(Fiscal) Winter Is Coming

Congressional Budget Office projections of federal government annual budget deficits.

Let me set the scene by reviewing a few numbers. The federal deficit is on course to hit $1 trillion annually by Fiscal Year 2020. With retiring Baby Boomers swelling Medicare, Medicaid and Social Security expenditures, deficits will increase inexorably for decades. The U.S. national debt stands at $21.7 trillion. As deficits pile up and interest rates rise, the national debt expressed as a percentage of the GDP, 78% today, will reach 96% by 2028. CBO projects that interest payments on that debt will increase from $263 billion in 2017 to $915 billion by 2028, putting increasing deficits on autopilot that no amount of budget cutting can offset.

Worse, those numbers don’t include hundreds of billions of dollars in liabilities from unfunded military and public employee pensions, federal pension guarantees for bankrupt companies, U.S. Post Office pensions, or defaulting student loans. Meanwhile, the trust funds for Medicare and Social Security are running out: Medicare in 2026, and the Old Age and Survivors in 2034. Washington is gripped by dysfunctional gridlock for at least two more years, and possibly longer, so nothing will be done to defuse these fiscal landmines before they explode.

CBO national debt projections.

Over the next decade, Congress will be coping with one fiscally driven political crisis after another. When another recession occurs in the not-too-distant future — the current business expansion has run twice as long as the average expansion since World War II, and JPMorgan Chase recently boosted its odds of a recession occurring in the United States within the next 12 months to 30% — the federal government will be too consumed with its own problems to bail out the states.

None of this seems to faze Virginia’s political establishment as the 2019 General Assembly session approaches. Why should we worry? After all, we’re one of only 14 states with AAA bond ratings, and we’re widely regarded as one of the best-managed states in the country.

Well, we are, aren’t we?

Source: Mercatus Center “Virginia State Profile,” 2017 “Ranking the States by Fiscal Condition

It’s time to get real. In the 2018 edition of its “Ranking the States by Fiscal Condition” report, based on Fiscal 2016 data, the Mercatus Center at George Mason University ranked Virginia 13th in terms of overall fiscal health but only 28th by cash solvency. Similarly, an October report by Moody’s Analytics declared, “The states least prepare to weather another recession are: Louisiana, Oklahoma, North Dakota, New Jersey, Montana, Kentucky, Virginia…” (my emphasis).

Virginia escaped a downgrade to its credit rating earlier this year only through a last-minute infusion of cash into its cash reserves. Secretary of Finance Aubrey Layne was so concerned about Virginia’s ability to weather a recession-induced revenue downturn that he asked his staff to calculate the effect of another 2007-2008 recession on the state budget. The results are horrifying.

To be clear, Layne is not predicting a recession of the same magnitude as the last one. But if the U.S. had one recession as sharp as the so-called Great Recession, it could have another. The scenario is not outside the bounds of the possible.

Under a 2007 Repeat scenario, General Fund revenues, now about $21 billion a year, would shrink $2.6 billion the first year, $3.7 billion the second year, and $3 billion the third year before bottoming out — $9.3 billion in all. The General Fund goes to K-12 schools, higher education, public safety and corrections, mental health, payments on the state debt, the environment, and, of course, the metastasizing Medicaid program. Cuts amounting to 44% would be calamitous and disruptive beyond imagining.

That’s the near-term problem. The longer-term problem is what I call hidden deficit spending. True, the Virginia Constitution requires the state and localities to balance their budgets every year. But the General Assembly has proven adept at skirting the Constitution.

The first trick is under-funding pension funds and other retirement obligations such as retiree medical care. The Virginia Retirement System has a $5.4 billion funding shortfall that will have to be made up eventually. Fairfax County, which administers its own pensions, has a $5.6 billion shortfall. The Washington Metropolitan Area Transit Authority, which operates the Washington region’s mass transit system and is partially funded by Virginia, is $3.5 billion shy of what it needs. Last year, Chesterfield citizens were shocked to learn that their school system had accumulated an unfunded liability for an obscure “supplemental retirement program” that could reach $99 million. There are hundreds of cities, counties, towns, and independent authorities in Virginia, many of which administer their own pension plans. No one knows what their total pension liability is. No one has bothered to add it up.

