How Bad Can It Get? You Don’t Want to Know.

Try taking $9 billion out of this, and see what happens. Image source: Department of Planning and Budget

The United States is enjoying 112 months of uninterrupted economic expansion. We’re basking in one of the longest business cycles in American history — the average expansion since World War II has lasted 58 months. Unless someone has repealed the laws of economics, sooner or later, we’ll experience another recession.

There is a widespread belief among economists that the longer and stronger an expansion lasts, the more complacent people get about the chances of anything going wrong. They take greater financial risks, misallocating capital and seeding the next financial crisis and recession. Compound inevitable investor greed and folly with years of highly stimulative central banking policies in the U.S., Europe, and Japan that expressly encouraged people to take more risk — resulting in unprecedented borrowing and debt accumulation around the world — and the global economy could be cruising for a major bruising. When the next recession comes, it could be a doozy.

How would another 2008-scale recession impact state government finances here in Virginia? Someone asked that question of Virginia Finance Secretary Aubrey Layne, and he gave an answer at an Oct. 25 hearing of the Senate Finance Committee. (You can hear his remarks here. Go to the 23-minute mark.)

Layne emphasized that he knows of no mainstream economist who is predicting such an event, at least not in the next 24 months. But the fiscal consequences would be cataclysmic. Virginia’s General Fund budget would experience three years of what Layne, in his understated manner, described as “fairly significant” declines in revenues:

Year 1 — $2.6 billion
Year 2 — $3.7 billion
Year 3 — $3 billion

Those numbers are cumulative. The declines would total $9.3 billion over the three years. As a point of comparison, the FY 2019 General Fund budget is a bit more than $20 billion. That wouldn’t be a mere budget crunch. It wouldn’t cause routine pain and hardship. It would mark the end of state government as we know it. It would unravel the social fabric.

As Layne noted, Virginia has limited policy “levers” to pull to counteract such a drastic revenue fall. The Commonwealth is prohibited from running deficits, and it can’t print money. The state has about $1 billion in reserves — that would get wiped out in the first year. 

Broadly speaking (this is my analysis, not Layne’s), Virginia has three options: raise taxes, cut spending, or engage in fiscal sleight-of-hand. Higher taxes would reduce the state’s long-term economic competitiveness, crippling the state in the long run. As for cutting spending, many argue that the state is already under-investing in key areas such as K-12, higher education, mental health… and the list goes on. So-called “unmet needs” are limitless.

That leaves fiscal sleight of hand. Remarkably, Virginia has retained one of the gimmicks it adopted during the last recession — the “accelerated sales tax,” in which the state compels large retailers to accelerate payment of the sales tax by a month. That created a significant bump of revenue in 2010 when the state needed it most. But budget makers never fully unwound the measure. Lawmakers, suggested Layne, might consider reverting to the traditional way of collecting the tax. (Total state sales tax revenue this year is projected to be around $3.5 billion. Unwinding the accelerated payment, I presume, would entail foregoing about 1/12th of that sum, about $300 million.)

The state also could do what it did from the last recession, short-changing payments to the Virginia Retirement System and paying back the balance over time. But this time around, we’d be ten years closer to actually needing the money to pay for the pensions and healthcare benefits promised to the latest wave of retiring state employees. Borrowing from the VRS at this point would be reckless in the extreme. Without getting into specifics, Layne suggested that legislators might want instead to “look at” the retirement benefit plan obligations.

One other option would be to refrain from issuing long-term debt. Virginia tends to borrow up to the limit of its bonding capacity. (To preserve the state’s AAA bond rating, bipartisan policy dictates that debt payments not exceed 5% of General Fund revenue). Exercising self-restraint now would preserve the state’s debt-issuing capacity in the event of a major revenue downturn.

The Northam administration is preparing its budget recommendations for the next fiscal year, and legislators will have a lot of their own ideas on how to modify it. Virginia will benefit from windfall revenues from a variety of sources, and likely run a budget surplus, too. This may be one of Virginia’s few remaining opportunities to put its fiscal house in order before another recession. Failure to prepare for the inevitable downturn would be unforgivable.

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21 responses to “How Bad Can It Get? You Don’t Want to Know.

  1. We worry about a sustainable environment. That makes sense even though reasonable people can disagree about the details.

    Why don’t we worry about a sustainable state government? (Let’s put aside federal and local government for now.) Government spending grows faster than increased income. Why is that sustainable? It isn’t. People who want to protect or increase spending generally want someone else to pay for it. Now reasonable people can disagree with what programs are worth funding and by what amount. But in a global economy, we cannot afford a bloated and inefficient state government.

