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Winter 1991
   
Opening Albany's Books
Edwin Rubenstein
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Edwin S. Rubenstein is an economic consultant. An adjunct fellow of the Manhattan Institute, he also writes an economics column for National Review.

In Albany the most common explanation for the state’s fiscal crisis runs like this: As the national and particularly the regional economy have slowed, New York, like most nearby states, has had an unexpected revenue shortfall. New York was particularly hard hit because of the large recent cuts in state income-tax rates. The resulting revenue loss has been so severe that despite several years of relatively restrained spending, the state now faces a huge and growing deficit not of its own making, a gap that can be filled only by tax increases or by substantial reductions in vital services.

Though there are elements of truth here, in substance this story is false. The deficit was not caused by a revenue shortfall. Revenues grew dramatically during the Eighties, despite and in part because of the tax cuts, and have continued to grow (though more slowly than Albany projected) even as the economy has slowed. Spending has not been restrained but lavish, far exceeding even the substantial increases that might have been justified by the boom of the Eighties. The immediate cause of the deficit has been not a shortage of revenue but an excess of spending.

Of course great needs, or bold new programs, might well justify rapid spending increases. But the increased spending did not go toward bold new programs, but to pay for the increasing costs of traditional services. Nor did the increases clearly improve the quality of these services. Much of the increasing cost of traditional services can be attributed to poor management, for which the Governor’s office, the Comptroller, the Legislature, and both political parties all deserve a share of the blame. As for the immediate fiscal crisis, that is largely the product of the state’s insistence on using budgetary shenanigans to spend beyond its means even during the boom, drastically overextending its commitments, and then not acting quickly enough when the economy started to tighten.

Spending vs. Revenues

The state’s economy has slowed significantly since late 1989. But this fall has been from a new, higher baseline established by the Eighties boom. During the Eighties, New York’s economy performed better than the most optimistic futurist would have dared to predict.

Though lagging behind neighboring states, New York grew faster than the nation. Real personal income rebounded from no growth to average annual increases of more than 3 percent. Per capita income rose from 8.1 percent above the national average in 1980 to 16.9 percent above in 1989. Despite the current economic slide, there are more than one million more New Yorkers working and paying taxes today than when Mario Cuomo took office in 1983. The state jobless rate declined from 8.6 percent to circa 5 percent, and at this writing is still below 6 percent. The deterioration in the state’s economy has been far less dramatic than the deterioration in the state’s fiscal condition.

As for revenues, while some tax sources have shrunk in recent months, total state tax revenues continue to grow. Tax revenues are up a startling 89 percent since 1983. (See Figure 1.) By comparison, inflation was up 33 percent and federal revenues expanded by 53 percent. This increase in New York State tax revenues represents more than $760 for every man, woman, and child in New York, a figure larger than the total per capita tax collections of some states. State income tax revenues have grown substantially even in the face of the income-tax rate cuts. (See “Did the Cuomo Tax Cuts Work?” NY: The City Journal, Autumn 1990).

Had state spending merely kept pace with the Eighties boom, Albany would have a multibillion dollar surplus today. But this opportunity was lost.

In 1983 New York State, despite the relative parsimony of the Carey years, already spent 29 percent more per capita, and 13.8 percent more relative to personal income, than the average of the other 49 states. Nevertheless, during the next eight years, state-funded spending rose 91 percent. By 1988, the latest year for which comparable data for all states are available, the state was spending 47.3 percent more per capita than the average of the other 49 states (see Figures 2 and 3), and 24.2 percent more relative to personal income.

From 1983 through 1988 New York State spending as a percentage of personal income rose by 7.1 percent (from 14.7 percent of personal income to 15.7 percent of personal income), an astonishing event considering that personal income rose by 47 percent during the same period. During the same period the state-spending-to-personal-income ratio for the rest of the 49 states dropped by 1.8 percent. (See Figure 3.) And despite the looming fiscal crisis, the state’s fiscal 1991 budget still calls for an additional 7.5 percent spending increase.

