Category Archives: Budgets

Fix the State Windfall from Federal Tax Reform

by Stephen D. Haner

Governor Ralph Northam recently announced the nomination of about two hundred economically-challenged portions of Virginia to become federal Opportunity Zones, a special designation similar to an enterprise zone created by the recent overhaul of federal tax laws. That’s good. But the economic opportunities available to all Virginians from the Tax Cuts and Jobs Act of 2017 are still in limbo.

Like most states, Virginia bases its tax code on the federal tax code – a practice called conformity.  The rules on income, deductions and credits that determine your federal taxable income serve as the starting point for your state taxes. Until 2002, Virginia’s conformity to the IRS Code was automatic. Starting in 2003 Virginia became a fixed-date conformity state, leaving it to the General Assembly to review and cherry pick from new federal tax provisions. It has chosen to de-conform from only a handful. Until now.

The 2018 Virginia General Assembly, following the advice of the administration, voted to conform to none of the tax changes for 2018. Individual and business taxpayers looking at the May 1 deadline for their first quarter state tax payments are having to base them on the 2017 federal tax code.

The federal changes were made late in the calendar year and their impact is still poorly understood at both the federal and state level. A decision in February to fully conform at the state level could have made state revenue projections less reliable. But it is not too soon for the state’s leaders to declare that their policy going forward is to conform to as many of the federal changes as possible, and to resist the temptation to let federal changes automatically result in a state tax increase for Virginians.

Full or almost full conformity to the rules should be the goal, with the tax brackets or rates then adjusted to produce revenue neutrality. If there is to be a revenue windfall, let it come from actual economic growth.

Inaction will produce higher state tax bills for many individuals due to changes to the federal standard deduction. Secretary of Finance Aubrey Layne recently told a legislative committee that a consultant has estimated more than 600,000 Virginia taxpayers will switch from itemized deductions to the standard deduction at the federal level for 2018. That will require them to also take the standard deduction at the state level.

At the federal level new lower tax rates offset the impact of losing those deductions. But with state tax rates staying the same, every $1,000 in lost deductions produces $57.50 in higher state income taxes. Even taxpayers who continue with itemized deductions at the federal level may see them shrink because of new limits, producing a higher state tax bill for them as well. To prevent a windfall the General Assembly will need to either increase the state standard deduction or lower individual rates.

The confusion caused by delayed decisions on conforming on business tax provisions is even greater, because the 2017 federal bill really reshuffled that deck.

A Virginia Department of Taxation presentation to the Assembly in January and one from the Division of Legislative Services highlighted new rules on losses claimed by businesses, on interest deductions, and on the amortization of research expenses.  There is a major new deduction for income from pass-through entities. The federal law doubled the expensing deduction for buying equipment from $500,000 to $1 million, one of the provisions expected to quickly juice the economy. The new law eliminates the domestic production activities deduction as a trade-off for lower federal tax rates.

When Virginia has refused to conform since 2002 it has usually been on business provisions like these and it may be tempted to do so again – putting Virginia companies at a disadvantage. It may also be tempted to try to tax all the off-shore income that Virginia-based companies are going to bring home and add to their federal returns.

Compare today’s lack of decision and discussion with the situation in 1986, when Congress passed the last major reform of federal taxes. There was an immediate push in Virginia to prevent a state-level revenue windfall. The push came from then-minority Republican legislators, and despite their minority status the issue struck a cord and the General Assembly responded with several positive changes to state tax brackets and personal exemptions.

The 1986 changes were not as complex and were not as focused on business taxes. But that focus on the business side this time around makes Virginia’s response all the more important. It is time to start this debate.

As his lobbying activities wind down, my former Roanoke Times colleague Steve Haner may again become a regular contributor to Bacon’s Rebellion, with a focus on some of the state and local issues that were the center of his career for four decades in Richmond. He will remain in business as Black Walnut Strategies for the near future. 

No Compromise on the AAA Rating

Virginia Secretary of Finance Aubrey Layne talks fiscal responsibility. Photo credit: Richmond Times-Dispatch

A downgrade of Virginia’s AAA credit rating could cost the Commonwealth between $33.9 million to $72.7 million in additional interest costs on its roughly $4.8 billion in state debt, says Secretary of Finance Aubrey Layne.

