Budget legerdemain no doubt is related to the rapid growth in state spending in recent years and leap in debt. State and local governments now use debt to fund investments that used to be done on a current budget basis, and some issue debt to cover up routine budget shortfalls. Total state and local bond debt outstanding leaped 93% between 2000 and 2009, from $1.2 trillion to $2.3 trillion.
It obviously takes a lot of gnashing of teeth in the outer darkness for state and local government to flatten, much less cut, their spending after a decade of 6% to 7% annual growth rates. Jumping municipal employment is the main reason for mushrooming spending in earlier years, and cutting often unionized state and local workforces is very difficult. Since the Great Recession started in December 2007 through April, private payroll employment has dropped 6.8%. Still, state and local jobs have declined but by much less, only 1.4%. In July, state and local governments, which employ 9.5 million, cut 48,000 jobs, 102,000 in the past three months and 169,000 so far this year.
Raise Taxes
In reaction to their financial woes, many state and local governments have attempted to raise taxes and fees. The usual suspects include higher sin taxes on tobacco and alcoholic beverages as well as taxes on companies based out of state but doing some business in the state. Attempts to raise taxes and cut spending have proved wholly inadequate to solving state and local government funding problems. And those woes appear chronic, especially if our forecast of slow economic growth and even deflation is valid. Rises in taxable personal and corporate incomes will be muted. Retail sales and taxes on them will be sluggish as consumers persist for the next decade in their saving spree, replacing the borrowing and spending binge of the last decade.
House prices are likely to fall further in the next year or so, under the weight of gigantic excess inventories. Even when those inventories are worked off, house prices will probably rise little, if at all, in a low inflation or deflationary climate. Historically, they've been flat after correcting for overall inflation and the growing size of houses over time. And now that house prices have fallen nationwide for the first time since the 1930s, home buyers no longer see their abodes as also great, leveraged investments, and want smaller, cheaper houses. That will also reduce assessments on property taxes.
Meanwhile, commercial real estate high vacancies and severe financial problems will take years to resolve, keeping prices depressed for some time (Chart 9 ). So, all things considered, local government property taxes are likely to be curtailed for many years. Meanwhile, municipal expenses will be hard to cut. Chronic high unemployment will spawn high Medicaid enrollment and costs. Welfare and unemployment benefit costs will no doubt rise as well.
Deteriorating finances are raising the risks of defaults on state and local obligations and even municipal bankruptcies. Harrisburg, Pennsylvania's capital, will not make a $3.3 million municipal bond payment on $51.5 million debt that's due in two weeks, and earlier this year, city officials discussed bankruptcy. Harrisburg also lacks the funds to continue payments for the $288 million debt on an incinerator project. Earlier, Jefferson County, Ala., home of Birmingham, defaulted on $227 million due on its disastrous sewer upgrades.
Taxpayer Revolt?
People working in the private sector apparently were willing to accept the higher pay, more job security and better retirement benefits for state and local employees in past years. High employment in the private sector and robust economic growth at least held out the hope that their lots would improve tomorrow. But with slow economic growth, limited income expansion and high unemployment now expected by them for years, voter attitudes appear to be changing.
Americans still want basic municipal services like police and fire protection, good schools for their kids, clean streets and garbage collection. But they apparently are deciding they're paying too much for those services; that 34% higher wages for state and local employees compared to private sector workers isn't justified as pay cuts multiply in the private sector and those laid off earn much less if and when they can find another job; that 66% higher benefit costs is over the top, especially as private sector employees are paying more of their health care premiums and seeing their defined benefit pension plans replaced by much more uncertain 401(k)s.
As taxpayers revolt, there are plenty of things that can be done to reduce state and local government costs in an orderly way. Following in the footsteps of bankrupt GM, two-tier wage structures are being established with existing employees continuing at current salary levels, but new hires paid the much lower wages adequate to attract qualified people. And the new people are enrolled in defined contribution pension plans that require employee contributions, not defined benefit plans, while their retirement ages are increased.
