walter russell mead peter berger lilia shevtsova adam garfinkle andrew a. michta
Feed
Features
Reviews
Podcast
Blue States, Red Ink: The Big Crunch is Coming

A new, high profile report by a distinguished bipartisan group of experts chaired by former Fed chief Paul Volcker and Former New York Lieutenant Gov. Richard Ravitch, shows that state finances are much worse than many believe, and that massive adjustments are coming our way.

While some have argued that talk of a crisis in state budgets is overblown, the report of the State Budget Crisis Task Force says that much of the recent improvement in the balance sheets of some states is the result of accounting gimmicks and the true picture remains dire. States have resorted to cheap tricks like delaying payments by a month or two to push the expense into the next fiscal year or selling off state assets for quick cash, but the long term mismatch between revenues and projected expenses remains out of control.

State pensions, along with Medicaid, are the largest drag on state budgets, and politicians have also been unable to resist the temptation to loot pension funds to pay for other liabilities. From the New York Times:

Desperate budget officials often see public pension funds as an almost irresistible pool of money. One common way of “borrowing” pension money is not to make each year’s “annual required contribution,” the amount actuaries calculate must be set aside to cover future payments. Despite its name, there is usually no enforceable law requiring that it be paid.

As a result, the report found that from 2007 to 2011, state and local governments shortchanged their pension plans by more than $50 billion — an amount that has nothing to do with the market losses of 2008, which caused even more harm.

When money is withheld from a pension fund, the arrears can snowball, because most states count on the money compounding at a rate of about 8 percent a year. Eventually the unfunded liability grows unmanageable. And states and municipalities have promised an estimated $1 trillion in health benefits — that most have not started saving for — to their retirees.

One sign of how serious these problems are: while some of the Task Force’s budget came from longtime deficit hawk Pete Peterson, George Soros’ Open Society Foundation cosponsored the group. This is not a group of partisan Republicans playing “gotcha”; this is a serious effort to come to grips with a major national problem.

An economic recovery will help states stave off the worst for a while as revenues rise, but the reality is that the way American state and municipal governments do business must change. We’ve said it before and we’ll say it again on this site, but the progressive, bureaucratic government model and approaches to social policy developed in the 19th and early 20th centuries are too cumbersome and too expensive for our times.

Features Icon
Features
show comments
  • http://www.ipoliticalrisk.com Brian Hasbrouck

    It’s funny your timing on this – well that and my timing of listening to the Reith Lectures. Niall Ferguson said most people in my generation (the “millenials”) would be in the Tea Party if they knew what was good for them. Although I disagree on that, I definitely think that portability will be the key phrase in the coming years and maintaining that will lead to greater efficiency gains and a more fair social compact. Regarding pensions I feel that Australia’s in the best I’ve seen. If I remember correctly from The Economist’s recap – both the employer and employee contribute ~12% of salary up to a cap and then at 55 you receive the lump sum to purchase an annuity (or whatever else you want).

  • thibaud

    Did you read the report, Mr Mead?

    Interestingly, many of its conclusions – e.g. MUCH more investment in infrastructure – don’t mesh with your proposed bleed-the-patient remedies.

    From the report’s conclusions, beginning with p. 84:

    “State tax bases have eroded and become more volatile; these developments have undermined fiscal sustainability. States should … seek reforms that would make their tax structures more broad-based, stable and productive.”

    “Federal deficit and budget balancing actions pose serious potential threats to state and local economies and governments”

    “Essential state and local infrastructure is starved of funding and necessary maintenance. This underfunding threatens the nation’s competitiveness; the longer it is ignored, the larger the problem it will pose.”

  • Jim.

    States may “seek” my income, but they need to be prepared for the eventuality that they don’t get it.

    Some people may be in a position to gain far more than they pay in taxes from a Eurosocialist agenda, but I’m not one of them… neither else is anyone with any sense of honor or shame.

  • thibaud

    Looks like Mr Mead just read the parsing of the report that was done by – heaven forfend – the hated New York Times.

