Sunday, June 28, 2009

State and Local Government Debt and the Tax Revenue Stream

One might hold the contention that during the last decade, State and Local Governments have been spending on expanding current services/capital projects, adding new services/new capital projects, and hiring a ton of employees, based on ever growing tax revenue.

That the expanded service aspect, in many cases, takes on the aspect of entitlements. That the expanded services/expanded capital projects went beyond the tax revenue stream and large amounts of debt was assumed to finance such items.

The powers-that-be that added the debt had the same mind set regarding tax revenue that those in the housing market had regarding home prices: what goes up continues to go up.

However, the tax revenue stream was a bubble that has burst and now their budgets are in shambles. One might harp upon this item: debt load acquired by these government bodies is unsustainable with tax revenue decreasing at an increasing rate. That the debt assumed was based on rising tax revenue that has now declined precipitously.

When tax revenues were rising, and this rise in tax revenue producing the mind set that the rise in tax revenue would continue forever, State and Local government bodies not only overspent, they magnified the overspending by acquiring debt to produce services/capital projects beyond that available from their general revenue stream.

Now that these government bodies must bring their budgets into equilibrium with the decreasing tax revenue, one might conclude they are not reaching budget equilibrium due in part to the following:

(1) these government bodies need to shrink the expanded work force they created. In many cases the work force is unionized and has major political clout. That is, this unionized work force is generally political supporters of the same legislators, governors, mayors, city councils, etc. that were in charge of creating the positions. That the same legislatures are in charge of reducing or eliminating the same unionized jobs they themselves created is clearly a conflict of interest. Therefore, great resistance occurs and job cuts are marginal at best,

(2) services/entitlements created are causing their own lobbyists to resist the cuts. For example, In North Carolina proposed cut backs has fostered a threat of a lawsuits,

(3) expanded capital projects financed through debt and based on the mind set of ever increasing tax revenue is a fixed cost that becomes increasing difficult to pay given tax revenues decreasing at an increasing rate,

(4) in some cases State and Local Governments cut their budget yet add back pork barrel spending.

Hence their budgets do not reach equilibrium which lends itself to the question of whether the debt issued in the past can be serviced. That is to say, the budgets were bloated in the first place. That major cut backs are needed to match revenue.

However, the cutbacks may need to be even deeper then merely reaching current budget equilibrium given the debt load taken on during the past 10 years. That is, the debt acquired requires budget austerity for years to come in order to service and retire the debt load acquired.

The Political Economy of the debt is that State and Local Governments do not have the political will to reduce labor and services. That candidates seeking election and re-elected political figures have relied on "spending" to indirectly buy votes. That the recipients of the spending are resistant to forgo services that benefit them. That unions are resistant to reductions in their union members.

The answer: Raise taxes? One might conclude that raising taxes merely perpetuates the problem outlined above.


However with 10%+ average unemployment, loss of household wealth, de-leveraging, etc. the public is highly resistant to tax increases. Further, tax increases may well be be predicted by The Laffer Curve and result in lower revenue. Finally, tax increases depress consumption and private capital formation which will exacerbate the unemployment rate.

Therefore, one might conclude an economic train wreck in State and Local government debt. It may very well acquire a cascading effect and certainly will affect new debt issuance.

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