Tag Archives: budget

Corporate welfare spending is not transparent

Over a century ago, the Italian political economist Amilcare Puviani suggested that policy makers have a strong incentive to obscure the cost of government. Known as “fiscal illusion,” the idea is that voters will be willing to spend more money on government if they think its costs is lower than it actually is. Fiscal illusion explains a great deal of public choices, including the popularity of deficit spending.

It also explains why the public knows the least about some of the most controversial items in the public budget such as corporate welfare. But some would like to change this. Here are Jess Fields and Tom “Smitty” Smith, writing in the (subscription required) Austin-American Statesman:

Texans believe in government transparency and accountability. For this reason, we have some of the most advanced open-government initiatives in the nation. Yet one policy area remains outside the view of the general public: economic development.

When local governments cut deals that result in millions in incentives, they can do it behind closed doors in “executive session” — legally — thanks to exceptions to the Open Meetings and Public Information Acts for “economic development negotiations.”

Fields is a senior policy analyst at the free enterprise Texas Public Policy Foundation, while Smith is the director of the Texas office of Public Citizen, a progressive consumer advocacy group started by Ralph Nader in the ‘70s.

Texans aren’t the only ones interested in making corporate welfare more transparent. The Government Accounting Standards Board (GASB) is considering rules that would require governments to report the tax privileges that they hand out to businesses. Here is Liz Farmer, writing in Governing Magazine:

Specifically, GASB is proposing that state and local governments disclose information about property and other tax abatement agreements in their annual financial statements. If approved, the new disclosures could shed light on an area of government finance and provide hard data on information that is assembled sporadically, if at all. Scores of public and private groups support the proposal and it has proven to be one of GASB’s most debated topic yet, as nearly 300 groups or individuals submitted comment letters to the board. But many still say the requirements don’t go far enough.

She notes that the proposal misses a number of tax privileges including:

  • Tax increment financing (TIF),
  • Agreements to discount personal income taxes,
  • “[P]rograms that reduce the tax liabilities of businesses or similar classes of taxpayers.”

Because of these omissions the new GASB rules may only capture about one-third of all tax expenditures.

Puviani would have predicted that.

Strong words from the SEC on Public Sector Pensions

As state and local governments begin to pull back the curtain on the true value of their pension liabilities with the implementation of GASB 68, Daniel Gallagher, Commissioner of the SEC issued an important statement last week, noting in plain terms that how governments measure their liabilities would have serious repercussions in the private sector. Here’s part of the remarks worth considering:

 …for years, state and local governments have used lax governmental accounting standards to hide the yawning chasm in their balance sheets…

The riskiness of a pension obligation depends on state law.[32]  If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate.[33]  Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability:  specifically, the Treasury zero-coupon yield curve.[34]  This would result in a discount rate in the low 3% range.

Obviously, the higher the discount rate, the lower the present value of the liability.  The difference between a discount rate in the range of seven percent and one in the range of three percent is in large part responsible for the hidden $3 trillion in unfunded liabilities that are currently going unreported.

This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees,[35] or not to make the promises in the first place.

In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games.  And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions.  We should not treat municipalities any differently.”

GASB 68 asks that sponsors use a high- yield, tax exempt 20-year municipal GO bond only on the unfunded portion of the liability. This will reveal bigger funding gaps in public sector pension plans. But it does not reveal the full value of the liability since it allows sponsors to continue using the higher discount rates on the funded portion of the liability.

 In addition to using the new GASB standards, Commissioner Gallagher advises that governments should also disclose their pension liabilities on a risk-free basis. This would have the effect of showing the value of these promises on a ‘guaranteed-to-be-paid’ basis. Commissioner Gallagher’s suggestions are extremely sensible and a call to basic transparency in public sector liability reporting.

Ignoring the value of pension benefits is not going to make them cheaper to fund, and the longer a state waits to accurately measure the liabilities and payments, the worse it gets. Just ask New Jersey –  which is struggling to balance its budget and meet a fraction of a fraction of the required annual pension contribution to its state pension system. The situation is so dire that it could trigger yet another downgrade for the Garden State.

 

What would a business-cycle balanced budget rule look like in Illinois?

A few years ago, I testified before the U.S. House Judiciary Committee. I’d been invited to talk about the design of a federal balanced budget amendment and much of my testimony drew on the lessons offered from state experience. Since 49 of the 50 states have such requirements, and since these requirements vary from state to state, I noted that federal lawmakers could learn from the state laboratory.