  • http://Inthisdimension.com Alex Scipio

    CA, for example, has a deficit, per Gov Moonbeam, of $16B; including money “borrowed” from municipalities and from the Feds, it’s around $75B. A recent report from Stanford illustrates the unfounded govt sector pension liability as $500B. BILLION. CA cannot possibly pay this bill. The other states would be foolish to provide a bailout. If Congress passed a state bankruptcy chapter, CA would refuse to declare bankruptcy as doing so would require abrogating public pensions & union contracts – and laundering taxpayer money through these unions and into Dem campaign coffers is the ONLY reason any Dems are ever elected.

    The people have the government they deserve. And the only realistic alternative is to throw the entire state out of the Union and let them break themselves up into workable pieces & apply for re-admission to the Union. Blue counties (8 of 58) can apply as the socialist swamps they have become and Red counties can apply as separate states with workable fiscs, and congress can readmit as desired.

  • Kris

    “State tax bases have eroded and become more volatile; these developments have undermined fiscal sustainability. States should … seek reforms that would make their tax structures more broad-based, stable and productive.”

    Oh dear. I see they’ve drunk the GOP/TP kool-aid!

    [/sarc]

  • Anthony

    Former lieutenant gov. Ravitch and guest discussed report finding on PBS (Monday evening). Generally, state fiscal difficulties tied to revenue imbalances as well as unfunded pension liabiliies – with average politician avoiding hard public policy choices.

  • thibaud

    #3 Jim – yes, state and local tax systems are broken. Absurdly overweighted toward one or another tax vehicle, and desperately in need of reform.

    A pity we don’t have the simplicity and clarity of the Canadian or Swedish or Dutch tax systems. Oh wait, they’re evil tyrannical s0CiALi$$$ts!!!

    Whose pensions are sustainable, who have higher growth rates and lower unemployment and lower deficits than we do.

    Never mind.

    /emily l.

  • dearieme
  • http://thepencilofnature.net Lorenz Gude

    Funded by Soros. Published in the New York Times. Touted as bipartisan. Pfui!

  • Don

    WRM should submit his copy to thibaud for fact checking.

  • Jon Burack

    thibaud,
    I am not sure what point you think you are making against WRM. The fact that the report says more infrastructure spending is needed only underscores the disaster of these unfunded pension liabilities. It means money for that future infrastructure investment is instead going to have to go to consumption, with the present generation robbing the next generations to no advantage at all but their own. Or perhaps you think the states are going to massively increase taxes to cover both these infrastructure needs and the huge actual (as opposed to phoney) pension liabilities? If so, dream on.

  • thibaud

    Jon – the points are:

    1. Our state-local problem is one of bad governance, not “socialism” vs “capitalism.”

    2. Reforming state-local government will enable us to achieve what well-governed nations like Canada, the Netherlands and Sweden have achieved: stable, solvent pensions, a secure safety net, and growth rates that our higher, with lower unemployment and deficits, than we have.

    3. The reforms in #2 above do not entail starving the state or reliance on unicorns. They require

    – thorough tax reform to make it more balanced, more fair, and more progressive (see the report’s recommendation, above)

    – a balanced economy that, like the tax system, is NOT weighted heavily toward privileged princes of high (and low) finance

    – an ethos of mutual provision, including appropriate investments in things like infrastructure, help for working families with small children and also a safety net for the poor, the elderly and the infirm.

    While calling for good governance, Mead is also constantly attacking every one of those requirements.

    This is not helpful.

    It’s a crude distortion, for a parochial and ill-informed US audience, of the social, political and economic realities of other nations that have achieved far better governance and better economic results than we have.

    We can do better, and so can, I think, the author of this blog that is increasingly linked to and cited by GOP pundits and readers.

  • thibaud

    [hostile characterizations of those with whom commenter disagrees deleted in the interests of comity with reminder to commenter that the ice on which he stands is thin] a good place to start diving in (after the exec summary and the recommendations) would be the discussion of what in the authors’ view is the biggest fiscal challenge of all for the states, Medicaid.

    Surprise, surprise: the authors note the shocking conclusion that the ACA is actually helping to solve the problem!

    page 20:

    “Implementation of the Affordable Care Act (ACA)

    “The ACA, as validated by the Supreme Court, could have a huge impact on state Medicaid programs if states choose to participate in the law’s enlargement of eligibility….

