Tag Archives: Maryland

Maryland’s New Budget Proposal

Maryland’s fiscal challenges did not occur over night and, in fact, the state has been running structural deficits for the past several years. The Governor’s recent proposal to balance the state’s budget consists of two major components: (1) having the state share the costs of the teachers’ pension system with county level governments and (2) modifying the state’s tax code.

Cost Sharing:

As the system currently stands, local governments in Maryland determine teacher salaries but the state, however, picks up the entire cost of teacher pensions. The Governor’s proposal would essentially split these costs – the state would continue to pay for a portion of the teachers’ pension costs but county governments would also pick up a portion of the cost. Although some consider this to be an extreme reform, the principle behind the reform is really not that severe.

When the average family in the U.S. makes their budget for the week or the month they must include everything they spend money on – groceries, gas, health insurance, and etc. Governor O’Malley is essentially asking county governments to do the same. He is asking units of local government to budget for what they spend money on, which includes teacher pensions.

This proposal is definitely a step in the right direction. Splitting the cost of pensions with the county governments introduces more transparency and accountability into the teachers’ pension system. More importantly, cost-sharing introduces a better sense of fiscal discipline for county level budgeting.

Tax Code:

The second component of the Governor’s proposal consists of modifying the state’s tax code – increasing the tobacco tax, getting rid of tax loopholes in the mining industry, implementing a tax on internet sales, and changing the tax structure for high income earners. There seems to be some confusion on this final point. To be clear, as I understand it, this is not an increase in the tax rate but rather it’s a decrease in the number of tax exemptions for high income earners.

Some of these ideas are certainly better than others, but what’s important about these tax reforms is that Governor O’Malley is seemingly trying to introduce neutrality into the tax code. If this is in fact what he is trying to do, then it’s a step in the right direction. State’s that introduce neutrality and generality in their tax code by getting rid of tax loopholes, reducing the number of exemptions, and broadening their tax base have been able to lower tax rates while increasing revenues.

Taking Reform a Step Further:

The Governor is taking Maryland in the right direction by introducing structural reform into the state’s budgeting process. This budget proposal, however, is only one of many steps that need to be taken. If Maryland really wants to get its fiscal house in order it needs to continue focusing on institutional reform. One reform, for example, that the Governor should consider is implementing an effective spending limit – specifically, one that ties spending growth to the sum of population growth and inflation.

For more on this topic, watch my recent interview with Fox-5 news:

Gov. O’Malley Outlines $311 Million in New Revenue for Maryland: MyFoxDC.com

An Unbalanced Budget: Fiscal Pollution

Yesterday I appeared before the House Judiciary Committee to talk about a balanced budget amendment to the U.S. Constitution. The other witnesses were Former Governor and Attorney General Richard Thornburgh, Former CBO Director and current president of the American Action Forum, Douglas Holtz-Eakin, and Professor Philip Joyce of the University of Maryland.

I began by pointing out the enormity of the problem: CBO projects that absent policy change, the nation’s debt will be 90 percent of GDP in just seven years. This is an important figure because research suggests that when national debt levels get much above this point, their growth rates tend to slow. In the median case, they slow by 1 percentage point and in the mean case, their growth rates are cut in half.

This may not sound like much, but to put it in perspective, I used the following chart.

What would current national income be if—in 1975—the U.S. had accumulated the sort of debt that we are about to accumulate and the nation’s growth rate had slowed by 1 percentage point? This is indicated by the dashed line in the middle. Today’s GDP would be about 1/3rd smaller than it actually is. And what would national income be if we had grown at half our actual pace? This is indicated in the bottom line. Today’s income would be 45 percent smaller than it actually is. To get a feel for this magnitude, notice the blip in the top right corner of the actual GDP line. That is the Great Recession that began in 2008. As I told the Judiciary Committee:

The most calamitous economic contraction in decades pales in comparison to the lost income associated with persistently anemic economic growth from too much debt.

