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Monday, December 20, 2010

Monday, December 20, 2010

The Debt Crisis and the Austerity Trap

State officals are caught in a mental loop, and it is nicely visualized by state treasurer Bill Lockyer's forlorn op-ed in the Los Angeles Times.  Arguing that "California Isn't Broken," and anxious to head off implausible suggestions that the state could default on its debt, Lockyer and coauthor Stephen Levy write,
During the current fiscal year, general fund revenues are expected to total $89.4 billion. Education spending under Proposition 98 will total $36 billion. That leaves $53.4 billion available to pay debt service on bonds — more than eight times the $6.6 billion the state will need.
Thus is raised the specter, in its very denial, that the state might spend the entirety of its non Prop 98 money on servicing its own debt.

The article goes on to debunk the myths that California has lost more jobs and businesses than other states, that its decline is worse than that of the country's, and that its structural budget deficit is caused by runaway spending:
Thirty years ago, general fund expenditures totaled about $7.43 for every $100 of personal income. In the 2009-10 fiscal year, that ratio was almost $2 less, at $5.52 for every $100 of personal income. In the current fiscal year, per capita general fund expenditures will total $2,246, less than the $2,289 spent 10 years ago and roughly equal to the inflation-adjusted level of 15 years ago.
But then what? The obvious question is, "so what's wrong with spending less"?  The next obvious question is, since we still have a deficit, why not spend still less than we do right now?  These are entirely rational questions for our austerity culture, and they need direct and concrete answers. Nobody is going to care about cuts in general unless Lockyer, Jerry Brown and the new Sacramento order can rekindle belief in a causal connection in which cuts in public investment causes economic decline.  But how will they, and who will help them?
Jerry Brown is the original small-government Democrat: in the 1970s he was already running as an austerity governor for the "era of limits" he later proclaimed in Cedar Rapids during his presidential campaign tour in January, 1976.  His promise this month to cut the governor's budget was first made in his inaugural address in January, 1975.  Circumstances have not given Brown much reason to change his mind.  He has said, "The depressing spirit of the age ungratefully feeds off the boldness of the past.  Where there should be saving for the future, I see frantic borrowing."  Thee occasion was his second inaugural address in 1979.

Arnold Schwarzenegger built his governorship around repeated calls to cut state spending. Brown just recently promised to do the same, only worse.   Arnold's version was more "blood makes the grass grow."  Or "throw mama from the train."  Jerry's version is "Curb Your Enthusiasm."  But the implication is very Arnoldian: Brown may propose mid-year cuts in all sectors of state government. He assured K-12 that this would happen to them.  We may be facing the same thing at UC and CSU: general fund cuts mid-year, perhaps the return of employee furloughs to make up for them, possibly mid-year tuition hikes, who knows?

What is Brown going to offer that's different from Arnold?  In his presentation, he moved from budget basics to an illustration of persistent deficits (slide 7), to a clear portrait of declining expenditures (slide 10), to a conclusion that stressed that California is a Bottom-5 state in major public sector measures, including ratio of state employees to population (slide 16) and student-teacher ratios (slide 17).  The strategy seems to be what driver's education courses used to call Red Asphalt: show the 15 year olds pictures of bloody car wrecks so that we are scared into driving well by seeing the deadly consequences of our careless acts.  Show the causal connection between budget cuts and lowered educational resources.

Educationally and democratically this is the right strategy: don't tell the people the answer you already have, but lay out well-organized analysis that allows them to reach their own conclusions.  Others have tried this before on this same topic of California's public spending being low rather than high.  Los Angeles Times columnist Michael Hiltzik made an excellent short case using LAO data in May 2009.  It will help to have the state's governor pulling in the same direction.  But what about the causal case between public funding cuts and economic decline -- not just less government but less economy?  How to work in personal hardship and stunted hopes?

The discussion raised a vital issue, but a different one: the burden of debt.  Lockyer did most of the lifting here.  He showed that during the governorship of Arnold Schwarzenegger, the state's debt nearly tripled from $34 billion in 2003 to $91 billion in 2011  (slide 1), and that debt service has tripled as well, to over $6 billion a year or nearly 7% of state general fund revenues (slide 2).  The pace of this increase has caused the state's bond rating to fall to A1 (slide 5), and has added over 1 percentage point (110 basis points) to the interest California needs to pay on this interest (slide 8). 

These numbers reveal the extent of the disaster for the citizens of the state.  The increase in annual debt service during the Schwarzenegger administration of about $3 billion is about the same as what the state spends on all programs for the developmentally disabled, or what it spends on the University of California.  In other words, during the Schwarzenegger era, the state came to pay the annual costs for an entire second University of California entirely to the holders of its new public debt.

The Brown-Clinton tradition of Austerity Democrats has a history responding to "check" by taking pieces off the board.  Some members of their party are trying to head this off by painting the demand for austerity as a Republican trick:  the Republican right creates public insolvency on purpose so it can cripple government and "drown it in the bathtub," in right-wing activist Grover Norquist's famous phrase.  Progressives also point out that this is happening on the federal level with the extension of the Bush tax cuts, whose stimulus effect will be far outweighed by the nearly $1 trillion in new deficits it will create.  The same is true in Europe, particularly in bastions of Anglo-American-style financialized capitalism like Ireland and Britain, where a crisis of private debt that threatened massive bank insolvency led to simultaneous 100% bailouts of private investors and simultaneous cuts in the public sector to pay for it.  Ross McKibbin summed this up in a piece on Tory strategy in the UK by saying, "the crisis allowed the Conservatives to transform a crisis of the banks into a crisis of the welfare state."  This is precisely the crisis that Brown is inheriting in California, and it is important to point this out.

