Archive for category Budget
Budget Lessons from the Old Dominion
Posted by Joshua Sharf in Budget, Colorado Politics, HD-6 2010, PERA on August 31st, 2010
This, from the Wall Street Journal, describes how Virginia managed to close its budget gap:
Here’s something you don’t see often these days: a government running a budget surplus. Governor Robert McDonnell announced last week that Virginia closed fiscal 2010 some $400 million in the black. That’s a radically improved financial picture from a year ago when the state faced a $4.2 billion two-year budget hole.
The usual suspects—the big business lobbies, the Washington Post—thought a major tax increase was needed. So did the previous Governor, Democrat Tim Kaine, who proposed a $2 billion tax hike before he left town, on top of two major Virginia tax increases in the previous eight years.
Mr. McDonnell has proved otherwise. The newly elected Republican put a freeze on hiring and took the knife even to such politically sensitive programs as school aid, police and Medicaid to cut hundreds of millions of dollars. Total state spending has been reset more or less to 2007 levels. If Congress were to do that, the federal deficit could fall by more than $900 billion, or two-thirds.
It’s true that Richmond used too many budget tricks to make the surplus appear larger than it really is. Sales tax payments were accelerated by one month to count in 2010 rather than 2011. Several hundred million dollars were borrowed from the public-employee pension reserve—money the Governor promises to repay by 2013. Most fiscal experts think the real surplus is closer to $87 million. But given the lousy economy, Virginia’s budget achievement is laudable. (Emphasis added)
Virginia does biennial budgeting, so they’ve passed their FY11 and FY12 budgets already. Virginia’s general fund is about $15.5 billion, and its total budget is about $38 billion, so either way, it’s about twice Colorado’s. Virginia was facing a $4.2 billion deficit over two years, so it was also roughly proportional to the $1 billion hole we face in FY11-12.
We could begin with a meaningful hiring freeze ourselves. Despite the Democrats’ claim of a hiring freeze, the Bureau of Labor Statistics tells a different story:
It also makes the urgency of converting PERA from a defined-benefit to a defined-contribution plan even more plain. (For the basics on public pensions, see this primer.)
In the past, I’ve posted on the difficulty of forecasting, how despite the best intentions and best information, the folks at Legislative Council have a hard time seeing revenue crises before they hit. Bloomberg has a fine posting on why this is so:
How do economists fare when it comes to real forecasting, to predicting GDP growth and inflation one year out? About as good as a coin toss, according to Bryan’s research. Less than half the economists did better than the “naive” forecast, which is based on no understanding of the economy and merely assumes next year’s outcome will be the same as this year’s. It’s what you’d expect if the results were purely random….
I want to hear a plausible scenario, based on what we know and what we expect, for how things are going to play out in the U.S. and on the global stage. Getting the number right is a job for an accountant. Putting that number in the context of a larger trend is a job for an economist.
We don’t know when revenue will recover, and we don’t know when the next drop will hit. As a result, we need to be careful not to build in additional structural spending when times are good.
Unfortunately, we’ve already used up all those gimmicks that make the Virginia surplus look larger than it is. For us, it’s going to be even more painful, which means it’s going to call for a seriousness that’s been lacking. It’s going to call for the guts to make difficult cuts, and the courage to defend them before the voters – even in odd-numbered years.
The Wrong Way on Pensions
Posted by Joshua Sharf in PERA on August 24th, 2010
Via this morning’s Denver Post:
The city and the fire department union were at odds over how pension benefits are paid. The city wanted to continue the current pension plan, similar to a 401(k).
The union wanted to have the Fire and Police Pension Association of Colorado take over management of its pensions. The city feared losing control of the pension process.
An outside arbitrator recently sided with the fire union.
But this month, the City Council rejected that recommendation, which would have forced the issue onto the November ballot.
After meeting in executive session Monday afternoon, council members changed their mind, although even those who supported it said it could cost the city more money down the road, based on the future unpredictability of financial markets.
…
The resolution passed by an 8-2 vote. Another matter to put the issue before voters in November was tabled indefinitely, killing it.
This is a terrible development, taking one, relatively small public pension (although not to the people of Aurora) entirely in the wrong direction.
PERA is underfunded by at least $20 billion. It’s underfunded because it’s a defined benefit plan, and because politicians have traditionally found it easier to vote new benefits, listening to rosy return estimates and aggressive discounting. There is enormous default risk associated with these pensions, and it’s sad to see the City of Aurora going down the same path with its firemens’ pension.
