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Stop the Coming State and Municipal Bailouts By: Robert Locke
FrontPageMagazine.com | Monday, November 25, 2002

The gradually unfolding economic downturn has already wiped out the projected federal budget surpluses of the next few years. It is making a similar mess of state and municipal budgets, and will inevitably result in calls for bailouts of some of them. These calls must be firmly resisted, even if this means forcing governments into bankruptcy. For this would simply be a bailout of governments that have grown far too big on the 90’s boom, and would merely enable their profligate ways to continue. In fact, some real bankruptcies may be one of the best serious chances we have to break the growth of big government.

The most likely places to want bailouts are:

New York City

New York State


But these are just the tip of the iceberg; many more states and municipalities will probably come forward.

There are at least five problems with conducting bailouts:

1. They enable spendthrift policies to continue.

2. They enable the politicians who created the mess to say in office and never face the electoral wrath that would come if voters saw their incompetence made manifest by bankruptcy.

3. They conceal from the public that a mess was ever created, preventing the voters from learning a needed lesson that would discourage them from electing spendthrift politicians in future.

4. They encourage future spendthrift policies by creating the expectation that the Federal Government will always be there to deliver a bailout if anything goes wrong.

5. They violate the principle of political accountability: that those localities that make dumb decisions, pay the price for them.

The fourth point is largely a matter of tax-exempt bond finance. State and municipal spending depends upon the willingness of the bond market to continue to buy the bonds issued by these governments at a reasonable interest rate. If the government concerned is perceived as a payback risk, their bonds will not sell, choking off their ability to keep spending. More importantly, a turn towards big spending will result in a higher interest rate even before the point of absolute insolvency is reached. The presumption that a bailout will be available undoes this crucial discipline.

These governments’ problems are entirely their own fault and bailing them out will just enable them to avoid addressing their fundamental problems. The powers that be will heave a huge sigh of relief that as they rediscover the eternal political truth that business-as-usual always goes on. If, of course, we let it.

Let’s now turn to New York City as an example, simply because I know it the best and because New York is guaranteed to try to trade on public sympathy over 9-11 to milk the federal teat. New York’s problems are similar in kind to, though more intense than, the problems of other governments.

The key to understanding New York’s problems is this: 9/11 is not the problem. The municipal welfare state is the problem. New York’s city government is grossly bloated. It spends more than twice as much money per person as Los Angeles. It is so large, in fact, that only four states have bigger budgets: California, Texas, Florida, and New York itself. Its budget is probably larger than the budget of the state you live in.

But don’t think this means high-quality services for city residents. This money mostly doesn’t mainly go on standard municipal services that provide value to normal middle-class citizens. It does not go to police, fire, sanitation, roads, subways, railways, buses, schools, parks, libraries et cetera. It mainly goes for social welfare services for the city’s poor population, many of whom are not even Americans.

People usually ask me at this point, "Didn’t Giuliani fix all that?" Well, yes and no. His principal contribution to the government of this city was to make those parts of it that are under direct mayoral control – above all, the police – do their jobs properly. For the most part, they now do, which is why we have the safest streets of any major city in America and doing business with City Hall is not much worse than dealing with any other government bureaucracy. He also applied the national welfare reform to New York, cutting the welfare rolls roughly by half by forcing recipients into the job market.

So why didn’t this cut the municipal budget? It did, in the sense that we would be in much worse shape today without the Giuliani reforms. But like most governments in this country, New York’s government grew markedly during the 90’s boom. (You can blame liberal New Yorkers all you want, but the fact is that everybody in America lost their fiscal discipline in recent years.) The momentary restraint imposed by the early-1990’s sense of crisis melted with the bull market, to which New York is unusually exposed because so much of Wall Street is located there. Narcotized by prosperity, Americans forgot that they believed in small government. Worse, booming tax revenues enabled governments to raise spending without legislating tax increases, though of course "bracket creep" raised not only absolute but percentage tax levels. Without the help of explicit tax increases, in 1998, New York City’s budget increased 6%, twice the rate of inflation. In 2000, it increased 5.7%. In 2001, it soared a scandalous 9%, three times the inflation rate.

New York’s projected deficit for 2002 is $6 billion. Only half of this can be attributed to loss of tax revenue due to 9/11. If the city’s budget had been in good shape before 9/11, the attacks would not have been a problem. The city’s projected budget for the fiscal year $6 begins next July boosts spending by about $3 billion, largely because of increases automatically built in to the budget, including rising debt payments and salary and pension hikes.

The key constituency resisting budget cuts is not the public, but the municipal unions and the social-service industry. Large sections of the city’s social services budget should simply be eliminated wholesale. There is no reason for the city to provide any services at all to the homeless, which simply encourage them to remain in the city. Most municipalities do little or nothing.

