Federal Bailout Won’t Fix States’ Finances



Illinois State Capitol in Springfield (Library of Congress)

This contagion has nothing to do with coronavirus.

Bailing out the Illinois state pension system is the worst idea from a week in which we were discussing the health benefits of mainlining Lysol.

(Please do not mainline Lysol. It will kill you.)

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Irresponsible state and local governments are attempting to exploit the fear and disruption of the coronavirus epidemic to push off the consequences of their decades of reckless and culpably dishonest policies onto the federal government. This will inspire a great deal of conversation about “moral hazard” and “fairness,” but the fundamental problem is something else: Such a bailout would not work because it would not actually solve the real-world problems that threaten to cripple state and local finances.

Contra Mitch McConnell, the Senate majority leader, this is not exclusively a “blue state” problem.

State and local governments are facing short-term financial problems that are tied to the epidemic and the imposition of social distancing, lost tax revenue prominent among them. With businesses forcibly closed and unemployment soaring, there is less money coming into state, county, and city tax coffers. Some states are better prepared for this than others: Wyoming maintains a “rainy-day” fund that has socked away in it funds equal to 109 percent of the state’s annual government expenditures. Alaska has more than half a year’s expenditures tucked away, North Dakota 30 percent, New Mexico 27 percent. Most states have a good deal less, and some have very little: New York has only 3 percent, Pennsylvania 1 percent, and Senator McConnell’s home state of Kentucky less than 3 percent. Illinois, to nobody’s great surprise, comes in at 0.0 percent, no doubt from spending all its money on Chicago-style avocado toast.

Conservatives often have been critical of these funds, characterizing the reserves as excessive and arguing that the funds should be drawn down to finance tax cuts. In uncertain times, Wyoming’s big fat fund looks pretty smart.

Illinois still looks like Illinois.

The thing about unforeseeable circumstances is, they’re unforeseeable. Nobody knows which days are going to be rainy, though we do know with a reasonable degree of confidence how many rainy days there will be in a year or a five-year period. Responsible people and governments save up for emergencies — even if they do not know what the emergency is going to be.

Or they used to. But when credit is cheap, the ability to use debt in lieu of emergency savings can be very alluring. And it even may make financial sense on a limited fiscal horizon.

Because the United States has for so long relied on driving down interest rates as a form of economic stimulus, carrying lots of debt and very little cash savings may make financial sense on any given day or in any given week. If you can get a 3.5 percent mortgage with inflation at 2 percent, then it makes more sense to keep your money invested than to drain your brokerage account to buy a house or make a big down payment. If you are the federal government and can get your money for nothing, then there’s a certain sort of logic to running big deficits. State and local governments can’t usually borrow quite as cheaply as Washington can, but the incentives are much the same.

The political incentives are even more powerful than the financial ones. A few curmudgeons and your favorite scold aside, everybody likes spending. Nobody likes paying taxes. If you can get an extra $1 trillion a year to throw at the voters without taxing them an extra $1 trillion a year, then that has strong appeal.

But the shenanigans get more complicated than that. One of the largest problems facing state and local governments, from Illinois to Oklahoma and from Los Angeles to Dallas, is “unfunded liabilities,” meaning the differences between the promises governments have made to their employees and the money they have set aside to pay for those things.

This mostly has to do with pensions and medical benefits in retirement. Government workers are a powerful political constituency — they run California — and they want the same thing everybody else does: more. In order to keep them happy, governments may give them bigger salaries, but these have to be paid for on an ongoing basis, which means putting these expenditures in the budget and collecting taxes to pay for them. Those taxes are not very popular with the people who have to pay them. So what governments do instead is ask their employees to forgo larger increases in salary today in exchange for more-generous pensions and retirement benefits in the future. But instead of saving the money they’ll need to pay those future benefits, irresponsible state and local governments spend that money in the here and now, shortchanging their pension funds.

The short-term problem for ailing state and local governments is diminished tax revenue from the epidemic. That is precisely the kind of problem that can be mitigated through ordinary fiscal responsibility: Don’t take on debt in good times, carry reserves when possible, diversify revenue streams. State and local governments have long experience riding the revenue roller-coaster. In California, much of the state’s revenue comes from capital-gains taxes, while in Texas much comes from energy, and both of those states maintain rainy-day funds precisely because of their experience with the volatility of their important revenue streams. States should carry larger reserves. It is true that it is easier for Alaska to do this than it is for New York State, because Alaska has all that oil revenue, but New York State lacks oil revenue because of Governor Andrew Cuomo’s fracking ban — not because of a lack of oil.

(What’s your excuse, Pennsylvania?)

If you doubt that the pension issue is central here, consider Illinois’s request for a federal bailout, which proposes $10 billion in pension aid but only $1 billion to help provide health care to poor people. It also seeks $15 billion in unrestricted assistance to the state and $9.6 billion in direct aid for the cities. This proposal was put together by the Democratic state-senate leader in Illinois, Don Harmon, who knows that current and retired employees are 35 times more important to him and his party than are poor people who need health care — and he did the numbers accordingly.

Congress cannot solve the problems in Springfield or in any other state capital — even if it knew how, and even if it wanted to. If Washington were to dump a few billion dollars into the lap of the feckless cartwheeling goobers who run Illinois, the underlying problem of chronic underfunding of future pension liabilities would remain, and Illinois would be right back where it is today in a year or two. A bailout would not solve the problem — it would keep the problem from being solved.

Under our Constitution, Congress cannot simply dictate to Illinois how it organizes its own affairs, and those affairs are going to have to be reorganized. Specifically, Illinois is at some point going to have to enter into negotiations with its pensioners and current employees and get them to agree to accept substantially reduced benefits. The state cannot tax its way out of this hole. Illinois’s unfunded liabilities right now are $137 billion. Another way of saying that is that Illinois has about 15 years’ worth of pension contributions to make up for. Given that making up this deficit would cost Illinois 100 percent of its tax revenues for about four years, it is unlikely to be able to make up the shortfall even if it wanted to. The state already is running chronic deficits as it is.

When it comes to the question of aid to state and local governments, Washington has to distinguish the short-term problems from the long-term problems. And the long-term problems will not — and cannot — be solved in Congress.

Illinois and other states with similar problems have a few tools for addressing them: higher taxes, lower spending, reduced benefits, and a few outside possibilities such as asset sales, something Illinois governor J. B. Pritzker has sought to explore. How to mix and combine those approaches is a question of politics. That is has to be done is a question of math.

And there is no sense in trying to bail out these states until they address the real problem: the epidemic of irresponsible government.


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