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In the U.S., Crisis in the Statehouses

18 minute read
David Von Drehle

In New Jersey, taxes are high, the budget’s a mess, government is inefficiently organized, and the public pension fund is blown to kingdom come. Which makes New Jersey a lot like most other states in 2010. What makes the state unusual is its rookie governor, a human bulldozer named Chris Christie, who vowed to lead like a one-termer and is keeping his promise with brio. He has proposed chopping $11 billion from the state’s budget — more than a quarter of the total — for fiscal year 2011 (which starts July 1). He’s backing a constitutional cap on property taxes in hopes of pushing the state’s myriad villages and townships to merge into more efficient units. He’s locked in an ultimate cage match with the New Jersey teachers’ union. It may be the bitterest political fight in the country — and that’s saying something this year. A union official recently circulated a humorous prayer with a punch line asking God to kill Christie. You know, New Jersey humor. And in an interview with the Wall Street Journal, Christie didn’t talk about the possibility that his fiscal initiatives might be compromised or defeated; he pictured himself “lying dead on State Street in Trenton,” the state capital. Presumably that was a figure of speech.

The tone of the New Jersey budget battle may be distinctive, but many of the same notes can be heard in state capitals across the country. From Hartford to Honolulu, once sturdy state governments are approaching the brink of fiscal calamity, as the crash of 2008 and its persistent aftermath have led to the reckoning of 2010. Squeezed by the end of federal stimulus money on one hand and desperate local governments on the other, states are facing the third straight year of staggering budget deficits, and the necessary cuts will cost jobs, limit services and touch the lives of millions of Americans. Government workers have been laid off in half the states plus Puerto Rico. Twenty-two states have instituted unpaid furloughs. At least 28 states have ordered across-the-board budget cuts, with many of them adding deeper cuts in targeted agencies. And massive shortfalls in public pension plans loom as well.

(See a stimulus report card.)

Almost no one — and no place — is exempt. Nearly everywhere, tax revenue plummeted as property values tanked, incomes dwindled and consumers stopped shopping. Falling prices for stocks and real estate have made mincemeat of often underfunded public pension plans. Unemployed workers have swelled the demand for welfare and Medicaid services. Governments that were frugal in the past are just squeaking by. Governments that were lavish in the good times, building their budgets on optimism and best-case scenarios, now risk being wrecked like a shantytown in an earthquake.

How the Money Ran Out

For the first time in four decades of collecting data, the National Governors Association (NGA) reports that total state spending has dropped for two years in a row. In hard-hit Arizona, for example, the state budget has sagged to 2004 levels, despite blistering growth in population and demand for government services. Starting with the 2008 fiscal year, state governments have closed more than $300 billion in cumulative budget gaps, with another $125 billion already projected for the coming years, says Corina Eckl, fiscal-program director at the National Conference of State Legislatures (NCSL). Similar figures aren’t collected for the nation’s counties, villages and towns, but when the National League of Cities surveyed mayors recently, three-fourths of them described worsening economic conditions.

(See 10 big recession surprises.)

Accustomed to the ups and downs of the ordinary economic cycle, elected officials and budget planners are facing something none of them have experienced before: year after year of shortfalls, steadily compounding. Ordinarily, deficits are resolved mostly through budgetary hocus-pocus. But the length and depth of the recession are forcing governments to go beyond sleight of hand to genuine cuts. And that makes lawmakers gloomy in all but a handful of states. (It’s a swell time to be North Dakota.) According to an NCSL survey, worry or outright pessimism is the reigning mood in the vast majority of capitals.

Many taxpayers might say that it’s about time spending dropped. But then they start hearing the specifics. Government budgets contain a lot of fixed costs and herds of sacred cows. K-12 education absorbs nearly a third of all spending from state general funds. Add medical expenses, primarily Medicaid, and it’s over half. Prisons must be maintained, colleges and universities kept open, interest on bonds and other loans paid. Real cuts provoke loud howls, and you can hear them rising in every corner of the country. College students have marched in California, firefighters have protested in Florida, and on June 10, Minnesota saw the largest one-day strike of nurses — some 12,000 — in U.S. history.

(Read “Municipal Bonds: The Next Financial Land Mine?”)