    Every dollar taken from taxpayers is one less dollar in the private economy that produces the growth in the economy and growth in incomes. Of course, we need to take dollars from the private sector in the form of taxes to fund state government. But then shouldn’t we insist that those tax dollars perform vital services in as efficient way as possible. And if we go beyond only the essentials, shouldn’t we insist that those extra dollars produce a return on investment that is at least as good as the private sector produces?

    We need to streamline state government and focus on better performance. We need to say no to special interests that seek a free ride on the taxpayers. We need to start by rooting out crony capitalism.

    • TMT, great analogy on sustainability (environmental vs. fiscal). There used to be a time when I could think of financial sustainability advocates at the state and federal level. I can’t think of them any more. Democrats want to spend and Republicans want to cut taxes and maintain or grow spending in many areas. There is no recipe for sustainability in that.

      The business cycle is well understood (although predicting downturns it with any precision is difficult, everyone knows they happen). The average impact to budgets is known. It is a relatively simple mathematical exercise to see that preparations should be made to buffer against downturns (or make adjustments to pay-as-you-go programs), but the political will is not there.

  2. Gosh, Jim, you have become such a shill for big government. Where are they holding your family at gunpoint? Who holds the note on your house? Yes, another recession WILL come and the state will face some very hard choices, in part because it has lacked the discipline to build up real reserves. When in the past ten years has there been any efficiency or reform effort, some true value engineering? Who dares challenge the state’s archaic structure, or the local system of constitutional officers that goes back to the English kings? What steps have been taken to insulate our tax revenue from future recessions by reducing the reliance on the personal or corporate income tax and increasing reliance on consumption or activity taxes? Former Speaker Howell did shove through some VRS changes which over time will have great impact, but the time to further tweak the retirement system is NOW, not during a recession.

    Bless their little hearts, few politicians can see beyond the next election, let alone plan for a decade into the future. I don’t see why its my job to bail them out by letting them tax me more.

    • Shill for big government? Me? I hope you’re being hyperbolic for rhetorical effect.

      I totally agree that the state governance system is antiquated and in desperate need of a radical overhaul. Indeed, that’s the only way out of the mess we’ve created. But state government does a lot of very important things, and it would be highly disruptive to our economy and society if it was suddenly unable to do those very important things any more.

  3. re: ” Higher taxes would reduce the state’s long-term economic competitiveness, crippling the state in the long run”

    ditto re: ” Every dollar taken from taxpayers is one less dollar in the private economy that produces the growth in the economy and growth in incomes. ”

    Treating taxes as if they are taken from taxpayers to disappear down a black hole is just plain wrong.

    Taxes employ people and pay salaries and it comes back into the economy just like private sector salaries do.

    I’m NOT advocating higher taxes but I AM saying that whether money is spent on a latte at Starbucks or paid in taxes to then fund a teacher or policeman – they’re essentially the same.

    The actual real difference is in terms of productivity. Does a private sector job generate more/better productivity?

    Does Fairfax raise taxes to buy more school teachers or should they lower taxes and fire teachers and let taxpayers spend that money on private school teachers? either way – you’re buying a teacher.

    By the way we should get Layne and Northam KUDOS for taking a hard look at the worse case AND for telling us what they found. That’s what real fiscal conservatives should do instead of borrowing money like the FEDs do or letting unfunded infrastructure liabilities accumulate like many local govt does. VDOT, to it’s credit does not hide the state of it’s infrastructure – it is transparent about it; they’ll tell you how many bridges or roads are deficient and they prioritize the money they do have.

    • The data shows irrefutably that people are migrating out of higher-tax states to lower-tax states. Virginia has shifted from a net beneficiary of this migration to a net loser. Increasing taxes — especially the personal income tax — will accelerate our brain drain.

      • Yep, yep, yep. You understand why I’m advocating fiercely for using the conformity debate as a way to lower personal income taxes for the working class, but you are with the Bad Guys saying the state should keep all them money!

        I posed a question the other day I cannot figure out how to answer, but when immigrants do come to this country (and many still do legally, if not enough) where do they go? When they have a choice, do they choose the low tax states? It would be hard to tease out the data because as noted those are the states with the burgeoning economies so they’d be the natural magnets for incoming talent anyway. I’m doubtful Virginia is that attractive anymore.

        • Regarding your question about immigrants: The traditional pattern is that immigrants tend to settle with others of their own nationality, language and culture. That’s why they tend to cluster in large, metropolitan gateway cities.

