Tag Archives: financial crisis

An Overview of the Virginia State Budget and Economy

By Adam Millsap and Thomas Savidge

Virginia’s economy has steadily grown over time in spite of expenditures outpacing revenues each year since 2007. However, economic growth within the state is not evenly distributed geographically.

We examine Virginia’s revenue and expenditure trends, highlighting the sources of Virginia’s revenue and where it spends money. Then we discuss trends in state economic growth and compare that to recent personal income data by county.

Government Overview: Expenditures and Revenue

Figure 1 shows Virginia’s general spending and revenue trends over the past ten years. According to the Virginia Comprehensive Annual Financial Report (CAFR), after adjusting for inflation, government expenditures have outpaced revenue every single year as seen in Figure 1 below (with the exception of 2006). The red column represents yearly expenditures while the stacked column represents revenues (the lighter shade of blue at the top represents revenue from “Federal Grants and Contracts” and the bottom darker shade of blue represents “Self-Funded Revenue”).

VA expend and rev 2006-16

During the recession in 2009, expenditures climbed to $40 billion. Expenditures hovered around this amount until 2015 when they reached $41 billion. Then in 2016 expenditures dropped to just under $37 billion, a level last seen in 2006.

On the revenue side, the majority of Virginia’s government revenue is self-funded i.e. raised by the state. Self-funded revenue hovered between $24 and $29 billion over the ten year period.

However, revenue from federal contracts and grants steadily increased over time. There were two sharp increases in federal contracts and grants: 2008-2009 jumping from $8 to $10 billion and then 2009-2010 jumping from $10 to $13 billion. While there was a drop in federal contracts and grants from 2015-2016, the amount of revenue received from federal contracts and grants has not returned to its pre-2009 levels.

What is the state of Virginia spending its revenue on? According to the Virginia CAFR, state spending is separated into six major categories: General Government, Education, Transportation, Resources & Economic Development, Individual & Family Services, and Administration of Justice. The spending amounts from 2006-2016 (adjusted for inflation) are depicted in Figure 2.

VA expend by category 2006-16

As shown, the majority of spending over the ten year period was on Individual and Family Services. Prior to 2008, spending on Education closely tracked spending on Individual and Family services, but from 2008 to 2010 spending on the latter increased rapidly while spending on education declined. From 2010 through 2015 spending on Individual & Family Services was just over $15 billion per year. It dropped from 2015 to 2016, but so did spending on education, which maintained the gap between the two categories.

During the ten year period, Education spending hovered between $10 and $12 billion until it dropped to $9 billion in 2016. With the exception of Transportation (steadily climbing from 2010-2016), spending on each of the other categories remained below $5 billion per year and was fairly constant over this period.

Virginia Economic Growth & County Personal Income

After examining Virginia’s revenue and expenditures in Part 1, we now look at changes in Virginia’s economic growth and personal income at the county level. Data from the Bureau of Economic Analysis (BEA) shows that Virginia’s GDP hovered between $4 and $4.5 billion dollars (after adjusting for inflation), as shown in Figure 3 below. The blue columns depict real GDP (measured on the left vertical axis in billions of chained 2009 dollars) and the red line depicts percent changes in real GDP (measured on the right vertical axis).

VA GDP 2006-15

While Virginia’s GDP increased from 2006-2015, we’ve condensed the scale of the left vertical axis to only cover $3.9-4.35 billion dollars in order to highlight the percent changes in Virginia’s economy. The red line shows that the percent change in real GDP over this period was often quite small—between 0% and 1% in all but two years.

Virginia’s GDP rose from 2006-2007 and then immediately fell from 2007-2008 due to the financial crisis. However, the economy experienced larger growth from 2009-2010, growing from roughly $4.07-$4.17 billion, a 2.3% jump.

Virginia’s economy held steady at $4.17 billion from 2010 to 2011 and then increased each year up through 2014. Then from 2014-2015, Virginia’s economy experienced another larger spike in growth from $4.24-$4.32 billion, a 2% increase.

Virginia’s economy is diverse so it’s not surprising that the robust economic growth that occurred from 2014 to 2015 was not spread evenly across the state. While the BEA is still compiling data on county GDP, we utilized their data on personal income by county to show the intra-state differences.

Personal Income is not the equivalent of county-level GDP, the typical measure of economic output, but it can serve as a proxy for the economic conditions of a county.[1] Figure 4 below shows which counties saw the largest and smallest changes in personal income from 2014 to 2015. The red counties are the 10 counties with the smallest changes while the blue counties are the 10 counties with the largest changes.

