Can Americans afford slower economic growth and a lower standard of living in the future? That will be the impact of growing government debt on the economy, according to a a policy brief released by the Stanford Institute for Economic Policy Research.
Michael J. Boskin explains:
How does a high debt-GDP ratio slow growth? Higher debt ratios eventually crowd out investment, as holdings of government debt replace capital in private portfolios. The lower tangible capital formation reduces future income. To the extent the reduced capital formation slows the development and dissemination of new technology, this effect will be amplified. Every dollar borrowed requires future interest be paid, whose present discounted value equals the debt. So future taxes must go up to cover the interest unless future spending is cut. The prospect and then reality of higher tax rates, plus increased uncertainty about future fiscal policy, slows growth and also raises the specter of higher inflation eroding the value of the government debt and/or a financial crisis, which might sharply raise interest rates.
So despite what some politicians claim, more government deficit spending and debt actually hurts the economy. What's needed for economic growth is private investment, not government investment.
What does lower economic growth mean? If the U.S. government continues to recklessly run up the debt, projections have the average family losing as much as 30 percent of their potential income by 2050. That is, families would be one-third poorer because of the burden of government debt.
Politicians like to set up a false choice between fiscal austerity and stimulating the economy, when in reality, the two aren't mutually exclusive. Debt or prosperity? It's our choice.
Last night's presidential debate (despite the focus on foreign policy) featured much talk on skyrocketing debt and unsustainable entitlement programs. Protecting the middle class from growing debt isn't a problem unique to the federal government. Pennsylvania is facing its own fiscal time bombs, including annual pension costs that are set to rise by more than $1,000 per household over the next five years.
Pension obligations are constitutionally protected, so how do lawmakers fully fund workers' pensions without dramatic tax increases? The answer may be found in reducing the rate of growth in Medicaid, the largest item in the state budget.
Pennsylvania Medicaid spending from all funding sources has grown by 7.7 percent annually for the last 20 years. Forecasts from the Independent Fiscal Office and the federal Government Accountability Office indicate Medicaid spending will continue to grow faster than the economy, absent reform.
Simply slowing this rate of growth would save billions in future Medicaid spending. As the chart below shows, if Medicaid spending grew by 3 percent per year instead of its historic rates of growth, Pennsylvania would save $4.2 billion annually by 2017.
By addressing the largest cost driver in the state budget, lawmakers can fund our pension obligations with no tax increases, and can even improve Medicaid outcomes. As Florida has proven, more local control improves the quality of care and reduces waste, slowing the growth in spending.
However, any change to Medicaid programs requires federal flexibility. Solving the commonwealth's fiscal crisis—including funding pensions for public employees—without further burdening taxpayers must begin with granting states authority to manage Medicaid.
One of our PolicyBlog readers asks: What bills would help address the Four Alarm Fire you keep speaking about? Here are a few bills we have been tracking:
Taxpayer Protection Act (would limit growth of government spending)
- SB 7 - Statutory limit to state spending. More info on the Taxpayer Protection Act.
- HB 974 - Statutory limit to state spending (identical to SB 7).
- HB 116 - Constitutional limit to state spending.
- SB 1540 - Shift to defined contribution plan for new state and school employees.
- HB 2453 - Shift to defined contribution plan for new state employees, with incentives for current employees.
- HB 2454 - Shift to defined contribution plan for new school employees, with incentives for current employees.
- There are additional House bills that put some workers (like state lawmakers) into defined contribution plans, some bills offering "hybrid" plans, and some with optional defined-contribution plans.
- None of these bills represent the comprehensive 5 point pension reform plan.
- SB 10 - Constitutional amendment to prevent implementation of health insurance mandate.
- HB 42 - Prevents implementation of health insurance mandate.
- Forthcoming legislation from Rep. Stan Saylor (co-sponsor memo) - prevent Medicaid expansion in Pennsylvania.
- HB 1261 - Welfare code, imposes work requirements and other changes to save an estimated $173 million. ENACTED
- HB 1948 - Addresses abuse of EBT cards.
- HB 386 - Allows tax credits for charitable services in lieu of government program.
