Thursday, February 8, 2018

Fiscal Panic, Budget Cuts and LSRA

In my previous article on austerity and fiscal panic here in Wyoming, I explained that we have already seen the very first signs of it: the efforts by legislative statists and Governor Mead to raise taxes by hundreds of millions of dollars is, in fact, a panic-driven attempt at responding to a macroeconomic and fiscal crisis. It is the first real example we have seen in this crisis, so we are still early enough in this crisis that we can pull out of it.

If they persist, however, their panic-driven measures to balance the budget will in fact exacerbate the crisis. Tax hikes and spending cuts under fiscal panic have a very specific purpose, namely: to secure funding for government regardless of what happens to the rest of the economy.

Two types of budget cuts

Non-panic reductions in government put the private sector first, then adjust government accordingly. Panic-driven measures, by contrast, put government first, then force the private sector to adjust to the needs of government. This is why efforts to balance the budget under fiscal panic always involve, and often start with, tax increases: since the goal is to save government at any cost, reductions in spending will come only as a last-resort measure, and only when public resistance to higher taxes becomes an acute re-election threat.

When spending cuts eventually take place under fiscal panic, they are not the cuts that secure a fiscally sustainable government, nor are they the types of cuts that are helpful to the private sector. They will always be the kind of cuts that minimizes the agony for government workers and the political price that legislative statists believe they have to pay.

A key element in this type of spending cuts is the "cheese slicer" method. Instead of prioritizing cuts to some functions of government while protecting others (law enforcement, infrastructure), this method cuts away an equal percent of spending from all programs of government, regardless of how those programs serve the private sector. Infrastructure, for example, is essential to thriving businesses, as is reliable, serve-and-protect minded law enforcement.

Public schools, on the other hand are not essential to the private sector. Education is, but not public schools. The same applies to health care: private hospitals and medical clinics are just as good as - empirically, in fact, better than - health care provided by government.*

Tomorrow, we are - finally - going to work through a fiscal-panic scenario here in Wyoming. It will be based on the premise that the legislative statists have realized that their voters will resort to pitchfork democracy if they try to raise taxes. Therefore, the scenario will inject fiscal panic budget cuts into the 2017-18 biennium budget.

What about the money in the bank?

Before we get there, though, we need to take into account (pun intended) the money our state government has in the bank. We will think of the two accounts aimed at stabilizing the state budget, the Legislative Stabilization Reserve Account (LSRA) and the Budget Reserve Account (BRA), as one pile of budget-stabilizing funds. That, of course, is what they are there for, but the circumstances under which the money can and will be withdrawn are not entirely clear, especially in a fiscal-panic situation. 

As reported in the latest budget, LSRA and BRA have a total balance of a bit over $1.6 billion. This is after deducting the $221 million that the governor proposes be taken from LSRA for the 2017-18 budget. With this money in the bank, the state could in theory survive for quite some time without major spending cuts.

In practice, the depletion of these accounts will have a direct effect on the state's credit rating. In May last year, Standard & Poor downgraded Wyoming:
The agency cited that annual retirement contributions have been “somewhat less that the actuarial annually determined contribution” and also cited the $8.2 billion Wyoming Retirement System's 7.75% return assumption as aggressive. It said those combined factors have contributed to a “relatively low three-year average pension funded ratio of 78%.”
So long as our state government does not borrow money, our credit rating is not going to affect the state budget. That will change, however, as we continue to spend down our accounts. The day when we run our accounts so low that borrowing becomes a real option, our credit rating may already be so low that borrowing becomes prohibitively expensive. 

Even before that, borrowing costs can have a tangible effect on our state. A prudent way to guarantee sound state finances is to separate investments in real estate and infrastructure from current expenditures. While current expenditures are paid for with current revenue, investments would be funded entirely through loans, either bank or bond. If we spend down our reserve accounts on a continuing basis, we drive up the cost of investments, forcing taxpayers to fork over more money for interest payments - which in turn will take money away from current expenditures. 

In other words, while $1.6 billion is a nice stack of cash to have in the bank, each and every one of those dollars can only be spent once. To use them to cover current expenditures during a budget shortfall is wise and prudent, but only if that spending is accompanied by a plan for permanent reductions in government spending. 

Under fiscal panic, no such plan exists. All the legislature does is play defense, and the purpose of that defense is to avoid as much painful budget cuts as possible. If the cost is a plunge in credit rating and a surge in interest rates, then so be it. Therefore, our fiscal-panic scenario will be based on the premise of ample use of the LSRA and BRA accounts to cover a runaway budget deficit. 

That's all for today. Thanks for reading. See you back here tomorrow. 
*) Interestingly, government itself seems to be aware of this. Public hospitals often use private companies to staff their medical-professional positions. This makes for a hybrid solution that is not really good for either party, but helps keep costs down to a certain degree. A long-term plan to privatize all health care in our state would be the way to go.

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