“If S&P downgrades and the other two follow, which they usually do, it could cost us millions,” Layne said, as reported by the Daily Press. “No governor, no secretary of finance, no legislator wants to be the guy on whose watch we lost the triple-A.”

Layne based his remarks on a preliminary assessment by the Public Resources Advisory Group, a New York-based consultancy hired by the state. The fragility of the state’s top bond rating has become an issue as the Governor Ralph Northam and the General Assembly continue to tangle with deep structural divisions over the fiscal 2019-20 biennial budget.

Thirty-four million dollars ain’t chump change. But in a two-year state budget of $114 billion, it’s a rounding error. OK, it’s a big rounding error, but it’s still a rounding error. Why do Virginians worry about the bond rating so much?

“Maintaining Virginia’s Triple-A bond rating is more than saving on the cost of borrowing, it is a recognition of being one of the best managed states in the country,” House Appropriations Chair Chris Jones, R-Suffolk, said, as quoted by the Richmond Times-Dispatch. Referring to the three bond-rating agencies that grade government debt, he added, “Virginia has been a Triple-triple A bond rated state for as long as bond rating agencies have conferred the rating, a distinction held only by a handful of states.”

The AAA bond rating is a red line that both Virginia Republicans and Democrats agree must not be breached — a rare example of bipartisan consensus. By itself, a downgrade to AA would not be the end of the world. AA is still investment grade, and Virginia still could issue bonds relatively cheaply. But allowing the rating to slip is like an alcoholic thinking, what the heck, it’s just one little drink, what could go wrong?

Over a couple of decades, AA degrades to A, and then to BBB. Next thing you know, you’re Illinois with billions in unpaid bills and a massive pension liability. And then you’re Puerto Rico, too fiscally feeble to respond effectively to a natural disaster.

At some point, whether ten years in the future or twenty, the federal government will face a fiscal crisis. The national debt exceeds $20 trillion, deficit spending soon will be adding another $1 trillion a year, interest rates on that debt are rising, and Washington, D.C., is neither interested in reforming the entitlement state nor in scaling back America’s global military commitments. Meanwhile, the Medicare Trust Fund for hospital expenses will run out in eleven years and the Social Security Trust Fund will run out in 16 years. And that’s the favorable scenario because it assumes no recessions between now and then.

When Washington plunges into crisis and chaos, we Virginians will be glad we have a federal form of government. And we’ll be glad the state has a AAA bond rating. While Illinois and New Jersey collapse into fiscal insolvency, the Commonwealth will be able to preserve essential functions of government. Virginia’s ability to maintain an orderly government and society is literally what’s at stake. That dystopian future is still a decade or two down the road, so prophesies of calamity seem like scare mongering. But absent a sea change in public and political sentiment that seems nowhere in evidence, that is where we’re heading, and that is why there can be no compromise on the AAA rating.

Can the U.S. Outgrow Its National Debt?

10-year economic growth — the critical variable. Graphic credit: Congressional Budget Office

In previous posts I have described the Republican-backed 2017 Tax Cuts and Jobs Act as a Hail Mary pass, a gamble that by boosting economic growth the United States can outgrow the burden of chronic deficits and a rapidly accumulating national debt. I wasn’t optimistic, but I was willing to wait and see. After the passage of the most recent budget, which will increase spending and push deficits even higher, I became downright pessimistic.

Now comes the Congressional Budget Office (CBO) with its latest 10-year budget forecast, which takes into account the tax cuts and the latest budget. There’s plenty of gloomy news. But the damage isn’t as dreadful as I had feared. There is a glimmer of hope, although it is dim one.

First the bad news: CBO estimates that the deficit for fiscal 2018 will be $218 billion larger than what it had previously forecast. And it projects a cumulative deficit that is $1.6 trillion larger than the $10.1 trillion that it had previously prophesied for the 2018-2027 period. Debt held by the public  (not including Social Security and Medicare trust funds) will rise from 78% of GDP to 96% by the end of the decade.

The CBO also struck a Boomergeddon-like tone by making the following points:

  • Federal spending on interest payments on that debt will increase  substantially, aggravated by an expected increase in interest rates over the next few years.
  • Federal borrowing will reduce national savings. The nation’s capital stock will be smaller, and productivity and total wages will be lower.
  • Lawmakers will have less flexibility to use tax and spending policies to respond to unexpected challenges.
  • The likelihood of a fiscal crisis in the United States will increase. Investors could become unwilling to finance the government’s borrowing unless they are compensated with very high interest rates. If that happens, interest rates on the federal debt will rise suddenly and sharply.