The data seem very clear: State personal income and state revenues have increased enormously since 1983; nevertheless the state has outspent its growing resources. The fiscal crisis was caused by too much spending, not too little income.

Budget Games

Why then do so many people believe exactly the opposite? Part of the reason surely is the opacity of the state’s financial records. The state’s affairs are tangled in a network of trust accounts, special funds, and off-budget enterprises apparently calculated to confuse potential critics.

To measure total state spending without the distorting effects of interfund shuffling, and to facilitate meaningful comparisons with other states, I have here used total or all-funds spending as the basis for my analysis, which most disinterested experts would agree is the only sensible procedure.

Many New York officials, however, do not like the all-funds approach. They would like public discussion to focus on general-fund or on-budget spending. Governor Cuomo, in fact, has criticized the author’s previous use of the all-funds approach, arguing:

... the “All Funds” budget ... include[s] billions of dollars of federally supported appropriations, plus capital costs. Historically, the State’s General Fund has been used as a more realistic barometer of spending, and for good reason. The General Fund more accurately portrays tax-supported expenditures.

—Letter distributed to NYS editors, July 30, 1989

True, the general fund once was a reliable measure of state spending. In recent years, however, many state expenditures long considered general-fund items have been shifted off budget, to special-revenue, capital, and debt-service funds. As Figure 4 shows, off-budget spending has exploded in the past eight years, growing by 306 percent, or 7 times the rate of inflation. Over the past eight years, a total of $5.9 billion has been added to off-budget spending. In the 1990-91 budget, off-budget spending is slated to rise 27 percent, or more than 14 times the increase reported for the general fund. All in all, more than 20 percent of total state spending (excluding federally supported spending) is excluded from the general fund, up from 9.7 percent at the start of this administration.

In the past, the assignment of spending to off-budget accounts was based on management or accounting considerations. “Special-revenue” funds, for example, served as depositories for federal grants, which were then passed through to local governments. But a recent study by the Peat Marwick accounting firm found no rationale for the recent fund shifts other than to give the illusion of spending restraint in the general fund.

Since 1983, regulatory agencies such as the Public Service Commission, the Banking Department, the Insurance Department, the Commission on Cable Television, the Worker’s Compensation Board, and the Consumer Protection Board have been reclassified from the general fund o special-revenue funds. The most common justification for moving these agencies off budget is that they are financed not by ordinary tax revenues but by fees levied on the industries they regulate.

The imposition of such “user fees” in lieu of general taxes is a sound economic practice that can curb inadvertent government subsidies to the affected businesses: Under the fee system businesses pay for their own regulation. But it makes no sense not to count the budgets of these regulatory agencies as part of general state spending. To the consumers, employees, and shareholders who indirectly pay them, user fees feel no different from taxes. As with tax revenue, the need for fee revenue rises and falls with the efficiency of the agencies that spend it. Fees, however necessary, are a general burden on the economy just like taxes, and sop up some of the state’s taxing capacity.

Finally, fee revenues and tax revenues are fungible. That is, a new dollar in fee revenues should free up a dollar in tax revenues either to be returned to the people via a tax cut, or to be used for new spending. Only by looking at the all-funds figure can we know whether most of the tax dollars freed up by fees went to new spending or were trimmed from the budget and returned to the voters.

In this budget year, the state will spend $3.1 billion in user fees and other special charges, $500 million more than last year. The use of fee revenues to move items off-budget has spread so that many traditionally tax-supported activities have disappeared from the general fund:

• Fees on heavy trucks are paying the salaries of 196 administrative and clerical workers at the State Department of Transportation.

• At the Department of Agriculture, 33 employees who used to be paid from tax money are being paid from assessments on dairy producers and farms, and from fines and fees paid by the food industry.

• About $100 million in new assessments on utilities is paying for, among other things, a Consumer Protection Board project to study utility issues of importance to the poor.

