TOPICS IN POLITICAL ECONOMY

COSTA MESA: FACE OF THE FUTURE?

Severe financial stringency in government, business and nonprofits can concentrate minds and wills wonderfully.  It provides the incentive to take actions that people know make sense but have been too difficult politically to implement when revenues were ample.  That is what is happening at all levels of government today.

Perhaps the most drastic restructuring, short of declaring bankruptcy, is taking place in the relatively wealthy city of Costa Mesa, California.  Earlier this month, facing a large budget deficit, it sent termination notices to more than 200 of the city's 450 employees.  Truly necessary services will be maintained by outsourcing to both private firms and other municipalities.  For example, fire fighting services will be obtained from the County government, which feels it can cover the city with 15 fewer firefighters. 

One major reason for the budgetary bind: mandatory pension fund payments of $15 million this year and a likely $25 million annually within five years - in a budget of less than $100 million. The City Councilman who led the restructuring battle is quoted as saying, "we see the train wreck coming and the only questions are how bad it will be and how quickly we want to try to stop it."

Costa Mesa's elected politicians are facing the future squarely - not "kicking the can down the road" like so many other state and local governments and the federal government.  In an important sense, they are "re-inventing government" under the threat of bankruptcy, just like a few American steelmakers changed radically and successfully the way management and labor worked together to make steel when severely pressured by foreign competition. (We should remember that a host of them did disappear because they could not change fast enough.)  

Three cheers for Costa Mesa's leaders - and that handful of state governors who have taken up similar challenges. May they show the way for others. 

DEFICITS, GOVERNMENTS AND THE SIN BUSINESS

There is one positive feature of  today's massive federal and state budget deficits. They force politicians to look at ways to save money/raise revenue that don't involve taxes. Here are some ways to do just that, my suggestions stimulated by a sparkling op-ed , "The Sin Business is Not for States," by a clever New Yorker, Dayan Brashich.

He surveys the mess governments have created by taking over, to varying degrees, the gambling and liquor distribution businesses, as well as spending billions in an unsuccessful "war" on drugs.

The Demise of OTB. Brashich's thoughts were occasioned by the final chapter in the bankruptcy of New York's Off-Tracking Betting Corporation (OTB).  At one point it was the nation's largest bet taker. Brashich contrasts the old customer-friendly (illegal) bookie system of placing bets and the sorry shape of OTB in its final days. It went out of business owing the state $11 million and over $600 million in benefits for its employees.

New York and every other state ought to consider letting private entrepeneurs set up betting shops - and taxing them.  Just like in Nevada and the United Kingdom and Ireland. 

Then there's Pennsylvania's monopoly liquor store system: in its last fiscal year it managed to show income of only $72 million on sales (net of excise and sales taxes) of $1.5 billion. A new Republican governor with party majorities in both houses of the state's legislature is under increasing pressure to privatize, maybe, a manifestly dysfunctional, patronage-ridden system.

Free Mary Jane. Finally, there is a brief discussion of Colorado's experiment with "medical marijuana." Apparently the state collected $21 million in user fees and taxes last year. What if all states adopted a more lenient approach to the production and distribution of "Mary Jane."  Brashich cites a recent Harvard economics department paper which calculates that legalizing marijuana would save governments $14 billion (2008 dollars) annually in enforcement costs and yield $6.5 billion in tax revenue, assuming it was taxed at rates comparable those on alcohol and tobacco. "Hard" drug legalization would yield double these figures.

In short, a more rational approach to letting people engage in what some consider "sinful" activities could play an important part in tackling the mountains of debt facing the federal and many state governments today. 

Read Brashich's op ed for instructive entertainment;  then read the Harvard paper for some credible data on the cost and lost revenues to governments from current policies towards illegal drugs.

  

TALKING POINTS FOR WOULD-BE BUDGET CUTTERS

Here are some powerful arguments, in one form or another, that most serious budget cutting politicians are using these days.  Readers might pass some of them on to their own elected representatives at the federal, state or local level. 

