouTube video produced by John Papola and my colleague at the Mercatus Center at George Mason University, Professor Russ Roberts. As far as rap videos about macroeconomics go, it is the best I’ve ever seen. It has certainly passed the market test with over 2 million views.

Today, Russ and John released a follow-up called Fight of the Century: Keynes vs. Hayek Round Two. Watch it and marvel (then forward to all of your friends):

New Jersey debating the Abbott Decisions

Governor Christie’s reduction in school aid touched the third rail of New Jersey’s budget the Property Tax Relief Fund, most of which is dedicated to school funding according to a court-approved school funding formula. As past governors have experienced altering school funding in N.J. raises the specter of violating the state constitution’s “thorough and efficient” education clause according to the court. This policy rigidity is just one of the unintended consequences of the 1976 decision in which the court remade school funding and the state’s fiscal map.  In spite of billions spent on the state’s poorest school districts outcomes have barely budged.

A case brought by the Education Law Center argues that Christie’s actions violated the state’s constitution. The court is hearing arguments and will decide whether Christie’s $1.7 billion reduction is permissible or must be restored.