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One Last Look at State and Local Finances

by John Rubino on January 3, 2011 · 19 comments

The slow-motion state and local train wreck is becoming old news before it even happens. So this is our last look at the subject for a while, I promise. But two recent articles are must-reads. The first is from Manhattan Institute senior fellow Steven Malanga on the increasingly brazen tricks that states are playing on their creditors and citizens. The second is about how pension obligations are leading cities to make some really badly-timed tax increases.

State House Shell Games

For years, trickery and quick fixes have just fed the spending habit. Today the budget holes are cavernous.

Over the past two years, states have faced accumulated budget deficits of some $300 billion. Federal stimulus money helped cover about two-thirds of that gap, but state governments have had to close the rest themselves. To do so, many have resorted to tricks and gimmicks that Thomas DiNapoli, New York State’s comptroller, speaking about his own state’s budget, described as a “fiscal shell game.” Such shenanigans mortgage the future for quick fixes in the present, and are a bigger part of states’ fiscal woes than most taxpayers know.

One common maneuver has been to fill budget holes with borrowed money. Arizona is Exhibit A. Since the housing bubble burst in 2007 and the state’s economy began to contract, Arizona has borrowed approximately $2 billion, relying on new debt to close 17% of its budget deficits, according to a report in the Arizona Capitol Times newspaper on Oct. 8. Among the loans: $450 million that the state plans to pay back with future revenues from its lottery. The cost to the state over the next two decades will be about $680 million in principal and interest.

Arizona has also sold its state government buildings, including those that house its Assembly and Senate, to generate $1 billion in one-time revenue. But the sales were part of a gimmick: No buyer stepped forward to purchase the buildings. Instead, the state issued more than $1 billion of notes backed by the rents that it will pay on the buildings—at a cost of $1.5 billion over 20 years. The state remains in control of the buildings, and a financial trustee collects the state’s payments and issues checks to buyers of the notes. Since the borrowing is technically being repaid by rents—not tax revenues, as in the case of lottery revenues—Arizona was able to borrow the money despite a provision in its constitution that explicitly limits state borrowing to just $350,000.

States don’t only play the debt game in recessions. To make an annual contribution for public employees’ retirements, Illinois borrowed $10 billion in 2003, depositing the sum in its pension funds. But in the boom years that followed, the state still failed to make adequate contributions. So Illinois had to borrow again in 2009, issuing some $3.5 billion in new debt at a cost of $4.5 billion in future principal and interest payments. This year, it borrowed yet another $4 billion for the same reason.

Some budget trickery betrays pledges made by lawmakers to taxpayers. One common example is “sweeps,” when a state shifts money from accounts dedicated to specific purposes, like highway maintenance, into general accounts where the money can be spent on anything.

One honey pot is the tax revenue designated by federal law for upgrading 911 emergency-response systems. An August survey by the Federal Communications Commission reported that states redirected $135 million in these taxes last year to spending for other purposes. New York is a serial abuser: Since 1991, the Empire State has collected an estimated $600 million from its 911 tax. But only $84 million has actually gone to local officials for upgrading emergency services.

These fund transfers have become so routine that New York must now do “reverse sweeps.” For example, New York created a fund 20 years ago to finance bridge and road construction and maintenance. But it often transfers money out of it and into the state’s general accounts—only to replace what’s been swept by borrowing more. About a third of the Dedicated Highway and Bridge Trust Fund’s disbursements, or nearly $1 billion, now goes toward debt service, a figure projected to rise to 70% by 2014. And so New York is shifting tax dollars back from its hard-pressed general fund to help pay off the transportation account’s debt.

In some states, fund transfers have provoked opposition, particularly in cases where the government grabbed money from accounts that are not taxpayer-funded. Since 1975, New Hampshire has operated a medical-malpractice insurance fund financed by physician premiums to provide them with liability protection when they have difficulty obtaining it elsewhere. The fund has built up a surplus of $140 million, and last year the state tried to seize and sweep $110 million of it into its general fund. But the doctors sued, and the state’s Supreme Court blocked the transfer.