As the football follows its trajectory into the end zone and a half dozen receivers stretch out their hands to catch it, the outcome of the Hail Mary pass is still “up in the air.” In less metaphorically strained words, the game isn’t over yet.

This CBO statement surprised me: While the federal budget deficit grows sharply over the next few years, later on, between 2023 and 2028, “it stabilizes in relation to the size of the economy, though at a high level by historical standards.”

That’s huge! The danger is that the national debt will grow faster than the economy, thereby posing an ever-increasing burden until the economy collapses. But if that burden stabilizes, even at a higher level, there may be hope that the U.S. can muddle through as (another bad metaphor alert!) the Baby Boomer pig moves through the entitlement pipeline. Eventually, a few decades from now, the entitlement crisis will ease and deficit spending will shrink.

The CBO assumes that tax cuts will goose economic growth this year but that growth will moderate in future years — from a peak of 3.3% this year to 1.8% by 2020, 1.5% for the two years after that, and 1.7% for the five years after that. But a plausible case can be made that a combination of deregulation and tax cuts will stimulate faster long-term growth, even in the face of the inevitably higher interest rates. If so, CBO would be underestimating growth and tax revenue. In this optimistic scenario, growth as a percentage of GDP actually could shrink and Boomergeddon could be averted.

On the gloom-and-doom side, the CBO also assumes steady-state economic growth over the next 10 years. But a recession could knock the props from under the growth projects, running up deficits, the national debt, and interest payments on the debt. Indeed, a major recession could trigger a full-scale fiscal crisis. The current business cycle is already almost 10 years old, one of the longest in U.S. history. What are the odds that it will last 20 years? Almost nil.

The key variable is the rate of economic growth. If it exceeds the CBO’s modest expectations, the U.S. has a fighting chance of avoiding Boomergeddon. If we see another black swan event — a trade war breaking out, North Korea firing a nuclear weapon, Iran blockading the Persian Gulf, the overheated Chinese economy imploding, a run on Italian banks, or a surprise insolvency in the hyper-leveraged, hyper-connected global economy sparking a financial panic — we could experience another 2007-scale recession — but this time with annual $2 trillion-a-year deficits. Hold on to your hats, people, it’s going to be a wild ride.

Petersburg Backs Away from the Precipice

Petersburg City Manager Aretha Farrell-Benavides

The City of Petersburg looks like it has finally dug out of its fiscal hole. City Manager Aretha Ferrell-Benavides presented a $73 million budget to City Council last week that restores funding to schools and public safety even while building up the cash reserve by $950,000.

Last year the city lurched from crisis to crisis after the discovery in 2016 that it was running a $20 million deficit. After bringing in consultants with the Robert Bobb Group, the city slashed funding across the board, cut salaries, and laid off administrative employees.

The proposed fiscal 2019 budget is $1.1 million smaller even than last year’s, yet it manages to increase public safety by $3 million and schools by $0.3 million. The city bond rating has been upgraded from junk to bond status, reports the Richmond Times-Dispatch.

The budget is spartan, no doubt, and many Virginia localities would find it unacceptably austere. One could argue that the budget fails to invest enough into K-12, one of the worst-performing school systems in the state. One could further argue that the budget is still fragile, thus vulnerable to a slowdown in the economy and tax revenues. But there is no nay-saying that Petersburg has survived one of the worst fiscal disasters experienced by a Virginia locality since the Great Depression. Government administration is far more disciplined as as a result, and the city is fiscally stronger than it has been in years.

Most remarkable of all, Petersburg pulled off this fiscal feat without benefit of government bail-outs or reneging on its debt. Kudos to Fredericksburg, to the Robert Bobb Group, to the citizen activists who kept the pressure on, and to the city officials who did what they had to do.

Bacon’s bottom line: There are two lessons to be learned here. First, Virginia’s system of government worked. The McAuliffe administration didn’t panic. The Secretary of Finance provided some professional assistance but didn’t turn the city’s fiscal plight into a broader political crisis. The Commonwealth made it clear from the beginning that Petersburg’s problem was Petersburg’s to solve. And rather than expend its political capital on blaming others and seeking bail-outs, Petersburg’s political leadership submitted to the discipline imposed by the Robert Bobb group.

