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State & City Budgets:

Dangerous Hot Potato

By   Shlomo Maital

      US State and Local Budget Deficit/Surplus, 1960-2016

     Amazon has just announced it will split its new headquarters buildings between Long Island City, Queen’s, and Northern Virginia, and a smaller center in Nashville.   According to CNBC: “The company said it will receive up to $2.2 billion in performance-based incentives from the three areas: $1.5 billion associated with its investment in Long Island City, $573 million in Arlington and up to $102 million in Nashville. The incentives take the form of cash grants and tax credits, and some take effect over time.”

     The announcement highlights an interesting fact. As MIT Dean Lester Thurow noted once, companies once paid taxes to cities, and now cities pay taxes to companies (like the huge grants Amazon received). True, Amazon will invest substantially – but giving over $2 billion to a company whose stock is worth $800 billion? That made $3 billion in profit in 2017?   From city budgets that are already strapped? Amazon’s Jeff Bezos, of course, cleverly strategized by creating a competition among cities over who would give him the best deal.  

   And there is a much deeper problem, too.

   The U.S. federal government recorded a $100.5 billion budget deficit in October, an increase of about 60 percent from a year earlier. That is the gap between what the federal government spent and what it earned in taxes, in just one month!. On a yearly basis, the federal deficit is headed for a record 1 trillion dollars, or over 5 % of US GDP. The cause? Mainly, the massive Trump tax cut passed in 2017. Most of it went to businesses, and they in turn spent it on buying back their shares and on dividends. Very little went to capital investment.

     How will this deficit affect ordinary Americans? The press focuses on the massive $20 trillion US public debt that future generations will have to pay, as the federal government borrows tons of money to pay its bills. But there are deeper reasons for concern.

     Many experts predict an imminent slowdown in the US economy – perhaps, a recession. What happened in the last recession that followed the 2008 financial crash?

     According to Tracy Gordon, Brookings Institute, Washington, “More than in past economic downturns, state and local governments were a prominent casualty of the recent recession. States in particular saw their revenues plunge. Although state taxes have been rebounding, local property taxes have dipped, consistent with a two- to three-year lag between home prices and property tax rolls. These reductions coincide with state cutbacks in local aid, further squeezing local budgets.

       [See Figure: State & Local Government Deficit/Surplus 1960-2016]

   Why is this a potential serious problem? Gordon continues,    

     “These are critical issues because states and localities perform most of the activities we commonly associate with government. They undertake most direct spending on public goods and services (including their expenditures from federal funds), and they bear primary responsibility for investments in education, social services, and infrastructure that directly affect our national economy and quality of life. States and localities are also key economic players, comprising 12 percent of Gross Domestic Product (GDP) and employing 1 out of 7 workers – more than any other industry, including health care, retail sales, and manufacturing.”

   In other words, state, local and city governments supply the things that underpin quality of life – health care, education, transportation, infrastructure. They generate one dollar in every 8 dollars of GDP and employ one worker out of every seven.

     So, here is a scenario that is a cause for worry. The US economy goes into recession in late 2019. The trillion dollar federal budget deficit swells dangerously. The federal government slashes spending where it can – cutting financial aid to state governments. State governments (many are constrained by law to balanced budgets) in turn slash their grants to municipal, local and city governments.

     And these, in turn, slash spending on the things that make life pleasant, or bearable, for most Americans. Potholes? Traffic jams? Dangerous roads?   No money available to fix them.

     This is a dangerous game of ‘hot potato’.   And it’s not a pipe dream. It happened in 2010.   Deficit hot potato passes from the federal government to the state government, which in turn tosses it on to local and city government. The buck stops there, and that hot potato burns our fingers. It happened before – it will happen again.

     On a recent trip to the US, my wife and I made frequent use of WAZE. WAZE kindly told us about every pothole. And there were a whole lot of them.   I don’t recall that feature in other countries.

       Even in good times, city budgets are strained. Seeking re-election, mayors spend their money on the short-term, while costly long-term capital spending is neglected. (Why spend money to help some future mayor, maybe a rival, get elected?).  

       There is a solution. Let state legislatures require cities to build five-year capital expenditure budgets, to accompany the one-year operating budgets. Let the federal government help the states and cities pay for interest costs on debt that finances capital spending. Protect those five-year budgets zealously from ‘theft’ (shifting spending from long-term to short-term).  

       Conservatives will scream, socialism!   Five-year plans are used, for instance, in China. OK – ever looked at China’s infrastructure? Fast trains, brand new airports?

       Hot potato crises for city budgets make no sense. It’s time for a change.

        Half the world’s population now lives in cities. By 2050 that will rise to 75%.   How cities spend their money and raise their revenues will have a huge impact on the wellbeing of the people who live in them. And there is a ‘hot potato’ problem. It’s time to fix it.

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Blog entries written by Prof. Shlomo Maital

Shlomo Maital
June 2019
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