Now states are even casting a covetous eye at private bank accounts. This year Michigan decreased the time that money can sit unclaimed in a citizen’s bank account before the state claims it to three years from 15. The state projected the move could provide its general fund with a one-time boost of $200 million.

Illinois, meanwhile, passed modest pension reforms earlier this year that apply to new workers. The savings won’t materialize for years—but the legislation included language that allowed the state to calculate the future savings and apply up to $300 million toward closing this year’s budget gap.

Time and again, the quick fix just feeds the spending habit. In 2004, Gov. Arnold Schwarzenegger promised that California could get out of its hole with borrowed money, and voters approved $10.9 billion in deficit bonds. Relieved of its immediate financial squeeze, Sacramento discarded fiscal discipline and went on a binge, hiking spending by nearly a third, or $34 billion, over the next four years. Today the state is back in the hole, facing a $25 billion budget deficit over the next 18 months.

Pensions Push Taxes Higher

Cities Tap Homeowners for Revenue as Workers’ Retirement, Health Costs Rise

Cities across the nation are raising property taxes, largely citing rising pension and health-care costs for their employees and retirees.

In Pennsylvania, the township of Upper Moreland is bumping up property taxes for residents by 13.6% in 2011. Next door the city of Philadelphia this year increased the tax 9.9%. In New York, Saratoga Springs will collect 4.4% more in property taxes in 2011; Troy will increase taxes by 1.9%.

Property-tax increases aren’t unusual, in part because the taxes are among the main sources of local revenue. But officials say more and larger increases are taking hold. “This year we have seen a dramatic increase in our cities and towns having to increase property taxes” for pensions and other expenses, said Jack Garner, executive director of the Pennsylvania League of Cities and Municipalities.

Local officials and government workers say a confluence of factors is driving the increases, including the need to make up for staggering investment losses from the financial crisis and rising costs as more workers retire. In addition, benefit increases promised in flush times are coming due as revenue flounders, and some cities have skipped payments to their pension funds over the years.

In Upper Moreland, a township of about 26,000 near Philadelphia, the Board of Commissioners voted this month to raise its 2011 property tax for residents by 13.6%, the first such rise in five years. That means a $67 annual tax bump on a $135,000 home, the average value there.

Pension and health-care costs are likely to make up more than a fifth of the town’s $17.8 million operating budget for next year, said finance director John Crawford, a Republican.

In 2005, Upper Moreland contributed around $100,000 to its pensions. This year, it contributed $681,000. In 2011, it will pay an estimated $1.1 million. Healthy investment returns used to cover a large portion of the town’s contribution to its pension funds. Now, lower returns—coupled with higher costs as more workers retire—mean Upper Moreland is paying more.

In addition to those figures, the state of Pennsylvania annually contributes $250,000 to Upper Moreland’s pensions, Mr. Crawford said. Local Pennsylvania governments only receive pension aid from the state if they make the payments to their pensions recommended by actuaries.

Upper Moreland’s payments on current workers’ health care were $2 million in 2010 and are estimated to reach $2.63 million in 2011, Mr. Crawford said.

“If it hadn’t been for the escalating costs,” in pension and health-care benefits, he said, “the board may have succeeded in going through another year without a tax increase.”

Many of the same issues are hitting Philadelphia, which earlier this year increased its property tax by 9.9%, the first bump since the early 1990s. That’s a $270 annual payment increase for residents living in homes valued at $100,000, said Rob Dubow, city finance director.

Philadelphia’s pension fund is 45% funded—meaning its assets represent 45% of its long-term liabilities—and the city’s payments are projected to increase to $600 million in 2015, up from $230 million in 2004. Actuaries recommend pension systems be 80% funded.

Rolling Meadows, a Chicago suburb, is raising its property taxes next year by 9.8%, on top of a 16% jump in 2010, due to increased police and fire pension costs, said Mayor Ken Nelson. Those increases are the largest in nearly 20 years, he said. The local police and fire pension funds are around 45% funded.