And don’t count on the shaky economic recovery for relief. After plunging in 2009, tax receipts are stabilizing in many places — but the next big shoe is fixing to drop. Having poured billions of dollars into state coffers through the stimulus act of 2009, the federal government is poised to close the tap. President Obama made an unusual Saturday night request to Congress last week for $50 billion in emergency aid to the states to stave off layoffs of teachers, firefighters and police. But it’s an election year, and there is scant appetite among vulnerable Democrats in Washington for more zeros at the end of the federal deficit. (Only the federal government is allowed to run deficits; states and cities must balance their budgets or face default.) Already, 11 states are projecting major budget gaps — greater than 10% of general-fund spending — well into 2013. Such persistent budget woes are unprecedented in the era of modern American government. You’d have to go back to the 1930s to find a parallel.

Crisis in the Statehouses

On the grand scale, this fiscal fiasco is playing out in California and New York. Both states boast economies far larger than that of Greece, which so disturbed the world economy this spring. And both are paralyzed by structural deficits far larger than their politicians seem able to grasp. The impasse in California between Republican governor Arnold Schwarzenegger and the Democrats controlling the legislature appears set in concrete. Last year, the Golden State was reduced to issuing IOUs; this year’s budget, some $19 billion in the hole, is once again a shambles. In New York, Democrats control all the levers, but they can’t find a cost-cutting deal acceptable to the public-employee unions that helped elect them. The deficit in Albany is $9.2 billion.

Read “How California’s Fiscal Woes Began: A Crisis 30 Years in the Making.”

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Or you can picture the crisis through the other end of the telescope, through the eyes of one young lover of books. Not long ago, 9-year-old Campbell Jenkins of Charlotte, N.C., heard from his mom that two-thirds of the library branches in Mecklenburg County might be closed for lack of funds. “We were completely freaked out,” says Campbell’s mother Jessica. So the next day, young Campbell organized a letter-writing protest among his third-grade classmates. Not content with words, the kids also sold lemonade and donated the proceeds — $595 in an empty pretzel jar — to their branch-library manager. “It was really heartwarming,” says Heather Gwaltney, whose son Gavin, also 9, joined the effort.

This all comes as a shock to the folks of Charlotte, who long ago grew accustomed to seemingly endless prosperity. The seeds of Bank of America, among other empires, were sown there. “People are asking, ‘We’re Charlotte, North Carolina. We’re big banks. How did we get like this?’ ” says county budget director Hyong Yi. The answer is rooted in that once booming economy. As Charlotte burgeoned, the county approved $1.5 billion in bonds to build a new courthouse and new schools, expand its jails, improve its parks and — irony alert — open state-of-the-art libraries. Then the recession hit. Local unemployment rose to 11.7% in January — twice what it was two years earlier. Homes and commercial real estate lost value, which dried up the county’s chief revenue source, property taxes. The result: a 5% reduction in the upcoming budget, $71 million in cuts on top of $76 million in cuts the year before. Losing nearly $150 million in two years — an eternity of lemonade stands won’t fill that hole.

(See how some Americans are facing the prospect of long-term unemployment.)

At the last minute, county commissioners allocated an additional $3.5 million for libraries, sparing at least some of those facing closure. Campbell Jenkins’ branch is safe — for now — but budget woes in the Tar Heel State look like an ongoing problem. A spokesperson for North Carolina governor Bev Perdue said the outlook remains grim: “Next year will not be pretty.”

When Main Street Acted Like Wall Street

The collapse of a Wall Street institution like Lehman Brothers looks nothing like the threatened closing of a branch library in the Charlotte suburbs. But whether the characters are mighty or meek, this unfolding economic disaster story is in fact a series of variations on a single theme. When times were good and the future seemed bulletproof, all sorts of grand ventures were floated on waves of debt. No one cared, because everyone planned to be richer when the bills came due. The arbitrageurs of leveraged derivatives, the cash-strapped subprime home buyers, the government grandees issuing bonds and boosting pensions — all were versions of the same doom-shadowed figure. Only if the bubble burst would the bills become unpayable. How did so many people forget all at once that the bubble always bursts?

(See Wall Street’s worst days.)

Strapped for cash, state and local governments so far have taken mostly predictable steps. They’ve depleted their rainy-day funds; of all the cash expected to be on hand in state treasuries by the end of the 2010 fiscal year, two-thirds of it will be held by just two states, Alaska and Texas, which enjoy income from vast energy deposits. By comparison, 14 states are expected to have reserves of less than 1% of their annual spending — basically they’re living hand to mouth, hoping their checks don’t bounce. And a majority of states will have reserves well below safe levels recommended by the National Association of State Budget Officers. Leery of broad tax hikes in a bad economy, governments have instead chosen to shake the sofa cushions and punish the naughty, closing loopholes, cracking down on tax evaders and raising levies on tobacco, alcohol, gambling, soda pop and candy — even bottled water in Washington State. Nearly half the states have hiked fees for higher education, court services, park access, business licenses — or all of the above.