Reducing government spending in 2011 and beyond has three primary objectives:

1. Reducing current and future budget deficits and the crippling tax burden they mandate for the younger generation. We should not burden young people with old folk's excessive consumption and mindless handouts to business enterprises. Cases in point: lucrative pensions in the public sector, ethanol subsidies, and free bus passes for seniors. 


2. Reduce the needless intrusion of legislation and bureaucrats into how we live and work in our communities.  Cases in point:  the mandated phase-out of incadescent light bulbs, the design of health care insurance, and the font size of highway signs.


3. Head off a future financial “melt down” when investors (foreign and domestic) refuse to buy government debt (Federal, state, and local) - or will do so only at crippling interest rates. Case in point: the punishing interest rates Greece, Ireland, and Portugal have to pay as a result of their financial meltdowns.

Implementation.  Two basic points here:

1. Any set of budget cuts must keep in mind the maxim "the budget is the skeleton of the state stripped bare of all its misleading ideology."  The budget-cutting exercise should establish a consensus of what core functions of government are essential, which are merely "nice to have," and which are egregious rip-offs of taxpayers.  Rip-off case in point: farmers being paid to grow nothing.


2. Pay no attention to the argument, "but my program only costs each taxpayers $1 a year."  There are lots of programs that cost "only" $150 million a year (the number of taxpayers, roughly).  In fact, the Catalog of Federal Domestic Assistance alone lists over 1,600 grant programs for you to apply to (and it excludes most foreign aid programs). If each of these averaged $150 million a year, we are starting to talk big money. 

Case in point: The Corporation for Public Broadcasting (CPB) has objected to President Obama's proposed $460 million advance appropriation for FY 2013  for itself, since it is "only" a 3.4% increase over the prior year. However, the House of Representatives has zeroed out the entire amount, presumably because they believe there is no convincing argument in the age of the internet that the federal government needs to be in the domestic broadcasting business - and it is time to get spending under control.

The best the CPB can do in its press releases is to refer to jobs "at risk" at the 1,300 or so public radio/TV stations around the country - and ask its affiliates to lobby on its behalf over the air (as my local station is doing).  Talk about the dangers of media concentration and Rupert Murdoch!

The struggle to bring government spending (and deficits) under control is similar to that waged by a few, lonely voices who decried the pell mell extension of mortgage credit to poorly-qualified home mortgage borrowers after 2005.  Let's hope the current effort has more success than than the earlier one.

 

THE NEXT "TOO BIG TO FAIL" CHALLENGE

What event is most likely to characterize the next big financial upheaval?

A Run on the Treasury. My candidate is a "run" on the U.S. Treasury. Foreign holders of Treasury bonds and bills suddenly refuse to re-invest maturing securities in new issues or seek to sell existing holdings. As a result, bond prices fall (and yields soar), the U.S. dollar weakens, stock markets plunge and worriers about the sky-rocketing federal budget deficit say, "I told you so."

What might be the catalyst for the "run"?  The most likely candidate at this point is a default by a major state or local government on its financial obligations. But why would foreign holders of U.S. Treasury securities be bothered by this?

The short answer is, because Gerald Ford is no longer President. In 1975, when New York City effectively defaulted, Ford told the City to "drop dead" (as the New York Post headline put it) when the local politicians - and not a a few financial types -petitioned for federal aid. As a result, the City (and State of New York) was forced to take the initiative and put its house in order. It worked out a financing plan with its lenders and employee unions. At that point, with a credible plan in hand, much like a Chapter 11 bankruptcy, the federal government did step in and provide temporary financing for the City.

Why won't this model be followed in the future?  Because after you've bailed out Citibank, CIT, General Motors and AIG on short notice, Washington is unlikely to refuse to rescue California, Illinois and a host of other large sub-federal governments when they can't pay their bills or their lenders. It will make no difference whether or not they have credible restructuring plans.  

