Wednesday, December 8, 2010

How compromise "works" in Washington

In an August post Taxing the "rich" and "not-rich" I offered an alternative to just extending the "Bush Tax Cuts" or just extending those tax cuts for folks who earn less than $200,000. I further noted on the subject November 7th:
It appears now that both parties are ready to screw around with the so-called "Bush Tax Cuts." That's because finding someone with any imagination or talent in Congress or the White House appears to be an impossible task....

...We won't get any policy changes. Just more name calling.
So having said that, ordinarily I would ignore the latest policy fiasco by the Obama White House with regard to the tax cuts and achieving compromise. But never in my wildest imagination could I have foreseen the dimwitted compromise proposal that appears to have come out of a few meetings between the President and the Republicans in Congress.

It's an "ignore-the-deficit, free-lunch-for-everyone" policy proposal. In what is a curious piece of irony, many Congressional Democrats and Republicans are balking while the White House is attempting to sell the deal. No one knows exactly what all is in the deal. Yes, it's one of those that has the feel of another Health Care Bill. For instance, if you were in Davenport, Iowa, you would have picked up the Quad City Times and read:
A deal to extend the Bush-era tax cuts also includes action on ethanol and biodiesel credits, U.S. Sen. Chuck Grassley, R-Iowa, said Tuesday.

The details aren’t clear yet, but Grassley told reporters that the ethanol and biodiesel tax credits would get a temporary extension, through 2011.

The biodiesel credit of $1 a gallon expired last year, and farm-state lawmakers have blamed the expiration for the idling of biodiesel plants.

The ethanol credit, at 45 cents per gallon, is scheduled to expire at the end of the year.

Grassley said the biodiesel credit extension also included applying it retroactively to 2010.

Many of the details of the tax compromise aren’t known. U.S. Sen. Tom Harkin, D-Iowa, said Tuesday he didn’t know whether the tax credits were in the deal or not.
You may be puzzling a moment wondering how such a policy proposal might have gotten into this deal, but keep in mind that when Obama was a Senator from Illinois, another corn producing state, he pushed these credits.

The compromise, for sure, includes continuing the income tax rates currently in effect at all income levels and retaining the 15% maximum rate on capital gains and dividends.

It also includes an estate tax of 35 percent on estates worth more than $5 million. There currently is no estate tax, but it is scheduled to jump to 55 percent on estates exceeding $1 million at the end of the year. So this compromise is a nice reduction for the wealthy families and a fine exemption for those in the upper reaches of the middle class.

It also includes a provision that allows businesses to expense the full cost of capital investments each year for the next two years. Apparently this is without any of the restrictions currently found in the Small Business Jobs Act of 2010 enacted in September that has a phase out for taxpayers having more than $2 million in annual eligible investment, may be taken only up to $500,000 of eligible investment, and is limited to current year taxable income.

This is the huge conglomerate version of the Small Business Jobs Act. Well, to be fair, it is unclear whether it is identical to the Administration proposal in October that would create or increase the size of a taxpayer’s net operating loss, which generally can be carried back for up to two years, and carried forward for up to twenty years. But where else are they going to get the outline for this provision?

It also includes a one year reduction in the Social Security withholding on employee's pay checks. The "FICA" withheld would drop from 6.2% on wages up to $106,800 to 4.2% resulting in a 16.1% reduction in FICA revenue. (You remember Social Security? It's that entitlement program that the recent special commission on the deficit said needed to cut benefits because it wouldn't have enough money.)

And, of course the proposal will extend unemployment benefits another 13 months for those who have been unemployed for an extended period of time.

One thing about it. The new increased debt created by this proposal will get new money into the economy. I can't see any way of avoiding having the Federal Reserve buy the Treasury Bonds that finance this just like they are currently doing to finance our increasing debt. It's a cool way of printing money.

As long as we're just printing money anyway, how about approving that $250 giveaway proposed for Social Security recipients who aren't getting a cost of living increase? But then, I guess they could just plant corn.

When you look at all this you have to say to yourself that voting in Congressional Republicans, who express serious concern about the deficit and oppose spending programs, offers real government largesse - something for almost everyone and a lot for the very wealthy. It feels like the Bush Years. Way to go guys!

And President Obama is a winner too because he finally can now prove that political compromise really works to benefit all. (That's sarcasm, in case I'm too subtle.)