      • That may or may not be true but you avoided the core issue about taxes and the fact that they too create jobs………

        • Actually, it’s not a core issue — it’s a totally tangential and irrelevant issue. I don’t know anyone, and I mean anyone, who denies that tax revenues support jobs. Of course they do. There simply is no debate over the matter. The question is whether transferring jobs from the private sector to the public sector saps productivity, innovation, and longer-run economic growth. A huge body of evidence suggests that it does. You appear to be unwilling to acknowledge the point.

          • Actually there’s NOT a “huge body of evidence”… at all.. and that’s why it’s most often quantified this way, and I quote: ” Higher taxes would reduce the state’s long-term economic competitiveness, crippling the state in the long run.”

            Tell me HOW, if that dollar goes right back into the economy, just as a private sector dollar does – that it “cripples it”?

            That’s just grade A hogwash.. but it works.. it’s very effective and it’s taken as an article of faith by rubes and others who don’t fancy themselves as rubes. It “works” but it’s patently false.

            We never actually quantify the difference between a dollar in the private economy and a dollar in taxes.

            And it’s clearly not even the case if we trade a dollar for roads or public safety for a dollar for pornography or a dollar spent on seafood on vacation.

            Both public safety and transportation water/sewer, libraries also generate productivity.

            It’s just a belief – that has never been really quantified in any reasonable way where someone can say (for instance): a dollar for govt produces only 90 cents whereas a dollar in the private sector produces $1.10.

            Over and over – people DO say that a dollar for govt takes a dollar out of the private sector – as if that dollar goes into a black hole and takes a dollar out of the economy. You don’t hear folks saying that a dollar at McDonalds is better than a dollar spent Police – only that that dollar in tax – is a dollar wasted on government.

          • Larry, I thought the core issue of this thread was about fiscal responsibility, not the relationship of tax structure or rates to economic growth. That is a very complex subject and detracts from a meaningful discussion of whether the state is prepared for a potential downturn.

    • Larry – if we just spent our tax dollars on teachers and police officers, I don’t think we’d (Virginians) have a financial problem and be involved in such disagreeable disagreements.

      We’d increased spending on K-12 education and post-high school education at rates that greatly exceed increases in students, teacher salaries, population and inflation. We’ve added dozens of programs and administrators over the years. We cannot stop the City of Alexandria dump raw sewerage into the Potomac while we are taking on climate change.

      We need to eliminate programs that are duplicative or that don’t produce their projected results. We need to lay off workers who aren’t in line jobs. Business always looks for ways to cut staff that don’t help provide customer service. We need to stop crony capitalism and subsidizing businesses.

      We need the federal government to enforce the immigration laws. We have native born poor people. We don’t need to import more. We need to cut to the point where the WaPo editorial board attacks Northam daily.

      • re: ” We need to eliminate programs that are duplicative or that don’t produce their projected results. We need to lay off workers who aren’t in line jobs. Business always looks for ways to cut staff that don’t help provide customer service. We need to stop crony capitalism and subsidizing businesses.”

        I totally agree but does that tell us how MUCH we SHOULD be paying in taxes? It sounds like a blind and dumb way to decide what services we want and which ones we don’t or we do but done more cost effectively. None of this has much to do with the basic concept that taxes harm the economy because they take away from the economy – as if the taxes are going into a black hole rather than paying salaries that go back into the economy just like private sector salaries do.

        So, let me ask you – how many soldiers do we have that do nothing but “stand-by” ? how man do we need? how do we know we have enough or not enough? These same questions can be asked about other govt positions.

        “We need the federal government to enforce the immigration laws. We have native born poor people. We don’t need to import more. We need to cut to the point where the WaPo editorial board attacks Northam daily.”

        What we need is to stop demonizing immigrant workers – which the anti-immigration folks do – it don’t matter if they are “illegal” or not – it’s the fact that they are immigrants and not “our kind”.

        If you want to stop illegal immigration – prosecute the companies that hire them. Put those companies out of business. Then you’ll see an end to folks coming here for work.

        The real question here is – is it illegal immigration we really want to deal with or is this some right-wing jihad against brown people and they’ve sucked in the rubes to join them?

  4. re: immigrants – some of the wags who comment here will say they go to where the most/best freebies are….

    but again – taxes go to hire people and those people buy houses and food just like the folks who are hired in the private sector.

    Sure people want lower taxes – they want lower-cost health care and less expensive license plates… but that does NOT mean that their taxes don’t benefit them with important services that they just take for granted – for instance when they call 911 or expect their kids schools to have “sports” or music or help for their child in school.