In my view, the nation’s fiscal problems owe much to the incentives that politicians face. Around 1:27:45 I make this point:

The basic problem here is one of externalities. This is a problem that is familiar to environmental economists.  If a factory…in the process
of making a product for consumers, is allowed to bilge smoke into the air, that’s an externality. And they will make too much of the product unless it is internalized. So here, what’s happening is that this current generation is allowed to externalize the costs of government onto the next generation….The costs of reform, the costs of avoiding this kind of economic contraction that we are staring at will be borne by people like me, the median voter. But the costs of the status quo will be borne by my daughter. She cannot vote. Until we can internalize that externality, I think we are going to continue to make the wrong choice because none of you have the incentive to make the right choice. It’s not your fault; you are all good people, you are servants of the public and you are listening to what your constituents and your median voters are saying. But the incentives that they offer you are not right.

A balanced budget amendment, by internalizing this externality, would correct these misaligned incentives. Simply put, it would “make each generation that benefits from government services pay for the costs of producing them.”

The video is here (my testimony begins at 54:30). Here is my written statement.

Unfortunately, despite the ardent wishes of my 7th grade civics teacher, these sorts of hearings are not, primarily, about weighing the evidence and changing minds. Instead, they have much more to do with scoring political points and solidifying already-hardened positions. Nevertheless, I found that most of the Congress-people who disagreed with me were polite. And I hope that this leads to opportunities for more fruitful exchanges down the line.

Local Governments in the United States

From an article in Stateline:

There are 89,476 local governments in the United States. They include counties, cities, villages, towns and townships, as well as special districts that handle utilities, fire, police and library services.

The authors of this article look at the number of local governments in each state relative to its population, finding that the average for the United States is 3,451 people per unit of local government. North Dakota (249), South Dakota (411), and Nebraska (687) were on low end of the spectrum whereas Hawaii (71,595), Maryland (22,553) and Virginia (15,658) where on the high end.

Illinois, in particular, finds itself in an interesting situation in this data. Although the state has only 1,835 people per unit of local government, its total number of local governments (6,944) is far greater than any other state. To put this into perspective, Pennsylvania (4,871) and Texas (4,835) rank second and third, respectively, for states with the highest number of local governments.

So what explains the proliferation of local governments in Illinois? One likely cause is a debt loophole in the state’s constitution. Specifically, the 1870 Illinois Constitution limited the amount of debt that a unit of local government could issue but allowed localities a dodge: the special district. In other words, each unit of local government was allowed to get around its legal debt limit via the creation of a special district. Since that time, the state has created 3,249 special districts. This phenomenon of special district creation as tool for expanded fiscal reach is investigated by Bennett and DiLorenzo in their book, Underground Government.

Does Illinois’s situation suggest the need for consolidation? If so, what is the optimal number of governments for a state to have and how is this determined? It’s not necessarily obvious at first glance: what are these governments, how did they arise, what do they do, and how do they finance their operations?

The concept of consolidating governments to increase efficiency has been the root of much debate in public policy. However, as Ostrom, Tiebout, and Warren argue,

It would be a mistake to conclude that public organizations are of an inappropriate size until the informal mechanisms, which might permit larger or smaller political communities, are investigated.

Thus, when debating over whether or not consolidation will increase efficiency, it’s necessary to understand the institutional environment in which the units of local government were created as well as the underlying informal mechanisms connecting them.

How a US downgrade affects the states

Last night’s news of a downgrade of long-term US debt from AAA to AA+ by S&P will have a ripple effect. But whether or not interest rates rise depends on how the market incorporates this information and whether it has anticipated this.

As far as states go, in July, Moody’s put five states on a downgrade watch list: Tennessee, South Carolina, Virginia, Maryland and New Mexico. And they gave six reasons: 1) employment volatility; 2) high federal employment relative to total state employment, 3)  federal procurement contracts as a percent of state GDP, 4) Size of Medicaid expenditures relative to state spending, 5) variable interest rate debt as a percent of state resources and 6) the size of the operating fund balance as a percent of operating revenues.

On August 4th these states were removed from the list and retain their AAa rating.

