Near the Abyss

When I was a kid, I read an article that said if you were in a rowboat in the middle of the Niagara River less than one-quarter mile above the falls, it was too late. You couldn’t row hard enough to get to shore.

Credit card debt has done much the same to some people. They can’t earn enough to get out from under the burden of accumulated interest payments.

Nobody ever thought that this could happen to a state. Not to a sovereign entity with the power to tax. But it is time to ask the question: could the State of New Jersey really reach the point where it cannot pay its bills and is functionally bankrupt?

My father raised this possibility in a public forum in Atlantic City two weeks ago. One might think that it would be news when a former governor suggests that the state might face conservatorship or some other functional equivalent of bankruptcy. This is not implausible. We have bonded indebtedness of $32 billion, a pension funding shortfall of nearly $60 billion, and unfunded post-retirement health care benefits that probably exceed $60 billion, so we’re talking about $150 billion. If we shut all state government functions and aid programs and close all schools for five years, we might raise enough in taxes to pay off these liabilities.

It may be that taxing power is not unlimited after all. The state only collects sales taxes when people buy things. It collects about 40% of its income tax revenues from only about 35,000 households. A fifth of our $12 billion in income tax revenue has been from capital gains; kiss that money goodbye. And fair or not, the richest among us can most easily change their legal residence, so if marginal tax rates go too high, there is a risk that we kiss more of these taxpayers goodbye altogether.

There are only two forms of discipline that apply to government. One is political discipline, or the will to establish clear priorities and withstand the pressure of interest groups. Two is market discipline. We’ve learned this fall that market discipline can be quite unpleasant. Market discipline, as applied to states, can mean forced cuts due to the absence of traditional tax revenues and an inability to borrow. Goldman Sachs recently suggested to its clients that New Jersey may not be so creditworthy.

We would do well to avoid market discipline if that is still possible. That means a focus on the big ticket items in government, and on controlling the compensation negotiated by certain interest groups who wield substantial political power.

Every recent governor has deferred pension payments to some future date, but none has been willing to undertake fundamental pension reform that would stabilize the system while providing workers with a fair and secure pension. Few elected officials are willing to support education reforms that could improve results and cut costs. We need to act on win-win prison reform that would lower costs and improve the administration of justice. Few are willing to reform bargaining procedures that give some local cops higher pay than members of the president’s cabinet. We also need to address the separation of powers in our state constitution because our high court has effectively assumed the power of appropriation in certain parts of the state budget. The idea of the US Supreme Court deciding on how to spend huge chunks of the federal budget is rather unimaginable. The list goes on and on.

It is hard to get a nomination, perhaps in either party, on a platform of fiscal responsibility because voter turnout is low in primaries and interest groups wield disproportionate influence. But at some point, we must learn from the lessons of history. One lesson is that government spending should be countercyclical. Ironically, the state government has reduced capacity to help now because there was no fiscal discipline during boom times.

In the summer of 2007, the Star Ledger did a retrospective on the underlying causes of the Newark riots. The tax base deteriorated, gradually at first. That caused a decline in services. In particular, the quality of education suffered, which in turn caused more of the middle class to move out. Newark was caught in a vicious downward spiral. If we are not careful, the same fate could await our entire state. It would be ironic and catastrophic if a combination of well-intentioned spending programs together with certain parasitic practices in the public sector led the state to the same fate.

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