Some thoughts:

  • These two stories illustrate the dilemma in which states and cities find themselves. Using budgetary tricks to hide growing deficits pushes an ever-bigger problem just a short way down the road, where it will inevitably cause chaos. But raising property taxes to fund growing pension liabilities will be self-defeating by making homeowners poorer and less likely to spend. So higher property taxes equals lower sales taxes equals an even bigger deficit.
  • The idea that states and cities are, unlike the federal government, required to balance their budget every year is apparently a myth, since states have found ways to borrow to cover their deficits. Which means they’re speculating on margin with their workers’ nest eggs. Individual IRA accounts are forbidden from doing this because it’s too risky.
  • How can a pension be only 45% funded when stocks are up 80% in the past two years? Imagine what these funds would look like if the Fed hadn’t artificially expanded asset prices with all that newly created money.
  • The pension costs cited in the second article look unsustainable, so something really big will have to happen soon. Look for “draconian” to make all the overused-words lists this year.

 

  • Bruce C.

    “…this is our last look at the subject for a while, I promise.” Thank you. A watched pot never boils.

    Q: What’s more boring than your city’s finances?

    A: Someone elses city finances.

    • Thomas

      “Q: What’s more boring than your city’s finances?
      A: Someone elses city finances.”

      I find this very odd, unless you have bank account which is overflowing. To everybody else city’s finances are your personal finances too, sooner or later. Unless you don’t pay tax.

      Even other cities circulate back to your money via federal tax, it just takes a bit longer.

  • Andy jones

    The federal Reserve is already considering buying the Muni Bonds from state governments. look for another “stimulus” by summer 2011 for the state governments.

    • Bruce C.

      Andy,

      I agree. That’s one of my predictions for 2011. Here are a few more:

      The Fed will begin to buy municipal bonds. As QE2 comes to an end this summer, the need for more QE will remain (in part because it will be impossible to stop it) and municipal bonds will then be purchased instead of Treasury bonds. This “QE3” will be justified on the grounds that muni purchases will keep municipalities functioning so as not to upset ”the recovery”, which is to say to keep municipal workers employed, pensioners flush, and bond rates down. Not to worry though, that will also help maintain asset values for the big banks and insurance companies.

      China will buy PIIG bonds. This will solve two problems for China (and one for the ECB). It provides a politically plausible reason to diversify its foreign exchange reserves away from the dollar, and it will support consumption from the Eurozone (its largest trading partner) by not imposing austerity conditions as the IMF/ECB has done.

      Everyone will learn about financial derviavtives problem. As more and more people question why debts are being monetized rather than making the bond holders take loses, the truth will finally emerge that forcing bond loses will literally ignite a global financial Armageddon because of interconnected deriviative contracts. Here’s a bonus prediction: As people grasp the implications of an unavoidable/inevitable implosion of the Western fiat money system, they’re gonna get upset.

      Consumer spending will decrease. For many reasons consumers will figure out that paying down debt and conserving cash will be the best strategy in 2011. This will hold for either inflationary or deflationary expectations. In both cases debt servicing costs increase along with prices for essential products and services. Fears of income reductions due to job loss, downsizing, reduced work loads, medical insurance cost increases, etc. will spur cash saving versus buying more shit from China.

      Food and energy costs will increase. Most food and energy producers purchase supply via 6-month futures contracts that will start expiring in Q111. Six months ago commodity prices were benign upon which those producer costs were based, which is why food and energy costs have risen relatively little so far. Next year those higher costs will have to be passed on to consumers regardless of economic conditions.

      The euro will not break up in 2011. From all that I’ve read the euro/eurozone is more of a political experiment than an economic one and the politicians of the core countries are strongly committed to it both intellectually and emotionally. To me that means that they’ll do anything and everything to keep the ball in the air.

      All of the major stock markets will go up. The US market may be “over bought” and investors may be too “bullish” but two trends that I think will extend the rally, almost without interruption, is the global devaluation of all currencies and the growth of a “middle class” among 86% of the world’s population. US Corporations are focused almost compleltly overseas, using foreign labor and selling to foreign businesses and consumers. Most large US corporations receive the majority of their revenue from overseas. US manufacturing will continue to leave, and “good” middle class jobs will continue to disappear, because of higher labor costs and regulations (like “Obama care”) compared to the developing economies. In other words, US wages and, therefore, consumption will continue to drop because the wages for US employees will have to compete with foreign labor. So corporate profits will continue to increase, especially in dollar terms as the US dollar leads the pack towards implosion. Bad news for the US wage earners and the basic US economy, good news for US corporations and equity values and those who work to facilitate this trend.