Places with a lot of exposure to risk, or a “high dependence on federal economic activity,”  include Virginia and Massachusetts. This doesn’t mean that these states and their local governments will see their interest rates rise, or be downgraded, or that they are in any danger of default.  It simply means their books will be scrutinized with this risk exposure in mind.




Governor Christie’s pared down budget

The Star Ledger reports that Governor Christie, “took an axe” to the state’s budget and “slashed $900 million in a budget he blasted as ‘unconstitutional.'” Cuts were made to state aid to municipalities, college tuition aid, Medicaid and aid to suburban schools leaving $640 million in surplus. He also vetoed bills to tax millionaires for more school funding aid.

In an analysis of New Jersey‘s fiscal problems we found that these areas are some of the primary weaknesses in New Jersey’s budget. The school aid formula, guarded by the court since 1976, effectively prevents the legislature and Governor from making appropriations decisions. This result of the court’s involvement in school funding has been a fiscal and educational disaster for the state. Since the 1970s many changes in tax rates have been to the income tax in order to fund schools and provide aid to municipalities. Over thirty years later and there are few to no improvements in urban school districts. The price for New Jerseyans is one of the most progressive income taxes in the nation and a property tax crisis.

As for Aid to Distressed Cities this program highlights another long-running problem in New Jersey’s fiscal landscape. Several of its cities rely on state aid in lieu of property tax revenues because they have not recovered from long-running economic problems. The problem with state aid is that it masks the cost of spending to local residents,  subsidizing local inefficiencies and the continuance of failed approaches to local economic development.

Inefficiencies and poor performance are rampant in areas that have relied heavily on aid, notably the education system. What is needed is the kind of reform being discussed by some leaders in the state – both Republican and Democrat. Cities like Camden need to be able to try new approaches to schools. A new pragmatism among Democratic city leaders in other parts of the country shows a willingness to confront fiscal reality and ask: how much of our budget is being consumed by unsustainable benefits packages and how much is left over to  run the city? Atlanta, Georgia, Montgomery County, Maryland are two such recent examples.

Abusing disability pensions in Montgomery County?

The Washington Examiner takes a look at  disability pensions in two counties: Montgomery County, Maryland and Fairfax County, Virginia. Each county has a similar-sized police force. Between 2000 and 2008, no Fairfax County police offers received a disability pension. Between 2004 and 2009, a total of 91 police officers and 49 firefighters and sheriffs deputies received disability pensions. A further 34 Montgomery County firefighters either received disability payments or have an application pending in 2010.

Councilman Phil Andrews (D-Gaithersberg) is investigating the practice, “What is suggests is that disability retirement here is used as an alternate retirement system.”

Why? It’s a good deal, a retiree receives two-thirds of their annual salary in a tax-free pension. Secondly, according to one anonymous police officer, “Do you have any idea how easy it is to claim disability?”

The price tag of fiscal evasion in Maryland

To replenish the Transportation Trust Fund (TTF) Maryland residents may expect higher gas taxes, tolls and parking rates. The Blue Ribbon Commission On Maryland Transportation Funding told lawmakers these measures could raise $600 million in new revenues, on top of $200 million in bonds. The reason for the measure is to plug the hole left by lawmakers who have become accustomed to dumping the TTF into the General Fund in order to balance Maryland’s budget. The committee further proposes the state pass a constitutional rule barring such raids.

As I document in my recent paper, “Maryland’s Fiscal Slide,” what seem like small one-time maneuvers to close budget gaps ultimately weaken fiscal discpline and come with a price. Maryland has been dipping into the TTF since 1984 as the fund also became more reliant on bonds. The result is Marylanders now looking at higher taxes and fees, as well as interest payments on transportation bonds.

The Backdoor Bailouts

The Washington Post reports:

States that have borrowed billions of dollars from the federal government to cover the soaring cost of unemployment benefits would get immediate relief from the Obama administration under a plan to suspend interest payments for the next two years.