Discount That Optimism
Posted by Joshua Sharf in Colorado Politics, Finance, PERA on July 28th, 2010
On Sunday night’s Backbone Business, we discussed the problems with (mostly) public pensions. PERA, Colorado’s Public Employee Retirement Administration, is not exempt from these issues.
The biggest issue with public pensions is that, for some reason, they’re allowed to game the number that describes how much money they need to have in hand in order to cover future expenses.
We should always discount future cash flows according to the required rate of return of the project. In this case, the project, a government guarantee, should be discounted at the same rate as comparable government bonds. Corporate pensions, a company guarantee, discount at a rate equivalent to a basket of highly-rated corporate bonds, since that closely matches their obligation.
The economic reason for this is that a lower interest rate is associated with lower risk. If you discount at a lower rate, it implies a higher level of safety, and therefore, creates an obligation to have more money on hand to cover those expenses. Since the level of risk associated with a state pension is the same as the level of risk associated with a government bond, they should be discounted at the same rate. Otherwise you have equivalent risks paying different returns which creates all sorts of arbitrage opportunities.
The problem is that government pensions are allowed to discount at the expected rate of return of their investments, in effect presenting a risky investment as though it were a sound one, and therefore underfunding the plan.
Currently, PERA takes full advantage of this loophole, and discounts its obligations at 8%, the expected return on its investments. Needless to say, despite whatever reforms were passed in the last session, it’s not enough, and the taxpayers are going to be left holding the bag.
Eventually, we are going to have to transition to a defined contribution plan, and with the unfunded obligation growing rather than shrinking, the sooner we make that decision, the less painful it will be.
PERA Nears A Deal – UPDATED
Posted by Joshua Sharf in Budget, Colorado Politics, Finance, PERA on January 8th, 2010
The Denver Post is reporting that negotiators are nearing a deal on PERA, the generous defined-benefit plan that most state workers have benefited from over the years:
The major changes to the Public Employees’ Retirement Association include increasing employee and employer contributions by 2 percent and reducing cost-of-living increases for current retirees from 3.5 percent this year, capping them at 2 percent….
Several issues remain to be resolved, most revolving around age of retirement and years of service needed to get full benefits, but both men said those issues could be resolved by the time lawmakers convene for their 120-day session next week….
So let’s assume that accounting for the government worked the same as accounting for a private pension. In fact, in this case, there’s no good reason why it shouldn’t. Basically, the plan has assets and obligations, but both of those change over time. So the inputs to the model are 1) Actuarial Assessments, and 2) Interest Rate Assessments.
Actuarial assessments include things like Years of Service, Age of Retirement, Years of Benefits, Salary Increases (due to seniority), Benefit Increases (due to age). Interest rate assessments include benefit inflation, health care inflation, discount rate, and return on plan assets.
The things that can be adjusted generally fall into Actuarial Assessments, and that’s where the article focuses. Retirement age and years of service all fall into this category. What’s critical is the stuff that’s left out. We have no idea what the plan’s assumed rate of inflation, discount rate, rate of benefit inflation or health care inflation are, or what the assumed return on investment is. We don’t know what they’ve assumed them to be in the past. If those numbers are unrealistic, or even aggressive, we’ll likely find ourselves right back in the same place a few years from now.
Consider a simple scenario, where the plan assumes a constant 8% real return on plan assets. Historically, this might be reasonable. But if the bulk of the return is in the out years, the plan will have depleted its assets before those returns can catch up, and will run out of money. (Cool graphs on this topic here.) If you could forecast how returns would change over time, you’d have a more accurate model, but the fact is, as we’ve seen time and again, it’s impossible to make those sorts of predicts 5 years out, never mind 25 years out. Which means that the solvency of any defined-benefit plan is mostly guesswork. Promises of long-term solvency are simply mirages.
Maintaining a defined-benefit for incoming and even current employees is not realistic (promises made to those already retired must be honored). The only fair way to move forward is to transition to a defined-contribution plan, which has only assets, and by definitions, no liabilities. Unfortunately, the political will for this move doesn’t seem to exist.
UPDATE: According to the actuarial projections accompanying PERA’s legislative recommendations, they are indeed projecting a constant 8.0% return for the next 30 years. This strikes me as aggressive. But they key point to remember is that these returns are never constant, and that the shape of that returns curve strongly affects the ending balance. There is simply no way for even the best prognosticators to get that right, and worse, no acknowledgment in the docs that it even matters.