These are the tried-and-true responses to dips in the business cycle, but as the woes drag on from year to year, the job of closing budget gaps grows more difficult. Now larger issues and harder choices are being laid bare, beginning with the sprawling mess that is Medicaid. Created by Congress, administered by the states and paid for by a patchwork of federal, state and local governments, the health care system for America’s poor is a jumble in the best of times. With enrollments growing rapidly, that jumble is becoming a train wreck.

According to the NGA, the number of people covered by Medicaid will grow again next year by an estimated 5.4% on average. Meanwhile, anticipated funding is expected to grow hardly at all. That might not spell disaster for a state like Nebraska, which anticipates just 2% enrollment growth. But in foreclosure-racked Arizona, officials are planning for a jump of more than 17%, and the budgetary pressure is enormous. As Governor Jan Brewer put it in her state-of-the-state address this year, government revenues have sagged to 2004 levels, and “some people … say we should just adopt the 2004 budget.” But Arizona’s Medicaid rolls have grown by 475,000 patients since then.

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What’s going to give? Prepare for a free-for-all. The states are pressing Washington to maintain the emergency Medicaid supplement that was part of the stimulus package. So far, congressional moderates are blanching at the price tag. If the Beltway budget hawks win that battle, states plan to squeeze the patients, who are currently protected by strings attached to the stimulus money. No federal supplement means no more strings. Already various states are contemplating tighter eligibility rules, lower benefits, higher co-pays and other restrictions. And then there’s the ongoing fight between the states and the medical system. Governments are wringing money from doctors and hospitals coming and going: first they are cutting payments for Medicaid services, and then they are raising fees on Medicaid providers.

Just as ugly is the issue of public-employee pay and benefits. The mess in New Jersey is just an extreme example of a widespread problem: many state and local governments have made the mistake of courting the votes of public employees by fattening salaries and benefits, all the time imagining that pension-fund investments could only go up. Tales of lavish retirements for relatively youthful public servants have been making a lot of headlines lately. The New York Times reported that some 3,700 retired New York State public employees earn more than $100,000 a year in pension payments, including a former policeman in Yonkers at the ripe old age of 47. California’s pension poster boy is a Bay Area fire chief who, at 51, was collecting more than $241,000 a year in retirement pay. The Pew Center on the States, a nonpartisan research group, estimates that states are at least $1 trillion short of what it will take to keep their retirement promises to public workers. Two Chicago-area professors recently calculated the shortfall at $3 trillion. According to Pew, half the states ran fully funded pension plans in 2000, but by 2008 that number had dwindled to four.

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It’s tough to cut the benefits of police officers, firefighters and schoolteachers. But the long recession has cast a glaring light on the fact that public and private workers increasingly live in separate economies. Private-sector employees face frequent job turnover, relentless downsizing, stagnant wages and rising health-insurance premiums. They fund their own retirement through 401(k)s and similar plans, which rise and fall with the tides of the economy. Many public-sector workers, by contrast, enjoy relative job security, and the number of government jobs rose even as the overall unemployment rate shot just past 10%.

B Is for Bankruptcy

The crash of 2008 has also left some civic leaders with eggy faces — and possibly worse. In Georgia, at least a dozen Atlanta-area municipalities and agencies embraced the “exotic, high-risk derivative securities” called swaps in hopes of lowering the cost of bond issues, according to an investigation by the Atlanta Journal-Constitution. They paid nearly $300 million in fees for the privilege to such investment banks as Goldman Sachs, JPMorgan and UBS. Then, when the deals went sour, the same governments paid another $100 million to cancel them.

(See the top 10 financial collapses of 2008.)

Busted swaps led to even more dire consequences in Birmingham, Ala. Former mayor Larry Langford was sentenced in March to 15 years in federal prison for bribery in a pay-for-play scheme involving sewer-bond swaps in 2002 and 2003. That debt was only a part of a municipal spending spree for a domed stadium, transit improvements and a scholarship program — worthy causes, perhaps, but now unaffordable in a city where a sky-high sales tax of 10%, even on food, has failed to produce the anticipated revenue. New mayor William Bell is trying to mop up, proposing a 10% wage cut for city workers, closing libraries and recreation centers and canceling a city program to provide laptops for grade-school students. As for sewer rates: they have quadrupled, and there’s speculation that Birmingham is headed for bankruptcy.