      Oil will reach $400 per barrel. I admit that this seems incredible, and I’m definitely having fun and going out a limb here, but I base that on two “reasons”. The first reason is that OPEC will suddenly and “unexpectedly” end the petrodollar agreement and begin accepting payment in alternative currencies. That will obviously have enormous and unprecednted consequences, one of which will be to lower demand for the dollar significantly and thus it’s relative value to other currencies. Now, the reason I’m predicting that oil will reach $400 in particular is because of what I consider to be a “Freudian slip” by an analyst who is famously considered to be the most accurate one in the world. Based upon her proprietary quantitative analysis she was quite confident US and global growth would continue. When asked to comment on the effect of higher oil prices she said ‘we can handle $100 oil, but not $400 oil’. Weird, huh?

      Americans who oppossed the extension of the current tax rates will NOT voluntarily send more money to the IRS than is lawfully required of them. Warren Buffet and Bill Gates, in particular.

      • Brad Thrasher

        Hey Bruce C.,

        A Happy and prosperous New Year to you & yours.

        Yes on the Fed buying up all the bad paper in sight including muni’s. Yes on China & Europe. Yes on food & energy price inflation. Yes on the Eurozone as Germany finally realizes its manifest destiny without a shot ever being fired. Yes on the stock markets going up as Fed policy re-inflates.

        Not sure on the dollar/oil. The dollar remains strong, perhaps stubbornly so, such that a prudent man might reconsider previously held views, if not market positions. Rick Santelli posed an interesting question today. Which dollar? The USD Index, which is Eurocentric remains strong. When viewed against commodity based (Canada, Australia)and mercantile economies of Asia (China, Japan) and emerging nations (Brazil, India) the USD is weak.

        Erin Burnette offered up a factoid yesterday that can’t be ignored. The USA remains the world’s largest manufacturer.

        Either way, doom & gloom or we somehow manage to preserve the status quo, I’m not hopeful. After breaking from the monarchy, we’ve established an oligarchy.

        To heck with global, go local!

        All the best,
        Thrash

        • Bruce C.

          Hi Thrash,

          Thank you. Happy New Year to you & yours as well.

          About the dollar and oil: The dollar index is roughly 58% euro so if China supports the euro, and there is strong European supportive sentiment., not to mention the resource-backed currencies, the dollar should fall. However, a stronger dollar is more consistent with my deflationary mega-theme. Net-net, I wouln’t enter the bet either way.

          The oil comment does seem crazy, but either things are just going to plod along as they have or there will soon be sudden paradigm shifts. There are so many potential domino triggers. If the Congress raises the debt ceiling then the markets may go ape-shit, for example.

          • Brad Thrasher

            Hey Bruce C.,

            I wasn’t clear enough. Actually, $400 bll oil may seem nuts as prediction but as metaphor, you make a great point. Commodities will bury the dollar or become the proverbial nail in the dollar’s coffin.

            Commodities are real stuff owned by real people demanding real value.

            All the best,
            Thrash

  • http://realestaterecord.blogspot.com/ Tyrone

    I’m reminded of one of my favorite statements…

    FOA 2001:
    “My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today’s dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! Worthless dollars, of course, but no deflation in dollar terms! “

    • Bruce C.

      Tryone:

      I like that quote too and I agree with it in theory. However, the fiat money system we have is not simply a counterfeit machine in the basement of the NY Reserve bank, that could – in theory – print enough currency to pay off every penny of debt on the planet. The fact is that those who control the money supply would have nothing to gain by doing such a thing, on the contrary. For one thing, by hyperinflating the currency they would destroy their own “wealth”. Secondly, and more imporatntly to them, they would lose their control of other people and institutions. What fun is there in being just another debt-free zero? To them, none.