Thursday, December 2, 2010

Jerry Brown brings out the dreamers, idealists, and fools

Outgoing Republican Governor Arnold Schwarzenegger called the California Legislature into Special Session this month to deal with the fact that the current 2010-11 General Fund Budget appears to be out of balance by at least $6 billion.

It appears that the majority Democrats will simply refer his proposals to committee and go home until January as is normally the case.

In January, incoming Democratic Governor Jerry Brown will offer his budget proposals which apparently Democrats think will be more acceptable than what Schwarzenegger's spokesman called "ugly cuts." His fellow Democrats must think that Brown will offer miracle solutions in response to the need to reduce General Fund expenditures by 42±% of 2007-08 cash expenditures.

When Jerry Brown was in the Governor's Office the last time, he talked about communications satellites which many now remember upon as forward thinking despite earning him the nickname "Governor Moonbeam." This was the 1970's and space was indeed the "new frontier" for the dreamers among us. And it is the dreamers among us who keep America moving forward.

Now, after his reelection to the Governor's Office, the press has started offering dream scenarios of Brown moving to create a new State Government, the idealists are setting expectations where Brown is going to resolve the State's budget problems without devastating education and welfare, and the fools in the Legislature seem to think some bright idea will make the deficit disappear.

Unfortunately, when you're Governor of California fantastical dreaming doesn't help you and your state, even if it has been the home of Disneyland for nearly 60 years.

In the 1970's Brown thought Californians should get out of their autos and stopped building much needed freeways. Besides contributing to the accidental deaths of thousands of Californians, this foolish and unrealistic dream ignoring the habits and desires of Californians and put the State's primary transportation system in a deep financial hole from which it has never recovered.

Now we read about his reputation for being cheap which will save everything. He has hunkered down dealing with the nitty-gritty details of the budget.  Let's take a side-trip to the real past here in order to show how the big picture tends to escape Jerry's view.

During his last stint as Governor in the 1970's, there were two 800 pound gorillas the Governor needed to confront.

The first of these gorilla's was the rapidly inflating real estate prices/values which resulted in rapidly growing property tax revenue which impacted heavily on the middle class. Brown reduced some spending at the state level, but didn't lift a finger to alter the growing spotlight on skyrocketing revenue - he proudly just stored the surplus revenue, creating what became known as the "obscene State surplus" during the Proposition 13 debate.

The second gorilla was a August 30, 1971, California Supreme Court decision - Serrano v. Priest - in which (with only one dissent) the court stated:
We are called upon to determine whether the California public school financing system, with its substantial dependence on local property taxes and resultant wide disparities in school revenue, violates the equal protection clause of the Fourteenth Amendment. We have determined that this funding scheme invidiously discriminates against the poor because it makes the quality of a child's education a function of the wealth of his parents and neighbors. Recognizing as we must that the right to an education in our public schools is a fundamental interest which cannot be conditioned on wealth, we can discern no compelling state purpose necessitating the present method of financing. We have concluded, therefore, that such a system cannot withstand constitutional challenge and must fall before the equal protection clause.
While he was earning the Governor Moonbeam nickname, these two gorillas remained at large here on Earth in California. By the time of Proposition 13 several years into Brown's tenure, neither Brown nor the Democratically controlled Legislature had adequately addressed Serrano, which offered an equity goal which at least partly could have been accomplished using most of the "obscene State surplus" to reduce property taxes while establishing some level of balance between rich and poor school districts.

Instead of providing leadership for the real world, Brown talked about satellite communications and Californians not relying on the automobile. While the former idea would become ripe for State use fifteen years later, the latter idea was reflective of just how out of touch with 95% of Californians Brown really was. It was Brown's failure as a leader to honestly address these issues before and after Proposition 13 was adopted that got us into the budget crisis he now is struggling with.

Californians are now are hopeful about Brown. He's rolling up his sleeves, working hard on understanding the budget crisis and his options, choosing not to go to the White House with other Governors. This image does not correspond to reality, again.

Brown was Governor from 1975-1983, so he understands budgeting. Brown has been the second most significant elected State Officer, just behind Governor, as State Attorney General during the entire period of The Great Recession. What is it Brown needs to study to gain an understanding of the State Budget situation and why didn't he fully understand it as a former Governor and current Attorney General?

As with all government, the State uses "fund accounting" which means that each fund, other than a general fund, derives revenues for specific purposes. Brown understood this 30 years ago.