• The Department of Social Services had no support from special-revenue funds in 1983; it now uses $116 million from sources such as fines for foodstamp fraud to help defray its $270 million budget.

All these changes may represent sound economic practice. They do not represent a reduction in state spending.

As for the claim that the all-funds measure should not be used because it includes federally supported programs, this is wrong on several counts. Federal aid cannot be easily isolated from state-supported spending. Much federal aid comes as matching funds tied to state spending increases. Conversely, nonmatching federal aid is at least partly fungible with other state revenues, so an increase in certain types of federal aid should permit a decrease in the use of state funds. Because of such complications, it makes sense, when assessing a state’s fiscal performance over time, to count federally supported expenditures, provided one does so consistently.

Moreover, the inclusion of federally supported expenditures in the all-funds measure actually makes the state’s recent fiscal record look slightly better. As Figure 4 shows, “net state spending” includes all general-fund and off-budget state-supported spending, but not federally supported programs. Net state spending increased 91 percent from 1983 through 1991, but federally supported spending lagged behind, increasing just 82 percent. Because of that lag, all-funds spending increased less than it would have if federally supported spending had kept pace with state-supported spending.

One-Shot Deals

Moving traditionally on-budget items off budget, and claiming that fee funds have replaced tax funds when they have merely supplemented them is, to be sure, dishonest. But in themselves such practices need not produce a fiscal catastrophe. A far more dangerous sleight of hand, and one increasingly used in New York State in recent years, is the use of nonrecurring “one-shot” revenues to drive spending levels beyond the state’s true ability to pay. Even in boom years such practices encourage the state to commit itself to increases in spending far beyond those allowed by normal economic growth. When the boom stops, and the list of available one-shots grows short, disaster looms. Indeed, if one-shots must be used at all they should be saved to “fill in the gaps” in hard times, not to overextend the state’s commitments when times are good.

Yet it was just at the tall end of the boom that New York State began to overindulge in one-shots. In fiscal 1986, the state succeeded in having the Urban Development Corporation sell bonds to cover the cost of prison construction. Not content to cover construction costs for that year alone, bonds were sold to cover the costs for prior years as well. Presto! This “back- bonding” produced a painless $255 million windfall to New York State.

With that apparent success, the binge was on. In 1987 the state found a way to justify withdrawing $325 million from the State Insurance Fund (a worker’s compensation fund for employers and workers) and $69 million from the Battery Park City Authoritu’s accounts. The following year the Tax Stabilization Reserve Fund, a.k.a. the “Rainy Day Fund,” proved irresistible: $133 million of reserves were siphoned off. Another $300 million was drained from the State Insurance Fund.

In fiscal 1989 the state discovered $110 million in what it declared “superfluous” reserves in a trust fund set up to cover death and disability benefits. Another $123 million windfall transpired from selling Empire State Plaza bonds. (The plaza was completed in 1974.) In refusing to turn Medicaid funds over to private carriers, Albany discovered yet another way to raise cash—$54 million in this case. The insurance fund was good for another $250 million.

In the past two fiscal years the one-shot trickle has become a torrent. SUNY bonds were refinanced: $111 million. The Hazardous Waste Removal Fund was raided: $84 million. Ditto the Housing Finance Agency ($30 million) and Court Facilities Funds ($36 million). The Dormitory Authority was ordered to sell $68 million in bonds to pay for a new laboratory for the State Health Department. “Back-bonding” for work done in previous years on Mental Health Department facilities produced another $67 million. Those old standbys—the State Insurance Fund and the Aggregate Trust Fund—came up with a combined $290 million. A state office building (or a prison) is to be sold to the state’s own Urban Development Corporation. A highway will be sold to the State Thruway Authority. New actuarial assumptions developed for the Teachers Retirement System will enable school districts to forgo $354 million in pension contributions, in effect shifting this money to Albany as state aid to education.