VA county pers. inc. map

As depicted in Figure 4 above, the counties with the strongest personal income growth are concentrated in the north, the east and areas surrounding Richmond. Loudon County in the north experienced the most personal income growth at 7%. The counties surrounding Richmond experienced at least 5.5% growth. Total personal income in Albemarle County grew by 5.7% while the rest of the counties—Hanover, Charles City, Greene, Louisa, and New Kent—experienced growth between 6.2% and 6.7%.

With the exception of Northumberland, the counties in which personal income grew the least were along the western border and in the southern parts of the state. Four of these counties and an independent city were concentrated in the relatively rural Southwest corner of the state—Buchanan, Tazewell, Dickenson, Washington and the independent city of Bristol. In fact, Buchanan County’s personal income contracted by 1.14%.

Cross-county differences in personal income growth in Virginia from 2014 to 2015 are consistent with national data as shown below.

US county pers. inc. map

This map from the BEA shows personal income growth by county (darker colors mean more growth). Nationwide, personal income growth was lower on average in relatively rural counties. Residents of rural counties also have lower incomes and less educational attainment on average. This is not surprising given the strong positive relationship between human capital and economic growth.

And during the most recent economic recovery, new business growth was especially weak in counties with less than 100,000 people. In fact, from 2010 to 2014 these counties actually lost businesses on net.

Conclusion:

Government spending on Individual and Family Services increased during the recession and has yet to return to pre-recession levels. Meanwhile, spending on education declined while spending on transportation slightly increased. This is consistent with other research that has found that state spending on health services, e.g. Medicaid, is crowding out spending in other areas.

Economic growth in Virginia was relatively strong from 2014 to 2015 but was not evenly distributed across the state. The counties with the smallest percentage changes in personal income are relatively rural while the counties with the largest gains are more urban. This is consistent with national patterns and other economic data revealing an urban-rural economic gap in and around Virginia.


[1] Personal Income is defined by the BEA as “the income received by, or on behalf of, all persons from all sources: from participation as laborers in production, from owning a home or business, from the ownership of financial assets, and from government and business in the form of transfers. It includes income from domestic sources as well as the rest of world. It does not include realized or unrealized capital gains or losses.” For more information about personal income see https://www.bea.gov/newsreleases/regional/lapi/lapi_newsrelease.htm

Eight years after the financial crisis: lessons from the most fiscally distressed cities

You’d think that eight years after the financial crisis, cities would have recovered. Instead, declining tax revenues following the economic downturn paired with growing liabilities have slowed recovery. Some cities exacerbated their situations with poor policy choices. Much could be learned by studying how city officials manage their finances in response to fiscal crises.

Detroit made history in 2013 when it became the largest city to declare bankruptcy after decades of financial struggle. Other cities like Stockton and San Bernardino in California had their own financial battles that also resulted in bankruptcy. Their policy decisions reflect the most extreme responses to fiscal crises.

You could probably count on both hands how many cities file for bankruptcy each year, but this is not an extremely telling statistic as cities often take many other steps to alleviate budget problems and view bankruptcy as a last resort. When times get tough, city officials often reduce payments into their pension systems, raise taxes – or when that doesn’t seem adequate – find themselves cutting services or laying off public workers.

It turns out that many municipalities weathered the 2008 recession without needing to take such extreme actions. Studying how these cities managed to recover more quickly than cities like Stockton provides interesting insight on what courses of action can help city officials better respond to fiscal distress.

A new Mercatus study examines the types of actions that public officials have taken under fiscal distress and then concludes with recommendations that could help future crises from occurring. Their empirical model finds that increased reserves, lower debt, and better tax structures all significantly improve a city’s fiscal health.

The authors, researchers Evgenia Gorina and Craig Maher, define fiscal distress as:

“the condition of local finances that does not permit the government to provide public services and meet its own operating needs to the extent to which these have been provided and met previously.”

In order to determine whether a city or county government is under fiscal distress, the authors study the actual actions taken by city officials between 2007 and 2012. Their approach is unique because it stands in contrast with previous literature that primarily looks to poorly performing financial indicators to measure fiscal distress. An example of such an indicator would be how much cash a government has on hand relative to its liabilities.

Although financial indicators can tell someone a lot about the fiscal condition of their locality, they are only a snapshot of financial resources on hand and don’t provide information on how previous policy choices got them to their current state. A robust analysis of a city’s financial health would require a deeper look. Looking at policy decisions as well as financial indicators can paint a more complete picture of just how financial resources are being managed.