The best requirement, I argued, would have the following characteristics:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

Michigan Republican Justin Amash has proposed an amendment along these lines. It would be phased-in over 9 years and from there on out would stipulate that outlays “not exceed the average annual revenue collected in the three prior years, adjusting in proportion to changes in population and inflation.” Because it requires balance over three years rather than one, Amash calls it the “business cycle balanced budget amendment.”

Writing in Time, GMU’s Alex Tabarrok points to Sweden’s positive experience with a similar rule. And economists Glenn Hubbard and Tim Kane also endorse such a rule in their book, Balance.

Now, some Illinois state lawmakers have put together a proposal for a state rule that appears to be largely based on this model. It requires:

Appropriations for a fiscal year shall not exceed the average annual revenue collected for the 3 prior years, adjusting in proportion to changes in population and inflation.

(Unlike the Amash plan, however, the Illinois plan is not phased in over a number of years. Rather, it takes effect immediately upon passage of the bill.)

To see how it might work in a state, I decided to take the Amash Amendment for a test drive, using Illinois data. The solid blue line in the figure below charts Illinois’s actual general revenue from 1990 to 2012 in billions of current dollars. The dashed blue line phases in an Amash-type “business cycle” balanced budget rule. Once fully phased-in, it would limit spending to the average revenue of the three previous years, with an adjustment for inflation and population growth.

BCBBA

Notice three things:

  1. From 1990 to 2002, and from 2004 to 2007, the rule would have kept Illinois spending in line with Illinois revenue, and would have even allowed the state to run surpluses.
  2. In lean years (like 2008) when revenue levels off, the limit actually continues to rise. That’s because it is based on a longer time trend. This means that it wouldn’t require the sort of draconian budget cuts that balanced budget critics often fear. The accumulated surpluses from previous years could also be used to soften the blow.
  3. Lastly, note the (9 percent) revenue uptick from 2011 to 2012. The amendment would prudently make legislators wait a few years before they can go out and spend that money.

Does an income tax make people work less?

Harry Truman famously asked for a one-handed economist since all of his seemed reluctant to decisively answer anything: “on the one hand,” they’d tell him, but “on the other…”

When asked whether an income tax makes people work more or less, the typical economist gives the sort of answer that would have grated on Truman like a bad music critic.

If, however, we change the question slightly and make it more realistic, it’s possible to give a decisive answer to the question. Income taxes do reduce overall labor supply. This is something that economists James Gwartney and Richard Stroup explained in the pages of the American Economic Review some 30 years ago. And last week, the CBO’s much-discussed report on the ACA and labor-force participation illustrated their point nicely.

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Credit Warnings, Debt Financing and Dipping into Cash Reserves

As 2013 comes to an end recent news brings attention to the structural budgetary problems and worsening fiscal picture facing several governments: New Jersey, New York City, Puerto Rico and Maryland.

First there was a warning from Moody’s for the Garden State. On Monday New Jersey’s credit outlook was changed to negative. The ratings agency cited rising public employee benefit costs and insufficient revenues. New Jersey is alongside Illinois for the state with the shortest time horizon until the system is Pay-As-You-Go. On a risk-free basis the gap between pension assets and liabilities is roughly $171 billion according to State Budget Solutions, leaving the system only 33 percent funded. This year the New Jersey contributed $1.7 billion to the system. But previous analysis suggests New Jersey will need to pay out $10 billion annually in a few years representing one-third of the current budget.

New Jersey isn’t alone. The biggest structural threat to government budgets is the unrecognized risk in employee pension plans and the purely unfunded status of health care benefits. Mayor Michael Bloomberg, in his final speech as New York City’s Mayor, pointed to the “labor-electoral complex” which prevents employee benefit reform as the single greatest threat to the city’s financial health. In 12 years the cost of employee benefits has increased 500 percent from $1.5 billion to $8.2 billion. Those costs are certain to grow presenting the next generation with a massive debt that will siphon money away from city services.

Public employee pensions and debt are also crippling Puerto Rico which has dipped into cash reserves to repay a $400 million short-term loan. The Wall Street Journal reports that the government planned to sell bonds, but retreated since the island’s bond values have, “plunged in value,” due to investor fears over economic malaise and the territory’s existing large debt load which stands at $87 billion, or $23,000 per resident.