A Promise of Bailouts. If you want a reasonable basis for this prediction, consider what recently happened on Capitol Hill. On May 18th, the U.S. Senate rejected an amendment to the pending financial reform legislation which would have prohibited the use of any federal funds to bail out any state or local government which had defaulted on its financial obligations (or was at risk of doing so) in the absence of a natural disaster. The vote was 47 in favor (all Republicans plus 6 Democrats) and 50 against.

So, when the balloon goes up as California (or Illinois or . . . ) goes down, the fed's bailout window will be wide open, again, fueling even further the massive federal deficit - and spooking our foreign creditors. 

Unless there's another Jerry Ford out there.

ON LAND USE AND HARDENING OF THE ARTERIES

Growing old tends to be characterized by increasing reluctance to change the way one thinks, acts or behaves; a body that is increasingly stiff, brittle, and sclerotic becomes prone to such ailments as broken hips, deafness and heart disease.

Societies, too, grow old and exhibit symptoms similar to those of aging persons. However, some societies - unlike individuals, whose death can be forecast within a modest margin of error by actuaries - can be rescued by outstanding leaders or transformed by untidy revolutions from within or hostile forces from without.  So, what does growing old have to do with New England land trusts today and the landowning Catholic Church of fifteenth century England?

The extent to which a society is able to adjust the ownership and utilization of land and property is a powerful litmus test of its capacity for change without an untidy revolution. In a healthy society, ownership and utilization of land is always susceptible to change – to reflect underlying demographic pressures and technological change, and the economic forces which are set in motion by these two factors.

New York City - and the island of Manhattan in particular - is a prime example of a community which is able to reinvent itself almost continuously in response to demographic pressures and technological change. While each major initiative occasions considerable controversy and lawsuits, sometimes spread over an extended period, eventually a locale or neighborhood is transformed, whether by skyscrapers or immigrants or a major piece of infrastructure. Even when the original function of a major piece of land remains unchanged, such as Central Park, the City has been able, in effect, to restructure property rights and responsibilities in a way which revitalized the contribution of the land to the local community. In New York City’s case, it was through the transfer of park maintenance and development responsibilities to private nonprofit organizations.

The inability of a community or state to rejuvenate the way in which land is used, despite powerful demographic and technological forces pressing for change, is an indicator of political atherosclerosis. One of the chief sources of strength and vitality in the early Ottoman Empire was the practice whereby land grants made by the Sultan to worthy warriors and others were valid only for the lifetime of the recipient; when he died, title reverted to the Sultan and was duly reassigned to another worthy. The hard fought ability of landlords to "enclose" farmland for sheep raising in fifteenth century England, while imposing considerable hardship on tenant farmer who had previously cultivated it, was a major step forward in the industrial revolution.

In Western Europe the ownership of vast tracts of land by the Catholic Church and its various entities gave rise to centuries of conflict and struggle. The problems of massive rural estates tied up in "latifundia" in the Roman Republic or Latin America have been cited by many historians as pernicious heavy hands on economic progress.

In short, the capacity of a society to change land use is significant indicator of its political health. By this criteria, much of the U.S. is aging fast and in poor political health. Well-intentioned persons – and tax write-off hungry millionaires – are engaged in a well-documented upsurge in transferring ownership or development rights over land to tax-exempt entities typically known as "land trusts." According to one pressure group, the Land Trust Alliance, 800,000 acres a year are being rendered immune to further development. The total acreage protected in one form or another by such trust is probably on the order of at least 35,000,000 acres, excluding national parks and forests. In a country of many millions of acres, this may not seem like much, but in the communities where this activity is concentrated, it is having a major impact.

When hundreds of acres of prime land are taken off the tax rolls, every piece of taxable property is subject to further levies. With less buildable land available, land prices rise, raising the cost of housing. Communities react by cobbling together "affordable housing" programs which typically use tax breaks, federal and state subsidies and charitable contributions to keep the hired help nearby. I am most familiar with townships in Connecticut and Rhode Island, and the Northeast is the leader in the establishment of private land trusts – but California and Colorado are not far behind.