The figure here displays the types of actions, or “fiscal distress episodes”, that the authors of the study found were the most common among cities in California, Michigan, and Pennsylvania. As expected, you’ll see that bankruptcy occurs much less frequently than other courses of action. The top three most common attempts to meet fundamental operating needs and service requirements during times of fiscal distress include (1) large across-the-board budget cuts or cuts in services, (2) blanket reduction in employee salaries, and (3) unusual tax rate or fee increases.

fiscal-distress-episodes

Another thing that becomes clear from this figure is that public workers and taxpayers appear to be adversely affected by the most common fiscal episodes. Cuts in services, reductions in employee salaries, large tax increases, and layoffs all place much of the distress on these groups. By contrast, actions like fund transfers, deferring capital projects, or late budget enactment don’t directly affect public workers or taxpayers (at least in the short term).

I decided to break down how episodes affected public workers and taxpayers for each state examined in the sample. 91% of California’s municipal fiscal distress episodes directly affected public employees or the provision of public services, while the remaining 9% indirectly affected them. Michigan and Pennsylvania followed with 85% and 66% of episodes, respectively, directly affecting public workers or taxpayers through cuts in services, tax increases, or layoffs.

Many of these actions surely happen in tandem with each other in more distressed cities, but it seems that more often than not, the burden falls heavily on public workers and taxpayers.

The city officials who had to make these hard decisions obviously did so under financially and politically intense circumstances; what many, including researchers like Gorina and Maher, consider to be a fiscal crisis. In fact, 32 percent of the communities across the three states in their sample experienced fiscal distress which, on its own, sheds light on the magnitude of the 2007-2009 recession. A large motivator of Gorina and Maher’s research is to understand what characteristics of the cities who more quickly rebounded from the Great Recession allowed them to prevent hitting fiscal crisis stage in the first place.

They do so by testing the effect of a city’s pre-existing fiscal condition on their likelihood to undergo fiscal distress. After controlling for things like government type, size, and local economic factors, they found that cities that had larger reserves and lower debt tended to weather the recession better relative to other cities. More specifically, declining general revenue balance as a percent of general expenditures and increases in debt as a share of total revenue both increase the odds of fiscal distress for a city.

Additionally, the authors found that cities with a greater reliance on property taxes managed to weather the recession better than governments reliant on other revenue sources. This suggests that revenue structure, not just the amount of revenue raised, is an important determinant of fiscal health.

No city wants to end up like Detroit or Scranton. Policymakers in these cities were forced to make hard choices that were politically unpopular; often harming public employees and taxpayers. Officials can look to Gorina and Maher’s research to understand how they can prevent ending up in such dire situations.

When approaching municipal finances, each city’s unique situation should of course be taken into consideration. This requires looking at each city’s economic history and financial practices, similar to what my colleagues have done for Scranton. Combining each city’s financial context with principles of sound financial management can surely help more cities find and maintain a healthy fiscal path.

No, bailouts are not something to celebrate

Robert Samuelson at the Washington Post is celebrating the auto bailout.

Last December I had a piece in the Post in which I argued that “pro-business” policies like bailouts are actually bad for business. I offered five reasons:

  1. Pro-business policies undermine competition.
  2. They retard innovation
  3. They sucker workers into unsustainable careers.
  4. They encourage wasteful privilege seeking.
  5. They undermine the legitimacy of government and business.

Read my piece for the full argument.

But aren’t things different in the midst of a major economic and financial crisis? Shouldn’t we have more leeway for bailouts in exigent circumstances?

No. Here is why:

First, we should always remember that the concentrated beneficiaries of a bailout have every incentive to overstate its necessity while the diffuse interests that pay for it (other borrowers, taxpayers, un-favored competitors, and the future inheritors of a less dynamic and less competitive economy) have almost no incentive or ability to get organized and lobby against it.

Bailout proponents talk as if they know bailouts avert certain calamity. But the truth is that we can never know exactly what would have happened without a bailout. We can, however, draw on both economic theory and past experience. And both suggest that the macroeconomy of a world without bailouts is actually more stable than one with bailouts. This is because bailouts incentivize excessive risk (and, importantly, correlated risk taking). Moreover, because the bailout vs. no bailout call is inherently arbitrary, bailouts generate uncertainty.

Todd Zywicki at GMU law argues convincingly that normal bankruptcy proceedings would have worked just fine in the case of the autos.

Moreover, as Garett Jones and Katelyn Christ explain, alternative options like “speed bankruptcy” (aka debt-to-equity swaps) offer better ways to improve the health of institutions without completely letting creditors off the hook. This isn’t just blind speculation. The EU used this approach in its “bail in” of Cyprus and it seems to have worked pretty well.

Ironically, one can make a reasonable case that many (most?) bailouts are themselves the result of previous bailouts. The 1979 bailout of Chrysler taught a valuable lesson to the big 3 automakers and their creditors. It showed them that Washington would do whatever it took to save them. That, and decades of other privileges allowed the auto makers to ignore both customers and market realities.

