Earn What You Spend

It has become common to read about bankruptcies in businesses.  We all know the big names that went bust: AIG, Lehman, Bear Stearns.  But we also know those in our own locales: restaurants are closing, banks are going belly-up, retail stores shuttering.  What we often don’t realize is that governments - from cities to states to nations -  are just as capable of going bankrupt as these companies.  

We start with a couple of basic facts.  Our economy is contracting.  Wages are decreasing.  Unemployment is increasing.  Real estate values are dropping. 

Then look at the primary sources of revenue for governments: income taxes, employment taxes, property taxes, sales taxes.  So the basis of each of these revenue sources is dwindling, and municipalities are thus seeing a massive, across-the-board drop in overall revenue. 

Yet expenditures are, if anything, increasing - state-financed health care and unemployment insurance are straining the system like never before.

California, in particular, is incredibly hard hit, facing a $41 billion deficit:

The state, nearly out of cash, has laid off scores of workers and put hundreds more on unpaid furloughs. It has stopped paying counties and issuing income tax refunds and halted thousands of infrastructure projects.

California has also lost access to much of the credit markets, nearly unheard of among state municipal bond issuers. Recently, Standard & Poor’s downgraded the state’s bond rating to the lowest in the nation.

California’s woes will almost certainly leave a jagged fiscal scar on the nation’s most populous state, an outgrowth of the financial triptych of above-average unemployment, high foreclosure rates and plummeting tax revenues, and the state’s unusual budgeting practices.

New York - both the state and the city - is facing similarly dire straits.  As much fun as it has become to hate investment bankers and their bonuses - the truth is that those bonuses not only kept restaurants in business (and thus people employed), they were also a significant source of tax revenue.  New York City alone is facing a budget deficit of $4 billion in 2009. 

It could be worse than the infamous downturn of the 1970s.  According to one expert - 

While many see the financial crisis of the 1970s as among New York’s bleakest days, he believes this current crisis could be more painful. Back then, the state’s fiscal health was solid, and the state was ultimately able to help the city. But this time, “if anything, the state is definitely in much worse shape,” because of its own deficit of approximately $14 billion, and the prospect of mounting costs in the future for pension, health care and debt service expenses.

Why is the city in such shape?  Again, the tax base is disappearing: 

Personal income taxes in the city are expected to decrease 35 percent between 2007 and 2009: a drop unprecedented in recent memory. The number of tourists fell for the last two quarters, by roughly 5 percent, compared with the previous year. And, anecdotally, [this economist] has noticed deep discounts at retailers all over the city, well beyond the traditional post-holiday discount season, as well as unusual real estate deals in which landlords are offering prospective tenants free rent for a month or other enticements.

How we deal with such crises is important - a city or state going bankrupt has far larger consequences than your local restaurant shutting down.  Often in a downturn it is more important than ever for a state to spend - crime rates tend to go up, so we need more police.  There is no play book for what is to happen next.  Let’s hope our politicians can put aside their differences and tackle these issues.