Source: American Society of Civil Engineers, “2015 Virginia Report.”

The second trick is under-funding maintenance of public infrastructure such as roads, bridges, highways, mass transit, water and sewer plants, water and sewer pipes, fire and police stations, communications systems, administrative buildings and school buildings. Infrastructure depreciates, slowly at first but with increasing speed if not properly maintained. Even well-maintained facilities have a limited lifespan and need replacing. Government can let maintenance slide a year or two without ill results, but persistent under-funding can create a huge liability when everything starts falling apart — as the Richmond Public School system has discovered to the consternation of all.

Average age of city/county infrastructure. Source: Moody’s Analytics

A decade ago both cities and counties in Virginia were devoting significant resources to capital expenditures. Since peaking in 2009, however, capital spending as a percentage of capital assets has declined markedly for cities and precipitously for counties. As a consequence, the average age of infrastructure, as calculated by Moody’s Analytics, has gotten considerably older. For cities, the average age has increased from about 13 years to 17 years; for counties, the average age had gone from about 7 years to more than 10.

The third trick isn’t even a trick — it’s the use of shameful accounting gimmicks. Prime example: the accelerated sales tax. During the last recession the General Assembly told retailers to accelerate payment of the sales tax by a month, allowing the state to collect 13 months of taxes in 12 months. The legislature has rolled back accelerated collections for smaller retailers but not for larger retailers accounting for the bulk of tax revenues. What’s the legislature going to do next time — order retailers to pre-pay taxes based on sales that have not yet occurred?

Virginia’s economy is performing pretty well this year, and the state will have more revenue to spend in the next biennial budget. Broadly speaking, lawmakers have three choices when they convene the General Assembly session in January. They can spend increased revenue, they can return some of it to taxpayers, or they can shore up the Commonwealth’s balance sheet.

Spending and rebating revenue is fun for politicians. Stashing the money in rainy day funds and paying down pension liabilities isn’t. But if Virginia experiences another recession like the last one, we’ll curse ourselves for our failure to set money aside when we had it.

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23 responses to “(Fiscal) Winter Is Coming

  1. Wow! I don’t know how much time you spent in researching preparing this but it’s impressive and you deserve kudos for the effort.

    And Haner is going to have to step up his game to keep pace!

    I have, as usual, a comment about: ” Meanwhile, the trust funds for Medicare and Social Security are running out: Medicare in 2026, and the Old Age and Survivors in 2034.”

    Social Security and Medicare Part A are essentially pay-as-you-go programs. The “trust funds” are actually a bit of an anomaly in terms of the actual structure of the programs. The trust funds are actually reserves that have been built up over time by excess revenues from FICA taxes that were higher than actually needed and so a pot of money accrued.

    All things equal -you can take that entire pot of money away – and FICA taxes will continue to generate about a trillion dollars a year – almost as much as the income tax generates. That money will be collected and then immediately spent on Social Security and Medicare and that’s actually the way the program is supposed to function.

    The “glitch” is that all such funds whether FICA/Social Security or public or private pension funds have to periodically re-balanced actuarially. We see this, for example, in the Virginia VRS pension as well as the Fairfax County pensions – both need to be adjusted for things like retirement age and how much workers contribute, etc. Social Security also has to be adjusted but because it requires an act of Congress and Congress is all over the map on fiscal issues including the deficit and debt – little is being done.

    But fixing Social Security and Medicare Part A is child’s play compared to the deficit/debt. It pretty much can be fixed by fairly minor tweaks in retirement age, some other well understood options – https://www.cnbc.com/2017/07/11/2-simple-tax-changes-that-would-fix-social-security-for-good.html

    Medicare Part B and Medicare Advantage, on the other hand, are going to bankrupt the country if they are not changed. Basically, taxpayers are subsidizing health care for those on Medicare to the tune of about $500 a month per recipient and retirees who are well off are using that subsidy to further build their own wealth rather than paying more for their own legitimate health care expenses.