While I consider myself a moderate libertarian, I draw the line at the right of individuals to perpetually freeze the utilization of physical property. How can anyone today forecast the best use to society of a particular tract of land a hundred years from now?  Isn’t it extraordinarily presumptuous of anyone to think that they have the foresight to be able to do this? Why not limit the ability of donors’ restrictions on land grants to, say, a maximum of fifty years?

Isn't it time to revisit and repeal the tax and foundation laws that encourage what is, in the final analysis, a mindless urge to "stop the world" – at least that part of it in which the more fortunate citizens of society have their second homes?

PENSIONS AND POLITICS

    Pension promises get people into trouble.  But it makes a great deal of difference if we are talking about private versus state and municipal government pensions. (I save discussion of the federal government’s Social Security program for another day.)

    When defined benefit pensions are promised by publicly-held corporations, those commitments are scrutinized by auditors, stock market analysts, the government’s Pension Benefit Guarantee Corporation and the Securities and Exchange Commission, among others. If it looks like a company is going to be unable to meet its commitments, the media gets excited. Politicians start to accuse corporate chieftains of either incompetence or putting the interests of shareholders ahead of the rank and file. Not infrequently, heads roll and bankruptcy beckons. But eventually a solution which roughly apportions pain among the directly interested parties – shareholders, retirees, and taxpayers – is usually found.

    Not so for municipal government pensions. The release this past August of the Kroll report on San Diego’s pension fund debacle, which has left the City with a $2 billion hole in its finances, makes this abundantly clear.  As Arthur Levitt, Jr., former SEC Chairman and overseer of the independent audit put it in the Los Angeles Times,

The evidence demonstrates not mere negligence, but deliberate disregard for the law, disregard for fiduciary responsibility and disregard for the financial welfare of the city's residents over an extended period of time.

    The central problem with state and municipal government pensions is that powerful employee unions are frequently instrumental in electing the politicians. There has been a growing (and understandable) tendency for unions and elected officials to agree to substitute pension promises for outright wage and salary increases in many bargaining situations.  Whereas 100% of the wage and salary increases would show up immediately in operating budgets (and thus require a tax increase or expenditure cuts elsewhere in the budget), pension promises typically require very small immediate outlays.  Instead, the estimated cost of the promise is buried in a financial footnote. The Reason Foundation's 2005 study demonstrates clearly the perverse incentives inherent in defined pension plans for public employees.

    Estimating the financial implication of a promised pension is a murky combination of art, science and assumptions.  To keep required outlays for funding future pensions as low as possible, elected officials frequently use highly optimistic assumptions about future returns on pension fund investments, or longevity assumptions about their retirees.

    When the reality of a large gap between the value of promises to retirees and assets on hand to meet those promises looms too large to ignore (as was the case in San Diego), elected officials sometimes decide, with great encouragement from investment bankers, to “double up.” They do this by issuing long term general obligation bonds, putting the cash into the pension fund and investing the proceeds in the stock, corporate bond and “alternative asset” markets. So funding pensions now becomes a bet between the cost of the bonds (which do not enjoy tax-exempt interest rates) and the return on the invested cash. (If you want to know about pension bonds, see my article for the Government Finance Officers Association.)

    The poster child for bad bets on pension funding is my local government – the City of Pittsburgh. In the late 1990s the city issued roughly $275 million in pension bonds and tossed the cash into a woefully underfunded pension plan.  Interest payments on the bonds to date have been roughly $144 million.  Total returns on investments made with that cash are on the order of $98 million, meaning City of Pittsburgh taxpayers are about $46 million worse off for having their elected politicians play the stockmarket with borrowed money.

    There is more bad news to come. Starting in 2007, financial statements of state and municipal governments will have to reflect the cost of promised retiree health benefits (corporations have had to do this for the past ten years or so). The yawning gap between politicians’ promises and government’s ability to meet them will widen precipitously for communities  like Pittsburgh. The temptation to “double up” with pension bonds will be even stronger, particulary where they haven't been tried before.

     Isn’t is about time for political leaders to level with employees, retirees and taxpayers, and start the painful process of designing better ways to save for retirement that the private sector has been engaged in for the past decade?