The federal meltdown and state and local

governments

Jean Sussman

January 6, 2012

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Outline

• What is the issue

• Why we should care

• Short term and long term responses

• Key questions moving forward

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The issue

Recession hit local and state governments hard

– Federal (and state) governments not meeting financial commitments

– Compounds effects on weaker local economies

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The issue

• Largest collapse in state revenues ever

– State and local expenditures outstrip revenues: states have combined shortfall of $103 billion in FY 2012

– Still 15% behind pre recession levels

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The issue

• Change in local/state/federal government relationship– New Federalism– Last 20 years increased state/local

responsibility for services

• Adverse change in funding: transfers drying up

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Why should we care?

State and local governments perform important services

•Schooling at all levels•Roads and transportation, including airports•Recreation•Public safety•Courts•Water and sanitation•Support for the most vulnerable

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Why should we care?

State and local government contribution to economy

• 15% of GDP – same as durable goods

• Account for 50% of public spending

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State and local expenditures

• Education: 35%

• Welfare: 20%(including federal Medicaid $$)

• Highways: 7%

• Administration 5%

• Public safety 5%

• Corrections 7%

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State and Local Revenues

Personal income tax 15%

Sales tax 23%

Property tax 20%

Corporate 3%

Federal gov’t 21%

Other 14%

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Why should we care?

Some changes are beyond state and local control

– Demography – rural areas– Aging of population– Immigration– Regional shifts– Decline in manufacturing and rise in services

• Income and tax bases

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Short and long run responses

Limited options especially for local governments• Limited taxing authority

• Costs don’t go down– pensions, health care

• Unfunded mandates and reduced transfers

• Personnel costs -collective bargaining mandates

• Many states already mandate tax caps/limits

– Required pension payments can exceed tax cap increases

• Cuts reduce demand - compounding effect

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Short run response

Lack of rainy day funds, unlike previous recessions

– States lowered taxes– Should have built reserves– Anti-tax sentiment not new

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Short run response1. Budget process

– Take care of encumbrances– Put unspent fund balances into general operations – Change balances kept to manage risk – Spend down reserves

2. Efficiencies

3. Re-examine role of government– Program cuts, layoffs, right sizing

4. Increase taxes

– Over 30 states– User and discretionary fees

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Short run response

5. Federal government lessened impact – ARRA

• $ 160 billion given to states from 2009- mid 2011

• But only about $6 billion in 2012

– Housing market assistance

– Temporary tax cuts

– Drying up – likely to prolong recovery

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Short run response

Results

• Budget gaps partially filled: taxes, cutbacks, federal help

• Spending cuts reduce demand – Jobs, suppliers, non-profits, benefit payments – all reduce

consumption and reduce demand for goods and services

• Recovery of state and local governments protracted– Expiration of federal aid– Sluggish economic growth --job creation and housing values

• Rethink role of government

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Longer run response

Required: a balanced approach to changing services and taxes.

Efficiency: How to balance the budget while causing least harm to overall economy

Equity: How to balance the budget while remembering a key purpose of government is to protect most vulnerable

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Longer run response

Required: recognition of structural imbalance at local government level

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Longer run response

Lots needs fixing• Health care costs• Consolidation of government operations• Efficiencies • Pensions• Unfunded mandates• Criminal justice• Taxes • Education

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Longer run response

Government Consolidation

• Entities

• Across entities

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Longer run responsePublic sector pensions

• Contributions– 401 K

• Salary equity with private sector

• Aging of labor force

• Retirement age

• Health care

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Longer run response

Criminal Justice• Share of state budgets now 7% and rising

– doubled in 20 years

• But recidivism is high

• US has highest incarceration rate in world

• 6X higher for blacks

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Longer run responseTaxes•Careful with what is cut –effect of economy

–Jobs: multipliers–Infrastructure

•Feds can’t keep shifting responsibilities to states and local governments without looking at property and sales tax equity issues

Taxes will have to change and likely increase for many of us

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Longer run response

Taxes, cont.So question is about what kinds of taxes

•Income tax

•Sales tax

•User fees

•Entitlements

•What to do about local tax funding?

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Longer run response

Taxes, cont.

• Progressive income tax – efficiency and equity– “The hardest thing in the world to understand is the Income Tax."

