Wednesday, May 4, 2011

"Connecticut's Budget - Centrism will not Solve the Deficit"

Sydney M. Williams

Thought of the Day
“Connecticut’s Budget – Centrism will not Solve the Deficit”
May 4, 2011

The anti-Christie resides in Hartford. At least that is how Connecticut’s governor Dannel Malloy referred to himself after describing the New Jersey governor as “bombastic” in a New York Times interview in February, and after hearing Chris Christie’s response that he would be waiting at the border as taxpayers fled Connecticut.

Both governors, like those in several other states are facing large deficits. Cumulatively, state deficits in 2011 amounted to $191 billion, forty-five percent of which was the responsibility of ten states, all of whom have constitutionally mandated balanced budget provisions. What makes New Jersey and Connecticut so fascinating is that they have chosen two very different roads out of their respective labyrinths. New Jersey’s deficit, at 37.5%, is more dire than that of Connecticut, which is “only” 21.6%. However, there are only eight states whose deficit as a percent of their budget is greater than that of Connecticut, and the Nutmeg state carries the highest public debt on a per capita basis of any state.

The biggest difference between Mr. Christie and Mr. Malloy is that the latter has chosen to use tax increases to close roughly $1.5 billion, or roughly 45%, of the budget gap. Everybody, rich and poor, would be affected. For the wealthy, a luxury tax (ala Senator Mitchell’s infamous insertion into the 1990 federal budget of a similar tax, which failed to raise the expected revenues and devastated boat builders,) an increase in the top income tax rate to 6.7% and a hike in estate taxes. For the less fortunate, the new governor has proposed an increase in the sales tax to 6.25% from 6.0% and would broaden the number of products and services subject to such a tax. He would also raise taxes on gasoline and cigarettes.

In his February budget address to the Legislature, Mr. Malloy said that the sum of all the items in his budget could be summed up in one word: “jobs.” He is right, in that jobs are needed. He is wrong, if he expects that higher taxes will attract jobs, assuming he means private sector ones. He has to realize that there is competition for jobs and that the state must offer incentives – making the state “business friendly.” Instead, I fear, he will chase them away.

What Mr. Malloy, and others who occupy similar positions, will not admit is that it has been their spending programs and their lack of financial discipline that have brought us to this position. Over the past twenty years, according to Saturday’s Wall Street Journal, the population of Connecticut grew 9%, median income rose 54% and spending increased 146%. The problem is nowhere near as complex as the one that faced Sherlock Holmes in the “The Dog That Didn’t Bark.” We are in trouble because those with whom we entrusted the reins of government spent recklessly. As voters, ultimately we are responsible, but now the writing is on the wall in indelible, magic-marker lettering.

Behavioral economics play a role. When taxes increase, habits change. Like most politicians, Mr. Malloy fails to understand (or worse, maybe he does) that it is far easier for the wealthy to avoid taxes than the poor. It is they who can afford the high priced lawyers and accountants who can navigate between the Scylla of ever-moving tax rates and the Charybdis of ever-changing regulation.

The legendary hedge fund manager Michael Steinhardt was famous for clearing out his portfolio every year or so – selling all positions. Allegedly he did this because over the months there would be positions in the portfolio that, given what he now knew, should not be there. The selling was cathartic. It allowed him to start anew. His exceptional performance over more than three decades demonstrated the wisdom of his decision. Our governments (federal and state) should take similar action as regards the tax codes. In the past five years, the U.S. Federal Tax Code has grown from 16,845 pages to 71,684. What a difference it would be to start with a fresh slate – a one page tax form – that eliminated the myriad and mystifying tax deductions, credits and exemptions that proliferate throughout those pages! If we took such action, as time elapsed, we can be assured that new regulations, deductions, credits and exemptions would slip back in, perhaps to encourage (or discourage) human behavior. But, in the interim, the cleansing would provide renewed hope and confidence.

Thomas Jefferson once said: “Every generation needs a new revolution.” I would suggest that every generation needs a new tax code – one that starts with a blank slate.

The country and the states are facing massive debt problems and unsustainable deficits. A recovering economy may serve to mask the depths of those problems, but that relief (if in fact it occurs) would only be temporary. A Pew research piece out a couple of weeks ago suggested that the states’ shortfalls for retirement funds and retiree health plans were $1.26 trillion. According to Pew, if the actuaries who prepared the data had used a more realistic discount rate of 4.38%, the unfunded liability would have been $2.4 trillion.

There are those who argue that we should find a “middle way” through this dilemma, but it is always more important to find the right way. Divisive politics create tension; they are blamed for dividing the electorate along party lines; they create a fear concern that nothing will get done; but, again, doing the wrong thing is usually worse than doing nothing. This is no time to be centrist. The problems are too massive. The truth may not be politically palatable, but it must be faced. Many of those who measure and predict expected returns continue to live under the illusion that financial returns during the last thirty years are the norm. They are not. For the last thirty-one years, the S&P 500 (price only) has compounded at 8.5%, about 300 basis points above the very long term average . There is a debt and deficit problem. Unfortunately the solution will take radical measures, not typically found by those seeking consensus.

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