    Similarly – the Military spends way, way too much on really stupid and wasteful programs in the name of “defense”. We spend on defense MORE than the next 10 countries in the world – to include ALL of our allies as well as Russia and China! And a LOT of our costs are on military pensions and benefits. 99% of our military never serves in a war zone. They basically stand by “ready” – and we pay dearly for that. I’m not arguing against readiness nor our duty to safeguard the world – but we are not doing it in a fiscally responsible way.. of all things the govt throws money at – including entitlements – the military is among the worst.

    So – our esteemed Founding Fathers created our system of governance and politics and are said to be “brilliant” and “visonary”. I say – when we reach the point where money rules our elections, and elected feel more loyalty to their respective political parties and willingly stand by why we go to hell in a fiscal hansbasket – our system ain’t so hot and something needs to change because as Jim Bacon warns – no matter who the POTUS is – even the current idiot – our deficit and debt seem to roll on to disaster. Of course what should we expect when we have so many “skeptics” on other things like science? They don’t believe in Climate Change nor fixing the deficit/debt!

    • Have you seen the climate change fuel tax increase riots in France? And in Europe, there isn’t much skepticism about Climate Change. Maybe they have figured out that this a big transfer of money from ordinary people to landowners on the French Rivera.

      Recently a study was released showing 63% of immigrants were on welfare. That estimate has also been criticized as being too high. But either estimate demonstrates we are importing poverty, something that is not helping the deficit issue. And what fries me is that every parent who adopts a child from overseas must submit income tax returns and other financial information to prove that the child is not likely to become a public charge. Why is there a difference?

      If hard decisions need to be made for American citizens, why are we importing poverty and incurring major costs? It makes no sense. Why doesn’t every immigrant need to prove that she is financially stable or that his sponsor is and is going to support the immigrant?

      • The comparison with the Yellow Vest rioters is apt. Income inequality is another name for the limits being reached here.

        But we have to agree to disagree on the cost to the rest of us of those immigrants. The economists say we must import their labor, particularly their skilled labor, for our economy to remain healthy, and they pay plenty of taxes on that labor here. And anecdotally, i.e. just my observation, it’s first-generation newcomers to this Country who seem to be doing half the work around here, or more, when you need to get something done in NoVa. They bring a work ethic that more than makes up for the assistance they require to get their feet on the ground.

        • Yup – we want the low cost labor but we don’t want to be responsible for the impacts of that low cost labor on the folks who get paid and have to find a way to pay for shelter and food.

          So, we demonize them – which is in my view really moronic.

          But it’s very effective politically.

        • Acbar – I’m all for encouraging skilled immigrants from overseas. The problem is that we are bringing in unskilled labor who generate a lot more costs than they pay in taxes.

          FCPS has well more than 25% of its students qualifying for free and reduced priced lunches, which is a marker for many other educational expenses. School officials have said off the record that the reason we have large class sizes in non-poor parts of the county is the need to put resources in poor areas, most of which have high populations of parents who aren’t here legally.

          Why have wages stagnated? The post-baby boom generation is smaller and the scarcity of workers should have pushed wages up. But when you open the doors to unauthorized workers, you see wages stagnate.

          I’m all for a compassionate program for people who have been here illegally for say ten years, paid taxes and stayed clear of the law, except for minor infractions. But we cannot do that until we get control of the borders. And as we robotize society over time, there will be fewer and fewer unskilled jobs. The unskilled will be more and more marginalized and their children will take to the streets in riots. No nation can survive unless it can control its borders.

    • Larry, you always say the same thing about Social Security, and this obscures what the CBO projection shows. Redeeming the Trust Fund over the next 16 years or so is going to drive about $3 Trillion in debt in current terms, which is about 15% of GDP. To put this in perspective, the Civil War drove the U.S. to a 25% debt level, so it certainly is not insignificant. The CBO projection includes this, which is one of the reasons why the CBO projection ramps so steeply.

      We have only been at these debt as a percentage of GDP levels during WW2. At that time, the debt could be financed internally. Today, we are much more dependent on external sources. I think Jim’s points are valid.