    Again – not advocating higher taxes – advocating some recognition that taxes do not go into fiscal black holes as if they hurt the economy. That’s just plain illiterate – in terms of economics.

    People expect government services like traffic signals, police, and school buses for their kids but then they turn around and claim that taxes “harm” the economy – as if VDOT, Police officers, teachers and school-bus drivers don’t spend their tax-funded salaries like private sector employees do.

  5. We don’t like taxes. I HATE taxes. I HATE it when I get my tax bill from the county – I cannot believe they are taking that much money from me when I don’t use any of their feaking services! TRUE TRUE TRUE!

    I’m even more agast at tax time. At the end of the day – nearly half of my income goes for government.

    And yes I do much wonder why the county nees more GIS personnel or the local Judge threatens bad stuff if he doesn’t get a new building.

    but in terms of “productivity” – I also know what a lot of people spend their extra money on and it’s not essential things at all.. Even low income folks would rather buy a burger from McD for more than it would cost to cook it. So how do we characterize that dollar at McDonalds as more “productive” than that dollar paying for a deputy or a traffic light?

    And listening to some – we’d take that dollar from paying the deputy to give the guy buying a McD burger – and I quote: “more money in his pocket because people know better how to spend their dolars than Government does”.

    Again – I do NOT advocate higher taxes for more government services but the idea that a dollar for government is a wasted dollar that cripples the economy is balderdash. Thousands and thousands of jobs result from taxes collected and spent on doctors and other medical care. But again – is a dollar in the private sector for a knee replacement any more or less “productive” than a Medicare dollar for the same doctor doing the same procedure?

  6. Back to the basic thesis of Jim’s post.
    It is irrefutable that there is a direct correlation between taxes and economic prosperity – as taxes increase there is an inflection point at which the electorate’s prosperity will decline and ultimately go bankrupt;

    It is irrefutable that governments which base their revenue and spending structure on a ponzi scheme that increasing future contributors will cover the deficits of current spenders court horrific economic disaster if those “increasing contributors” don’t materialize as ultimately and always they will not;

    Almost all taxes are based on the assumption of an implicit ROI — ie schools, police, roads, air transport, health care, even welfare,et al theoretically increase the ability of the body politic to be more productive. But just like corporate capital projects which don’t produce, the costs can easily and quickly exceed the ROI unless managed aggressively. Unarguably and unfortunately, the very DNA of government militates toward the degradation of the ROI of any tax-based expense administered by un-elected and unaccountable individuals. And, equally obvious, any “capital expense” which exceeds the ability of its creator to fund it will produce bankruptcy rather than return.

    Less clear is the antidote to the inevitable metastasizing of government expense and inefficiency and ultimate social disaster, other than bankruptcy and the attendant social disaster. Greece was saved by the EU saying “no more: but with unfathomable distress to many of its citizens–to cite some current examples of Boomergeddon outcomes. The horrible Venezuela disaster is a case study for this discussion.

    Jim’s analysis of the potential consequences of our national fiscal path and Virginia’s? cannot be credibly refuted . Will we see corrective action in our political process or meet the fate that worries him? The current positions and rhetoric of our illiterati appear to be headed to an economic disaster the inevitability of which is well-documented by the last several hundred years of experience throughout the world with the policies currently preached in our Universities, media, entertainment, and of course by at least half our politicians.

  7. re: ” It is irrefutable that there is a direct correlation between taxes and economic prosperity – as taxes increase there is an inflection point at which the electorate’s prosperity will decline and ultimately go bankrupt;”

    Actually, it’s NOT irrefutable unless you can show data to back this up. Otherwise it’s a belief without any real evidence.

    Taxes pay for services just like fees in the private sector pay for services. In fact, some taxes go directly to the private sector to pay for products and services. Much of DOD works this way – all those weapon systems are built by the private sector – with collected taxes. Even at the local level – infrastructure is built – not by govt workers but private sector workers – and paid with taxes collected.

