State Tax Revenue, State Spending, and the Real Estate Bubble
State government tax revenue and associated state government spending was in fact related to the real estate bubble. Related in that much tax revenue was generated by the real estate bubble.
State government tax revenue and state government spending from 1995 until the demise of Lehman was related to the following two propositions:
(1) that politicos through the mechanism of government fueled the real estate bubble by creating public policy (community reinvestment act, Fannie and Freddie, etc.) that caused an inordinate amount of capital to be directed into residential and commercial real estate as well as causing marginal buyers to enter the market as these marginal buyers now qualified for loans of which they would not have qualified without government intervention into the market,
(2) that John B. Taylor’s book Getting Off Track is likely the most empirical explanation of the creation of a cheap money bubble by the Federal Reserve. That the cheap money bubble, in and of itself, set the stage (created the environment) for the ensuing financial shenanigans in the residential and commercial real estate markets, (1)
As the real estate bubble was in its many stages of bubbling-up, state tax revenue began increasing at an increasing rate. The tax revenues thrown off by the real estate bubble helped fill state tax coffers.
From the mid 1990’s until the recession of 2001 state governments increased spending in an unsustainable fashion. During the 2001 recession states suddenly found themselves with spending outpacing revenue and the alarm bells went off. Enter the Federal Reserve created cheap money bubble. (2)
As the Federal Reserve induced cheap money bubble played out the real estate bubble continued. As the bubble continued through its stages headed for its eventual collapse, the transactions associated with the bubble continued to throw off tax revenue to state governments.
Hence we have a real estate bubble beginning in the mid 1990’s and ending basically with the collapse of Lehman. We also have state tax revenues increasing in the mid 1990’s, dropping off momentarily during the 2001 recession, then marching on until the demise of Lehman.
Rent Seeking
During this period of increasing state government revenue “rent seeking” increased. What is “rent seeking”?
‘ "Rent seeking" is one of the most important insights in the last fifty years of economics and, unfortunately, one of the most inappropriately labeled. Gordon Tullock originated the idea in 1967, and Anne Krueger introduced the label in 1974. The idea is simple but powerful. People are said to seek rents when they try to obtain benefits for themselves through the political arena. They typically do so by getting a subsidy for a good they produce or for being in a particular class of people, by getting a tariff on a good they produce, or by getting a special regulation that hampers their competitors. Elderly people, for example, often seek higher Social Security payments; steel producers often seek restrictions on imports of steel; and licensed electricians and doctors often lobby to keep regulations in place that restrict competition from unlicensed electricians or doctors.’ (3)
During this period of basically uninterrupted state government revenue growth, one stealth rent seeker was public sector unions. Hence increasing tax revenue of state government became a natural rent seeking target for public sector unions. With increasing state government revenues, union representatives of public sector unions lobbied, through rent seeking, for their supposed right to the increased tax revenue stream. The rent seeking activities of public sector unions is “stealth” in that:
(1) wage increases make too much headline hence the unions want additional employee benefits and retirement benefits as these benefits generally don’t make headlines like a “wage” figure makes headline,
(2) work place rules, sick pay, vacation time, etc. are buried in state employee manuals were the public have minor access,
(3) “total compensation” is then much enhanced yet the “wage” figure still seems somewhat reasonable.
What goes up must continue to go up and rent seeking rigidity
Rent seeking activities are not something granted by "government". Governments do not "think" nor grant benefits. Its important to remember that politicos through the mechanism of government think and grant benefits.
Governments never learn. Only people learn. - Milton Friedman
Politicos that grant rent seeking activities generally due so through a phenomena known as political constituency building. That is, by granting rent seeking activities the selected beneficiaries then become supporters of the particular politico or group of politicos. Hence any reversing of the rent seek activity is opposed by the beneficiaries and hence opposed by the sponsoring/associated politico or group of politicos.
Taking back a rent seeking benefit, reversing such benefits, voids the concept of what goes up must continue to go up. You see, rent seeking activities are in no way related to Sir Isaac Newton proposition that what goes up must come down.
Hence the past rent seeking activities, in this particular case rent seeking activities of public sector unions, becomes rigid in that neither the beneficiary (union) nor sponsor (politicos) want to return any rent seeking gains.
Tax revenue and rent seeking
Politicos like to discuss "government tax revenue". That is, politicos love to label items in political terms. One must not lose sight of the fact that "government tax revenue" is really your tax dollar. Politicos love to lament special interest groups. Yet the same politicos grant rent seeking requests on a regular basis to build constituency.
Hence politicos use your tax dollar to build constituency. Nice huh?
Notes
(1) Getting Off Track, , How Government Actions and Interventions Caused, Prolonged, and Worsened the Finacial Crisis, John B. Taylor, Hoover Institution Press, 2009.
(2) Red Ink Rising, The Economist, print edition, 08/09/2001.
Minister of Silly Walks is a classic. Nice post. I like the Friedman quote too. Reminds me of another one I saw in one of his videos while addressing a college crowd. An audience member said something like, "doesn't government have responsibility to...". His response, governments don't have responsibility. These buildings don't have responsibility. People have responsibility.
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