All in all, $5.6 billion worth of “special-effect” revenues have been dredged up since fiscal 1986—$1.8 billion in 1991 alone. The one-shots are an unsustainable source of revenue. The very need for them should have been an early signal that the state was spending beyond its means. A state government pressed for cash as early as 1986 clearly needed to make spending cuts. Soon the state will be deprived of most one-shot revenues because practices such as claiming a $354 million saving by redoing some actuarial tables profoundly sway the credit markets. As the credit markets tighten, fiscal rectitude will be forced on the state government. The inevitable spending cuts will be far more drastic and painful than they needed to have been.

Local Largesse Lost

Spending increases, not revenue shortfalls, caused the current crisis. That leaves us with the all-important question of whether the spending increases were necessary or productive. To answer that question requires some attention to the major state spending programs. But it also requires a look at local government spending in New York, which provides perhaps the most powerful evidence that recent state spending has been excessive.

Most states that rank high for state government spending rank much lower for local spending, and vice versa. This is to be expected: In states where the state government pays for a lot of services the localities need do less; where the state is parsimonious, the localities must do more.

In New York this trade-off does not happen. We are among the national leaders for both state and local government spending. Relative to personal income, New York state and local governments spend 31 percent more than the rest of the country. In 1988, New York’s combined per capita state and local government spending was 55 percent higher than in the rest of the country ($5,026 versus $3,243 per capita). The next highest-spending industrial state, Massachusetts, spends 21.5 percent less on a per capita basis. New York could save $19 billion—enough to seal many years of fiscal gaps—just by reducing spending to Massachusetts’ level.

Thus though New York’s local governments are lavish in their provision of services, at least in dollar terms, Albany falls to take advantage of this largesse by trimming its own spending. Moreover, Albany not only fails to take advantage of the high level of local spending, it bears substantial responsibility for the size of local expenditures.

State regulations determine the level and cost of many services provided by localities. Albany mandates at least 65 percent of Rensselaer County’s budget, according to John Buono, Rensselaer County executive. New York is one of only 14 states that forces local governments to pay for part of Medicaid. Local governments in New York account for about 80 percent of all local government Medicaid spending nationwide. Albany prescribes staffing levels for nursing homes. State regulations determine the amount of courtroom space and jail cells that counties must build, as well as the type of food they must serve to inmates. Counties are required to house state prisoners, for which the state pays only a fraction of the actual cost.

This year Albany initiated a new program for handicapped schoolchildren, requiring counties to provide transportation during the school year, and special youth programs when school is not in session. Even as the state mandates an increasing amount of local spending, it has revoked revenue sharing for counties, and reduced the proportion of certain state fees (e.g., motor vehicle fines) returned to governments.

When local spending increases because the state requires it, only a bookkeeping illusion attributes that rise to the locality. Also, when the state mandates raises in local spending, and therefore local taxes, it limits its own ability to raise revenues. In this sense, much of what passes for local spending In New York is actually a state expense.

Where the Money Is

As for where the money went, ask anyone in Albany and you will get pretty much the same answer: not to new programs. Most of the increases in state spending seem to have gone to education, welfare, and Medicaid programs. Much of that money seems to have been wasted. New York pays far more per capita than most other state governments for these functions and there is little evidence that it gets more for its money. In some cases it clearly gets less.

Education

Elementary and secondary education, the single most expensive governmental function in New York State, cost New Yorkers $934 per capita in 1988, or almost one-fifth of total state and local spending. New York’s educational expenditures have long been far above the national average, but between 1983 and 1988, state education spending rose an additional $7.1 billion, or 49 percent. It cost $7,561 to educate each pupil in New York State public schools in 1988-89, more than any state except New Jersey. The national average was $4,541.

Despite this spending binge, average New York SAT scores declined seven points between 1980 and 1990, making New York 45th in the nation, down from 36th in 1980. By contrast, New Jersey was able to increase SAT scores by 28 points over the same period.