Second, Petersburg’s resurrection serves as an example for other governments to emulate. Illinois, Chicago, and Hartford, Conn., are one recession away from fiscal collapse, and a dozen other states and localities are not far behind. Here in Virginia, we forced poor, economically struggling Petersburg to face the music — and it did. When the inevitable occurs, our congressional delegation must steel itself to the inevitable crocodile tears and special pleading from other jurisdictions and say, “If Petersburg did it, so can you.”

Does Anybody Notice the $300 Million Tax Increase Baked into Medicaid Expansion?

Governor Ralph Northam (left), Richmond School Superintendent Jason Kamras, and Senator Mark Warner met yesterday to discuss Medicaid expansion and school funding. Photo credit: Richmond Times-Dispatch

Governor Raph Northam and U.S. Senator Mark Warner hit the road yesterday with the media in tow, making the case that Medicaid expansion will free up $421 million over two years for other priorities such as K-12 schools.

“When we talk about education, we have to talk about health care,” Warner said during a roundtable discussion at Albert H. Hill Middle School in Richmond, as reported by the Richmond Times-Dispatch. “We’ve got to do this.”

Meanwhile Secretary of Finance Aubrey Layne is making the case that enacting Medicaid expansion is necessary to preserve Virginia’s coveted AAA bond rating, which is teetering on the edge of a downgrade.

That’s quite the rhetorical jiu jitsu move. For years, Republicans have opposed expanding Medicaid under the provisions of the Affordable Care Act on the grounds that it would be fiscally irresponsible, running up state Medicaid expenditures even after accounting for a 90% federal contribution, and competing with other priorities such as K-12 schools, higher education, and pay raises for state employees.

How is it possible for the Commonwealth to simultaneously expand Medicaid at an estimated cost of $300 million over the next two years and free up $421 million for other programs, as the Washington Post quotes Northam as saying? Two things. First the state cost of Medicaid expansion would be offset by means of an “assessment” — in other words, a tax — on the net patient revenue of Virginia’s acute care hospitals. Surprised to hear about that? Yeah, so am I.

Second, Medicaid expansion will allow the state to reduce spending by $380 million on indigent care funding, state spending on mental health, prison inmates and various programs for the poor, according to the House version of the budget. (I can’t figure out where Northam gets his $421 million estimate.)

Voila! That’s $380 million (or $421 million if you use Northam’s figure) that can be spent on other things, such as directing money into the state’s cash reserves and/or K-12 schools. Regarding those reserves, the state has only $281 million set aside in the event of a several revenue downturn, with $154 million scheduled to be injected this year. The budget submitted by former Governor Terry McAuliffe would have added $281 million, but the proposed budget adopted by the House would add only $91 million over the next two-year budget, and the proposed budget adopted by the Senate would add only $180 million.

Bacon’s bottom line: Does the public realize that there is a $300 million tax increase embedded in this plan? I did not understand that to be the case until I read the news accounts with a fine-tooth comb. The Times-Dispatch and Washington Post coverage mentioned the tax only in passing deep in their stories. Of course it’s in the interest of Democrats to downplay the tax increase, but, remarkably, I’ve seen nothing to suggest that Senate Republicans, who oppose expansion, have made an issue of it.

Let’s imagine an alternate universe in which Virginians said, (a) we want Medicaid expansion, and (b) we want to fund it without a tax increase on hospital revenues, which likely would be passed on to patients in the form of higher hospital charges. If the state is generating savings in the realm of $400 million a year from Medicaid expansion, why not just apply those savings to the 10% state share of the program? Why the necessity of adding a roughly $300 million “assessment?”

According to the numbers we’ve been given, paying for Medicaid expansion with savings to state programs would leave about $100 million left over to plunk into the state’s cash reserve. Of course, that approach wouldn’t allow Northam and Warner to tell people that “Medicaid expansion” will help Virginia schools, and it wouldn’t put as much money into the state’s cash reserves as Layne would like.

I find it astonishing that the hospital assessment has not become a hot-button issue. Health care costs are out of control as it is, and a $300 million tax on patient revenues can only make the problem worse (unless you believe that hospitals will settle for lower profits, in which case I’ve got some great swamp land in Florida I’d like to sell you.)

