One Last Look at State and Local Finances
The slow-motion state and local train wreck is becoming old news before it even happens. So this is our last look at the subject for a while, I promise. But two recent articles are must-reads. The first is from Manhattan Institute senior fellow Steven Malanga on the increasingly brazen tricks that states are playing on their creditors and citizens. The second is about how pension obligations are leading cities to make some really badly-timed tax increases.
For years, trickery and quick fixes have just fed the spending habit. Today the budget holes are cavernous.
Over the past two years, states have faced accumulated budget deficits of some $300 billion. Federal stimulus money helped cover about two-thirds of that gap, but state governments have had to close the rest themselves. To do so, many have resorted to tricks and gimmicks that Thomas DiNapoli, New York State's comptroller, speaking about his own state's budget, described as a "fiscal shell game." Such shenanigans mortgage the future for quick fixes in the present, and are a bigger part of states' fiscal woes than most taxpayers know.
One common maneuver has been to fill budget holes with borrowed money. Arizona is Exhibit A. Since the housing bubble burst in 2007 and the state's economy began to contract, Arizona has borrowed approximately $2 billion, relying on new debt to close 17% of its budget deficits, according to a report in the Arizona Capitol Times newspaper on Oct. 8. Among the loans: $450 million that the state plans to pay back with future revenues from its lottery. The cost to the state over the next two decades will be about $680 million in principal and interest.
Arizona has also sold its state government buildings, including those that house its Assembly and Senate, to generate $1 billion in one-time revenue. But the sales were part of a gimmick: No buyer stepped forward to purchase the buildings. Instead, the state issued more than $1 billion of notes backed by the rents that it will pay on the buildings -- at a cost of $1.5 billion over 20 years. The state remains in control of the buildings, and a financial trustee collects the state's payments and issues checks to buyers of the notes. Since the borrowing is technically being repaid by rents -- not tax revenues, as in the case of lottery revenues -- Arizona was able to borrow the money despite a provision in its constitution that explicitly limits state borrowing to just $350,000.
States don't only play the debt game in recessions. To make an annual contribution for public employees' retirements, Illinois borrowed $10 billion in 2003, depositing the sum in its pension funds. But in the boom years that followed, the state still failed to make adequate contributions. So Illinois had to borrow again in 2009, issuing some $3.5 billion in new debt at a cost of $4.5 billion in future principal and interest payments. This year, it borrowed yet another $4 billion for the same reason.
Some budget trickery betrays pledges made by lawmakers to taxpayers. One common example is "sweeps," when a state shifts money from accounts dedicated to specific purposes, like highway maintenance, into general accounts where the money can be spent on anything.
One honey pot is the tax revenue designated by federal law for upgrading 911 emergency-response systems. An August survey by the Federal Communications Commission reported that states redirected $135 million in these taxes last year to spending for other purposes. New York is a serial abuser: Since 1991, the Empire State has collected an estimated $600 million from its 911 tax. But only $84 million has actually gone to local officials for upgrading emergency services.
These fund transfers have become so routine that New York must now do "reverse sweeps." For example, New York created a fund 20 years ago to finance bridge and road construction and maintenance. But it often transfers money out of it and into the state's general accounts -- only to replace what's been swept by borrowing more. About a third of the Dedicated Highway and Bridge Trust Fund's disbursements, or nearly $1 billion, now goes toward debt service, a figure projected to rise to 70% by 2014. And so New York is shifting tax dollars back from its hard-pressed general fund to help pay off the transportation account's debt.
In some states, fund transfers have provoked opposition, particularly in cases where the government grabbed money from accounts that are not taxpayer-funded. Since 1975, New Hampshire has operated a medical-malpractice insurance fund financed by physician premiums to provide them with liability protection when they have difficulty obtaining it elsewhere. The fund has built up a surplus of $140 million, and last year the state tried to seize and sweep $110 million of it into its general fund. But the doctors sued, and the state's Supreme Court blocked the transfer.
Now states are even casting a covetous eye at private bank accounts. This year Michigan decreased the time that money can sit unclaimed in a citizen's bank account before the state claims it to three years from 15. The state projected the move could provide its general fund with a one-time boost of $200 million.
Illinois, meanwhile, passed modest pension reforms earlier this year that apply to new workers. The savings won't materialize for years -- but the legislation included language that allowed the state to calculate the future savings and apply up to $300 million toward closing this year's budget gap.