- HB 185 - Tax credits for private long-term care coverage (would move individuals from relying on Medicaid for Long-Term Coverage into private insurance).
- HB 2175 - Reforms and reduces the RACP program, which borrows money for "redevelopment projects" (includes Arlen Specter Library, sports stadiums, and corporate headquarters). Program should be eliminated, but reforms are a step in the right direction.
- SB 100 - Would implement the cost-savings recommendations of the Justice Reinvestment Initiative, estimated to save $253 million over five years. ENACTED
- HB 135 - Expected to contain language to implement the reinvestment recommendations of the Justice Reinvestment Initiative. More details.
Ending taxpayer collection of dues for government unions' political efforts
- HB 1418 - Payroll deduction could not be part of government union collective bargaining contract.
- SB 1040 - No government payroll deductions for the benefit of a private organization.
If you have question for the next PolicyBlog mailbag, email ideas(at)CommonwealthFoundation.org.
Yesterday, Moody's Investor Services downgraded Pennsylvania's bond rating one level. The downgrade implies Pennsylvania bonds are riskier than previously assessed, and it could make it more expensive for the commonwealth to borrow because of the resulting higher interest rates. As the state plans to issue more than $1.5 billion in bonds over the next year, this could result in millions in additional interest payments each year.
The downgrade was based on the substantial unfunded pension liabilities and required future payments to fund state and school employees' pensions. The rating action also criticizes Pennsylvania for spending more than revenue (dipping into reserves) over the past few years. According to Moody's, Pennsylvania's challenges include:
- A financial position that remains weak, made worse by needing to use budget reserves to cover spending.
- High debt driven by unfunded pension obligations, coupled with underfunding pension systems for seven years. Over the next few years, higher pension payments will consume more state dollars and reduce flexibility.
- Slow economic growth due to demographic trends. Population growth is below average, and Pennsylvanians are older than average, factors that will diminish future tax revenues.
Effectively, Moody's is sounding the alarm for the Four Alarm Fire the Commonwealth Foundation has been warning about. Our policy points on pension costs notes the state government and school district contributions to pensions will nearly triple over the next five years.
On the other hand, Moody's praises "recent improvements in governance," including passing a budget on time for the second year, and a willingness to be proactive when fiscal challenges arise. It will take more of that to fireproof Pennsylvania's economy.
Legislative leaders and Gov. Corbett have been negotiating a state budget and, according to the latest reports, are $233 million apart in terms of General Fund spending. Why the disagreement if there is "money to spend"?
For starters, overall state spending increased 40 consecutive years prior to the current budget, causing a four-alarm fire in Pennsylvania's fiscal house. Dramatic increases in pension contributions, along with rising debt payments, welfare costs, and corrections spending will take more tax dollars in the future unless we address the problems now.
Moreover, the budget approved by the Senate in May would spend $300 million more than expected revenues for next year. Despite last year's reduction, state spending has still outpaced inflation and population growth over the last decade.
The Pennsylvania Budget Chart Book offers visuals of these and other key trends surrounding the debate over state spending.
The chart of the day shows the growth in Pennsylvania General Fund Debt service over the past decade: from $350 million in fiscal year 2002-03 to $1.1 billion in Gov. Corbett's proposed budget.
Total state debt grew 90 percent from 2002 to 2011. This growth in state debt represents one siren of the Four Alarm Fire threatening Pennsylvania's fiscal house.
More Unemployment Compensation reform is moving through the Pennsylvania House. Yesterday, HB 1754 sponsored by Rep. Ron Miller, and HB 1852 sponsored by Rep. Seth Grove, cleared the Labor and Industry Committee. Both bills are designed to strengthen anti-fraud provisions.
Specifically, HB 1754 would establish a definitive definition of "willful misconduct." Currently the vague definition often allows employees who are fired for their own misconduct to collect unemployment benefits. HB 1852 increases the number of weeks individuals who commit UC fraud are barred from collecting benefits, called penalty weeks, from four to 10 weeks. The bill also removes the four-year limit on the imposition of penalty weeks.
Pennsylvania's Unemployment Compensation system is broken and bankrupt. The state paid $227 million in fraudulent claims last year and still owes about $3 billion in loans. The state started borrowing money from the federal government to pay claims in March 2009 and ran up a debt of almost $4 billion at its peak.