    “For states that want to increase coverage for the insured [e.g. Texas, Virginia], the ACA is a bargain… [ACA's] Health iInsurance Exchanges could make private insurance more affordable, thereby … REDUCING enrollment in Medicaid [at the margin]…

    “Furthermore the [ACA's] restriction on insurance companies’ ability to restrict provision to people with “pre-existing conditions” will, as a budget matter, undoubtedly be welcomed by all the states….”

    /end excerpt

    Note this interesting little observation by the authors about the impact of Paul Ryan’s ludicrous plan to slash medicaid and use block grants to the states:

    “… if the federal government later [ie, under the GOP's or Ryan's plan] caps or block-grants Medicaid, the states could be left on their own with a very expensive program….”

    Very awkward for the starve-the-beast crowd.

    Of course, the whole mess could be made vastly easier, and cheaper, and more effective, if we had universal healthcare supplemented by the ACA’s innovations in private markets, such as information exchanges and other ways of enabling supplemental private insurance to be offered across state lines.

    But that would be “socialism.”

  • Kris

    “Paul Ryan’s ludicrous plan to slash medicaid and use block grants to the states”

    That evil moron Paul Ryan obviously took seriously thibaud’s advice that we learn from Canada.

  • thibaud

    Paul Ryan’s not “evil”, Kris. He’s a nice man. Means well. Great hair.

    But his plan is ridiculous.

  • Goldwaterite

    From my home state of Maryland: Folks are voting with their feet over [Obama disciple & 2016 wannabe] Gov. Martin O’Malley’s “millionaire tax” and other business-unfriendly policies. The smart folks are moving across the Potomac to Virginia faster than Gen. Lee’s army retreated from Gettysburg.
    I’m glad I am still an expatriate.

  • Kris

    thibaud@16 is quite right, and I confess that my previous comment was misleading. I therefore urge the readers to substitute the following for my previous comment: “I am assured that Paul Ryan is a nice man, but what does it say about the GOP/TP that one of their standard bearers took seriously thibaud’s advice that we learn from Canada?”

  • Ellen K

    Thibaud,
    I appreciate what you are saying about seeking stability, but when you try to compare the US economy and population to far smaller Scandinavian countries, you ignore that the very diversity we claim to celebrate is what is driving us down. We have a free educational system, which many abuse and ignore in the process of disrupting every chance of delivery to those who want an education. We have freedom to move and seek employment anywhere, yet people will stay in places like Newark or Philadelphia or Comptom rather than moving to someplace better. There are generations of people who have become adult wards of the government. In doing that, they don’t seek fairness, they seek security at any cost and truly do not understand why it is wrong to claim the profits of someone who worked their entire lives. Until we get over the idea that equal is always fair and that everyone is magically entitled to a prize, the US will not beat this challenge.

  • TJM

    Rather ironic that Dem politicians who claim to “love” the people, rob the people of their pension money to support projects that benefit union members almost exclusively. If instead of defined benefit plans, all of these government pensions programs had been converted to defined contribution plans, we wouldn’t even be discussing this issue, since the politicians could not touch that money then. Last point – Congress should not have pensions of any kind. They can open a 401(K) OR IRA like the rest of the canaille

  • thibaud

    Ellen – in several ways, Canada’s even more diverse than we are: they’re officially bilingual and include a very large linguistic and cultural minority that within living memory has spawned violent separatists.

    Holland is very multicultural today; Sweden’s less so, but both of them are as large or larger than all but a handful of American states.

  • http://kavanna.blogspot.com Kavanna

    … so does this mean some people will start apologizing to Meredith Whitney?

    And Niall Ferguson is right: anyone under 60 who isn’t supporting the Tea Party is insane.

  • thibaud

    Kavanna – “… so does this mean some people will start apologizing to Meredith Whitney?”