You’ve got to give Northam political credit. He and House Republicans are very close to pulling off the trick of expanding Medicaid and “freeing up” hundreds of millions of dollars for new spending without Virginians even noticing that they’d be indirectly paying for a $300 million tax increase on hospitals. This guy is good.

Medicaid, Pensions Kneecapping State Budgets

Graphic credit: Wall Street Journal

Take heed Governor Ralph Northam! Take heed Virginia House and Senate budget negotiators!

One in five tax dollars collected by state and local governments across the United States go to Medicaid and public-employee health and retirement costs. Of the $136 billion growth in inflation-adjusted taxes collected by state and local governments between 2008 and 2016, two-thirds went to funding Medicaid and pensions, according to the Wall Street Journal:

The picture will get worse as Medicaid expenditures metastasize and pension backlogs build. Medicaid’s annual cost, which was $595 billion in 2017, will exceed $1 trillion in 2026. States pay about 38% of that tab, although the percentage varies from state to state. A relatively affluent state, Virginia pays a higher percentage than average.

As Medicaid and pensions crowd out other spending, states have cut back on higher education, infrastructure, and aid to localities. Across the country, state cuts in support for higher education have prompted public colleges and universities to jack up tuition and fees, thus transferring costs to students and their families.

“The more we stare at the data, the more we realize all roads lead back to Medicaid and pensions,” says Dan White, a director at Moody’s Analytics, of the top three credit rating agencies.

Many localities are just one recession away from bankruptcy. The finances of Illinois, Connecticut, and New Jersey are in particularly perilous condition. Connecticut’s state capital, Hartford, narrowly averted bankruptcy last year. These high-tax states are caught between a rock and a hard place. Increasing state income taxes raises only a fraction of the anticipated revenue because they encourage wealthy taxpayers to leave for lower-tax climes.

States and localities shouldn’t expect much of a bail-out from Uncle Sam. As a different Wall Street Journal article today notes, interest payments on the national debt are doing to the federal government what Medicaid and pensions are doing to state governments.

To be sure, the U.S. federal government enjoys an unparalleled capability to borrow more money. And borrow it will. Interest payments swallowed 8% of federal revenue last year, the highest share of any AAA-rated country. Moody’s thinks that figure will triple to 21.4% by 2027.

“As interest is rising, that crowds out other spending,” says William Foster, a Moody’s analyst.

Many observers point to Japan as a nation with a national debt burden per capita twice that of the U.S. as a reason to be sanguine about the national debt. Japan may have lost its AAA rating, but it still has no problem borrowing. That analysis overlooks something that Japan has that the U.S. does not — a high personal savings rate. The U.S. personal savings rate was 2.4% in 2017. The savings rate in Japan fluctuates wildly from month to month but averaged out to 18% last year. In December, Japan’s personal savings hit the insane rate of 50%. Accordingly, as a percentage of tax revenue, Japan’s interest payments were only 5.3% — lower than the U.S. rate of 8.3%. Also, thanks to massive domestic savings, Japan does not rely upon fickle foreign creditors like the U.S. does.

Regardless, Republicans have pushed through a tax cut that, despite punching up the economic growth rate, will reduce revenues. Meanwhile, Republicans and Democrats have joined to enact a budget that boosts both defense spending (a Republican priority) and non-defense spending (a Democratic priority), while refusing to touch entitlements.

“We’re in a full-blown era of free-lunch economics where no one says no to anyone anymore,” Maya MacGuineas, president of the Committee a Responsible Federal Budget, told the Journal.

Virginia’s economic and tax revenues seem manageable for the next year or two, but budgets can unravel with horrifying speed. Very few foresaw the 2008 recession, much less its severity. Very few will see the next recession. Even fewer will be prepared. Will Virginia?

Enjoy It While It Lasts

Woo hoo! Tax cuts and spending increases — it doesn’t get any better than this. The United States is about to enjoy its biggest fiscal stimulus since Barack Obama’s American Recovery and Reinvestment Act of 2009. All this spending and tax cutting is going to feel great for the next couple of years — especially here in Virginia, which could be the single biggest beneficiary in the country of the budget deal’s $165 billion boost to Pentagon spending over the next two years. Who needs Amazon when you’ve got the federal government with its limitless credit card?

