October 25, 2010

Unsustainable At Every Level: Congress Fiddles and We Get Burned

by Hal Gershowitz

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The new buzzword in these difficult times for the United States and world economies is “unsustainable.”  Again and again economists and politicians have said that the path on which the U.S. is headed is “unsustainable,” a description with which Federal Reserve Chairman Ben Bernanke recently agreed.  Our annual budget deficits exceed a trillion dollars, the total published cumulative national debt is $14 trillion and we have tens of trillions of dollars in unfunded obligations under Social Security and Medicare.  To that we can add the off the books bad mortgages of Fannie Mae and Freddie Mac of almost $300 billion.  Through June 2010 the U.S. Treasury has injected $144 billion into those entities to maintain a positive net worth.  Economists had long warned that this day was coming but the Democratic left in Congress led by Barney Frank assured us they were good as “gold” (check the price of an ounce of gold and see what you would rather have).

On top of this the value of the U.S. currency has plummeted and the decline of the dollar without some intervention or a fix to the system of exchange rates, we are told by some economists, cannot for too much longer be “sustained” without the dollar being replaced as the international measure of exchange by the euro, or by a basket of currencies.  The effect to our economy of losing this trade advantage would be enormous.  All of that has been endlessly discussed in this election year and the American people seem to have heard and understand that alarm bells are going off all around them.  Even the Federal Reserve, which is supposed to be the adult in an assemblage of fiscal juveniles, is, once again, about to go on another money printing binge in order to fund the purchase by the central bank of the government’s debt.  This strategy, which is not universally embraced, even among the governors of the Fed, is intended to keep the cost of money unrealistically low; the thought being that cheap money will stimulate the economy.  Except that it hasn’t and it sets the country on an uncertain course into uncharted territory with significant risk of unintended consequences. Small wonder finance ministers throughout the developed world are warning that this practice also simply is unsustainable.

Less attention has been given to the plight of the 50 states comprising our union.  State and municipal governmental budgets are challenged as never before.  Much of the problem can be laid at the door of elected officials especially Democrats, who are dependent on public employee unions for electoral financial support and who fail to stand up and say no to the incessant and increasing demands for more and more pay increases, health benefits, early retirements and lifetime pensions.  These costs consume enormous and ever growing amounts of state and local budgets and crowd out other expenditures which historically have been local responsibilities . . . e.g., roads, bridges, other infrastructure, etc.  Up to now states and municipalities have floated increasingly sizeable bond issues to pay for these capital costs to the point where some of these bonds, once considered like Fannie and Freddie “good as gold” have been downgraded, the result of which increases the interest paid by the issuer to compensate for the increased risk to the investor.  Given the choice investors the world over are choosing gold.

Chairman Bernanke in a speech he recently delivered in Rhode Island stated:

“The same underlying trends affecting federal finances . . . also put substantial pressures on state and local budgets.  … In many states, the retirement of state employees together with continuing increases in health-care costs will cause public pension and retiree health-care obligations to become increasingly difficult to meet.  Estimates of unfunded pension liabilities for the states as a whole span a wide range, but some researchers put the figure as high as $2 trillion at the end of 2009.  Estimates of states’ liabilities for retiree health benefits are even more uncertain because of the difficulty of projecting medical costs decades into the future.  However, one recent estimate suggests that state governments have a collective liability of almost $600 billion for retiree health benefits.  These health benefits have usually been handled on a pay-as-you-go basis and therefore could impose a substantial fiscal burden in coming years as large numbers of state workers retire.”