More On That Stimulus Money
Posted by Joshua Sharf in Budget, Colorado Politics, National Politics, Stimulus on November 17th, 2009
So I thought, for just a moment, that I had figured out just how Colorado’s Congressional delegation got expanded to upwards of 64 districts. There are two parts to the report – who got the contract and where the work will actually be done. So for this contract, the work is done at Ft. Drum, NY’s CD-23. And here, there’s no Congressional District at all, I suppose. But, alas, it turns out that Colorado’s 23rd Congressional District isn’t mentioned at all on the list, so that can’t be it. It would have made sense, them confusing our Bill Owens for their Bill Owens, but no.
So looking at the list of recipients, I see where Nederland Refrigeration, Air Conditioning, and Heating Corporation received $91,595. I’m not even going to ask.
And about that $912 that the Teller County School District received, that was apparently part of a larger, $10,037 grant. The $912 was for infrastructure, but the project description mentions none of that:
No jobs were created. Funding is being used to assist current employees in obtainining credentialing and improving educational background. Employees are also being trained to communicate with two Hispanic families moving into the area.
So no jobs were created. Current employees are getting to go to enrichment programs, which I’m sure will no doubt raise their market value when they decide to move, and someday may help their young charges do better at school, but hardly counts as “stimulative.” Likewise the Rosetta Stone software they’re getting for the new families moving in. No reason at all to use the money teaching those families English, which is of far greater economic value in an English-speaking country, one would think.
Ah, the Stimulus, the gift that keeps on giving, although not quite in the way it was advertised. Go look at the lists yourself! It’s hours of good, clean fun!
Weep Not, Ben; Other Opportunities Abound
Posted by Joshua Sharf in Budget, Colorado Politics, National Politics, Stimulus on November 16th, 2009
Sadly, Rocky Mountain Alliance Blogger Ben DeGrow has declined the chance to run in Colorado’s 7th Congressional District. Maybe he’s angling for one of those jobs created in the Colorado 30th.
That’s right. At the bargain price of just of $1 million, the Federal Government has created or saved 14 jobs in CD-30. Of course, the additional 14 jobs created in CD-64 came for only $33,000. Of course, the folks down in Greenwood Village, who saw 650 jobs created, at a net loss of $111 million to that zip code, are positively steaming with jealousy. And I’m sure that the New Energy Economy will benefit from the loss of $60 million locally by the National Science Foundation. And, Teller County Schools, don’t spend all $912 in one place. Yeah, I’m talkin’ to you, Michelle.
Of course, we know this is all true, since Governor Ritter has signed a Statement of Transparency stating that he intends to ask for and spend the Stimulus money involved.
The Very Expensive “New Energy Economy”
Posted by Joshua Sharf in Budget, Colorado Politics, Economics, Energy, Taxes on November 3rd, 2009
There are times when one wonders whether or not the writers for the Denver Post actually read the Denver Post. Then, there are times when one wonders whether is would make any difference if the did.
On October 14, the Post carried an AP story noting that the new German government, a coalition between the Christian Democrats – Mark Steyn’s right of left of right of center party – and the Free Democrats, who actually permit themselves the luxury of promoting free markets now and again, would be cutting Germany’s legendary solar subsidies, which the country had maintained for about two decades. Apprently, subsidizing expensive energy doesn’t look so good during a recession, and Germany is willing to forego the expensive green jobs that such industry creates:
Investors expected Germany to cut back on solar subsidies this year as the recession sapped demand and tightened government budgets, said Benedict Pang, an analyst with Caris and Company in San Francisco.
“During the downturn, the wheels started to come off” in Germany, Pang said. “A lot of solar companies have weaned themselves off of that market.”
…
Germany has guaranteed renewable energy generators fixed payments for the power they produce to encourage the production of solar panels and several of the world’s leading producers of the technology are based here.
A week and a half later, Bloomberg reported that the Germans had done just that:
Chancellor Angela Merkel’s new junior partner in government, the pro-business Free Democrats, approved a four-year coalition program that points Germany toward tax cuts and a reprieve for nuclear energy….
Separately, the government will seek talks with solar-energy industry on possible “adjustments” to avoid “excessive subsidies,” according to the coalition draft.
So naturally, it was a source of much rejoicing when the German company, SMA, no longer able to make money on its home turf, shifted production to Colorado, bringing with it its prize of 300 jobs, at a cost of a mere $12,000/job to the Colorado taxpayer.
Now, that’s not as much as the colossal $240,000 per job – plus the added cost of the actual electricity – that Germany’s worked itself up to. And the so-called “green jobs” trap has been largely responsible for the depth and intractability of Spain’s contractiion during the global recession. Of course, they’re paying about $600,000 a job, so we’ve still got a ways to go to match that.