The common-sense conservative wisdom that raising taxes drives out productive businesses has been confirmed by past experience in New York. In 1990, democratic mayor David Dinkins raised taxes by $1.5 billion to close a budget gap. While the national recession ended soon after the Gulf War in 1991, New York continued to decline economically. In 1991 alone, the city lost 192,000 jobs, a record for any city in a single year.

Similarly, the common-sense conservative wisdom that government is fat, inefficient, and can be reformed found confirmation four years later when Republican mayor Rudolph Giuliani faced a similar situation. Instead of raising taxes, he cut discretionary spending and pushed through productivity increases in city departments. For example, he combined the city’s three police forces (regular, transit, housing) into one. The result: the first city budget in 50 years that was actually smaller than the year before.

Our current mayor, Republican Alan Bloomberg, got elected partly because he spoke out for fiscal discipline in the wake of 9-11. Unfortunately, instead of making good use of the public’s understanding of the need for this, he has been lax, making only small cuts and allowing overall spending to grow. Worse, he kept the last year’s budget alive by borrowing $1.5 billion by means of various one-shot deals.

Where should the city cut? Here:

1. The city shed nearly 20,000 municipal jobs in the early 90’s, then added them back in the last 4 years. Get rid of them.

2. Gut the central bureaucracy of the school system, recently placed under mayoral control for the first time in decades.

3. Make city workers pay for part of their health-insurance premiums, just like federal and state workers do.

4. Privatize what can be privatized. Commercial trash is already collected privately; why not residential?

5. Cut the city’s Medicaid program, the most extravagant in the nation.

6. The city’s airports pay the city government a pittance for rental of the land they sit on. This should be adjusted.

7. The city spends money to build housing, on the theory that there is a "shortage of affordable housing." This should stop. Make housing affordable by undoing the over-regulation (zoning, building codes, unions) that makes it expensive. And if this doesn’t work, fine: it helps push out poor people, of whom New York must endure more than its fair share. The poor consume more in public services than they pay in taxes; the middle class pays for them.

8. The city owns housing projects in prime residential areas. They should be sold off. The entire Lower East Side, for example, could be gentrified in 5 years if this were done. Gentrification turns money-costing public housing into tax-generating private housing, reducing the tax burden on everyone else.

Although there is no reason for total taxes to be raised, it may be advantageous to raise some taxes so as to allow lowering others. Obviously, one should tax more those things one wishes to discourage and tax less those that one wishes to encourage. For example, vehicles that pollute more (in a city that is out of compliance with the Clean Air Act) should be taxed more. The technology exists to check individual vehicles for compliance and fine those that are out of it. It costs $1.50 to enter Manhattan by bus or subway. You can drive in for free, clogging our streets with cars. Why? Put tolls, using the existing electronic EZ-Pass system, on those bridges and tunnels that don’t have them.

Ideally, neither New York nor any other governments should be bailed out. But if, through a spasm of public sentimentality passing itself off as "compassionate conservatism," any are, the public should demand that these bailouts come with as many strings attached as possible. My first hope is that this may result in conditions being imposed that will sink the deals. But if not, we are entitled to some conservative reforms in exchange for our money. These liberal governments are at our mercy; we should take full and ruthless advantage of this. The two fundamental strings that should be attached are these:

1. Bailouts must only come after all possible cuts have been made.

2. Bailouts must only come after all self-destructive government has ended.

The first count principally means getting government out of things it has no business being in and forcing it back to the basic provision of quality public services, not welfare handouts. It is a general axiom of government that the more inappropriate things a government tries to do, the less well it will do those things that are its appropriate function.

The second covers a multitude of sins. For example, New York should be told it can’t have a penny unless it abolishes rent control, an absurd violation of economic logic and property rights that has gone on for 60 years now.

What would a state or municipal bankruptcy look like? Municipalities file bankruptcy under Chapter 9. For a start, this enables them to abrogate their expensive union contracts. For a second, it enables them to restructure, i.e. not pay back on time, their debt. Frankly, this country needs a real government bankruptcy, in which bondholders feel real pain, to instill the discipline of fear that will turn them back into the constituency they used to be for small, responsible government.

Note: I would like to credit Steven Malanga’s excellent article in City Journal as a source for this article. I can’t help noting, however, than in keeping with City Journal’s neoconservative blindness on the topic, he doesn’t mention that mass immigration has been a key factor in driving New York’s (and California’s) budgets into the red. If you import masses of poor people who consume more in public services than they pay in taxes, what do you expect? (There isn’t the space here to go into the details of what’s wrong with the arguments that claim to refute this, but it’s basically a matter of playing with statistics and ignoring the fact that what we let into this country are new, poor immigrants, not people who have been here 30 years.)

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