A Decade of State and Local Gov’t Stagnation

First, a confession. If I was any good at marketing, I wouldn’t be putting up this post on the Wednesday before Thanksgiving, when everyone is more concerned with turkey and traffic than the state of the economy.

But I can’t help myself–I’ve just got to share this chart.

This chart shows that real state and local government output, as measured by the BEA, has been effectively flat since 2001. To put it a different way, the stagnation at the state and local government level started way before the 2007 recession.

What do I make of this? State and local governments are the only large economic entities in the U.S. economy who are not allowed to borrow to meet operating expenses. Households can borrow, companies can borrow, the federal government can borrow–but state and local governments cannot. (Added:State and local governments accounted for only 7% of the rise in domestic nonfinancial debt between 2000 and 2010).

Therefore they have been forced to match their size to the carrying capacity of the individual state and local economies. Hence we see the epic struggle of states such as California to trim their budgets and labor force.

In other words, the state and local fiscal crisis is less a failure of governance (though such obviously exists) and more a sign of weakness in the individual state and local economies going back a decade.

Added: Real state and local output includes investment spending and compensation for state and local employees, adjusted for price changes. It does not include most Medicaid spending (which shows up in personal consumption) and some other small categories of social benefits, such as workers compensation.

Comments

  1. hmmm. California, Oregon, Washington at any rate, have been hamstrung by voter tax limitation initiatives that have both mandated spending and mandated tax cuts and spending reductions. Consequently, California is pretty much unmanageable. These limitations go way beyond proportion 13. The require 2/3 votes for tax, require spending in education, energy and the environment and limit property tax growth to near zero.

  2. mike shupp says:

    The state of California, through its voters, has shot itself in the foot. Figuratively speaking, in fact, the state has shot often enough to amputate each and every toe. How does it do this? Every year it puts up a bond issue or two or six. Rinky dinky bond issues.

    Let’s spend 2.31 billion dollars to subsidize home mortgages for California vets! Let’s spend 1.85 billion dollars making parks safer for tottlers and young children! Let’s spend 4.9 billion on earthquake risk abatement! Let’s spend …

    You get the idea. Wonderful ideas, all so useful and inexpensive. But buried in the fine print is that the state is not financing ANY of these wonderful ideas through the regular budget. Each and every one is financed by selling state bonds which will be redeemed over the next twenty or thirty years, and each and every one effectively doubles in cost for interest payments. And almost all these issues pass, because they are so cheap and affordable.

    Were there 10 billion dollars of wonderful ideas in 1991? Of course there were, and we Californians will be paying a billion dollars for them still in 2011. And a billion for 1992′s bright ideas. And a billion for the clever notions of 1993. And a billion for the worthwhile …. The upshot is that Californians each year spend twenty billion dollars to secure ten billion dollars of benefits. And after a couplel of decades, that mounts up.

  3. You’re missing the real trend: from 1950 to 1990, state and local spending rose from 9% of GDP to more than 15%. Why we needed to spend so much more when federal spending was also increasing, I have no idea. What we need to do is take a hatchet to federal spending, because state and local are now plenty big enough to replace it. That way those who want lots of govt can congregate in socialist wonderlands like SF or NY or LA, while the rest of us can decamp from that metropolitan blight. That’s the beauty of our federalist system: the Massachusetts dummies can have their Romneycare, complete with an individual mandate and all the increased premiums and ER blockage, while those in Texas can opt for freer markets. The fact that the federal govt and its trillions of spending and debt have been rammed down our throats ever since FDR is a testament to how all institutions slowly die over time, and the US is no exception, with creeping stupidity followed by paroxysms and collapse.

  4. Technically, it is true that state and local governments are not permitted to borrow to fund operating expenses.

    However, relative to a true accrual accounting framework of expense accounting, many state and local governments do in fact “borrow” all the time.

    True, the law says they can’t borrow from the capital markets to meet operating expenses.

    But they do borrow all the time for operating expenses–from their suppliers (on a small scale) and from their employees (on a huge scale).

    Simple but small example: bill for services rendered in Fiscal Year 2011 arrives in the mail and your accounts payable department shoves it in a drawer and don’t open it until FY 2012. You have effectively borrowed from your supplier.

    More complicated but much bigger example: a big part of your employee compensation bill for current services rendered is “deferred compensation,” money that you have promised to pay them LATER for services they are rendering now. Pensions and health care coverage during retirement, for example. Or accrued unused sick leave. In a proper accounting framework, that ought to be recorded as racking up a current expense and incurring a future liability (i.e., borrowing).