This should serve as a warning to other states that continue to finance budget growth with debt while understating employee benefit costs. Maryland’s Spending Affordability Committee is recommending a 4 percent budget increase and a hike in the state’s debt limit from $75 million to 1.16 billion in 2014. Early estimates by the legislative fiscal office anticipate structural deficits of $300 million over the next two years – a situation that has plagued Maryland for well over a decade. The fiscal office has advised against increased debt, noting that over the last five years, GO bonds have been, “used as a source of replacement funding for transfers of cash” from dedicated funds projects such as the Chesapeake Bay Restoration Fund.

 

Maryland’s “severe financial management issues”

Budgetary balance continues to evade Maryland. In FY 2015 the state anticipates a deficit of $400 million. A fact that is being blaming on entitlements, mandated spending, and fiscal mismanagement in the Developmental Disabilities Administration. The agency has been cited by the HHS Inspector General as over billing the Federal government by $20.6 billion for Medicaid expenses.

For over a decade the state has struggled with structural deficits, or,  spending exceeding revenues. The state’s method of controlling spending – the Spending Affordability Commission – has overseen 30 years of spending increases, and its Debt Affordability Commission has compounded the problem by increasing the state’s debt limits in order to expand spending.

For the details, visit my blog post for the Maryland Public Policy Institute. Of related interest is the Tax Foundation’s recent ranking of government spending the states. Maryland ranks 19, and has increased spending by 30.5% since 2011  2001.

Why a shutdown threat won’t work

There are many people who think that the Affordable Care Act (ACA) is bad policy. I am among them. There are also many who think that the current trajectory of government spending is unsustainable and economically harmful. I am also among them.

Then there are people who think it would be wise to shut down the federal government if they can’t get language passed that threatens to defund the ACA. (Notice that I didn’t say language that “defunds the ACA”; I said language that “threatens to defund the ACA.” Much of the ACA is actually funded through mandatory spending so Congress would need to pass a full repeal of the bill to defund it. What these folks want is language in the budget resolution saying that the ACA ought to be defunded. The bill might strip out some discretionary funding but most of the ACA would go forward.)

I am not among them.

To help us think through the options, let’s borrow from game theory and employ a decision tree. The House (H) can either choose to pass a continuing resolution (CR) that funds the ACA or a CR that calls for de-funding the ACA. The Senate (S) can choose to pass whatever the House sends them or to reject it. If they reject it, and no CR is passed by October 1, the federal government will shut down. In this case, as the CRS puts it, “substantial ACA implementation might continue during a lapse in annual appropriations that resulted in a temporary government shutdown.” If the Senate passes whatever the House sends them, then it will go to the President (P) who can either sign it or veto it.

At the end you can see the outcomes and the way that each group feels about them.

Options are happy, sad, neutral, and outwardly sad but secretly happy. (click on the images to enlarge):

decision tree

 To figure out the most likely outcome (the “equilibrium”) you do a fancy thing called “backwards induction.” It is actually quite simple: think about how each player would act at each stage, starting at the end of the game, and cross off implausible actions. This will help you eliminate unlikely outcomes. This is what I’ve done below, with dashed lines indicating an action that a particular player is unlikely to take.  

We can with confidence cross off the possibility that the President will veto a CR that keeps the government open and fully funds his signature initiative or that the Senate would reject such a bill.

We can also cross off the possibility that the President would sign or that the Senate would send him something that calls for defunding his signature initiative.

That leaves us with two plausible scenarios: the House doesn’t use the CR as a means to attack the ACA, the CR passes the Senate, and the President signs it. This is the top branch of the game tree. House Republicans will be neutral about this outcome since they will have escaped blame for a shutdown but will have done nothing to stop the ACA. Senate Democrats and the White House will be pleased.

The other somewhat plausible scenario is that the House passes a CR calling to defund the ACA, and the Senate rejects it. The government would shut down and the ACA would mostly be untouched. I’m guessing Republicans would get most of the blame for shutting down the government since they lack a bully pulpit, aren’t as gifted as the president at communicating, and the ideological stereotype is that Republicans would like to see the government shut down any way. The White House and Senate Democrats will be outraged—simply outraged—that Republicans would do this but they will secretly be happy to have one more reason to say Republicans should never be trusted with power.