According to White House Press Secretary Robert Gibbs, the President’s proposal, “prevents future state bailouts, because in the future, states are going to have to rationalize what they offer and how they pay for it.” I’m not convinced.

First, a little background:

The unemployment system is jointly administered by the states and the federal government. To finance the program, both states and the feds tax the first $7,000 of wages paid to each worker, while some states choose to tax income earned beyond that first $7,000.

As the Post reports:

In tough times, states routinely borrow from the federal government to pay benefits. But when states have an outstanding balance for at least two years, federal law triggers an automatic increase in the federal tax to repay the loan. Such tax hikes already have taken effect or are imminent in Michigan, Indiana and South Carolina.

What the Post doesn’t mention (but Bloomberg does), is: “From 2009 until this year, the loans had been interest-free under a provision of the economic-stimulus program.”

Now the President wants to go further, suspending any interest payments the states owe to the federal government for the next two years. In 2014, he would then change the tax base so that instead of taxing the first $7,000 of wages, the feds and the states would each tax the first $15,000. 

It is this aspect of the proposal that the press secretary, evidently, believes “prevents future state bailouts.” This might be true if we assume that policy makers won’t respond to the extra tax revenue by increasing spending. But more fundamentally, it seems to me that the press secretary is glossing over the fact that the first part of the plan—suspension of interest payments—is a bailout.

For historical context, I turned to Robert Inman. In the first chapter of Fiscal Decentralization and the Challenge of Hard Budget Constraints, he writes (p. 57):

The first major wave of lower government defaults occurred during the 1840s, when eight states (Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, and Pennsylvania) and the Territory of Florida defaulted.

Maryland Representative William Cost Johnson (you can’t make that name up!) led the effort. As Inman explains, the rest of Congress didn’t agree with Mr. Cost; they refused to bail out the states (p. 57):

Importantly, opponents of a bailout stressed the strategic implications of such a policy; bailouts would signal an accommodating central government and encourage future deficits, defaults, and ultimately inefficient local governments. Congress said no, and there have been no state defaults since.

This marked a turning point in federal-state relations: through recessions, depressions and countless state fiscal crises, the strong no-bailout rule has survived nearly two centuries.

This made the US federal system unique. Unlike local governments in other countries, US states could not run up huge bills and export the costs to their neighbors. As Inman explains, other countries are not so fortunate to have such a strong no-bailout rule (p. 35):

The recent financial crises in Argentina and Brazil, largely precipitated by excessive local government borrowing, are prominent recent examples of how a fiscally irresponsible local sector can impose significant economic costs on a national economy.

The strong no-bailout rule in the US, however, has not prevented the federal government from increasing its role in state finance. Over the years, federal grants to state governments have steadily grown. Now, there are over 1,120 federal programs that are designed to aid the states. Today, federal funding now pays for nearly 1/3rd of all state spending.

What I find particularly alarming, however, is the recent growth in ad hoc state aid programs that are designed to offset short-term fiscal crunches. To me, these look an awful lot like bailouts. Consider the $135 billion in state aid in the stimulus which included:

  • A state fiscal stabilization fund designed to shore up deficits
  • A temporary increase in the federal Medicaid matching formula (FMAP)
  • Grants for various local projects from teachers to firefighters to police
  • The aforementioned interest-free loans for unemployment insurance
  • And much more

On top of that, the President successfully lobbied for an extension of the “temporary” FMAP increase and an extension of the federal-state unemployment insurance program (he was less-successful in last summer’s attempt to wrangle another $50 billion in state and local aid).

If somehow they could see this, I suspect that the senators and representatives who stopped a state bailout over 170 years ago might wonder if their “no bailout” stance really still stands.

Rating Governors

How are the Governors of New Jersey, Maryland, Washington, Michigan, New York, Virginia and Massachusetts doing?

We rate and offer an analysis of the state of the state addresses and budget proposals of these states at Public Sector Inc. So far, Governor Christie gets the highest marks. I offer my opinion on Governor O’Malley’s proposed budget in Maryland. Comments and discussion are welcome.