Tag Archives: South Carolina

We don’t need more federal infrastructure spending

Many of the presidential candidates on both sides of the aisle have expressed interest in fixing America’s infrastructure, including Donald Trump, Hilary Clinton, and Bernie Sanders. All of them claim that America’s roads and bridges are crumbling and that more money, often in the form of tax increases, is needed before they fall into further disrepair.

The provision of basic infrastructure is one of the most economically sound purposes of government. Good roads, bridges, and ports facilitate economic transactions and the exchange of ideas which helps foster innovation and economic growth. There is certainly room to debate which level of government – federal, state, or local – should provide which type of infrastructure, but I want to start by examining US infrastructure spending over time. To hear the candidates talk one would think that infrastructure spending has fallen of a cliff. What else could explain the current derelict state?

A quick look at the data shows that this simply isn’t true. A 2015 CBO report on public spending on transportation and water infrastructure provides the following figure.

CBO us infrastructure spending

In inflation adjusted dollars (the top panel) infrastructure spending has exhibited a positive trend and was higher on average post 1992 after the completion of the interstate highway system. (By the way, the original estimate for the interstate system was $25 billion over 12 years and it ended up costing $114 billion over 35 years.)

The bottom panel shows that spending as a % of GDP has declined since the early 80s, but it has never been very high, topping out at approximately 6% in 1965. Since the top panel shows an increase in the level of spending, the decline relative to GDP is due to the government increasing spending in other areas over this time period, not cutting spending on infrastructure.

The increase in the level of spending over time is further revealed when looking at per capita spending. Using the data from the CBO report and US population data I created the following figure (dollars are adjusted for inflation and are in 2014 dollars).

infrastructure spend per cap

The top green line is total spending per capita, the middle red line is state and local spending with federal grants and loan subsidies subtracted out, and the bottom blue line is federal spending. Federal spending per capita has remained relatively flat while state and local spending experienced a big jump in the late 80s, which increased the total as well. This graph shows that the amount of infrastructure spending has largely increased when adjusted for inflation and population. It’s true that spending is down since the early 2000s but it’s still higher than at any point prior to the early 90s and higher than it was during the 35-year-construction of the interstate highway system.

Another interesting thing that jumps out is that state and local governments provide the bulk of infrastructure spending. The graph below depicts the percentage of total infrastructure spending that is done by state and local governments.

infrastructure spend state, local as percent of total

As shown in the graph state and local spending on infrastructure has accounted for roughly 75% of total infrastructure spending since the late 80s. Prior to that it averaged about 70% except for a dip to around 65% in the late 70s.

All of this data shows that the federal government – at least in terms of spending – has not ignored the country’s infrastructure over the last 50 plus years, despite the rhetoric one hears from the campaign trail. In fact, on a per capita basis total infrastructure spending has increased since the early 1980s, driven primarily by state and local governments.

And this brings up a second important point: state and local governments are and have always been the primary source of infrastructure spending. The federal government has historically played a small role in building and maintaining roads, bridges, and water infrastructure. And for good reason. As my colleague Veronique de Rugy has pointed out :

“…infrastructure spending by the federal government tends to suffer from massive cost overruns, waste, fraud, and abuse. As a result, many projects that look good on paper turn out to have much lower return on investments than planned.”

As evidence she notes that:

“According to the Danish researchers, American cost overruns reached on average $55 billion per year. This figure includes famous disasters like the Central Artery/Tunnel Project (CA/T), better known as the Boston Big Dig.22 By the time the Beantown highway project—the most expensive in American history—was completed in 2008 its price tag was a staggering $22 billion. The estimated cost in 1985 was $2.8 billion. The Big Dig also wrapped up 7 years behind schedule.”

Since state and local governments are doing the bulk of the financing anyway and most infrastructure is local in nature it is best to keep the federal government out as much as possible. States are also more likely to experiment with private methods of infrastructure funding. As de Rugy points out:

“…a number of states have started to finance and operate highways privately. In 1995, Virginia opened the Dulles Greenway, a 14-mile highway, paid for by private bond and equity issues. Similar private highway projects have been completed, or are being pursued, in California, Maryland, Minnesota, North Carolina, South Carolina, and Texas. In Indiana, Governor Mitch Daniels leased the highways and made a $4 billion profit for the state’s taxpayers. Consumers in Indiana were better off: the deal not only saved money, but the quality of the roads improved as they were run more efficiently.”

It remains an open question as to exactly how much more money should be devoted to America’s infrastructure. But even if the amount is substantial it’s not clear that the federal government needs to get any more involved than they already are. Infrastructure is largely a state and local issue and that is where the taxing and spending should take place, not in Washington D.C.

 

 

Red ink flows in state-run prepaid tuition programs

In three years the Prepaid Alabama College Tuition Program (PACT) will run dry. The State Treasurer reports PACT which pays $100 million in tuition a year, has $347 million in investments remaining. To fulfill its obligations to all 40,000 participants over the next 20 years, PACT needs an additional $843.9 million. The state Supreme Court recently struck down a potential solution put forth by the legislature: cap payouts to 2010 tuition levels and have beneficiaries make up the difference. The remedy didn’t pass scrutiny due to a 2010 law that promises PACT be 100 percent funded.