If Republicans see all of this, they will likely flinch, hold their noses, and pass a CR that doesn’t touch the ACA and hopefully come up with more constructive ways to challenge the policy. But, it is a close call for some House Republicans so for this reason, I’ve only partially crossed off the first bottom fork of the decision tree. decision tree 2

What the tree doesn’t indicate is the long run consequences of a government shutdown. Two and a half years ago, when Washington was staring down a different government shutdown, I drew from the experience of U.S. states to conclude that a shutdown is not in the interest of those who advocate for limited government:

As is often the case, we can look to the American states for some guidance. It turns out that in 23 U.S. states, the government will automatically shut down in the event that the governor and the legislature fail to agree on a budget. In his work on budget rulesDavid Primo examined the theoretical impact of these provisions from a game theoretic perspective. He noted that in states with an automatic shutdown provision, “the legislature will be able to achieve its ideal budget, so long as the governor prefers it to no spending.” (p. 102)

He therefore predicted that states with such a provision will spend more than states without such a rule. He then tested the hypothesis, controlling for a number of other factors known to impact state spending and found that states with an automatic shutdown provision actually spend about $64 more per capita than other states. As he notes, “This effect is remarkably large, given that shutdowns occur rarely.” (p. 103)

This suggests that the federal government’s automatic shutdown provision—by making Congress’s desired spending level a take-it-or-leave-it offer—tends to bias the government toward more spending. By extension, it also suggests that a government shutdown will shift negotiating power toward those who favor more spending. So, paradoxically, fiscally conservative tea partiers stand to lose the most if the federal government shuts down.

Perhaps it is time for them to rethink their support of a shutdown.

 

Lessons from North Carolina’s proposed budget

In today’s Room for Debate at The New York Times, I discuss what’s good and what is worrying about North Carolina’s proposed biennial budget.

The good: a doubling of the state’s Rainy Day Fund and end to the estate tax. But a big controversy surrounds the legislature this week. Lawmakers decided to cut unemployment benefits by one-third. This move disqualifies the state from receiving additional emergency unemployment insurance funds from the federal government, affecting 170,000 jobless in the state.

The issue points to the perennial calls for reform to the federal-state Unemployment Insurance (UI) program. North Carolina is one of many states that must pay the federal government back what it has borrowed to offer extended benefits to its residents, or face higher payroll taxes. Their choices are tough ones to make: raise the state payroll tax (or taxable wage base) and replenish the trust fund – which has its own effects on the economy and the workforce – or cut benefits. A better solution is to re-think our approach to social insurance, something economists, such as Harvard’s Martin Feldstein, have been highlighting the structural flaws of UI since the 1970s.

n.b. update: a reader rightly notes at the NYT – the states must pay back the money they’ve borrowed from the federal government to continue paying benefits. But they don’t have to pay back the temporary EUC program. 

WMATA’s failures are institutional, not personal

Chris Barnes who writes the DC blog FixWMATA  is supporting a petition to replace the Board of Directors of the Washington Metropolitan Area Transit Authority. Frustration with the transit agency is growing among Washington-area residents as ongoing system repairs have made the system’s weekend service increasingly unusable. The situation has led to the birth of multiple blogs documenting WMATA’s failures. As an intern in DC from the Czech Republic recently summed up the situation, “Metro is both terrible and expensive.”

While the need for reforms at WMATA is clear, replacing the Board of Directors is unlikely to lead to significant improvements in the system. Rather, WMATA’s problems are institutional, and new actors facing the same incentives as the current WMATA Board are unlikely to produce better results. Some of the institutions preventing a Metro of reasonable quality and cost include:

1) Union work rules. Stephen Smith, my co-blogger at Market Urbanism, has done an excellent job of explaining how union work rules make transit needlessly expensive. One of the biggest culprits is requiring shifts to be at least eight hours and preventing the hiring of part-time workers. WMATA rationally runs trains and buses more often during morning and evening rush hours, but it is not permitted to staff these time periods at levels above mid-day staffing because of the eight-hour shift requirement. Combined with the above-market wages and benefits that WMATA employees make, these bloated employee costs prevent WMATA from achieving a higher farebox recovery rate and having more resources to dedicate to needed capital improvements.

2) Intergovernmental transfers. Over half of WMATA’s current capital improvement budget comes from the federal government, meaning that while the benefits of the system are narrowly bestowed on riders, a large share of the capital improvement costs are spread across U.S. taxpayers. This large dispersal of costs permits much more expensive transit than would be tolerated if all funding came from the localities that benefit from the system. Furthermore, with funds coming from the District, Maryland, Virginia, and the federal government, the flypaper effect comes into play. This means that a $100 million infusion from the federal government to WMATA will not reduce the cost born by local taxpayers by $100 million; rather, total spending on the project will increase with grants from higher level of government. Absent incentives to spend this money well, WMATA demonstrates that high levels of federal funding will not necessarily result efficiently carried out capital improvements.