Albert Einstein • Sales taxes: about ½ of state tax revenues. Yet

much is excluded– Better to widen base than increase current taxes – Taxing services– Taxing internet sales

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Longer run response

Taxes, cont.

Taxes vs. fees• Latter is increasing• Pay to use

– Higher education– Primary and secondary schools– Recreation– Technology enables this trend

• Equity?

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Longer run response

Taxes, cont. - entitlements• Preferential treatment of retirees regardless of

income. – Income shifts: wages to pensions, social security,

interest, insurance– 26 states don’t tax social security– 23 states at least partially exempt private pensions– With aging of population, less total income to tax

• 12% of seniors live below poverty level– 25% of children live below poverty level

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Longer run response

Taxes, cont.

• Property tax reform: 70% of local revenue, 30% of state– Relationship between home values and

property taxes– Distributional impact on schools– Layers of government

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Key questions moving forward

1. Where will future revenue come from?

2. What are long term cuts?

3. What will be long term effects of short term cuts in human services?

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Key questions moving forward

4. What structural changes will allow for greater efficiency in state and local governments?

5. Beliefs about equity and efficiency6. Belief about inter-generational transfers

Blessed are the young, for they shall inherit the national debt." Herbert Hoover

7. Where is political will?

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Bibliography• Bromberg, Neil E. “How the Federal Budget Crisis Will Impact Local Governments: The View from the National

League of Cities”, 23rd Annual Delaware Institute for Local Government Leaders. National League of Cities. Oct. 24, 2011

• Center for Budget and Policy Priorities. “Recession Still Causing Trouble for States”. Jan. 28. 2010.

• Cox, Raymond W. III. “Seeding the Clouds for the Perfect Storm: A Commentary on the Current Fiscal Crisis”, State and Local Government Review. Vol 41, No 3 (2009). Pages 216-22.

• Fahim, Mayraj. “Additional Revenue Sources are Hard to Find as US Cities Face Increased Responsibilities”, Citymayor.com. May4, 2005.

• Faulk, Dragney, Eric Schansberg. “An Examination of Selected Economic Development Outcomes from Consolidation”, State and Local Government Review, Vol 41, No 3 (2009). Pages 193-200.

• Fisher, Ronald C. “The State of State and Local Government Finance”, Regional Economic Development. Federal Reserve Bank of St. Louis. Vol 6, No 1, 2010. 22 pages.

• Fisher, Ronald C. “What Policy Makers Should Know About Property Taxes”, Land Lines. Lincoln Institute of Land Policy. January 2009. pages 8-14.

Bibliography

• Frugal Trader. “Defined Benefit Pension vs Defined Contribution Pension”, Milliondollarjourney.com. May 6, 2009.

• Gilani, Sham. ”The Looming Muni-Bond Meltdown: Profit From the Collapse --- and Then Again From the Rebound”, MoneyMorning.com. March 3, 2011

• Grennhut, Stephen. Vallejo’s Painful Lessons in Municipal Bankruptcy”, The Wall Street Journal. March 26, 2010/

• International City Management Association. “How It Plays In Peoria: The Impact of the Fiscal Crisis on Local Governments, icma.org. Sept. 14, 2009.

• Johnson, Nicholas. “Budget cuts or Tax Increases at the State Level – Which is Preferable When the Economy is Weak?”, Center on Budget and Policy Priorities. April 28, 2010.

• Krugman, Paul. “Keynes Was Right”. The New York Times. Dec. 29, 2011.

• Lucas, Jean-Marc. “US State and Local Government Finances: from Recession to Austerity”, Conjoncture. BNP PARIBAS. April 2011. pages 3-17.

• McNichol, Elizabeth, Phil Oliff, Nicholas Johnson. “States Continue to Feel Recession’s Impact”, Center on Budget and Policy Priorities. June 1, 2011.

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Bibliography

• Osborne. David, Peter Hutchinson. The Price of Government, Basic Books. 2004.

• U.S. Department of Commerce, U.S. Census Bureau. “State and Local Government Finances Summary:2009”, Economics and Statistics Administraion. Oct. 2011.

• Williams Walsh, Mary. “Alabama Governor Fails to Prevent County’s Record $4 Billion Bankruptcy Filing”, The New York Times. Dec. 6, 2011.

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