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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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 Infrastructure:  Europe, China – and America
By Shlomo  Maital 
 
    In Economics, there are not many principles we can cite with absolute certainty.  Here are two of them:
   1.  The rate of return on investment in Research and Development is in many cases astronomical.  In 1958 Prof. Zvi Griliches found that investing in research in hybrid corn “paid a return of at least 700 per cent”.   Few other social investments can rival this. Yet countries continue to underinvest in R&D.
   2.  The rate of return on investment in infrastructure (roads, transportation, communication, education) is equally astronomical.  Yet in the West countries continue to undersave and underinvest in infrastructure.
   The contrast between Europe, China – and the US under Trump is stark.
    The EU, not noted for bold innovation, is undertaking a huge infrastructure project that will link Malmo, a Scandinavian port, with Palermo, a port in Italy.  This project will help reduce the large gap between the wealthy Northern EU and the relatively poor Southern EU.  It will do much to knit the fractured EU together, in the wake of Brexit. 
     China has a bold vastly expensive program to build a new Silk Road, linking China with Europe, the Mideast and Africa.   The One Belt One Road initiative, now changed to “Belt and Road Initiative”   is, according to Wikipedia “one of the largest infrastructure and investment mega-projects in history, covering more than 68 countries, equivalent to 65% of the world’s population and 40% of the global GDP as of 2017.”
     And the US?   Well,  on a recent visit there, I used Waze (an application developed originally in Israel, now owned by Google) to navigate.  In the US,  Waze informs the driver of potholes. And, trust me – I heard about a LOT of potholes from Waze while driving in the eastern United states.  Some of them were big enough to swallow Trump’s ego.
      President Trump speaks often about infrastructure.  He has plans to fix it, including thousands of crumbling bridges. But here’s the catch.  The latest Trump tax cut put a huge hole in the government budget and added $1.5 trillion to the deficit.   So there is no money left for infrastructure investment.  The solution?  Trump thinks he can get private industry to finance it, using tax credits.
       This is science fiction.  Basic economics shows, the return on infrastructure investment is largely “social”,  that is,  not captured by private investors, but accruing in a diffuse manner to all of us.  So why would private money invest in it? 
         China, EU – and the US.  Another instance of how the US has become a Third World nation, and China, in the Third World, is becoming First World. 

Why U.S. Dams (and Society) Are Crumbling

By Shlomo Maital

dam

      Two newspaper items (one in New York Times, the other, Financial Times) reveal why America is crumbling.

         California’s Oroville Dam, America’s tallest, has a crumbling spillway that forces evacuation of 200,000 nearby residents. (A dam collapse in California in 1928 killed 400, as a wave of water swept over them). As early as 2005, experts spotted a design flaw in the dam – never corrected. Heavy rains filled the reservoir to capacity, and severe weather because of global warming reveals that this dam, and many others, are not up to the changing weather patterns, for which they were not designed.

         There are 1,585 dams in California, notes the NYT, and 90,000 dams across the U.S. Many are in poor shape. Why? “Government is more inclined to invest money in building new projects, than in less visible and glamorous maintenance”.

         America is a consumption-driven society that under-saves. A $500 b. trade deficit (imports minus exports) for nearly 3 decades is a symptom. China is not to blame. The U.S. itself is. It is comfortable to borrow money from China to buy consumer goods. Some 23 years ago, my wife Dr. Sharona Maital and I published an article, in the Journal of Socioeconomics, in which we warned about a drastic fall in savings behavior in the US and    Western countries. *   Nothing has changed since.

           The Financial Times notes today:

     “China ended a six-month streak disposing of its US Treasury holdings in December, adding to its position for the first time since last May as the country’s central bank seeks to manage capital flight. The country, which ceded its status as the world’s largest owner of haven Treasuries in October to Japan, added $9.1bn of US sovereign debt to its reserves in the final month of 2016, new data from the Treasury and Federal Reserve showed on Wednesday.”

         So, in the post-Trump era, America has gone back to borrowing, to buy consumer goods rather than maintain its dams, its roads, schools and infrastructure.

       And President Trump? He is rapidly running down his checklist of promises, issuing so far 11 Executive orders.   But what about that trillion-dollar infrastructure plan? Dead silence. Why? Because it will take a vast plan to design and implement it. In the current chaos of the new Administration, it is unclear whether the Trump presidency is up to the challenge – or even whether it is aware of the problem.  

         So America – at least, its dams and roads – are crumbling. I don’t see a solution in the near term.

 

* Shlomo Maital and Sharone L. Maital. “Is the Future What It Used To Be? A Behavioral Theory of the Decline of Saving in the West”. Journal of Socio-Economics, vol. 23, 1,2.   1994.

Blog entries written by Prof. Shlomo Maital

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