Only two funds have an immediate, significant problem with no potential solutions in sight - the General Fund and the Unemployment Insurance Fund. (Despite the political pandering of the past few years encouraged by an uninformed press, California's two public employee retirement funds don't face potential default until 2030 and we're already correcting for that potential.) Unless he's deaf and blind because he's old, as Attorney General he had to be in touch with this reality.

On December 24, 2009, it was reported by the folks at Bloomberg that "California Governor Arnold Schwarzenegger, anticipating a $21 billion state budget deficit, plans to ask President Barack Obama to ease mandates and minimums on social programs to save as much as $8 billion."  Surely Attorney General Brown knew this. Even though when the Legislative Analyst's Office issued it's updated report this month quoting $24 billion as the deficit size and all major California newspapers reported it as a shocking surprise, it couldn't have been a surprise to Brown.

Cash disbursements from the State General Fund reached a high in fiscal year 2007-08 of $107.3 billion. By 2009-10 disbursements were cut to $86.7 billion. That was a $20 billion or 19% reduction. At the end of the  2011-12 fiscal year, another $25± billion reduction in General Fund spending will be needed.

Despite what the typical California voter thinks, the breakdown of cash expenditures for State Programs and Local Government Assistance from the General Fund was as follows in 2007-08:

Total Education $52.2 48.7%
Total Health & Human Services $28.7 26.7%
Total Prisons and Jails $9.5 8.8%
Total Debt Payments $3.6 3.4%
Total Resources Protection $1.4 1.3%
Capital Outlay $1.3 1.2%
Everything Else $10.6 9.9%
Total Cash Disbursements $107.3
Debt payments will be $6± billion in 2011-12 and cannot be reduced as the voters approved all that spending.

The bulk of spending for Prisons and Jails is under the control of a federal court, beyond the control of the Governor and Legislature. This is because the totally uninformed voters approved the three strikes law without authorizing at least a 20% income tax increase to cover the costs.

General Fund spending for Resources Protection (CalFire, environmental law enforcement, state parks, etc.) was cut 15% by the end of 2009-10. This November the uninformed voters foisted upon their collapsing State Government a new environmental program while simultaneously making it impossible to establish fees to support the program.

"Everything Else" which includes such things as the court system had been reduced by 42.5% by the end of 2009-10. (Brown already is saving an estimated additional one-fourth of one percent in the "Everything Else" costs by not hiring a Chief of Staff for which he has been lauded by some.)

If Brown is as knowledgeable, wise and competent as even the more conservative press is discussing, he must have known all this as Attorney General who previous served eight years as Governor.

Since Brown has pledge to not increase any taxes immediately, he must make most of the $25 billion in cuts out of:
  • Education which is an area saddled with voter approved spending mandates and 
  • Health and Human Services, expenditures that mostly benefit our children and further reductions in which will result in the loss of at least two federal dollars for each General Fund dollar not spent.
In both areas, by the end of 2009-10 spending had been cut about 20%.  Those were the "easy" cuts. Here's what the big picture might look like after another $25 billion in cuts are factored in on a formulaic basis:
STATE PROGRAMS & 2007-08 % of 2011-12 % of % of
LOCAL ASSISTANCE Actual Total Possible Total Cut
Total Education $52.2 48.7% $26.1 42.1% -50.0%
Total Health & Human Services $28.7 26.7% $14.3 23.1% -50.2%
Total Prisons and Jails $9.5 8.8% $8.5 13.7% -10.4%
Total Debt Payments $3.6 3.4% $6.0 9.7% 66.2%
Total Resources Protection $1.4 1.3% $0.7 1.1% -49.5%
Capital Outlay $1.3 1.2% $1.4 2.3% 9.9%
Everything Else $10.6 9.9% $5.0 8.1% -53.0%
Total Cash Disbursements $107.3
Sure, there are always some things to be discovered and some innovations to be implemented. And perhaps shuffling duties around between State and local government can save some money. But this level of restructuring government deserves extensive serious policy discussion in an open forum by people who are aware of what it really means. Brown has a month for this, enough for any genius.

In fact, almost no one in the press understood the facts before the election and Brown made no effort to educate them. So the public was, and still is, ignorant of the facts. Now no one offers even a guess regarding how General Fund spending could be reduced 40% over the fours years from 2007-08 to 2011-12.