  2. Wait until that inevitable recession, or depression, hits our horribly bloated and corrupt system of higher education in this country. And hits folks loaded down with a $trillion+ of debt for trying to get an education in America. Rating agency corruption played a major roll in the last recession. That same corruption will play a bigger roll in the upcoming recession which might well cascade into a historic depression the likes of which we have never seen before. Current wild swings in the stock market, gridlock on our roads and in out government, and riots in our streets and on our campuses, are canaries screaming in our coals mines. Wake up, USA!

  3. “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.”
    ― Alexis de Tocqueville

    The problem was obvious while the founding fathers still lived, Larry. Jim was writing this, and our illustrious mayor here in the city was leading a rally screaming “more, more” for his school budget. Trump is one of many idiots, Larry. The process generates idiocy. Voters are the real problem.

    Having said that, given all the true things Jim said, he ignored what I think the General Assembly could and should do. First, a hatchet could be taken to government spending. Jim and I focus on the universities and their bloated and wasteful ways, but many other agencies of the state need the same treatment. Second, the tax code is terribly disconnected from the economy. It is not that I see the conformity revenue as a windfall to be returned, but as an opportunity to make some lasting reforms. A real tax reform effort might not produce less revenue, but more – by imposing the sales tax on more services, and by revisiting so many of the “tax preferences” which have no valid basis anymore, if they ever did.

    Jim sees the problem, but misses the better solutions.

    • I don’t know that I miss the better solutions so much as I didn’t have the space to explore them. I totally agree with Steve that Virginia needs to fundamentally re-think its tax structure and how it delivers core government services — K-12, higher-ed, transportation, land use, health care, infrastructure. Tweaking the existing structure won’t get us out of the mess we’re heading toward.

    • Steve says: “First, a hatchet could be taken to government spending. Jim and I focus on the universities and their bloated and wasteful ways, but many other agencies of the state need the same treatment.”

      Question: Has this been done in past? If so how, and why? How is it to be accomplished today? What needs to happen to trigger the will to cut?

      If the state can’t impose cost savings on its colleges and universities, how can we expect the state to take a hatchet to its own agencies?

    • I actually do agree with much of what you say Steve but I’m not in having of the “hatchet” approach no more than I would for our own personal budgets.

      It costs money to have a decent civilization – but I do agree, we have some mismatches in how we tax and how we spend but I bet we diverge on that.

  4. Regarding Jim’s post:

    Here, along with education, is a particularly big snake in Va.’s woodpile.

    “A decade ago both cities and counties in Virginia were devoting significant resources to capital expenditures. Since peaking in 2009, however, capital spending as a percentage of capital assets has declined markedly for cities and precipitously for counties. As a consequence, the average age of infrastructure, as calculated by Moody’s Analytics, has gotten considerably older. For cities, the average age has increased from about 13 years to 17 years; for counties, the average age had gone from about 7 years to more than 10.”

    This deferred maintenance suggests that rot riddles local governments throughout the state, a pervasive spread of the Petersburg Va. plague.

  5. The Wilder and Warner administrations made serious efforts to rationalize and reduce costs of state administration. Not all ideas were implemented, and the savings, though worthwhile, were modest. Nothing has been done in 14 or so years.

    In any case, administrative overhead is not the major cost driver of state spending. Medicaid stands at the top of the list.

    No one has tackled the costs driving medical spending higher.

    No one at the state level has tackled the land use/transportation nexus.

    No one has tackled the dysfunctions of K-12.

    No one has tackled the cost drivers of higher-ed spending.

    No one has tackled the drivers of inter-generational poverty.

    • I think we HAVE “tackled” a lot of these problems – but we are not as successful and we need to be. I’m a half-glass person – I do give credit to progress that has happened but also acknowledge we have a ways to go.

  6. The cost of government pensions is a major cause of budget problems, deferred maintenance and cuts in capital spending. The Fairfax County report on its county employees’ main pension fund issued in October 2018, shows a net unfunded liability of approximately $1.521 billion. $122 million for the police officers’ pension. $114 million for the other uniformed employees pension.