These jobs are incredibly expensive, as Colorado is about to find out, and apparently don’t survive the end of subsidies.
Let’s just hope that those interim committees take note of why Colorado beat out other US states:
[Colorado Office of Economic Development and International Trade's Pete] Roskop said other states were throwing more money for incentives at the company, but Colorado had lower costs for items such as corporate taxes and worker’s compensation insurance.
Then, there are the times when one wonders whether some people ever read the business pages at all.
Billions Short on Bureaucrats’ Wish List
Posted by Joshua Sharf in Budget, Colorado Politics on October 16th, 2009
That’s really how this morning’s Denver Post story should read:
The state would need an additional $8.5 billion per year in revenue to provide the level of services Coloradans want, a commission looking into the state’s long-term budget problems was told Thursday.
That’s bigger than the $7.5 billion general fund, the state’s largest pot of money that funds most operating needs.
Even to reach a “middle” level of services, the state would need an additional $2 billion a year, members of the Long-Term Fiscal Stability Commission were told.
So how to we know this? Who measure what Colorado really wants? Why, the department heads:
Those estimates come from legislative analysts who added up the amounts that officials from various state agencies said would be needed to reach the level of services that Coloradans want. (emphasis added -ed)
How the department heads determined “what Coloradoans want” is left the the readers’ imagination, but I’m guessing that the result more closely tracks what Colorado’s department heads want. I’m also guessing that not too many of them came back with a report saying that they really could manage with less. Whenever you ask a government department head how much he needs, the answer is, inevitably, “more.”
Note, by the way, that the $2 billion is still considerably larger than the decrease in tax revenue the government has had to deal with in this recession, and that a $8.5 billion increase would essentially double the size of state government. That size, by the way, has been relatively static at about 8% of state GDP for over a decade.
Democrats on the committee naturally took up the legislative committee’s description of this wish list as, “what the people think they want.”
Perhaps most disgraceful of all was Rollie Heath’s suggestion to circumvent little things like democracy:
More controversial was his proposal to ask voters in 2010 to allow a 23-member commission appointed by the Legislature, governor and Colorado Supreme Court to examine constitutional spending requirements and limitations like the Taxpayer’s Bill of Rights and Amendment 23.
That group would have the power then to refer any proposed changes to the 2012 ballot without needing to get legislative approval or collect voter signatures and would be exempt from a state law requiring all ballot measures be limited to just a single subject, Heath proposed.
“I think it’s more appropriate to have a body outside the General Assembly to look at the issues in ways that we don’t,” Heath said.
This is bizarre on many levels, not least the complete abdication of legislative responsibility, as well as an admission of the futility and uselessness of the commission that Heath is chairing at the moment. The inclusion of representatives from the Supreme Court on a policy-making body would, I suppose, just formalize an inappropriate role they’ve increasingly taken on in recent years.
So here you have it. Even as your salaries and job options are shrinking, the legislative Democrats are trying to find new ways to raise your taxes, to pay for their wish list, without having to take responsibility for it.
Legislative Council Predicts…
Posted by Joshua Sharf in Budget, Colorado Politics on October 2nd, 2009
Every three months, the Legislative Council comes out with a report saying that the state budget is in even worse shape than we thought it was. And with every report, we’re told how Legislative Council keeps missing because of the unprecedented speed and size of the change. Fortunately, we can go back and see how well the LC has done in the past. I don’t think I’ve seen the data presented this way before, but apologies if someone has done so.
The LC makes predictions up to 5 years out (although their latest report only goes through the FY2011-12), so here’s a rolling graph of the predictions of General Fund revenue (in $M) since March of 2000. The numbers are not net of TABOR, meaning they do not account for the TABOR limits, so it’s purely an estimate of gross revenues. The gaps represent reports that the LC has not posted on their site:
So the first thing you notice is that, no matter what the current conditions, LC almost always predicts a rising income curve even though that generally doesn’t reliably happen. In fact, it’s not just a rising income curve, it’s a almost always a constantly rising income curve. It looks like those pictures you used to draw in 1st grade, taking all the different-colored crayons or chalk or markers and running them along the page in unison. The current year estimates represent reality, but after that, LC assumes more robust growth rate that declines slightly towards Year 5.
Why? To put it simply, they have no idea what the actual economic growth rate is going to be, so they fake it. And it’s responsible for their consistent over-statement of future revenues throughout the decade.