Indeed, at least some of the blame for the entire 2008 debacle falls on the ‘too big to fail’ expectation that systematically encouraged most large financial firms to leverage up. While it was hardly the only factor, the successive bailouts of Continental Illinois (1984), the S&Ls (1990s), the implicit guarantee of the GSEs, etc., likely exacerbated the severity of the 2008 financial crisis. So a good cost-benefit analysis of any bailout should include some probability that it will encourage future excessive risk taking, and future calls for more bailouts. Once these additional costs are accounted for, bailouts look like significantly worse deals.

Adherence to the “rule of law” is more important in a crisis than it is in normal times. Constitutional prohibitions, statutory limits, and even political taboos are typically not needed in “easy cases.” It is the hard cases that make for bad precedent.

It’s Time to Change the Incentives of Regulators

One of the primary reasons that regulation slows down economic growth is that regulation inhibits innovation.  Another example of that is playing out in real-time.  Julian Hattem at The Hill recently blogged about online educators trying to stop the US Department of Education from preventing the expansion of educational opportunities with regulations.  From Hattem’s post:

Funders and educators trying to spur innovations in online education are complaining that federal regulators are making their jobs more difficult.

John Ebersole, president of the online Excelsior College, said on Monday that Congress and President Obama both were making a point of exploring how the Internet can expand educational opportunities, but that regulators at the Department of Education were making it harder.

“I’m afraid that those folks over at the Departnent of Education see their role as being that of police officers,” he said. “They’re all about creating more and more regulations. No matter how few institutions are involved in particular inappropriate behavior, and there have been some, the solution is to impose regulations on everybody.”

Ebersole has it right – the incentive for people at the Department of Education, and at regulatory agencies in general, is to create more regulations.  Economists sometimes model the government as if it were a machine that benevolently chooses to intervene in markets only when it makes sense. But those models ignore that there are real people inside the machine of government, and people respond to incentives.  Regulations are the product that regulatory agencies create, and employees of those agencies are rewarded with things like plaques (I’ve got three sitting on a shelf in my office, from my days as a regulatory economist at the Department of Transportation), bonuses, and promotions for being on teams that successfully create more regulations.  This is unfortunate, because it inevitably creates pressure to regulate regardless of consequences on things like innovation and economic growth.

A system that rewards people for producing large quantities of some product, regardless of that product’s real value or potential long-term consequences, is a recipe for disaster.  In fact, it sounds reminiscent of the situation of home loan originators in the years leading up to the financial crisis of 2008.  Mortgage origination is the act of making a loan to someone for the purposes of buying a home.  Fannie Mae and Freddie Mac, as well as large commercial and investment banks, would buy mortgages (and the interest that they promised) from home loan originators, the most notorious of which was probably Countrywide Financial (now part of Bank of America).  The originators knew they had a ready buyer for mortgages, including subprime mortgages – that is, mortgages that were relatively riskier and potentially worthless if interest rates rose.  The knowledge that they could quickly turn a profit by originating more loans and selling them to Fannie, Freddie, and some Wall Street firms led many mortgage originators to turn a blind eye to the possibility that many of the loans they made would not be paid back.  That is, the incentives of individuals working in mortgage origination companies led them to produce large quantities of their product, regardless of the product’s real value or potential long-term consequences.  Sound familiar?

The Myth of Deregulation and the Financial Crisis

In an opinion piece on American Banker, Rep. Jeb Hensarling wrote that:

The great tragedy of the financial crisis, however, was not that Washington regulations failed to prevent it, but instead that Washington regulations helped lead us into it.

Even putting aside the issue of causality, my colleague Robert Greene and I recently examined the data on regulatory growth as we sought to answer the question, “Did Deregulation Cause the Financial Crisis?” Our conclusion was that there was no measurable, net deregulation leading up to the financial crisis.

The data on regulatory growth came from RegData, which uses text analysis to measure the quantity of restrictions published in regulatory text each year.  The graph below shows the number of regulatory restrictions published each year in Title 12 of the Code of Federal Regulations, which covers the subject area of banks and banking, and Title 17, which covers commodity futures and securities trading.  Deregulation would show a general downward trend.  Instead, we see that both titles grew over that time period. The only downward ticks we see occurred because of some consolidation of duplicative regulations from 1997 to 1999 (see our article for more details on that).

As we wrote at the time:

[W]e find that between 1997 and 2008 the number of financial regulatory restrictions in the Code of Federal Regulations (CFR) rose from approximately 40,286 restrictions to 47,494—an increase of 17.9 percent. Regulatory restrictions in Title 12 of the CFR—which regulates banking—increased 18.2 percent while the number of restrictions in Title 17—which regulates commodity futures and securities markets—increased 17.4 percent.