These bills are a step in the right direction, but far from the substantive reform the House dismissed last spring.
Since 1986, state lawmakers have authorized more than $4 billion in borrowing for the Redevelopment Assistance Capital Program (or RACP). This is effectively debt for corporate welfare and other pork-barrel projects.
Last week, Gov. Corbett approved funding for the Arlen Specter memorial library, a Rendell-era RACP project Corbett campaigned against in 2010. In the end, the administration couldn't find a legal way to refuse the funding. Now House lawmakers are out to reform RACP and prevent future monuments to politicians.
HB 2175, unveiled at a press conference Wednesday with Rep. Mike Turzai and Rep. Rosita Youngblood, proposes to reform the way the Commonwealth incurs debt and shrink the RACP program. The bill reduces the RACP debt ceiling from $4.05 billion to $3.5 billion and then gradually to $1.5 billion over 20 years.
Pennsylvanians already owe $120 billion in combined state and local government debt—almost $10,000 for every man, woman, and child. Reforming RACP is an important first step in getting our debt under control, but a better solution would be to eliminate future RACP borrowing entirely.
Apart from the staggering amount of taxpayer debt, paid off over decades, the program is littered with economic projects of questionable benefit, from corporate headquarters to sports stadiums. Most recently, RACP was the source of a $3 million grant to the Second Mile, the charity founded by accused child molester Jerry Sandusky.
HB 2175 seeks to open up the process, requiring notification of the legislators affected, a public meeting to be held in the affected community, and certain information to be posted online.
HB 2175 was voted out of the House Finance committee today.
The Turnpike Commission wanted to ensure bondholders that, "the PTC remains committed to meeting all its financial obligations—including obligations to bondholders—by sound management of our debt load and by reinvesting in our toll-road system."
But while bondholders (and bond attorneys) may rest assured, taxpayers and drivers should not.
Act 44 may not result in a default—as a government monopoly, the Turnpike Commission can raise tolls without threat of competition, and bonds are further backed by Pennsylvania taxpayers—but that doesn't make it sound policy.
The Turnpike Commission's Annual Financial Report (see page 24) shows that the PTC lost $523 million, $1 billion and $891 million respectively each of the last three years. That should worry taxpayers and motorists.
The negative outlook reflects the possibility that larger than currently forecasted toll rate increases will be necessary to maintain sound financial operations and targeted debt service coverage levels. The outlook also incorporates the possibility that the turnpike could be tapped to pay for more of the state's growing unfunded infrastructure needs.
Let's not forget, Act 44 was created as an alternative to leasing the Turnpike to a private investor and manager. The claim was that a private company would ... wait for it ... raise tolls!
So is the commonwealth better off having borrowed $5 billion under Act 44 compared to getting $12 billion in an up-front lease payment?
The Turnpike Commission's persistent defense of Act 44 might make one think that its Chief Operating Officer is the Senate staffer who wrote the offending legislation.
The Pa. House is expected to vote this week on SB 1054, legislation to authorize $1.66 billion in state borrowing for the "capital budget." The annual cost of this bill would be $115 million per year for 20 years in annual interest and principle payments. In a memo to legislative leaders urging passage, Budget Secretary Charles Zogby claims the additional debt is needed to finance projects the commonwealth is already contractually obligated to fund.
Of this borrowing, $270 million would be for Redevelopment Assistance Capital Projects (RACP). Borrowing for RACP is one of the drivers of Pennsylvania state debt—a growing problem as interest payments continue to rise, while taxpayers' debt continues to grow year after year.
RACP borrowing has been used to fund everything from corporate headquarters to sports stadiums to the Arlen Specter Library. Most recently, RACP was the source of a $3 million grant to the Second Mile, the charity founded by accused child molester Jerry Sandusky.
In response, Rep. Rosita Youngblood (D-Philadelphia) is holding a press conference tomorrow to call for reforms to the RACP program to promote greater transparency and accountability. These reforms are much-needed, but better yet would be to eliminate future RACP borrowing altogether and stop accruing debt for corporate welfare.
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