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FIRE Policy News reports that cash from the federal gov is now the largest revenue source for state and local gov; States Are Getting Big Bailouts … And Some Observers worry they could get much bigger.

December 10, 2010

Finance, Insurance & Real Estate News

The January issue of FIRE Policy News (download full PDF) reports that cash from the federal government is now the largest revenue source for state and local governments, surpassing sales and property taxes. Fed monies include funding for education, housing, Medicaid, and other state programs.

States Are Getting Big Bailouts … And Some Observers worry they could get much bigger.

By Steve Stanek

The Federal government is already spending money to bail out state and local governments. The public just doesn’t realize it, because the bailouts are being disguised by transfer payments, subsidized bonds, and shady accounting.

The Bureau of Economic Analysis reports federal cash is now the largest revenue source for state and local governments, surpassing sales and property taxes. These transfers include federal funding for education, housing, Medicaid, and other state programs. States and local governments also have unfunded – and often under-reported – liabilities for pensions and health care benefits, according to Sheila Weinberg, CEO and founder of the Institute for Truth in Accounting. “What they have been doing in government budgets is flat-out lying,” Weinberg said. “Financial statements are so opaque. It’s scary now.”

Build America Bonds

The federal government is also helping states and local governments load up on debt to inflate spending. Policy experts contacted by The Heartland Institute are particularly troubled that Congress created a new breed of federally subsidized borrowing, called Build America Bonds, in the wake of the financial collapse of 2008. The U.S. Treasury covers 35 percent of the interest costs of the bonds. The Treasury Department in November released a report showing more than $150 billion in BABs had been issued through October 31, 2010. The BAB program was to expire at the end of 2010 but many law-makers and the Obama administration have been pushing to make the bonds permanent.

Here is what several policy experts have to say about state bailouts:

Stephen Entin

President and executive director of the Institute for Research on the Economics of Taxation, former deputy assistant secretary for economic policy at the Department of the Treasury, former staff economist with the Joint Economic Committee of the Congress

“Subsidizing state and local spending is bad policy. It encourages state and local governments to overspend, because they do not have to pay the full cost of the spending. It allows states to postpone the spending cuts they must make to bring their budgets back to sustainable levels, in line with the incomes of their citizens. “Ordinary tax-exempt bonds are treated much like saving in a Roth IRA and like the approach to saving that is part of the Armey Flat Tax. The lender has paid tax on the income that was earned and then saved and used to buy the bond. “When the bond interest is tax-exempt, the lender is spared an additional tax on the interest, which is what one ‘purchases’ when one buys a bond. This puts the after-tax saving on the same tax basis as after-tax income used for consumption, which is generally not subject to additional federal taxation, except for a few excise taxes. It is one of the ways of constructing a tax system that treats saving and consumption on a level playing field. “By contrast, Build America Bonds contain a federal subsidy of a fixed amount that is often higher than the tax paid by the saver on the original income. This creates a larger, non-neutral tax subsidy for saving that is directed to state and local governments. “I worry that these Build America Bonds may come to be regarded as backed by the U.S. government, and therefore by the U.S. taxpayers, in the same way that the bonds of Fannie Mae and Freddie Mac came to be viewed, which led to a bailout by the federal government. We need to make it clear that we are not going to bail out people who lend to states that overspend and later cannot pay their bills.”

Jonathan Williams 

Economist, director of the Tax and Fiscal Policy Task Force for the American Legislative Exchange Council, and coauthor of Rich States, Poor States: ALEC-Laffer Economic Competitiveness Index

“I think we have to be careful any time the feds give additional incentives for states or local governments to go into debt. The stimulus bill and Build America Bonds give them incentives to go into debt and to raise taxes for matching funds. I think states and local governments are looking to do questionable increases in spending because they have these debt subsidies. “Borrowing and spending sprees got them into trouble. This is not going to get them out of trouble. “Then there’s the issue of states losing autonomy to the federal government by taking this money. They’re going to have to say ‘no thanks’ to federal dollars. Until they do that, we will continue down the road to loss of federalism. Federal dollars never come without strings attached.”

Nicole Gelinas

Searle Freedom Trust Fellow at the Manhattan Institute, contributing editor of City Journal magazine, Chartered Financial Analyst, and author of After the Fall: Saving Capitalism from Wall Street—and Washington (2009, Encounter Books)

“I do not expect a TARP/stimulus in the same form in which it came in 2008/09—i.e., multi-hundred-billion-dollar, head-line numbers—any time soon. I think the problem is subtler. To avoid default, profligate states need market discipline— vigilant bondholders—in order to pare back their future liabilities for pension payments and health care. “They are not getting this discipline, because bond-holders in the most profligate states—including California and Illinois—believe, probably correctly, that they are ‘too big to fail.’ That is, that the federal government would never allow them to default because of repercussions for global money markets, etc. “Absent such discipline, bondholders will create a self-fulfilling prophecy. They will lend too much, and in several years’ time states will not be able to service their competing obligations and provide basic public services. That’s when the ‘too big to fail’ issue would come into play.”

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing editor of FIRE Policy News. This article first appeared in the January issue of Budget & Tax News and is reprinted with permission.

Also in this issue:

  • A new Illinois law banning employers from using credit scores in hiring decisions has led to strong debates over whether the common practice is a fair measure of an applicant’s eligibility.
  • Many people have been singing the praises of the Federal Reserve’s new round of “quantitative easing” to the tune of nearly $1 trillion, but prominent critics warn the Fed’s plan risks “currency debasement and inflation.”
  • The Federal Reserve is moving to involve government more deeply in credit card regulation, unveiling plans in October to tighten several regulations and block some industry practices.
  • Florida voters on Election Day overwhelmingly rejected a constitutional amendment that would have required a local referendum on each and every proposed change in city, town, and county comprehensive land-use plans.
  • U.S. Treasury Secretary Timothy Geithner has been pressing China to raise the value of its currency, but some economists and policy experts say his complaints amount to scapegoating Beijing for economic problems the United States and other Western nations have brought on themselves.
  • Government unemployment insurance funds across the country are running low, with several states, including Maryland and Rhode Island, considering either tax increases or calling for federal bailouts to generate additional funding.

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