Let’s enjoy the booming economy while it lasts. But let’s not fool ourselves either. When Virginia’s GDP suddenly perks up and revenues start surging, let’s not pretend that we have somehow “turned the corner” and are experiencing a “new normal.” It would be a huge mistake to see the fiscal stimulus as anything more than superficial prosperity purchased largely through the massive accumulation of federal debt. (I’ll give corporate tax restructuring and deregulation credit for being more than passing phenomena, but much of the economic euphoria will come from old-fashion deficit spending.)

Unfortunately, if something is too good to be true… it’s probably not true. Inflation, which has been quiescent for a decade, is now surpassing 2% annually. When you cut taxes, increase spending, and tighten monetary policy in the face of increasing inflation while the private-sector economy is booming, you get higher interest rates.

Higher interest rates will do two things. They will dampen the economy, acting as a regulator on growth. And they will increase the cost of borrowing for the world’s largest debtor, Uncle Sam, with $20 trillion in national debt. As new debt is financed and old debt rolls over, each 1% increase in interest rates eventually will add $200 billion a year to federal spending. We could find that a strong economy is actually worse for the deficit and national debt than a weak economy!

Since I wrote “Boomergeddon” almost eight years ago, the United States has squandered its opportunity to get its fiscal house in order. The problem, as I outlined back then, is that Democrats refuse to cut domestic spending, Republicans refuse to cut defense spending, and Republicans talk about cutting entitlements but are too scared to act because Democrats would crucify them. As we’ve seen in the latest budget deal, nothing about that political logic has changed.

Meanwhile, the Medicare Hospital trust fund is scheduled to run out be depleted in eleven years, and the Social Security trust fund is scheduled to run out in sixteen years. In 2019 when the Medicare trust fund runs out and Congress looks for ways to maintain benefits, the U.S. budget will be running annual deficits of about $1.5 trillion a year — and that’s according to a June 2017 forecast that doesn’t reflect the recent tax cuts and spending hikes, and assumes no big recessions between now and then. Faced with the prospect of putting Medicare and Social Security on a pay-as-you-go basis or dramatically raising payroll taxes, the U.S. will be facing the greatest fiscal crisis since the Great Depression. This political armageddon — or, as I call it, Boomergeddon — is only a decade away.

Oblivious to all this, the General Assembly is perilously close to agreeing to expand the Medicaid program in Virginia predicated upon federal promises to pay for 90% of the expansion — and even then the state is committing itself to adding roughly $300 million to its biennial budget. The Republicans’ insistence upon restricting the program to adults who are working or seeking work is nothing more than a face-saving device that will not alter the underlying fiscal dynamics. Ten years from now, when Uncle Sam is dealing with an exploding Medicare system, Virginia’s retired state employees, local employees, and teachers will be depleting the Virginia Retirement System. The VRS’s $20 billion in unfunded liabilities are, for reasons I have explained previously, likely to get get bigger, not smaller. At some point between now and ten years from now, we’ll also have to acknowledge that the Washington Metro isn’t the only component of the state’s transportation infrastructure facing a multibillion-dollar unfunded maintenance backlog.

Sadly, human nature being what it is, Virginia state and local governments will interpret the Trump boom as the sign of enduring prosperity, not an unsustainable spurt, and elected officials will crank up borrowing to pay for the endless list of “unmet needs,” which never seems to shrink in good times or bad.

I don’t know why I bother sounding the alarm. No one’s going to listen. Nothing’s going to change. But I can always hope, when it comes time to dissect the greatest social and economic tragedy in nearly a century, maybe someone will remember that someone saw it coming.

The GOP’s Hail Mary Pass

House Speaker Paul Ryan savors his biggest legislative victory.

Faced with a chronically slow-growth economy, expanding deficits, mounting federal debt, and a looming funding crisis for the U.S. welfare state, Republican congressmen are, to borrow a football metaphor, throwing a hail Mary pass into the end zone in the desperate hope of scoring a winning touchdown. They are gambling that tax cuts combined with President Trump’s deregulation agenda will boost economic growth from roughly 2% per year to 3% or more, reducing the tax burden for millions of Americans, creating new jobs, boosting wages, and bending the curve on long-term deficit projections.