      I’m not saying hyperinflation cannot or will not occur, but it will not be done on purpose and it is not inevitable. In fact, I personally am coming back around to the idea that true deflation is actually in the cards despite all the “noise” to the contrary. Despite all the alleged “money printing”, liquidity is actually drying up. Most people, let alone cities, states, governments and banks are cash poor. Ironically, an inflationary situation actually exacerbates deflation. In a highly inflationary environment demand drops, but instead of prices dropping supply decreases. There are shortages, among other negatively reinforcing problems, and THAT is deflationary regardless of prices. Bread may cost $100/loaf but if don’t got it … That’s when barter takes over until a new money system develops.

      You probably already know this, but the best thing “ordinary” individuals can do for themselves is to stop consuming so much and save cash (I didn’t say invest). Even if one has no debt, he’ll be screwed if cash-poor during inflation (because credit will not be available – at least not cheap credit), and he’ll be in the cat bird’s seat if deflation sets in. And, if the dollar is devalued to zero then your screwed anyway (though you could still kill some debt for what its worth), unless you have gold and silver.

  • Agent P

    “Erin Burnette offered up a factoid yesterday that can’t be ignored. The USA remains the world’s largest manufacturer.”

    That quote from Burnette is highly misleading. A country can statistically be regarded as the world’s largest manufacturer – with their primary residence/headquarters/Tax ID, etc., ‘here’, while the manpower/management/distribution sector resides in another country.

    What is that saying – ‘lies, damned lies and statistics’…?

    In the $Billions of dollars of consumer items, textiles, appliances, durable goods, consumer electronics, apparel, etc., how much of that stuff is ‘manufactured’ on U.S. soil, employing U.S. citizens?

  • Thomas

    “… how much of that stuff is ‘manufactured’ on U.S. soil, employing U.S. citizens?”

    If it’s more than 10%, I’ll be amazed.

    China has been largest manufacturer for years now. Not by company but actual factories and work force. An example: Everything Nokia makes is associated to “manufacturing in Finland” because it’s HQ is there. The fact that less than 5% of the production or workers actually are in Finland, is irrelevant in this context, thus it’s more a lie than a truth.

    Statistics show anything you want them to show. Nothing less, nothing more, unless you make a mistake.

  • Bruce C.

    Agent P and Thomas,

    I agree with both of you. A friend of mine owns a manufacturing company and he was recently trying to find vendors/suppliers to provide components for a new product and he was astonished to learn that not one thing that he needed was made in the USA.

  • Brad Thrasher

    Agent P, Thomas & Bruce C.,

    Not according to any respected data from JP Morgan PMI to OECD to the UN to the Commerce Dept. China is expected to pass the USA ending its 110 consecutive year streak as the world’s leading manufacturer.

    Heeding the lesson of history, particularly Joseph Goebles, I prefer to wait for the empirical evidence.

    All the best,
    Thrash

    • jimbo

      JPMorgan are crooks. They are not respectable. Regarding manufacturing, Erin and company go by dollar value. I go by volume. China blows the USA away in volume of goods produced, nuff said.

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  • Rachael

    You have to admire the level of coordination amongst local, state, and federal governments (worldwide in fact) in pushing the crisis to right about fall 2012. When fully half of the superstitious low-information population is expecting something drastic, a-la the Myan prophecy or whatever, the real fireworks will have been right under their noses all along and will accept any ‘solution’ put forward. I expect that fall to be the most interesting time in my life, no matter how long I live………

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  • Scott Lindsay

    I am not American but read about the economics of other cities especially after what has been going down in the USA.You see you guys are screwed blued and tatooed.Your country is bankrupt and so is your state and also your cities an it was all planed by your banks and investment houses like Wall Street.It is all part of globalizing your country along with other countries to be under the control of a couple of global banks like the IMF and the World bank.As your taxes go up the more money goes to these banks and now you will take your marching orders from them.This was never suppose to happen but it did and now the US is not free any more.

  • Rich

    With the constant Job Losses, and just complete slow down of the US. There is no way but for States to start running into financial problems. The numbers haven’t look good for a while. Look at them. Google : Daily Job Cuts
    Alot of problems out there


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