PACT worked for about 20 years until hit with the combination of unrelenting tuition inflation and a bear market which halved the plan’s investments.

Unfortunately, Alabama isn’t the only state with a prepaid program in the red. The Wall Street Journal reports South Carolina’s plan expects to run out of funds in 2017. Tennessee’s budget seeks an infusion of $15 million into its program. And West Virginia recently transferred funds from an unclaimed-property program to shore up its struggling prepaid plan.

In remarkably bad shape is IllinoisCrain’s Chicago Business finds that Illinois’ 12-year old $1.1 billion prepaid plan has the largest shortfall in the entire nation. Worse still, plan managers are making up for losses by embracing a huge amount of risk. In 2011, 47 percent of Illinois’ prepaid tuition plan was shifted into alternatives and investment expectations set at 8.75 percent. An expectation that far outstrips any other prepaid plan by a long-shot. (Florida has the country’s largest prepaid tuition plan and operates with an expected return of 4.3 percent on plan investments).

This year the agency that runs the prepaid program, the Illinois Student Assistance Commission ,has dropped that return assumption to 7.5 percent.  According to its actuarial report College Illinois! has enough money to pay out tuition for a few more years.

Prepaid plans are a type of 529 plan (the other is the college savings program) that allow parents to purchase contracts (or credits) for their children’s education.  The prepaid tuition plan locks-in tuition for the current year for eligible in-state colleges. Contributions are invested and benefits paid from those funds. To remain well-funded asset performance must track or exceed tuition increases. Given the rapid increase in college tuition which on average has increased 5.6 percent per year over the rate of inflation in just the past decade, it’s easy to see why so many plans have gone bust.

PACT participants who may not recoup their initial investments are understandably upset, “everything about the way the plan was promoted implied it was backed by the state.”

But, just how good is the state’s guarantee?

That is often in the fine-print. The WSJ finds three levels of guarantee in operation. 1) Full Faith and Credit – the state promises to pay for shortfalls if the fund goes dry. (Washington, Texas, Ohio, Mississippi and Florida)  2) Legislative appropriation – the legislature must consider an appropriation to cover shortfalls. (Illinois, Maryland, Virginia, South Carolina and West Virginia)  and 3) Fund Assets – the plan is solely backed by the assets in the plan. (Alabama, Michigan, Nevada, Pennsylvania, and Tennessee.)

Alabama’s PACT participants found they had little recourse in 2009.  Since the state doesn’t guarantee payment of tuition,they were technically out of luck. However, after a series of demonstrations and hearings in 2010 the Alabama legislature granted a $548 million bailout, tiding the plan over for the next three years. And then what? The state legislature filed a bill last week to tweak the previous solution to the court’s liking. It is again proposing to cap tuition payouts at 2010 levels.

Strangely, in spite of the risk present in pre-paid tuition plans they continue to provide a “flight to safety” for some investors. Last year growth in pre-paid plans outstripped growth in 529 college savings plans. The lure of higher returns attracts some who are banking on the ability of governments to keep their promise to pay it out regardless of market performance or the fine-print.

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.

 

 

 

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.

The State of Laziness

According to Bloomberg, here are the top ten laziest states:

Louisiana, Mississippi, Arkansas, North Carolina, Tennessee, Kentucky, West Virginia, South Carolina, Alabama, Delaware.

(I have no idea whether this survey method is valid).

Though it is provocative to label the good people of Louisiana “lazy,” I suspect that much of the observed difference in behavior can be traced not to inherent differences in the people but to differences in the institutions in which those people operate: the laws, the economy, the culture, etc. that constrains and shapes their actions.

A few years back, the Nobel laureate economist Ed Prescott (of Arizona State) analyzed the difference between American and European working habits. There was a time, in the early 1970s, when Europeans worked more than Americans. Now this is reversed: “Americans work 50 percent more than do the Germans, French, and Italians.” Prescott finds that differences in marginal tax rates are the predominant factor. So Europeans aren’t any lazier than we; they just face different incentives.

I wonder what institutional differences can explain differences in work effort across the U.S. states?

One can’t help but notice the over-representation of the South. Two centuries ago, Montesquieu wrote:

You will find in the climates of the north, peoples with few vices, many virtues, sincerity and truthfulness. Approach the south, you will think you are leaving morality itself, the passions become more vivacious and multiply crimes… The heat can be so excessive that the body is totally without force. The resignation passes to the spirit and leads people to be without curiosity, nor the desire for noble enterprise.

I seem to recall a similar observation from John Adams, but can’t locate it just now…or maybe I just don’t want to put in the effort to find it.

Virginia's Stimulus Reservations

The Virginia House rejected $125 million in federal stimulus funds to be used to expand unemployment benefits to part-time workers and those in job training programs. As mentioned earlier this week, concerns were raised that by accepting the funds, the state is also accepting a higher level of future spending on unemployment benefits — something it will have to pay for via
increased taxes on business once stimulus funds disappear.

Virginia joins South Carolina, Texas, Louisiana, and Alaska in expressing reservations about the strings attached to stimulus funding, a debate led by South Carolina Governor Mark Sanford, who on April 3 became the last governor to accept funds — after his formal rejection of the funds was denied by the Administration.

Addendum: Fixed typo in header — apologies for the oversight.