More Q&A: States Can’t Do Countercyclical Policy and Noise re “Unfunded Liabilities”

July 4th, 2011 at 1:41 am

Q: What with the much benighted Washington debate, what can the states do to improve the economy – or more specifically, fight unemployment?

A: The states can’t do much at all.  To the contrary, because they have to balance their budgets, when their revenues come in under their spending in a given fiscal year, they have to close those gaps in that year.   That means service cuts and/or tax increases, or in econo-jargon, their policy stance has to be procyclical when we need it be countercyclical.

My CBPP colleagues have tracked this problem throughout the recession (this is their most recent review).  The figure shows the magnitude of the gaps summed across all the states, compared to the last downturn.

A few points are instructive:

–clearly, this downturn has been much tougher on state budgets (as well as the federal budget) than the last one.

–things are improving; the recovery in GDP that began in mid-2009 has begun to show up in higher state revenues, and states expect their 2013 shortfall to be half as large as their 2012 gap.

–but the hole is deep and the damage severe; over the past three years, state and local governments have shed over half-a-million jobs.

There’s a very important Keynesian punchline here: since states cannot offset their budget gaps with deficit spending, the only countercyclical game in town is the federal gov’t. The state fiscal relief in the Recovery Act was fast-acting, effective stimulus, helping to retain needed jobs in communities, like teachers, cops, firefighters, sanitation workers, etc.  As the stimulus has faded, layoffs have accelerated.

Q: What’s wrong with the “unfunded liabilities” stories that conservatives tell about Social Security and Medicare?  This is where they make the case that over some very long time horizon, these programs are supposed to pay out tens of trillions more than they’re scheduled to take in.

A: These are mostly scare tactics, designed to mislead.  That said, there’s a useful point embedded in there: both programs need to undergo changes to meet their obligations.  But at least some of the folks who make the “trillions in unfunded liabilities” argument do so to make it seem like we can’t afford social insurance, which is nonsense.

There are two misleading tactics the UL types make.

First, yelling “trillions” in a crowded theater.  That is, failing to scale the liabilities by the size of the economy.  The net present value of the Social Security and Medicare shortfalls over the 75-year horizon are in the trillions, but as the share of the economy, which also grows over all these years, they’re around one percent.

Take a look, for example, at the table on page 83 of this doc (it’s the trustees’ report on Medicare).  It refers to the expected 75 year shortfall in the Hospital Insurance trust fund, which is $3.1 trillion!  Oh no!  But the next line shows that taxable payroll over this horizon is expected to be $400 trillion, so the shortfall is less than one percent.

The other thing the UL’ers do is calculate the shortfall over an infinite time horizon.  That’s just bad policy analysis.  Again, if you do the math relative to GDP or payrolls as you should, the shortfall amount is fractional, much like the 75-year results (see the tables a few page later in the trustees’ report).  But a moment’s reflection should lead you to wholly discount forecasts out to infinity.  Who knows what growth, productivity, and population trends will be that far out in the future?

We know that if we want these programs to last, we need to raise revenues or reduce benefits.   The fixes for Social Security are known and not deeply burdensome.  Lowering the growth rate of health costs is harder because we’re not sure how to do it.  But we know we must, both in the private and public sector, or else health spending will eat up far too much of our national income in the future (from about 17% of GDP today to twice that twenty years hence).  The ACA (health care reform) makes a strong stab at just that, though we won’t know how well it works until the Independent Payment Advisory Board—ACA’s main cost control mechanism—is up and running.

Most everything else is just noise.


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6 comments in reply to "More Q&A: States Can’t Do Countercyclical Policy and Noise re “Unfunded Liabilities”"

  1. Michael says:

    People lie in general. House is a good show because that’s true.

    But some philosophies view lying as part of the human condition — something to be dealt with and worked around. And some philosophies view lying as an ideal activity — something to be organized and exalted. Conservatism, by its authoritarian nature, views lying as a positive activity. And so any claim by a conservative has to be evaluated in the context of the fact that its holder clings to a philosophy that exalts lying.

  2. John L says:

    Even a 75 year time frame is deep into hand waving territory. How accurate would you expect a prediction about today made in 1936 to be? Well, that’s 75 years. It’s sort of useful just to see whether the numbers are in the right order of magnitude, but once you get past 30 years or so, the uncertainty and the discounts make numbers little better than guessing.

    • Michael says:

      Not just that, but discounts past 30 years put everything pretty much at zero. 30 years is forever, in a world with developed financial markets.

  3. David Kaib says:

    A couple of thoughts

    1) The reason states have to have balanced budgets is because of state constitutional provision, correct? So while this point is true, it doesn’t have to be. Obviously, that doesn’t help us now, but it’s worth noting that this problem is of our own making.

    2) Could state infrastructure banks (VA, IIRC, just authorized one) or state banks (along the lines of the Bank of North Dakota) at least mitigate the problem?

  4. Tom in MN says:

    Cycles are all about timing and it seems to me that raising taxes delays the negative effects on the state’s economy, while cutting spending (and hence jobs) is immediate. This would seem to be especially true of a tax hike on the very top end, as our Governor has proposed. What are your thoughts on this choice, one that most states seem to be answering with cuts and not tax hikes this time around?

    Also if states ran a surplus in good times, which would be countercyclical, they would be in the position to keep spending as tax revenues fell due to an economic slow down. Thus they could be countercyclical always, but would have to run an average budget surplus to do so, which appears politically unlikely.

  5. Paul Dietch says:

    Repeal the Windfall Elimination Provision…This was created by A. Greenspam and R. Ragean, it is a lie !! My S.S. benefits were reduced by $500 a month. Checked with a bank, and they said that $300,000 worth of my S.S. pension value was eliminated by this provision…From 1933-1983, after thousands of U.S. goverment actuary’s audits, no windfall was ever found !!! Suddenly in 1983, there was one !! Over 1,000,000 police, firefighters, teachers, state and federal employee American citizens had this massive scam put on them…In the federal installation i worked at the day this provision took effect, there were fistfights and violence. This is against federal law, the Windfall Elimination was the catalyst for this violence…