    These figures do not consider the Fairfax County Public Schools’ share of VRS’s unfunded liability, the county employees’ Social Security supplement pension or the Schools’ Social Security supplement pension. The middle item will not be available to new hires on or after July 1, 2019.

    So if we add just the unfunded liabilities listed above, we get $1.748 billion. The FY 2019 real estate tax rate produced $24.6 per penny. Dividing 1728 million by 24.6 produces a needed tax rate of approximately 71 cents more than the $1.15 per hundred or a real estate tax of $1.86 per hundred. That would have raised the average homeowner’s real estate tax bill to approximately $10,178 from $6293 (the average tax bill for 2018). I speculate that a $3885 increase in average real estate taxes during 2018 would have put Fairfax County residents ahead of Parisians in rioting.

    I hazard to say that even the idiots at the Washington Post would not advocate for a $3885 increase in average real estate taxes. But each additional $24.6 million of tax revenues devoted to funding pension liabilities is $24.6 million not available for county programs, employee compensation or debt service.

    As Jim suggests, Governor Northam and the GA need to find ways to cut government operating costs, as do every local elected official. But pension costs can still cripple government budgets.

  7. This is a minor point that does not take away from the basic message of your article, but I question your statement that “hundreds of cities, counties, towns, and independent authorities in Virginia, many of which administer their own pension plans.” There are six cities, two counties, and one town over 5,000 that administer their own retirement plans, but in some of those cities and counties the constitutional officers are in VRS. Towns under 5,000 are not required to be in VRS and the list in the link may not have them all, but I strongly doubt they have the capacity to have a private plan. (vaco.org/MiscellaneousStuff/ErikLocalities.pdf). I cannot find any list of those authorities and special districts with their own plan so that number may be unknown unless someone want to comb through their financial reports. The employees of many of the authorities, however, are covered by either VRS or their locality’s plans. Bosun

    • Glad to see Bosun joining the comments. Don’t always agree but often do and always find his comments worth reading!

      The bigger argument with the pensions seems to be from folks like TMT that we essentially are paying people too much money especially the amount we promise them on pensions – and it’s more than we can deliver and thats why we have these huge tax-eating budgets as well as unfunded liabilites.

      So is there agreement on the cause?

      And the solution is what? Less Fairfax teachers and lower pay also?

      Serious question.

      Of course, it’s hard to look at Fairfax financial situation in isolation. It’s not only the most prosperous region in Virginia, it’s one of but seven with a AAA credit rating. So if NoVa is “bad”, what is RoVa? worse? So we’re all going to hell in a handbasket on government spending and finances?

      Hmmm…. and the “solution” is to take a “hatchet” to it? cut the number of teachers and reduce the pay of the rest? Okay… is that something the majority of taxpayers would support? AH HA… I bet we find out that it’s really a distinct MINORITY of folks who actually do favor that hatchet.

      Damn Founding Fathers! They had this stinking bad idea about voters and government and elections and all that stuff… perhaps we should re-assess our situation and look to Russia or some 3rd world countries for better governance models, eh?

      • Larry, Fairfax County officials have publicly recognized that a reason that teacher salaries in FCPS lag those of nearby jurisdictions is the excessive costs for pensions. But then no other nearby jurisdiction offers anywhere near the pension plans that FCPS does.

        Pension costs are swallowing wages for most teachers.

  8. It is also way past time to look at the tax exempt status of nonprofits. I’m all for allowing nonprofits that provide services to people, including spiritual ones, or fund scientific research to be tax free. But we also allow for the tax-free status for private foundations (an ego trip, perhaps) and nonprofits that try to affect/effect public policy. Any nonprofit that pays people (either in-house or outside contractor/service provider) to influence public policy should be subject to federal income taxes.

    Likewise, a person leaving money at death or when living to a nonprofit should be limited to an amount that can be given tax-free. The excess should be taxed. I wonder how much additional money this would put in the treasury.

    • TMT, I agree on nonprofits, and would add that nonprofit financial advantages are probably being used to reduce competition and increase prices in areas like healthcare.

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