At Pedestrian Observations, Alon Levy provides a comparison of transit construction costs across countries, and finds that U.S. construction costs are exorbitant. The reasons for these cost disparities are many and not well-understood. One reason for high costs in the U.S., though, may be that the prevalence of  federal funding comes with the strings of costly federal regulations.

3) Accountability. While all U.S. transit systems suffer inefficiencies from intergovernmental transfers and union work rules, DC’s Metro has a unique governance structure that seems to produce particularly bad and costly service. WMATA has the blessing and the curse of being multijurisdictional. On the one hand, the Washington region is not plagued with the agency turf wars that New York City transit sees. Several of the system’s rail lines run through Virginia, DC, and Maryland, providing many infrastructure efficiencies and service improvements over requiring transfers between jurisdictions.

Despite these opportunities to provide improved service at a lower cost, WMATA’s lack of jurisdictional control seems to do more harm than good. No politician can take full credit for running WMATA efficiently, so none prioritize the agency’s performance. It’s a tragedy of the political commons.

Josh Barro has recommended directly electing the Board of Directors of WMATA to create elected officials with an incentive to improve service. This institutional change would be more likely to improve outcomes than replacing the current Board with new members who would face the same incentives. Clearly, WMATA’s Board of Directors is failing in its job to oversee quality and cost-effective transit for the region; however, replacing the board members without changing the institutions that they work under will not likely improve outcomes. Intergovernmental transfers and union work rules limit transit efficiency across the country, but WMATA’s interjurisdictional status exacerbates inefficiencies and waste.

Local control over transportation: good in principle but not being practiced

State and local governments know their transportation needs better than Washington D.C. But that doesn’t mean that state and local governments are necessarily more efficient or less prone to public choice problems when it comes to funding projects, and some of that is due to the intertwined funding streams that make up a transportation budget.

Emily Goff at The Heritage Foundation finds two such examples in the recent transportation bills passed in Virginia and Maryland.

Both Virginia Governor Bob McDonnell and Maryland Governor Martin O’Malley propose raising taxes to fund new transit projects. In Virginia the state will eliminate the gas tax and replace it with an increase in the sales tax. This is a move away from a user-based tax to a more general source of taxation, severing the connection between those who use the roads and those who pay. The gas tax is related to road use; sales taxes are barely related. There is a much greater chance of political diversion of sales tax revenues to subsidized transit projects: trolleys, trains and bike paths, rather than using revenues for road improvements.

Maryland reduces the gas tax by five cents to 18.5 cents per gallon and imposes a new wholesale tax on motor fuels.

How’s the money being spent? In Virginia 42 percent of the new sales tax revenues will go to mass transit with the rest going to highway maintenance. As Goff notes this means lower -income southwestern Virginians will subsidize transit for affluent northern Virginians every time they make a nonfood purchase.

As an example, consider Arlington’s $1 million dollar bus stop. Arlingtonians chipped in $200,000 and the rest came from the Virginia Department of Transportation (VDOT). It’s likely with a move to the sales tax, we’ll see more of this. And indeed, according to Arlington Now, there’s a plan for 24 more bus stops to compliment the proposed Columbia Pike streetcar, a light rail project that is the subject of a lively local debate.

Revenue diversions to big-ticket transit projects are also incentivized by the states trying to come up with enough money to secure federal grants for Metrorail extensions (Virginia’s Silver Line to Dulles Airport and Maryland’s Purple Line to New Carrolton).

Truly modernizing and improving roads and mass transit could be better achieved by following a few principles.

  • First, phase out federal transit grants which encourage states to pursue politically-influenced and costly projects that don’t always address commuters’ needs. (See the rapid bus versus light rail debate).
  • Secondly, Virginia and Maryland should move their revenue system back towards user-fees for road improvements. This is increasingly possible with technology and a Vehicle Miles Tax (VMT), which the GAO finds is “more equitable and efficient” than the gas tax.
  • And lastly, improve transit funding. One way this can be done is through increasing farebox recovery rates. The idea is to get transit fares in line with the rest of the world.

Interestingly, Paris, Madrid, and Tokyo have built rail systems at a fraction of the cost of heavily-subsidized projects in New York, Boston, and San Francisco. Stephen Smith, writing at Bloomberg, highlights that a big part of the problem in the U.S. are antiquated procurement laws that limit bidders on transit projects and push up costs. These legal restrictions amount to real money. French rail operator SNCF estimated it could cut $30 billion off of the proposed $68 billion California light rail project. California rejected the offer and is sticking with the pricier lead contractor.