12.22.08

What If New York Goes Bust?

Forget the car companies and Lehman Brothers. Two of the biggest states in the country are teetering on the edge of bankruptcy, thanks to ridiculous union agreements that can’t be changed.

UPDATE: Looks like the tsunami has arrived in California, with state legislators one vote short of a spending cut and tax-hike compromise to close a $42 billion budget deficit. (By comparison, that's twice the national debt during the Great Depression.)

California has been sending out IOUs instead of tax refunds, bills aren't being paid, workers have been furloughed two days a month without pay, and now Arnold is preparing to send out 20,000 pink slips—10 percent of the governor-controlled state headcount—in an attempt to save an additional $750 billion a year.

It's never a good idea to raise gas and sales tax in a recession, but at least it's a balanced plan: $15 billion in spending cuts, $14 billion in tax hikes, and $11 billion in new borrowing. But it won't solve the underlying problems facing the Golden State, where prison guards can earn 300k a year with overtime pay. Costs are going up, pensions are coming due, and expect more towns to follow the lead of Vallejo in declaring bankruptcy to get control of their budgets. States don't have that option, but many will wish they did before this year is over (I'm talking to you, New York).

What's really needed is a new Bear Flag Rebellion—citizens in afflicted states rising up to demand changes in their state constitutions if necessary to restore some political and fiscal sanity to their dysfunctional legislatures. But that's another column.

My previous post on this subject below:

If California and New York State were businesses, they'd be going bankrupt. If you're among the nearly 20 percent of Americans who live or work in these two states, the fiscal crisis is coming home for the holidays. And the worst is still on its way.

California, the world's eighth largest economy, will run out of money in March if the deadlocked legislature and Gov. Arnold Schwarzenegger can't come to an agreement on tax-hikes and spending cuts. Its bonds have been reduced to near-junk status after decades of borrowing and spending. State Treasurer Bill Lockyer summed up the situation in terms unhelpful to the tourist industry: "California's fiscal house is burning down."

We're not facing a cyclical downturn; we're facing a fundamental alteration of the facts of financial life in New York.

In New York, Gov. David Paterson is trying to control a deficit, which has doubled to $15 billion since August. He proposed a potpourri of taxes and fees totaling $4 billion, ranging from non diet soft drinks, taxis, and iTunes purchases to high-end luxury items like fur coats and boats.

Soon after assuming office, Paterson said, "The era of buy now, pay later and later is over." To his credit, he is trying to walk the fiscally responsible talk, proposing $9 billion in spending-cuts and resisting a rise in state income taxes. But government budgets have become a beast that is almost impossible to tame. Paterson announced a hard line hiring freeze in July, only to find out in October that 31,684 new employees had been added to the state payroll.

Here's the really bad news: the full impact of the financial crisis in New York has yet to be felt.

The dirty secret of Empire State budgeting is that New York City depends disproportionately on Wall Street for its budget and New York State depends on New York City.

In the last four months, the financial landscape has changed dramatically. Investment banks that have been the engine of the city's tax revenue for decades have disappeared entirely or morphed into restricted new entities. According to E.J. McMahon, my colleague at the Manhattan Institute, between 1980 and 2007 the securities industry's share of wages in the state rocketed from 3 percent to 18 percent, with the average Wall Street salary and bonus rising to $379,000. Wall Street revenues made up 20 percent of the state's budget. So the 40,000 local jobs lost in the financial sector are only the beginning. We're not facing a cyclical downturn; we're facing a fundamental alteration of the facts of financial life in New York. And the 20 percent unemployment in some upstate counties will not help ease the squeeze.

book-cover---wingnuts
Wingnuts: How the Lunatic Fringe is Hijacking America. By John Avlon. 304 pages. Beast Books. $15.95. ()

But New York is playing Ford to California's GM at this stage of the crisis. While the Golden State economy is comparatively diversified, its financial meltdown is further along, with entire cities and towns throwing in the towel and declaring bankruptcy.

The city of Vallejo—population 120,000—declared bankruptcy earlier this year because it was locked into spending 74 percent of its $80 million general fund budget on public-safety salaries. Police captains were entitled to receive $306,000 annually in pay and benefits, while 21 firefighters earned more than $200,000 a year, including overtime. After five years on the job, all were entitled to lifetime health benefits. Now two smaller towns north of San Francisco, Isleton and Rio Vista, also appear on the brink of bankruptcy.

In a preview of political fights to come, both New York State and California budgets are being crippled by outsized public sector union pension obligations that are now coming due in a perfect storm—a combination of an aging population, a declining tax base, and a fiscal crisis.

The Democrats who narrowly control both state legislatures have a notoriously cozy relationship with unions and they will be unlikely in the extreme to bite the hands that feed. But the unsupportable absurdities of the current arrangement are becoming evident.

The average state and local government employee now makes 46 percent more in combined salary and benefits than their private sector counter-parts, according to the Employee Benefit Research Institute—including 128 percent more on health care and 162 percent more on retirement benefits. New York City, for example, not only spends 10 times more on pensions than it did ten years ago, it now spends more on pensions and benefits for firefighters than it does on firefighters' salaries.

These tax-payer sponsored paychecks cannot be renegotiated in tough times to balance a budget. They can only go up, never down.

The Alice in Wonderland absurdity of the current budget debates was nicely illustrated by the president of the United Federation of Teachers, Randi Weingarten. She was quoted without irony in The New York Times saying, "We understand there will be cuts. The real question, will there be cuts, not just cuts against growth, but real cuts that will turn back the clock."

A close reading reveals that for union leaders like Ms. Weingarten, the only acceptable "cuts" are not cuts at all, but rather reductions in the rate of increase for public spending. She is willing, in effect, to receive a reduced bonus this year, but not the cut in pay or benefits that would constitute shared sacrifice in a financial crisis.

From East Coast to West, we've all become addicted to living beyond our means over the past decade. Members of Congress are all Keynesians now, and there doesn't seem to be a deficit hawk left in D.C. Wall Street's dizzying fall from inexcusable excess has left some investors decimated and wondering whether the entire financial industry was a self-serving fraud to begin with. But the real reckoning for tax-payers is still to come.

John P. Avlon is the author of Independent Nation: How Centrists Can Change American Politics. Avlon also served as Director of Speechwriting and Deputy Director of Policy for Rudy Giuliani's Presidential Campaign. Previously, he was a columnist for the New York Sun and served as Chief Speechwriter and Deputy Communications Director for Mayor Rudolph Giuliani. He worked on Bill Clinton's 1996 presidential campaign.