The other thing you notice is that the recession of 2001-2002 took a pretty hefty toll on state revenues, and that it caught the LC completely by surprise. If it hadn’t, they wouldn’t have had to adjust their predictions so radically. In fact, the decline in dollar amounts is pretty close to the decline in the 2007-2009 recession, although the falloff wasn’t as fast.
Another way of looking at this is on a percentage basis of the eventual revenue:
On this basis, the 2001 recession was every bit as bad – if not worse – for state revenues as the current one has been so far, it just took longer for the forecasts to fall. Remember, it was this recession, and the resulting drop in state revenues, that convinced the public to pass Referendum C. More on that in a moment.
The pattern of overestimating revenues and then mildly over-correcting is even more obvious if you synchronize the estimates at their endpoints. (The budget year ends in June, but the preliminary revenue numbers aren’t available until September, so 6 year projections stretch over 7 calendar years.)
Some of this might be understandable if the secular trends were of declining revenues, but it hasn’t been:
Which means that even in a era when the general trend has been upwards, the Legislative Council has overwhelmingly overestimated upcoming revenue. Again, this is almost certainly a result of using a plug-in number for economic growth during the out years. This is standard practice – we used to do something similar all the time when modeling companies’ top lines – but we weren’t responsible for their budgets. It clearly shows the dangers of actually relying on these predictions for budgeting and for policy-making. Certainly it contributed to the over-confidence that led to Amendment 23, and the same overconfidence that has led the legislature to spend every last non-existent dime of Referendum C monies.
Now about that. Proponents of TABOR, among whom I count myself, have often argued that TABOR’s limitations helped limit the damage from the 2001-2002 recession. Is this true? Well, probably, but it didn’t prevent the damage altogether, otherwise there would have been no cry for Referendum C. Nevertheless, by looking at the revenue estimates for one year, and comparing them with the TABOR-revenue estimates, we can see that the raw numbers varied much more than the TABOR-adjusted estimates. We use 2005 because it’s one year for which we have a full
As you can seen, the raw revenue estimates fell to as low as 72% of the original estimate, finishing up at 75%, while the revenues including TABOR refunds stabilized at 80% of the original. Someone doing budgeting even a year out would have had to cut an additional 8% from programs had they used the raw numbers, as we do under Referendum C, compared to someone who had limited himself to TABOR-adjusted revenues. This isn’t exactly Armageddon, but it ain’t chicken feed, either. Given the howls of pain that come from even modest cuts in government programs, the 8% surely must be counted significant.
None of this is intended to beat up of Legislative Council. They’re being asked to do an impossible job, and appear to be doing it much better and with more integrity than the governor’s office is. But to repeat – it indicated the foolishness of relying on long-term estimates for actual budgeting, and makes a case for the sort of conservatism that TABOR forces upon the legislature.
Civil Society Subsumed
Posted by Joshua Sharf in Budget on August 20th, 2009
A couple of weeks ago, the Mercatus Center noticed that Brad Pitt’s non-profit was seeking stimulus money for its mission to help rebuild New Orleans:
The Make It Right Foundation (profiled here on ABC’s 20/20) — as well as dozens if not hundreds of other local initiatives and non-profits — have done incredible work in rebuilding the Gulf Coast after Hurricane Katrina. But much of this success is due to their independence from large government bureaucracies. Stimulus funding has the potential to act as what Jane Jacobs called “cataclysmic money.” There is a real danger that if social entrepreneurs and non-profits like Pitt’s become dependent upon federal funds, they will in effect become arms of the federal government. This would have a dangerous effect on civil society, and reduce our resilience to disasters and shocks, whether natural or economic. (emphasis added -ed.)
Well, the news is that this has pretty much already happened with lots of non-profits. Many derive the overwhelming portion of their income from Medicare/Medicaid, or from state government grants and purchases of their services. Here in Colorado, for instance, Jewish Family Services reported in 2007 that roughly $2.5 million of $7 million in contributions, or 36%, came from government grants. Compare this with something like the Gathering Place, a drop-in shelter for homeless women, which received no direct government aid, and whose government purchases amounted to less than 10% of total income. No wonder organizations like JFS were lined up around the block to support Referendum C.
The degree to which these non-profits have become courtiers, to which they’ve essentially outsourced their fundraising operations to governments and a couple of lobbyists, is probably largely unknown to the public. It’s a whole new dependency class. If these guys get their way, there will soon be another effort to raise taxes, this time in the middle of a recession. And once again, the government-dependent non-profits will be complaining about how their critical services are about to be cut.
As Arnold Kling has pointed out, the ability to exit is ultimately more important than the ability to vote. The reason these non-profits are more responsive in the first place is that failure has consequences in their ability to fundraise.