In sun-drenched San Diego, meanwhile, a grand jury probing that city’s troubled finances found a recurring practice of skipping required payments to the city’s pension fund while simultaneously awarding ever more generous pensions to public employees. Legal? Apparently. Prudent? Nope. A once solvent system is now billions of dollars in the red. The grand jury raised a scarier question: Is San Diego still a “viable” financial entity?

Indeed, the B word has crept into so many conversations in communities around the country that a number of investors are worried that municipal bonds have become the latest debt-fueled bubble ready to burst. California’s public-employee unions are lobbying for a bill to ban government bankruptcies entirely, so worried are they about the possibility of widespread defaults to escape pension obligations. Perhaps more worrisome, though, is the risk that all this calamity will ultimately produce little in the way of lessons learned. States are already barred from formal bankruptcy, so although many of them are broke, somehow — given enough time — they will make ends meet. But will they do it only by tweaking taxes and killing innovative programs like Kentucky’s juvenile drug courts, which spend money up front on aggressive intervention and rehabilitation programs in hopes of saving the long-run expense of ruined lives in costly prisons? “It always will cost us more to remove [addicted criminals] from their communities and incarcerate them for years,” says District Judge Brandy Oliver Brown of Clark and Madison Counties, whose program of intensive drug testing and counseling will be shuttered by budget cuts. In Harrisburg, Pa., the city council needs to make $68 million in debt payments, mostly related to a mismanaged deal to modernize a trash-burning power plant, when the total city budget is about $60 million. A consulting firm has some ideas: freeze pay, furlough workers, double the property tax, sell city landmarks, artifacts and museums. In one Ohio county, a local judge urged citizens to carry a gun because the sheriff’s department was laying off half its deputies.

(See the top 10 bankruptcies.)

A few leaders have their sights set higher, trying to shape this crisis into a moment for significant government reform. Governor Jennifer Granholm of Michigan, a state devastated by the shrinking of the American auto industry, has called for an efficiency revolution. She has cut unneeded departments, sold excess state property and killed hundreds of obsolete boards and commissions. Having risen to power in 2002 on the shoulders of the state teachers’ union, Democrat Granholm this year successfully pushed a plan to coax thousands of senior teachers into retirement, to be replaced by a smaller number of younger teachers earning less generous but more sustainable benefits. “The 21st century economy is all about speed, access, intelligence and efficiency,” Granholm said in announcing her latest round of restructuring. “A 21st century government needs to be about the same things.”

Indiana Governor Mitch Daniels, a budget czar in the free-spending Bush Administration, has proved an efficiency fiend at the state level, privatizing bureaucracies, selling a poorly managed toll road, even harvesting the paper clips from state tax returns for reuse in government offices. Daniels took the controversial step of decertifying Indiana’s public-employee unions, a move that may endear him to Republican voters should he decide to run for President in 2012.

Modernizing government is no less painful than globalizing industry has been. Consider the proposal by Nebraska state senator Rich Pahls to merge many of the state’s 93 counties. The idea could mean boarding up stately old courthouses while forcing consolidation of such services as road maintenance, vehicle registration, even sheriffs’ offices — and many of the jobs that go with them. The bill died, in part because it seemed too frank an acknowledgment of the passing of small-town America. Yet surely its time will come: only 16 of the counties have more than 20,000 residents, and two are home to fewer than 500 people each. “I tell these people, You don’t ranch or farm the way they did 100 years ago,” says Pahls. “A ranch might have had 20 hands, and now they have four. They didn’t stay behind the technology.”

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The great reckoning of 2010 took us years to create and will be years in the fixing. It’s not as if the economic crisis isn’t plenty painful already. In government, as in life, there are cuts that injure and cuts that heal. As they continue to slog through the wreckage of the Great Recession, state and local leaders have a challenge to be surgeons rather than hacks and make this era of crisis into a season of fresh starts.

With reporting by Hilary Hylton / Austin, Texas; Bonnie Rochman / Charlotte, N.C.; Christopher Maag / Cleveland; Karen Ball / Kansas City, Mo.; and Elizabeth Dias and Katy Steinmetz / Washington

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