Time and again, the quick fix just feeds the spending habit. In 2004, Gov. Arnold Schwarzenegger promised that California could get out of its hole with borrowed money, and voters approved $10.9 billion in deficit bonds. Relieved of its immediate financial squeeze, Sacramento discarded fiscal discipline and went on a binge, hiking spending by nearly a third, or $34 billion, over the next four years. Today the state is back in the hole, facing a $25 billion budget deficit over the next 18 months.
Cities Tap Homeowners for Revenue as Workers' Retirement, Health Costs Rise
Cities across the nation are raising property taxes, largely citing rising pension and health-care costs for their employees and retirees.
In Pennsylvania, the township of Upper Moreland is bumping up property taxes for residents by 13.6% in 2011. Next door the city of Philadelphia this year increased the tax 9.9%. In New York, Saratoga Springs will collect 4.4% more in property taxes in 2011; Troy will increase taxes by 1.9%.
Property-tax increases aren't unusual, in part because the taxes are among the main sources of local revenue. But officials say more and larger increases are taking hold. "This year we have seen a dramatic increase in our cities and towns having to increase property taxes" for pensions and other expenses, said Jack Garner, executive director of the Pennsylvania League of Cities and Municipalities.
Local officials and government workers say a confluence of factors is driving the increases, including the need to make up for staggering investment losses from the financial crisis and rising costs as more workers retire. In addition, benefit increases promised in flush times are coming due as revenue flounders, and some cities have skipped payments to their pension funds over the years.
In Upper Moreland, a township of about 26,000 near Philadelphia, the Board of Commissioners voted this month to raise its 2011 property tax for residents by 13.6%, the first such rise in five years. That means a $67 annual tax bump on a $135,000 home, the average value there.
Pension and health-care costs are likely to make up more than a fifth of the town's $17.8 million operating budget for next year, said finance director John Crawford, a Republican.
In 2005, Upper Moreland contributed around $100,000 to its pensions. This year, it contributed $681,000. In 2011, it will pay an estimated $1.1 million. Healthy investment returns used to cover a large portion of the town's contribution to its pension funds. Now, lower returns -- coupled with higher costs as more workers retire -- mean Upper Moreland is paying more.
In addition to those figures, the state of Pennsylvania annually contributes $250,000 to Upper Moreland's pensions, Mr. Crawford said. Local Pennsylvania governments only receive pension aid from the state if they make the payments to their pensions recommended by actuaries.
Upper Moreland's payments on current workers' health care were $2 million in 2010 and are estimated to reach $2.63 million in 2011, Mr. Crawford said.
"If it hadn't been for the escalating costs," in pension and health-care benefits, he said, "the board may have succeeded in going through another year without a tax increase."
Many of the same issues are hitting Philadelphia, which earlier this year increased its property tax by 9.9%, the first bump since the early 1990s. That's a $270 annual payment increase for residents living in homes valued at $100,000, said Rob Dubow, city finance director.
Philadelphia's pension fund is 45% funded -- meaning its assets represent 45% of its long-term liabilities -- and the city's payments are projected to increase to $600 million in 2015, up from $230 million in 2004. Actuaries recommend pension systems be 80% funded.
Rolling Meadows, a Chicago suburb, is raising its property taxes next year by 9.8%, on top of a 16% jump in 2010, due to increased police and fire pension costs, said Mayor Ken Nelson. Those increases are the largest in nearly 20 years, he said. The local police and fire pension funds are around 45% funded.
These two stories illustrate the dilemma in which states and cities find themselves. Using budgetary tricks to hide growing deficits pushes an ever-bigger problem just a short way down the road, where it will inevitably cause chaos. But raising property taxes to fund growing pension liabilities will be self-defeating by making homeowners poorer and less likely to spend. So higher property taxes equals lower sales taxes equals an even bigger deficit.
The idea that states and cities are, unlike the federal government, required to balance their budget every year is apparently a myth, since states have found ways to borrow to cover their deficits. Which means they're speculating on margin with their workers' nest eggs. Individual IRA accounts are forbidden from doing this because it's too risky.
How can a pension be only 45% funded when stocks are up 80% in the past two years? Imagine what these funds would look like if the Fed hadn't artificially expanded asset prices with all that newly created money.
The pension costs cited in the second article look unsustainable, so something really big will have to happen soon. Look for "draconian" to make all the overused-words lists this year.