    No, it means that Meredith needs to start apologizing to all the folks who followed her disastrously wrong call on munis.

    http://www.cnbc.com/id/47014123/Meredith_Whitney_Muni_Call_Was_100_Wrong_Bond_Pro

    ” ‘I have come up with a new measure of risk, which is knowledge risk,” said the president and CEO of Lebenthal and Co. “Is the person who is talking about municipal bonds, corporate bonds, equities, what have you, knowledgeable and should people be listening to them?”

    ” ‘… I do know what I’m talking about because I have spent over 20 years in this business and another 20 growing up listening to it.’

    “Whitney issued her call in late 2010 that the muni business was about to suffer an implosion that would result in more than $100 billion worth of defaults.

    “On the heels of her success in forecasting the credit crisis, muni bonds sold off aggressively on her muni forecast. However, when the rash of defaults failed to materialize, the bonds began picking up again and finished 2011 earning about 10 percent.”

  • Jim.

    Some perspective on comparisons to Holland (the Netherlands), Canada, Sweden, Denmark, Norway, New Zealand, and other apparently enviable countries…

    http://strangemaps.files.wordpress.com/2007/06/350816052_0a392a0d28_o1.jpg

    Comparable GDPs:
    Canada… Texas. (Go brown jobs!)
    Norway… Minnesota. (Appropriate, somehow.)
    Denmark… Indiana.
    Holland… Pennsylvania.
    Sweden… North Carolina.
    Finland… Colorado.

    States and city-states compare as well…
    Singapore: South Carolina
    Hong Kong: Maryland
    But fear not, our own Washington, D.C. has the same economy as… New Zealand. (Lots of money in shearing voters, er, sheep.)

    A couple of (to me) surprises:
    Russia… New Jersey.
    Bangladesh… New Hampshire.
    Switzerland… Georgia.

    No surprise here:
    California… France. (Blue is doomed.)

  • thibaud

    Back to the topic at hand, the reasons that our public pensions are underfunded and what to do about it, the importance of the private equity/hedgefunders’ payouts should not be understated.

    If Simon Lack of JP Morgan’s correct – see the Economist article, above – that over time, roughly 80% of the returns in this crucial and enormous asset class go to the Mitt Romneys of the world, leaving only 20% for their pension fund institutional investors – then we have a very potent explanation for the pension funds’ failure to reach their target rates of return.

    Consider that “alternative investments” such as private equity and hedge funds and funds-of-funds (such as those that Simon Lack spent the better part of two decades selling) will make up maybe one-fifth of a balanced portfolio for a CalPERS or other huge pension fund.

    If 80% of your returns from an asset class that makes up one-fifth of your portfolio go, over time, into the Caymans Blocker and other accounts of the PE/hedgefunders – as opposed to going to pay pensions for Mom and Pop – then your pension will fall short of its target rate by about 1.6% annually, on average.

    Doing some quick rough estimates, if alternative investments are about one-fifth of the ~$3 trillion pension fund assets in this country – ie ~$600 billion – and if, instead of generating, say, a 10% return annually for the pension funds are generating only 2.5% because Mitt & his pals are creaming off most of the returns, then the cumulative losses to US state and local pensions each year total about (10%-2.5%) * $600 billion, or about 45 BILLION DOLLARS EACH YEAR.

    This is a rough estimate of the sum that is transferred each year from retirees to the PE/hedgefund industry. For no other reason that they can get away with it.

    And it is this annual loss that accounts for a big chunk of the shortfalls faced by most of our public pension funds.

    One more observation: Note that, were the 80/20 hedgefunder/pension split reversed, the hedgefunders would still reap enormous financial rewards, because of the sheer size of the assets under management and the tiny size and huge operating leverage of the hedgefund/PE industry.

    And the Romneys of our world would still be extraordinarily wealthy – even if their income were taxed as such, at the marginal rate, instead of via the ludicrous
    15% rate for their “carried interest” scam. Romney would in this fairer, more rational world be worth maybe $30 million instead of $300 million, and the other hedgefund and PE scammers would likely see their vast fortunes pared back to the 8- or 9-figure range.

    And our republic would finally have a shot at catching up to the likes of Holland when it comes to meeting its obligations to the citizenry.

    What’s Romney’s position on this? Care to guess?

© The American Interest LLC 2005-2014 About Us Masthead Submissions Advertise Customer Service