Although enrollment in New York State’s public schools is declining, there are more administrators and other nonteaching staff than ever before. The ratio of professional staff members to students dropped from one to 15 in 1980 to one to 12 in 1989, in part because of an increase in the number of administrators per student. Albert Shanker, President of the American Federation of Teachers, says there are more school administrators in New York than in all of Western Europe.

Welfare

At $707 per capita, welfare was second only to elementary and secondary education as a state and local expense item in 1988. Between 1983 and 1988, per capita welfare spending increased 60 percent in New York compared to 40 percent for the nation as a whole. New York’s welfare spending ranks first in the nation as a percentage of personal income, though New York ranks only eighth nationally in the percentage of the population on welfare, and 17th in the percentage of the population living below the poverty line.

The classic welfare caseload—persons on AFDC and home relief—has shrunk in recent years. New York’s welfare costs are high partly because its administrative costs are high. It cost New York about $1,118 to administer one AFDC case in 1988, or nearly twice the national average of $628. Only Oregon and Idaho—which clearly do not have New York’s economies of scale for welfare administration—spend more per case.

A description of Department of Social Services productivity from the Arthur Andersen accounting firm helps explain why administrative costs were so high:

Our analysis showed that 39 percent of the observed time was spent performing value-added activity (e.g., direct work); 23 percent was spent on nonvalue activity (e.g., filing, information retrieval, etc.); and 38 percent was spent on nonwork (e.g., idle time, nonbusiness talking, etc.).... The results confirmed a general sense of low productivity, and an overall lack of urgency in the conduct of daily work activities.

Medicaid

In recent years Medicaid has been the state’s fastest growing spending program. With only 10 percent of the nation’s Medicaid recipients, New York accounts for 20 percent of nationwide Medicaid spending. New York spent $4,163 per recipient in 1989 far more than any other state. (The national average was $2,318; California spent $1,654 per recipient.)

State officials often blame high state expenditures on demographics. “We have a high percentage of elderly people who need continuing, long-term, and nursing home care,” says Terence McGrath, a spokesman for the State Department of Social Services. Actually New York ranks 18th in the percentage of population over age 65-and 49th in the growth of that population. Nor is there much evidence that New York provides significantly higher-quality care than most states. New York, for instance, ranks third in the percentage of mothers who receive little or no prenatal care, worse than every other state except Texas and New Mexico. (See Figure 5.)

The real source of our Medicaid overspending is a complicated series of poor management decisions that doom the system to waste and inefficiency. Thanks in part to a plethora of state rules and regulations, skilled nursing home care, for instance, is fantastically expensive in New York, costing about $25,000 per recipient here versus $8,500 in the rest of the nation.

The most significant Medicaid increases, however, have come in hospital inpatient bills, which grew more than 230 percent between 1979 and 1989. Part of the explanation may be a shortage of nursing home beds, which has left many elderly patients “stacked up” in overcrowded hospitals awaiting transfers. New York Medicaid clients also spend more time in the hospital because they do not get enough regular checkups and other preventive care. This in turn, is partly because client care is managed much less aggressively and sensibly here than in states that use Health Maintenance Organizations and other “managed-care” programs for Medicaid patients. New York refuses to do this, falling to realize that cost containment, aggressive management, and quality care often go together.

How to Count Costs

These anecdotal overviews, however, are not the only evidence that the spending binge of the past eight years was unnecessary. Public-finance specialists have developed standard methods for comparing what a state spends to what it needs to spend, based on the experience of other states. These methods adjust for differences in the cost of living, state government salaries, the need for public services, etc. The best known of the various methodologies was developed by Robert W. Rafuse Jr., of the Advisory Commission on Intergovernmental Relations, a nonpartisan research organization supported by New York and other states.

Rafuse’s “representative expenditure system” is particularly exacting in the way it accounts for differences among the states in such factors as population characteristics, crime rates, local salary levels, and even the number of miles residents drive on state roads. The result is a rough-and-ready standard for whether a state is over- or underspending.

