January 24, 2011

The End of the Era of Tax, Overspend, Then Borrow The Difference

by Hal Gershowitz

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Finally; it seems we may have a Congress that takes seriously the urgent need to rein in the unsustainable deficits and the accumulation of public debt that so threaten the future well being of the nation.  Thank goodness for the most energized electorate in recent memory.  Its collective ire translated into large Republican gains in the Congress . . . gains that were largely attributable to the fact that the GOP made this subject the centerpiece of the 2010 campaign.  Woe is the politician who forgets why he or she was sent to Washington.  President Obama seems also to have gotten the message because he too talks the talk of fiscal prudence.  We’ll learn in this week’s State of the Union address whether he also is prepared to walk the walk.

In addition, at the state level, Republicans had a net gain of six governorships and 19 state legislature changes in which they gained 650 legislative seats.  Clearly, most of the several states now have political leaders who heard, loud and clear, a message, and an expectation, that they begin reducing the cost of government.  In 2010 and 2011, forty‑four states, that’s 88% of state treasuries, face budget shortfalls.  The combined budget gap for 2010 and 2011 is astronomical, estimated by several economic studies to exceed $350 billion.  California, with one of the nation’s highest sales tax (at 6.25%) and a top income tax rate of 10.56% (highest in the nation) according to the Wall Street Journal faces a budget shortfall of $42 billion in 2011 with a like amount projected in 2012, a whopping 22.2 percent of its total budget.  Bloomberg Businessweek projects $20 billion plus deficits through 2015.

As if this was not enough, California faces a $500 billion shortfall in public employee pensions with which elected officials have saddled their tax-paying constituents.   The once “Golden State” is not alone in its fiscal woes.  Illinois faces a budget gap of $13 billion in 2011.  On January 11 the Illinois legislature at the urging of Governor Pat Quinn passed a “temporary” 67% increase in the state’s personal income tax and hiked the corporate tax rate from 4.89% to 7%, prompting newly elected Wisconsin governor, Scott Walker, to invite businesses located in Illinois to come across the state line to relocate in Wisconsin.  Moreover, even after these enormous increases, the state still faces a $7 billion shortfall, probably to be covered by more borrowing, assuming there are those willing to lend the state money.  Another fiscal basket case is New York, which according to U.S. News Politics is staring at a projected $8.2 billion shortfall for fiscal 2011, as well as substantial unfunded pension obligations.

Let’s turn the spotlight, again, to California, a state whose citizens seem to be in denial about their plight.  That state continues to enact laws and publish regulations that make for a very hostile business climate.  Until last year, college tuitions were extraordinarily low and when, in order to close the 2010 budget gap, they were brought to market standards, hordes of students organized protests, some of them violent.

California’s annual government expenditures grew from $104 billion in 2004 to $145 billion in 2008 a 39% increase during a period when the annual CPI index hovered around 1%.  And it isn’t as if the state is providing services to a greater number of people.  In the last ten years, according to the Wall Street Journal, 1.4 million more nonimmigrant Americans left the state than entered it.  To keep film makers from fleeing to avoid the high costs of doing business, the state is offering $500 million in tax breaks to producers of motion pictures . . . interestingly enough, the same Hollywood stentorians who, at every opportunity, inveigh against the evil rich who pollute the world and cheat the middle class.

Just how desperate are California’s political class to bring in more revenues on top of their highest-in-the-nation taxes?  Effective this year the state legislature raised traffic fines to breathtaking heights.  It will now cost $214 to be stopped for going 1 mile per hour over the speed limit, $976 for parking in a disabled parking space, and $456 for not having mandatory child restraints.  We, of course, do not condone unsafe driving or taking away parking spaces from handicapped people, but penalties have always been designed to deter bad behavior, not to raise revenue.  Although we have not been able to substantiate it, it is widely rumored that the California State Highway Patrol has been told to issue in 2011 30 percent more traffic citations than last year.

This extraordinary structural budget problem cannot be solved by raising taxes or, in the short term, merely by cutting spending.  It will be necessary to rein in the costs of state employee salaries as well as pension and health care benefits as newly elected Governor Brown says he is determined to do.  No longer can the state afford to pay its employees at a scale above that which is earned by their counterparts in the private sector.  Early retirements of employees in their fifties at nearly their full salary and health benefits without any significant employee contribution and fixed defined benefit programs must be eliminated.  It won’t be easy.  Public employee unions are unlikely to give ground on the benefits they have already obtained in prior negotiations.  A decent start, however, might be to eliminate these benefits for new hires and partially reduce them for employees under age 50.

Perhaps the only fix that would be a game changer would be the enactment by Congress of a change in the federal bankruptcy laws to permit states to file for bankruptcy.  Presently there is no provision for state bankruptcies.  If there were, bankruptcy judges would be empowered to void or rewrite existing contracts.  This could be done with minimal risks to the bond market by excluding bond obligations from discharge in bankruptcy.

Make no mistake; this problem is a threat to the economic health of the nation.  On top of steep federal income taxes (which the Democrats will surely seek to increase after the two year extension of the Bush tax cuts expires), very high local property taxes, state taxes at unprecedented levels, social security taxes, Medicare taxes and a pending 2.9% increase to pay for Obamacare, people earning $250,000 could be paying in taxes up to 60 percent of each marginal dollar earned.  The remaining forty percent after tax money would, for the next two years, then be subject to the federal estate tax, now at 35 percent above $3.5 million dollars of wealth. The estate tax is then scheduled to revert back to the pre-Bush tax cut level of 55 percent.

It is almost axiomatic that this kind of crushing tax regime is not a prescription for bringing an end to the Great Recession, now in its fourth year, let alone safeguarding America’s preeminent position as the world’s largest economy.

We need leaders at every level of government to act like adults and be frugal with the public revenue they collect from the nation’s taxpayers.  They simply cannot go back, yet again, to the citizens they represent and ask for more money.  And we, all of us, will have to be willing to accept reductions in the services and benefits government provides.  It is time, 50 years to the week, after his stirring inaugural speech, to take seriously President Kennedy’s famous phrase “Ask not what your country can do for you, ask what you can do for your country.”

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7 responses to “The End of the Era of Tax, Overspend, Then Borrow The Difference”

  1. Iyablans says:

    We do need draconian cuts in all areas of spending. Let’s start with defense.
    Correct me if I missed something but so far,the new congress has done little but mouth platitudes and the same general babble about “big guvmnt” without offering one specific.I watched Eric Cantor from Virginia on meet the press yesterday and he was an embarrassment in his responses when asked to offer some concrete proposals.He kept repeating that”everything is on the table”yet refused to be pinned down as to what the remeidies for our fiscal bad health might be.
    O.K. the republicans have the chance,tell the president what they think we need to do. We are all listening

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  3. peter solomon says:

    Excellent, commentary but will Sacramento or Washington be willing to make any sacrifices? Other people have advocated change in federal law allowing bankruptcy for states – thus far to no avail.

  4. As long as the major goal of every politician is to be reelected – again and again – and the best way to go about this is to buy votes, don’t expect any significant (or, probably, insignificant) budget cuts. Term limits would help with this problem.

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