State and local governments still in desperate need of reform

Stephen Eide Senior Fellow, Manhattan Institute
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Lately, there’s been a surge of optimism about the overall health of state and local governments. USA Today and Bloomberg report that government work forces are about to start growing for the first time in four years. The public sector will thus be a net contributor to national economic growth instead of a drag on it.

We should expect to hear more of this in the coming months now that the housing market seems to have stabilized (property taxes provide about one-quarter of local governments’ revenues). But the impression that state and local governments are healthy is misleading and must be corrected in order to avoid undermining the momentum for reform built up since 2008. State and local governments face many serious structural problems.

The delayed housing recovery is not the only reason state and local government work forces have been shrinking since August 2008. State and local employees are overly expensive, primarily due to their above-market fringe benefits packages. The American Enterprise Institute’s Andrew Biggs and the Heritage Foundation’s Jason Richwine have demonstrated that public school teachers earn over 50 percent more in total compensation (salaries and benefits) than similarly skilled private sector workers, which means governments are overcharging taxpayers by $120 billion each year. Therefore, cheering the public sector’s success in boosting national employment is like praising an economic development program for creating jobs at a cost of hundreds of thousands of dollars apiece.

This pervasive overcompensation has created an enormous debt problem. All three levels of American government borrow to pay for operating expenses. State and local governments do so through systematically underfunding their pension and retiree health obligations. Retirement benefits are part of overall compensation and thus a cost of providing basic government services. But since most governments put off paying these bills in full, they’re effectively issuing debt that will have to be paid for by future taxpayers. Currently, state and local governments owe more for pensions and retiree healthcare ($4 trillion+) than they do for conventional bonded debt issued to pay for infrastructure improvements, new school buildings, and other capital expenses ($3 trillion).

State and local government is the most unionized industry in the nation. Public sector unions are generally harmful to the cause of good government because, in a unionized situation, all administrative problems become fiscal problems. Seemingly basic changes such as instituting drug or fitness testing for public safety employees or firing incompetent teachers, even when favored by the public and their duly elected representatives, must be subjected to collective bargaining. In practice, this means these changes come at a cost. No wonder public employee unions are sometimes referred to as a “fourth branch of government.”

Finally, there is state and local tax policy. As a recent New York Times series highlighted, corporate tax subsidies have proliferated in the past few decades, even in low-tax red states such as Texas. Subsidizing the film, tech, or auto industries will not promote long-term jobs or tax-revenue growth, and formal assessment and “clawback” mechanisms are still rare. Most local governments don’t even publish tax expenditure budgets.

In sum, state and local governments have only recovered if government performance is evaluated based on narrow economic criteria such as jobs lost or gained. A government job is an “input” that proves nothing about government efficiency or how well public services are being delivered.

The past few years have been a golden age of state and local government reform. While problems associated with pensions and collective bargaining have long been with us, reforms such as Scott Walker’s budget repair bill or this past summer’s pension reform referenda in San Jose and San Diego were only made possible by the opportunity provided by the fiscal crisis. With housing stabilized, the worst of the economic crisis may very well have passed for state and local governments. But state and local governments have not returned to strength. The need for further reform remains.

Stephen D. Eide is a senior fellow at the Manhattan Institute’s Center for State and Local Leadership.