Rabid anti-government types attack State Employees. Cutting State employee costs is not going to do much. Of that 2007-08 General Fund expenditures shown above, around 10% is for state employee costs including pension contributions (other than the two university systems). When you must cut 40% and you can't function without employees, don't expect meaningful savings to come from reducing state employee costs.

This brings us to the economy. At best, California's economy is at rock bottom. We've lost more than a million jobs since November 2007 (exactly how many more is a statistician's game). No "recovery" that includes replacing those jobs plus adding those jobs needed to employ an expanding workforce will be seen in the next decade.

Within that context we have calls for keeping taxes low and even providing incentives to help grow our State's economy. All these proposals are absurd. It's as if they all prefer to ignore the fact that we have a huge loan coming due on our Unemployment Insurance Fund.

In it's latest report, the State Employment Development Department tells us that the Fund will have a "deficit" of $16 billion by the end of 2012. A Legislative Analyst's Office report entitled California's Other Budget Deficit: The Unemployment Insurance Fund Insolvency October report explained that the fund has been borrowing from the federal government to cover basic initial claims (not extended claims which are covered by the federal government). That $16 billion is not just a deficit, it is a loan, a secured loan with terms.

We have this loan because we didn't collect enough money from private sector employers for unemployment insurance over the past 20 years. We acted in a manner that inflated private sector profits between 1990 and 2010 by perhaps 1% overall.

Had the amount we borrowed since January 2009 been repaid within a year, it would be interest free. The interest rate is about 5% and interest cannot be paid from Unemployment Insurance Fund monies. It will likely be paid from General Fund monies. The past failure to collect from employers could cost schools or child health care $800 million a year in Unemployment Insurance Fund interest beginning in 2012.

Further, unless the Legislature increases Unemployment Insurance rates significantly in order to (a) start collecting enough to cover the next big economic collapse and (b) to repay the loan, the federal government will increase increase the federal rate on California employers from 0.8% to as high as 6.2%. Regarding this maximum rate, the Legislative Analyst's Office stated:
We note that even this $6 billion tax increase would not be enough, at this point, to address the insolvency problem and cover the projected fund deficit.
And the LAO further noted:
If the state fails to make interest payments on time, employers would immediately face the $6 billion in costs that might otherwise be phased in gradually as described above. The state would also lose its entire federal UI administrative grant, which is typically around $400 million annually, until the interest has been paid. Absent these federal funds, UI administrative costs would most likely be backfilled by the General Fund.
The Unemployment Insurance Fund situation, in terms of California's economy, is remarkable for how negative an impact it could have in attracting employers in the long term. The only relief that could possibly be obtained would be if the federal government altered its policy.That's one reason why it seems almost irresponsible that Brown chose not to travel to meet with Obama and the other Governors and members of Congress.

Perhaps he has noticed that the Republicans in Congress are willing to let extended unemployment benefits expire rather than drive up the federal deficit. Maybe he already knows that getting Congress to bail out an irresponsible California is a losing cause and he is developing solutions that won't negatively impact on the State's economic recovery. He probably knows this because in January the Republicans take control of the House of Representatives and California is a State the Republican Party detests.

Anyway, budget idea discussions are going on in Sacramento.

We hear rumors about reducing the programmatic requirements school districts have to meet in order to cope with reduced funding. Those that want to continue to provide certain educational services could do so, if they can find the money elsewhere. After Proposition 13 Districts in many wealthier areas were able to get approval of special per-parcel tax levies that helped cover lost income. It is likely that Serrano guidelines are not being met in California today. So why not make it worse?

We hear rumors about shifting some General Fund service responsibilities to "local government" which is a euphemism for "county." Creative local policies could be developed for such programs as child health care. At the same time, funding mechanisms would be provided  - such as authorizing "local governments" to raise taxes locally.

This would, of course, lead to huge discrepancies in services available depending on in which county you resided. And probably this would lead to a Serrano type case, as health and social service programs are federally supported statewide programs. Counties are just an administrative arm of the State of California, not some imaginary a separate government free to do things like reduce service to kids in the poorer counties only.

It will be interesting to hear what big picture, long term budget solutions will come from Brown's rolled-up shirt-sleeve, midnight oil work.

One thing seems certain. It will not be a proposal to increase the 1% property tax rate established in Proposition 13 to 1½% in order to establish a stable $20 billion revenue source for education.

After all, some alternative to traditional public education must exist so that spending can be cut, just like highway construction was cut last time Brown was Governor when he so successfully got Californians out of their cars....