Tag Archives: Debt

Is American Federalism conducive to liberty?

In new Mercatus research, Dr. Richard E. Wagner, Harris professor of Economics at George Mason University tackles a fascinating question: Is the American form of federalism supportive of liberty?

His answer is a qualified ‘yes.’ Under certain conditions, American federalism does support liberty, but that very same system can also be modified resulting in the expansion of political power relative to the liberty of citizens. The question of what results from the gradual constitutional transformation of the American federalist system is a salient one for not only students of government but also policymakers.

The important conditions that determine which form of federalism prevails (liberty-supporting or liberty-eroding) are rooted in competition among governments. Today we are experiencing a very different kind of federalism than the one instituted by the Founders. For the better part of a century, the US constitution has often been amended in a way to encourage collusion among the states thus undermining a key feature of a liberty-supporting federalism.

Restoring a liberty-supporting federalism first requires a deeper diagnosis of the American federalist system. Dr. Wagner develops that possibility through a very engaging synthesis of public choice theory, Austrian and new institutional economics.  Student of Dr. Wagner may be familiar with many of these concepts, developed in his public finance books including Deficits, Debt and Democracy (2012, Elgar). Rather than summarize the paper in today’s blog post, for now I encourage you to read the piece in full.

The “pension tapeworm” and Fiscal Federalism

In his annual report to shareholders, Warren Buffett cites the role that pension underfunding is playing in governments and markets:

“Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made. During the next decade, you will read a lot of news –- bad news -– about public pension plans.”

He zones in on pension mathematics – “a mystery to most Americans” – as a possible reason for accelerating liabilities facing state and local governments including Puerto Rico, Detroit, New Jersey and Illinois. I might go further and state that pension mathematics remains a mystery to those with responsibility for, or interest in, these systems. It’s the number one reason why reforms have been halting and inadequate to meet the magnitude of the problem. But as has been mentioned on this blog before: the accounting will eventually catch up with the economics.

What that means is unrelenting pressure building in municipal budgets including major cities. MSN Money suggests the possibility of bankruptcy for Los Angeles, Chicago and New York City based on their growing health care and pension liabilities.

In the context of this recent news and open talk of big municipal bankruptcy, I found an interesting analysis by Paul E. Peterson and Daniel J. Nadler in “The Global Debt Crisis Haunting U.S. and European Federalism.”(Brookings Institution Press, 2014).

In their article, “Competitive Federalism Under Pressure,” they find a positive correlation between investors’ perception of default risk on state bonds and the unionization rate of the public sector workforce. While cautioning that there is much more at work influencing investors’ views, I think their findings are worth mentioning since one of the biggest obstacles to pension reform has been the reluctance of interested parties to confront the (actual) numbers.

More precisely, it leads to a situation like the one now being sorted out in federal bankruptcy court in Detroit. Pensioners have been told by Emergency Manager Kevyn Orr that if they are willing to enter into a “timely settlement” with the city and state, they may see their pensions reduced by less than the 10 to 30 percent now suggested. Meanwhile bondholders are looking at a haircut of up to 80 percent.

If this outcome holds for Detroit, then Peterson and Nadler’s findings help to illuminate the importance of collective bargaining rules on the structure of American federalism by changing the “rules of the game” in state and local finances. The big question for other cities and creditors: How will Detroit’s treatment of pensions versus bonds affect investors’ perception of credit risk in the municipal debt market?

But there are even bigger implications. It is the scenario of multiple (and major) municipal bankruptcies that might lead to federalism-altering policy interventions, Peterson and Nadler conclude their analysis with this observation:

[public sector] Collective bargaining has, “magnified the risk of state sovereign defaults, complicated the resolution of deficit problems that provoke such crises, heightened the likelihood of a federal intervention if such crises materializes, and set the conditions for a transformation of the country’s federal system.”

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.

When Does Each State’s Debt Reach 90 Percent of GDP?

Few economic studies have received as much attention as Carmen Reinhart and Kenneth Rogoff’s “Growth in a Time of Debt.” The attention is well-deserved. Reinhart and Rogoff have painstakingly assembled data on debt from over 40 countries covering 200 years, making it the largest dataset of its kind. They then examine the way debt impacts economic growth and find that as nations’ debt-to-GDP ratios go from 30 to 90 percent, their growth rates decline markedly. In the best case, their real average annual growth rates decline by about 1 percentage point; in the worst case, the growth rate is halved.