By that standard, New York’s expenditures are grotesquely overgrown. Mr. Rafuse’s latest research, covering the 1986-87 fiscal year, found New York’s state and local governments spend 52.4 percent more than the national average even after taking needs and costs into account (see Figure 6). New York ranked third in adjusted spending, behind Alaska and Wyoming. California spent only 12.4 percent above the national average. New Jersey and Massachusetts spent, respectively, 21.4 percent and 27.7 percent above the national average. Illinois and Pennsylvania spent below-average amounts.

Public welfare, at 197.8 percent of the national average, was the most lavishly overfunded governmental program in New York, according to Rafuse’s calculations. New York spent less than the national average in only one area: higher education, at 87 percent. (See Figure 6.)

Rafuse’s work contradicts the frequently repeated assertion that New York’s costs are high because of difficult local conditions. On his analysis it is hard to escape the conclusion that the state government has been overspending for years.

Political leadership ultimately comes down not to numbers, but to choices and values. It is always possible for an honest man to argue that the government should spend more, no matter how much it is already spending, or less, no matter how little. But it is impossible to deny that New York’s fiscal crisis was caused by an extremely rapid increase in spending, an increase so rapid as to outpace the normal growth in revenues from one of the most powerful economic booms in American history. It is nearly as difficult to argue that this huge rise in spending produced a comparable improvement in the quality of state services or the well-being of New Yorkers.

The Future

What about the future? The economic downturn has already reduced revenue growth far below the state’s projections. A year ago Albany claimed it would collect $28 . 9 billion in tax revenues for fiscal 1990; it got only $27.3 billion. When the 1991 revenue forecast is next revised, the fiscal crunch will look even worse.

The economy, however, will bounce back eventually. The scary part of New York’s fiscal problem is that even in the best of economic times large and growing deficits seem inevitable. By Albany’s own admission, this year’s budget is balanced with $1.8 billion worth of items it cannot count on next year. As one leading municipal bond trader comments: “The state has dug itself into a fiscal hole. Actually, it’s more like quicksand. Political considerations strongly favor the increased use of one-shot budget gimmicks to avoid permanent tax hikes and spending reductions.”

If Albany can not control the one-shots, spring borrowing, and chronic revenue overestimates, Wall Street will: Investors will demand higher interest rates to compensate for the higher credit risk. Institutional investors will balk at adding still more state paper to their portfolios without a credible financial plan. Investment advisors are already telling clients to lighten up on New York State bonds. If things continue as they have, the state will find itself where New York City was in 1975, albeit without the prospect of a bailout from a friendly superior level of government.

MORE WORKERS, LESS WORK

New York employs far more workers than most states and pays them higher wages, with little to show for it:

* The U.S. Department of Commerce’s annual survey of public sector employment shows that New York State had 634 state and local government employees for every 10,000 residents, compared to a national average of 494 state employees per 10,000 residents in the other 49 states.

* New York employs one state highway worker per 6.2 lane miles, more than twice as many workers per mile as the national average. Yet 60 percent of New York’s highway bridges were found to be deficient in 1988, more than twice the national figure.

* Between 1980 and 1988 the number of state government workers in New York grew by 31 percent, while the state population grew by 2 percent.

* New York’s state and local government workers are paid more than their counterparts in all but two states—Alaska and California. New York State employees were the highest paid in the Northeast for 34 of 43 positions, according to an Arthur Andersen study.

* The Andersen study also concluded that: “Productivity is perceived as a ’passing’ fancy by the line and staff managers in state agencies... Too many people view productivity as a revenue issue.... If revenue is not a problem, productivity is not discussed.”

* The average New York State employee is paid $2,250, or 8.8 percent, per year more than the typical New York State private-sector employee. In three of the four contiguous states, state government employees are paid less than private-sector employees.

 

 

 
State leaders blame the fiscal crisis on "revenue shortfall." A closer look uncovers a different story
City Journal Winter 1991.
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