Convinced that the tax cuts will prove to be a disaster for everyone but the rich, Democrats and the mainstream media have subjected the tax plan to relentless, unremitting attacks. Viewed in terms of static economic analysis, we are told, the tax cuts will inflate federal deficits by a cumulative $1.5 trillion over the next ten years. Suddenly, deficits matter!

Republicans respond that measures in the bill — accelerating write-offs for business investment, encouraging the repatriation of hundreds of billions of dollars in corporate profits to the U.S., and making the corporate tax rate more competitive internationally — will stimulate economic growth. Unlike the Democrats, I think that much will prove to be true. My question is: Will faster economic growth generate enough new tax revenue to offset that $1.5 trillion? Longer term, will it avert Boomergeddon?

Let’s dig into the numbers. The Congressional Budget Office’s current 10-year budget forecast assumes a modest 2.1% annual growth rate over the next ten years, a slight uptick from the trend established during the Obama years. But economic growth has accelerated to roughly 3% in the past couple of quarters, and the Trump administration’s deregulation + tax cuts strategy could nudge it even higher. Let us assume for purposes of discussion that, thanks to the tax cuts, the U.S. can grow the economy at a sustainable rate of 3.1% annually. What does an extra percentage point in economic growth get us in deficit fighting?

Well, the latest CBO federal revenue forecast for the next ten years is $43 trillion. A 1% boost in federal revenues will yield $430 billion, not nearly enough to close the $1.5 trillion gap. The analysis gets a bit more complicated because economic growth and higher incomes push Americans into higher tax brackets while a roaring stock market generates massive capital gains. So a 1% increase in economic growth could produce more than a 1% increase in federal revenue. Let’s go for the gusto and double the growth-to-revenue ratio, assuming that federal taxes increase actually increase by $86 billion per year over current projections. That’s still doesn’t close the ten-year $1.5 trillion gap.

Could the economy grow much faster than 3.1% over the decade ahead? I’m skeptical. First, Baby Boomers are retiring in droves, and the working-age population is stagnating. A growing labor force supports economic growth; a stagnant labor force undermines it. Second, the Federal Reserve Board, intent upon unwinding the monetary stimulus of the Obama years, will continue to raise interest rates. It goes without saying that higher interest rates are a damper to economic growth.

In summary, in my untutored opinion, I think that the U.S. will see modestly faster economic growth over the next few years. The Dems have predicted economic Armageddon. They won’t get it. The lives of millions of Americans will improve… in the short run. But Republicans are deluding themselves if they think modestly faster economic growth will reduce the nation’s long-term structural budget deficit. Entitlement spending is still running out of control, and the nation still faces a hideously painful fiscal reckoning. Our 20-year future still looks like Boomergeddon.

Northam Appoints Layne as Virginia CFO

Gov.-elect Ralph Northam (right) congratulates Aubrey Layne for his appointment as Secretary of Finance. (Photo credit: Richmond Times-Dispatch)

In an important signal of how he plants to govern, Governor-elect Ralph Northam announced yesterday his appointment of Transportation Secretary Aubrey Layne as his Secretary of Finance. Layne will replace Ric Brown, who is retiring after serving three consecutive governors in the office.

Layne, an administrator with a non-partisan, technocratic bent, works well with Democrats and Republicans alike. He served on the Commonwealth Transportation Board (CTB) during the McDonnell administration, and then was recruited by Governor Terry McAuliffe to oversee the commonwealth’s transportation agencies. According to Virginia Public Access Project data, he has contributed to Democrats, Republicans and independents over the years.

Layne made his mark as a pragmatic administrator willing to delve into the public policy thickets. He spent much of his first year as transportation secretary digging out of controversial public-private partnerships set up during the McDonnell administration while he had served on the CTB. He canceled the U.S. 460 tolled highway between Suffolk and Petersburg after it became clear that the project could not obtain a federal wetlands permit. He also reworked the terms of the multibillion-dollar Downtown-Midtown Tunnel project in Hampton Roads.

After putting out fires, Layne was heavily involved in rewriting legislation governing public-private partnerships. Then, under the framework of the new law, he implemented a partnership to upgrade the Interstate 66 transportation corridor in a process relatively free of angst and controversy. Also under Layne, the Virginia Department of Transportation implemented a scorecard for measuring and prioritizing proposed road and highway projects. The purpose of the scorecard was to base transportation investments on objective criteria relating to congestion, safety, the environment and economic development rather than politics.

