December 21, 2010
Way back in the last decade the United States had a huge housing bubble. The Wall Street banks made money hand over fist making and selling the loans that fueled this bubble. The economic policymakers and regulators who were supposed to prevent the growth of such dangerous bubbles, people with names like Greenspan, Bernanke, Paulson, and Geithner, assured the public that everything was just fine. When they were proved horribly wrong, they then congratulated themselves for avoiding a second Great Depression.
This background is important to any story on the financial problems facing state and local governments, since it is 90 percent of the picture. It also would be good if the public remembered this history, since many of the people who either profited from the bubble or failed to take measures to counter its growth are now at the forefront in demanding that state and local governments sharply reduce their budgets and that public sector employees take big cuts in pay and benefits.
On Sunday night, the CBS News show 60 Minutes joined this campaign. The piece begins by telling viewers that:
“in the two years, since the ‘great recession’ wrecked their economies and shriveled their income, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes.”
That’s not what the data show. If we look to the Commerce Department’s National Income and Product Accounts we find that in total state and local government spent $45 billion more than they took in (line 27). CBS does not give a source for the “nearly half a trillion” number.
It is also worth noting that any shortfall is due almost entirely to the recession caused by the collapse of the housing bubble. If revenue had increased in step with normal growth (2.4 percent real growth, plus inflation), state and local governments would have had an additional $290 billion since the start of the downturn.
Another way to think about the size of the state and local government shortfall is that we could envision the Federal government giving state and local governments trillions of dollars in loans at below market interest rates as they did with the Wall Street banks through TARP and the various Fed special lending facilities. If the state and local governments got $3 trillion in loans at rates that were 4 percentage points below the market rate, and then they relent this money at market rates, it would largely make up for the shortfall in revenue they have faced. (It would provide them with $120 billion a year in additional revenue.)
When the governments repaid their loans, plus the below market interest, the Treasury and the Fed would then get all their money back, plus a small premium. This would allow people like Treasury Secretary Timothy Geithner and the Washington Post editorial board to declare that they made a profit, just as they have with the TARP. This would be one possible solution to the fiscal problems faced by these governments.
The piece also told viewers at the onset:
“There is also a trillion dollar hole in their public pension funds.”
In fact, this shortfall is overwhelmingly attributable to the plunge in the stock market that followed in the wake of the collapse of the housing bubble. According to Federal Reserve Board data (Table L.119) if pension fund assets had increased at just a 5 percent nominal rate since the 4th quarter of 2007, they would have $935 billion more money at the end of the third quarter than is currently reported.
While some of us did try to warn of the risks that the housing bubble posed to the economy and financial markets (we were not featured on 60 Minutes, which was busy touting deficit stories even then), the primary fault of state and local officials was listening to Wall Street and the mainstream of the economics profession, not excessive pensions.
It would also be useful to provide a basis for assessing this “trillion dollar hole” since it is virtually certain that almost none of CBS’s viewers regularly deal with such numbers. The discounted value of GDP will be more than $400 trillion over the next 30 years (roughly the period in which this shortfall will have to be addressed). This implies that additional revenue equal to 0.25 percent of GDP over this period should be sufficient to cover this projected shortfall. By comparison, the increase in annual defense spending associated with the wars in Iraq and Afghanistan is approximately 1.8 percent of GDP, more than 7 times larger than amount of revenue needed to cover the projected pension shortfall.
Another point of comparison is the revenue that could potentially be raised from a financial speculation tax. Such a tax could easily raise more than 1.0 percent of GDP, four times the projected shortfall, with the incidence being born almost entirely by Wall Street banks and speculators.
The segment also includes assertions that imply state and local workers are overpaid. In fact, after adjusting for education and experience state and local workers earn slightly less than their private sector counterparts. Public sector workers do get higher pensions on average than workers in the private sector, but this does not offset the pay difference. It is also important to remember that many public sector workers are not covered by Social Security so that their pension is virtually all of their retirement income.
Interestingly, New Jersey Governor Chris Christie is presented as a heroic visionary in this story because of his willingness to make cuts in areas like public and education and to force workers to take pay cuts. In one instance he is shown telling teachers complaining about cuts in their benefits that they should get another job if they are unhappy with their pay.
While such an approach may be an effective short-term strategy it is absolutely disastrous in the long-term. At any point in time it will be difficult for long-time workers to leave their jobs with the state and find comparable employment elsewhere, especially in the midst of the worst downturn in 70 years. However, as new workers come into the labor force, lower pay and worse benefits in the public sector will make these jobs less attractive. This means that New Jersey’s schools and other public agencies will have less choice in selecting their workforce, which is likely to lead to a deterioration in the quality of education and other public services. This is not obviously far-sighted thinking.
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