To put this in perspective, if in 1975, the US growth rate had slowed by 1 percentage point, our current economy would be about 30 percent smaller than it actually is. And if our growth rate had been cut in half, then the current economy would be nearly 43 percent smaller than it actually is. In other words, an entire generation’s worth of economic growth would not have occurred.

Absent policy change, the CBO is projected that federal debt held by the public will be 90 percent of GDP within 7 years.

But what about the states? They, too, face a grim fiscal future. Harvard economist Jeffrey Miron recently examined this question for the Mercatus Center. In it, he concludes:

[S]tate government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound.

Miron then calculates the year at which each state’s debt will exceed the fateful 90 percent mark identified by Reinhart and Rogoff. To help visualize Miron’s work, I have created a short YouTube video that shows the states whose debt levels exceed 90 percent of state GDP at certain time periods. Absent policy change, debt in every state of the union will be greater than 90 percent by 2070. But many of us don’t have to wait that long. In a number of states, the day of reckoning will come much sooner.

 

Read Miron’s entire, informative, analysis here.

What is the Best Way to Rein in Debt? Can We Learn From Others?

The specter of a credit downgrade looms.  But far more frightening is the cause of the potential downgrade: a debt-to-GDP ratio that will balloon to 90 percent within 7 years and 100 percent within 10. Other nations that have experienced that level of debt have seen their growth rates cut in half.

Luckily, we are not flying blind. Others have wrestled with huge debt loads and some have made meaningful reforms. What’s more, these experiences have been exhaustively studied by economists and there is remarkable agreement about the most effective way to deal with a huge debt load.

I review that literature in a new, short, policy brief. Here is the bottom line:

The experience of nearly two dozen developed economies suggests that the surest way for policy makers to rein in destructive deficits and stabilize the debt is to cut spending, not increase revenue.

California may seek bridge loan before federal debt limit deal is reached

California Treasurer Bill Lockyear says the state may act quickly to obtain a bridge loan in order to pay for the $5 billion in revenue-anticipation notes (RANs) the state will sell in August. The reason for the quick action is the concern that a breakdown in federal debt limit talks might touch off a ripple effect in debt markets. If California doesn’t get its loan then it won’t be able to pay back the RANs and could be left with a budget shortfall at the end of the fiscal year.

An interesting story of debt dependency to be sure. But are Mr. Lockyear’s fears of US default, based on the remarks of Fed Chair Ben Bernanke, misplaced? Veronique deRugy points out if the the debt ceiling isn’t raised by August 2nd this doesn’t mean the US will default. The Treasury can prioritize payments (e.g. pay interest on the debt first). Treasury Secretary Geithner has the authority to make those payments first. In addition Treasury can convert government debt into publicly-held debt.

For more, watch Veronique on Bloomberg’s Reality Check.

Central Falls, R.I. “staring down bankrtupcy”

In October Central Falls, Rhode Island’s pension system will run dry. It’s the second town in the U.S. to face this scenario since Prichard, Alabama. The small town has a $80 million pension bill. Currently payouts represent one-quarter of the town’s budget. That will increase quickly once the fund runs out. As The New York Times reports Rhode Island’s municipal bankruptcy/pension dilemmas is unique. Rhode Island is a small state with 39 small municipalities.

Thirty-six of these cities operate their own pension funds and 23 of these are considered “in distress.” The question now is: what is Rhode Island’s responsibility should these cities ask the state for help? Some place the blame on Rhode Island’s collective bargaining laws – set in state statute- that put everything on the table for negotiation. But then there is the problem of the pension plan itself, instituted by the local government in 1972. Consider also the role that accounting standards  have played in underestimating liabilities. To date, Rhode Island has taken measures to reassure bondholders giving GO bonds priority over other forms of debt.

It is unclear how this will play out and the extent to which Central Falls’ deep fiscal problems could trigger problems throughout the state. In addition to multiple independent local plans. The state operates its own Municipal Employee Retirement System in which several towns participate. The state-run plan is less than 36 percent funded with an unfunded liability of over $12 billion.