One knotty issue eluded Layne’s technocratic touch: the Washington Metro. Severely under-funded over the years, the Metro commuter rail system needs $1.5 billion a year more over the next ten years to address maintenance backlogs and other issues that have led to deteriorating safety, on-time service and ridership. But Virginia shares power in the governing authority with Maryland, Washington, D.C., and the federal government, which gives the state limited leverage to effect reform.

Layne will have his hands full as finance secretary. While the short-term budget outlook has brightened this year and next, Virginia faces immense long-term challenges dealing with an ever-growing Medicaid budget, massive unfunded pension liabilities, intense clamoring for more money for K-12 schools, higher-ed, and mental health, among other priorities, and the continued unwinding of various gimmicks used to balance the budget in the last recession.

What’s more, if Northam pushes to expand Virginia’s Medicaid program under the authority of the Affordable Care Act, he undoubtedly will look to Layne to find the state’s 10% share to finance the expansion. Layne could be jumping from the frying pan into the fire.

Entitlements, Fiscal Limits and the Looming Age of Rage

Now that Democrats are close to parity with Republicans in the House of Delegates, there is renewed talk of Medicaid expansion in Virginia. Meanwhile, in Washington, President Trump and Republicans are pushing a tax-cut plan that would spur economic growth but, even with stronger growth, would increase deficits by $1.5 trillion over the next ten years. Nobody is talking about the $14.6 trillion national debt except as a cudgel against partisan foes. Even as Medicare, Disability, and Old Age and Survivors trust funds are projected to run out within a single generation, entitlement reform is not up for discussion.

Just a reminder… Here’s are U.S. budget deficits forecast by the Congressional Budget Office without counting proposed GOP tax cuts:

The “on-budget” deficit is what we conventionally think of the deficit. It does not include the draw-down of “off-budget” Medicare and Social Security trust funds. Data source: Congressional Budget Office.

Within eight years, the U.S. will be running $1 trillion-per-year deficits every year, pretty much forever. And the CBO forecast does not take into account the likelihood of a recession or two over the next ten years, in which case deficits will metastasize.

And here’s the off-budget forecast. Payouts for Medicare hospitalization, Social Security disability and Social Security old-age programs exceed tax revenues, but interest income on the assets will keep the respective trust funds in the black for the next couple of years. By 2020, however, the off-budget numbers shift  into deficit mode and plunge rapidly thereafter.

Barring major changes in U.S. spending programs or economic growth, here’s when the trust funds are expected to run out, according to Medicare and Social Security trust estimates:

  • 2028: Disability trust fund runs out of money.
  • 2029: Medicare hospitalization trust fund runs out of money.
  • 2035: Social Security trust fund runs out of money.

Back when the Simpson-Bowles commission tackled the deficit issue in 2010 — the last time Americans thought seriously about entitlement reform — the county had 25 years before keystone social safety net programs imploded. If Congress had acted then, it could have put the trust funds into fiscal balance with relatively minor tweaks (slightly higher payroll taxes, slightly reduced benefits, slightly older retirement ages) that had a large cumulative effect over many years. But a decade of delay will require more painful sacrifices, which means they likely never will be made.

If nothing gets done until the trust funds run out of money — what I call Boomergeddon — the programs will have to cut benefits to match revenues generated. We are only twelve years from massive dislocations to the Medicare program, and 17 years from disruptions to Social Security. Baby Boomers beware, your retirement will be a lot uglier than you realize.

As for those $1 trillion+ on-budget deficits every year, they put Virginia at special risk. Any Congressional effort to tame deficits without touching entitlements will require cuts to discretionary spending, the biggest pot of which is related to defense, intelligence and homeland security…. which happens to be Virginia’s biggest industry sector. Son of Sequester will subject the Virginia economy to chronic economic stress and fiscal pain. But instead of dealing with Virginia’s long-term structural issues, the next session of the General Assembly could well consume itself in a renewed debate over expanding Medicaid.

As Americans speak no evil, see no evil, and hear no evil, we hurtle toward an era of brutal fiscal limits, broken promises to millions of Americans, and polarization and rage that will surpass anything we see today.