This imprudence is having its effect on some of the largest infrastructure projects in the country.  Two weeks ago, New Jersey’s fiscally responsible governor, Chris Christie, cancelled a rail tunnel project running under the Hudson River because New Jersey could not bear the cost overruns on the project (once budgeted at $6 billion and now expected to come in at $14 billion).  There is much more to this story than poor planning and poor budgeting.  The project is a joint venture between New Jersey, the Port Authority and the federal government but the federal and Port Authority shares are capped at an aggregate $6 billion.  New Jersey taxpayers are on the hook for the balance.  Since New Jersey taxes are among the highest in the nation and the state is also beset with fiscal deficits arising from the same government employee costs described earlier, the Governor made a very logical decision, which liberals immediately derided as a terrible blunder and a disaster.  Regarding the state’s finances Governor Christie faced, the Wall Street Journal reported that

“From 2001-2008, New Jersey government spending increased by nearly 59%.  Not to worry, Trenton said: Tax increases can pay for it all.  Over that period the sales tax, income taxes and levies on cigarettes, casinos, corporate businesses and hotel occupancy all went up.  The state also raised billions of dollars in new fees and tolls.  The Tax Foundation says New Jersey’s state-local tax burden is the nation’s highest and, at 8.95%, its income tax is among the highest.

But even that hasn’t raised enough revenue, so the state has also maxed out its credit card.  In 2009 the state’s bonded debt hit almost $52 billion, up from $16 billion in 2001.  Add unfunded pensions and retiree medical benefits and total future state obligations now top $130 billion.

In 2002, pension costs were 8.6% of the New Jersey budget.  In fiscal 2011, they’re 16%, and that doesn’t include a $3 billion payment the state was supposed to make toward its $46 billion unfunded liability.  Had that not been postponed, the pension share of the budget would have been 26.5%.”

But there is an even more serious threat to the fiscal health of the states; the increasing demands placed upon them by the federal government … so-called mandates …usually “un” or “under” funded.

With mandates the Congress legislates national policy or standards and disguises the real costs by requiring the states to implement the requirements of the legislation.  Without these mandates the federal deficit would be higher so Congress forces the states to use their own budgets to carry out federal policy.  This cuts to the very heart of federalism since the Tenth Amendment to the Constitution states:  “The powers not delegated to the United States by the Constitution are reserved to the States, respectively, or to the people.”

The issue which, thus, emerges regarding mandates relates to the relationship between the state and federal governments regarding the sharing of sovereignty.  Courts, however, have usually deferred to Congress and refused to intervene in challenges by states to allegedly overreaching federal power.  The modern position taken by the courts can be best summed up by Justice Sandra Day O’Connor’s dissent in a case challenging federal authority (Garcia v. San Antonio Transit Authority) where she rebuked the growth of federal power at the expense of the states to Congress’ “underdeveloped capacity for self-restraint.”  Thus, such costly measures as those imposed by the Clean Water and Clean Air Acts are passed along to the states through mandates.  Moreover, Congress routinely attaches strings to federally funded programs that address policies ranging from financial accounting practices to the minimum wage, which must be paid on federally assisted construction projects.  By accepting federal assistance, the states prove an economic golden rule:  he who has the gold makes the rules.

Make no mistake; the current budgetary strain on the states has been very much their own doing and not just the result of mandates.  In 2009 federal stimulus money was made available to the states, but many states took the offer of that money as a way to postpone needed budget cuts.  In fact, many states increased their spending and now the chickens have come home to roost.  With no more stimulus money available to them and, according to the National Conference of State Legislatures, with the states facing an additional $28 billion of budgetary shortfalls, they are in crisis mode.

Adding to this dire situation, state officials are now first beginning to focus on what the costs passed on to them under the health care reform legislation will be.  Take our word for it; the costs will be enormous, particularly given the requirement of that law forbidding any reductions of Medicaid and Schip programs between now and 2014.  The states have now been reduced to becoming servants to the masters in Washington.

It is no wonder that in 2009 so-called “sovereignty resolutions” were considered by 37 state legislators.  These non-binding resolutions essentially serve notice to the Congress that they must cease and desist any actions outside their delegated powers.  Half of them were approved by at least one legislative chamber and in seven states the measure passed in both chambers.  These amount to a warning that we could face a constitutional crisis in the not too distant future.

It is clear that the fiscal crisis of the past few years has created fault lines in our federal system.  Citizen confidence in Washington as a source of solutions is rapidly hemorrhaging as the country watches the complete abdication of responsibility by Congress and the fiscal irresponsibility of the Obama Administration. Let us hope that our nation’s leaders start acting like leaders and stop playing political chicken before it is our form of government that becomes “unsustainable.”

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