    Same with VDOT. Gas taxes pay for private sector contractors who operate and maintain public roads.

    re: ” It is irrefutable that governments which base their revenue and spending structure on a ponzi scheme that increasing future contributors will cover the deficits of current spenders court horrific economic disaster if those “increasing contributors” don’t materialize as ultimately and always they will not;”

    Oh I totally agree and that’s exactly why the GAPP audit function mandates that local and state govt explicitly represent such things as liabilities -funded and unfunded. But if you go to any company that sells annuities – you’ll find that they also are planning on an ROI to help fund that annuity – and if the ROI does not happen – the amount of annuity falls short of what was promised. We have thousands of people who worked for the private sector and were promised pensions – and now it’s the US govt that is paying their pensions – not those companies.

    re: ” Almost all taxes are based on the assumption of an implicit ROI — ie schools, police, roads, air transport, health care, even welfare,et al theoretically increase the ability of the body politic to be more productive. But just like corporate capital projects which don’t produce, the costs can easily and quickly exceed the ROI unless managed aggressively. ”

    and this too I totally agree with – but this does not mandate some set level of taxes to be collected or not. They’re almost separate issues unless one thinks the govt inherently mismanages money and that’s simply not true overall. There are examples – yes.. there are many more where the govt does a good job of managing “aggressively”. It’s a half glass proposition rather than the idea that any/all govt spending is wasteful and does not return a good ROI.

    re: ” Less clear is the antidote to the inevitable metastasizing of government expense and inefficiency and ultimate social disaster, other than bankruptcy and the attendant social disaster. Greece was saved by the EU saying “no more: but with unfathomable distress to many of its citizens–to cite some current examples of Boomergeddon outcomes. The horrible Venezuela disaster is a case study for this discussion.”

    yep… but there are MANY, MANY more that are not bankrupt nor on the edge of it – some of them highly socialist like Norway.

    But such “outcomes” are self-limiting – Countries don’t go bankrupt and then fold up and close shop. Countries continue on forever in what form or another and what “bankruptcy” ultimately means is LESS services such as we see in the world’s 100+ 3rd world countries.

    re: Bacon’s Viewpoint.

    look around Virginia – out of 133 jurisdictions – 7 of them are AAA rated. Out of the 133 , maybe 5-10 or in terrible financial conditon. The vast majority in the middle are not broke and not going broke. In fact the credit agencies assign their ratings on a localities economy and it’s capacity to tax to pay for services. Low credit ratings go to localities that do not have good local economies.

    So – here’s the challenge. GO find the localities in Virginia that have terrible local economies and PROVE a correlation between HIGH TAXES and a “crippled” local economy due to those taxes. Typically the higher tax places are the opposite. They have robust economies AND high taxes to provide a wide range of services that benefit those who live there – and that’s actually what attracts employers and people who want to live there. Low tax places with skimpy or non-existent services and infrastructure DON’T attract employers or people.. Look at most of Virginia – Rural RoVa – terrible economies and LOW taxes…

    • re: ” It is irrefutable that there is a direct correlation between taxes and economic prosperity – as taxes increase there is an inflection point at which the electorate’s prosperity will decline and ultimately go bankrupt;”

      Actually, it’s NOT irrefutable unless you can show data to back this up. Otherwise it’s a belief without any real evidence.

      I’m pretty sure there aren’t too many scenarios where a 100% effective tax rate shows much economic dynamism. The real question is where the inflection point occurs and it probably varies by community. Areas that have some inherent economic advantage can and do have higher taxes. Other areas that do not have those advantages cannot without risk of losing tax base and businesses to lower tax areas.

      • Yes, right as usual, Izzo. Some highly qualified economic wizards, including Nobel winners, say large economies are so endlessly complex, subject to so many known and unknown variables, that it is impossible for foretell where any inflection point might occur, beyond semi-educated guesses based on how historic trends may have worked their will in the future.

  8. Larry – Fairfax County has been raising taxes at rates that exceed growth in income for years now (not every year but many times well over income growth). Do you think that is sustainable?

    At the same time, the County has been losing middle income people and, in many cases, retirees with higher than average retirement incomes. More people move out than in (negative domestic migration). Growth has been generally growing only from immigration from other nations. Many of these people moving in are well educated and well trained. But many more of them are low-skilled and lack formal education. Many of the latter are hard working but simply don’t bring much to the table beyond a strong back and a willingness to work hard. That was what the United States needed in the 19th and early 20th centuries.

    Due to changing demographics, the County spends much more on social services and additional educational programs every year.

    Fairfax County will always have high-income, high-wealth individuals due to its next door neighbor – Uncle Sam. But its’s becoming more stratified economically. And in that case, will have a very hard time economically when federal spending growth slows as it does periodically. County government and the Schools had a very hard time with sequestration.

    And we are seeing an unstoppable movement to the use of automated systems and robots, etc. to replace manual labor and to perform un- and semi-skilled tasks. https://www.cnbc.com/2018/10/30/the-worlds-first-humanless-warehouse-is-run-only-by-robots.html

    This will not lead to a stable society. Yet the left continues to argue that more and more taxes is the answer.

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