    Private sector firms are now required to record the full cost of current employees (including actuarial amounts sufficient to pay for accrued future retirement entitlements, etc.) as current expenses and they are required to set aside funds to provide for those costs at the time the services are rendered.

    Deferred compensation (primarily in the form of unfunded pension and retiree health care cost commitments) is a big form of borrowing for state and local government. A Pew Foundation study recently estimated unfunded accrued pension liabilities at $1 trillion. (https://docs.google.com/viewer?url=http://ctmirror.org/sites/default/files/documents/Trillion_Dollar_Gap.pdf&pli=1)

    And when those bills come home to roost (as they already have in some places), it will mean that the true current output of state and local government services will need to shrink as a growing share of tax revenue coming in needs to be dedicated to paying off liabilities for services rendered long ago.

    • You can try to put a lid on paying off liabilities. For example, you can ask retirees and near retirees to take a substantial haircut on their pension and health benefits, with the threat of layoffs affecting them or their unretired buddies, never mind municipal bankruptcy. After all, they cannot in general take back the work they did for several decades.

      All this does is teach current and subsequent generations, who are not stupid at least in this respect, that nobody can stiff you over work you have never done. That’s how it worked in Eastern European “communism”, and we know how *that* ended.

  5. It’s not true that “state and local governments … cannot borrow to pay operating expenses”. They can and do. The definition of balanced budget in government accounting is on a cash basis. The cash from borrowings is counted as receipts; cash debt service is also counted as expenses; but legally, borrowing to pay expenses is generally available and is done. As well, there is enormous intra-period borrowing to pay operating expenses because revenues fluctuate more than state and local expenses. There may be capital market and rating agency imposed external discipline of total debt outstanding and there may be some governmental units that have tight restrictions on borrowings but in the main it is being done all the time.

  6. This is just a secondary source but it documents the point I just made:

    http://www.nytimes.com/2010/03/10/nyregion/10ravitch.html

    • Mike Mandel says:

      Here’s the relevant statement from an authoritative source, the Center on Budget and Policy Priorities (emphasis added):

      Most states and localities are required to balance their operating budgets, even when the economy is weak. Closing operating deficits requires immediate action: most states have to enact balanced budgets, and gaps that develop during the year usually have to be closed within that year or biennium…

      …Almost all state and local debt is long-term debt incurred to pay for capital expenditures, not to cover operating expenses. (Unlike the federal government, states and localities maintain separate operating and capital budgets.) States issue long-term debt — various types of bonds — primarily for infrastructure projects such as roads and bridges, schools, water systems, and hospitals. States typically prohibit the use of bond proceeds for funding operating expenses….

      • From Buycaliforniabonds.com

        What are State of California’s Revenue Anticipation Notes (RANs)?
        RANs are short-term notes that fund the State’s cash management needs during a fiscal year. Each note is a promise by the State to repay investors the amount of money borrowed (the principal), plus interest, from the States available monies at the end of that fiscal year.

        What is the final maturity of RANs?
        Generally, RANs mature on the last day of the fiscal year (June 30) in which they were issued.

        What is the security for the payment of principal and interest on RANs?
        RANs are payable from all available monies in the State general fund, subject to use of such money for certain higher priority payments owed by the State. Those higher expenditure priorities include: payments required to public schools and universities; payments of debt service on general obligation bonds; repayment of loans by the general fund to State special funds which advanced moneys to the general fund; payment of State employee salaries, pension obligations; and certain other payments determined by court orders to be owed before payment of RANs. In order to obtain sufficient funds to pay RANs, the general fund may borrow money from the Special Fund for Economic Uncertainties and other special funds in the State treasury which have excess fund balances (called “internal borrowable resources”). Read the Preliminary Official Statement for a specific offering to obtain more information about the cash flow projections and sources of payment for RANs.

        End. As well, many states have, or at least have gotten away with, rolling over deficits from one year to another – borrowing from future tax collections. Then there are inter-fund borrowings; nonpayment of pension funding; setting aside reserves from borrowings and then hitting the reserves. There is much more of this going on than a think tank is going to be aware of.

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  1. [...] A Decade of State and Local Gov’t Stagnation – Michael Mandel [...]

  2. [...] A decade of state and local government [...]

  3. [...] The number of jobs created by new businesses peaked around 2000 and has been falling ever since. State and local government output suddenly stagnated around 2000. Globally, the energy intensity of GDP stopped growing around 2000, [...]

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