But the cure depends entirely on ending the current Hoovermania with countercyclical policies. My claim here is that we need Red Asphalt 2 - the movie that shows not what happens when you don't slow down and pay your debt, but what happens when you don't repave the roads where you might be tempted to drive too fast. There's one slide in the Brown budgetfest that gets at this.
This chart suggests that given current policy -- the continuation of Arnold Schwarzenegger's program of borrow and cut, the state will not get back to its 2007 employment level until 2015 - with a significant larger population. Given how young the state is, and how poor our public services are, this is a death-spiral that leads to social unrest sooner rather than later, and to the end of California as an advanced society.

This is the theme Brown needs to lead with: Rebuild or Die.  Rebuilding specific institutions, prominently including higher education, requires spending.  No way around it: there must be spending.


jan2128 said...

Actually it will require both spending and cutting.

There is ample room for efficiency improvements in the services provided by the state government. The easiest of these will be to combine programs a that are similar in nature (many of the social programs. Remove layers of needless administration and providing more authority to "front line" employees is also an excellent approach the state can take from the private sector. Things as simple as mandating at least 80% of toll booths must be Fastrak only have significant long term savings. Our public sector is mush like legacy airlines, slow and lumbering along. It needs to reinvent itself and trim the fat. Pension reform is a huge area for improvement. Switching to a defined contribution rather than a defined benefit must happen. This should be structured like any other 401k, the state matches up to a certain amount the employee puts into retirement. As someone in the private sector, I can only imagine what my tax rate will have to climb to without pension reform....

On the increased spending side you specifically mention roads. I will focus on maintaining and improving the existing roads (rather than expansion, which should be minimized while focusing on mass transit options/incentives). This is probably the easiest place to have the solution pay for itself by raising fuel taxes and vehicle license fees. Vehicle license fees should not decline with the age of the vehicle, they should be based on vehicle weight. Under our current system my 09 Prius vehicle fee (~$330) is 10 times (roughly) than that that of a 71 Chevy Blazer (~$31.00), yet the blazer damages the roads much more. Yeah, that makes sense....

Eliminate the child tax credit. You want more money for schools? There is your source, the parents having the kids. I have no problem helping pay for education, but I do not think parents should be paying less towards their child's education than I am. Since I do not receive that tax credit this is essentially what is happening. Combined that with providing a tax deduction for tuition (4 years for undergrad and up to an additional 4 years for grad), there will be a lot more dollars flowing into the education coffers.

This is from spending 5 minutes typing out of frustration after reading the super partisan post above. It is no meant to be polished, comprehensive or point by point rebuttal. It merely points out there are a lot of options you are not considering. I have barely scratched the surface here, there is a lot more that is not just "spend more" (revamping the tax code is a huge area for improvement, bringing more tech into the public sector has potential, continuing to raise the RPS, etc) It is time to get rid of the us versus them view and look at how we can actually move things forward.

Spending alone will not solve the problem. Neither will cuts. A combination of both will be needed.

Chris Newfield said...

Jan2128 - you make good suggestions here. My core principle is that mutualization - cost sharing for common goods - is both more just and more efficient. This means cost sharing for educating other people's children, as we did in the United States with enormous positive economic impact for everyone from 1850 on. It also means sharing the cost of retirement. We should pay as a society to educate young people to world levels and to retire older people decently. On the pension issue, the public sector should not follow the private sector into 401(k)s because that has degraded the financial security of going on two generations of retirees, overgrown the financial sector, misaligned incentives with social needs, among other things. In addition, the cost of these public sector pensions is greatly exaggerated. The Bureau of Labor Statistics calculates that defined benefit plans cost state and local governments $2.94 per hour worked (http://www.bls.gov/news.release/pdf/ecec.pdf). Is this amount that has bankrupted state governments? Since California is a bottom-5 state in percentage of state employees per citizen for which we are paying pensions, have we not already reduced these costs fairly dramatically? Didn't we already start the reform process this year by raising retirement ages for state workers (which I supported) and doing the same for new University employees? Finally, is there any evidence that the private sector's reduction of its own pension costs has revitalized our manufacuturing and/or small business sector? I know it has pushed costs onto the public sector, so you and I pay for Wal-Mart employee medical care rather than Wal-Mart, which is nice for Wal-Mart shareholders. But are there really economic benefits?
The argument of my post is that the game is rebuilding and revitalization, which means improving the capacity of the whole state's population to innovate. That's what made California great after World War II, and it's the only ethical way to do well in a world economy increasingly dominated by very low-wage but high-tech economies. To risk irritating you further by ending with another question, how can we rebuild when about 99% of our public discourse is about cutting rather than reconstructing our 2nd-rate infrastructure, and giving fewer resources to yet another group of employees?

Sandra Lee said...

I can completely agree with the comments. Moreover I can say that the problems are related the house and student loans that can not be repaid by the vast majority of borrowers. I think the problem is in the whole system with such long-term loans. People take a loan for the whole life and in such way they just become slaves of it. I guess that more useful is to find financial support in the short-term loans. Because you can completely control your spendings and make a repayment on time.

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