Wednesday, February 23, 2011

How much can a People afford?

I really don't want to come across as taking a side on a political issue. I have written extensively on politics in other venues and don't feel the need to do it here. So, read this as simply exploring the mechanics of taxpayer funded services. This is presently a hot topic. We see in the news here in the US many states trying to grapple with their budgets and huge debts and deficits. First let's talk a bit about what each of these is for clarification, then we'll look at how they happen and what it means for you and me.

So a deficit and a debt are two different things. Readers of Fiducate will know that a debt is money you owe - and more to the point, money you pay interest on to the lender. A deficit is the projected or actual difference between what you have budgeted and what you have coming in. For you and me, this might be what happens when we suddenly lose a job or take a pay cut. Our budget might have been nice and tight, ensuring we pay the bills, set aside savings and stay out of debt. But then our income level changes (downward). We suddenly have a deficit - more money allocated to go out than we have coming in.

Unless we want to go into debt as individuals (and get stuck in that life sucking trap paying interest and minimum payments for 20 years) we have to go back to our budget and decide what gets cut. Either we stop saving or we reduce expenses. In extreme cases, we may have to downsize our apartment or move to a less nice neighborhood to get a cheaper rent. In any case, we have to cut spending OR take on debt, which, as we know, has the effect of increasing our spending (by adding an interest payment to our budget line items) over the long haul.

So, for a municipal (local) or state or even federal government, how does this all work? Let's start by looking at the budget in general terms. A governmental body doesn't get a pay check like you and me, they typically are funded through taxation and fees. Taxes, as you no-doubt have observed, come in many forms. We pay income taxes, property taxes, sales taxes and sometimes special taxes called assessments for local improvements like sewer, public water or street repairs and construction. Then we have fees: building permits and inspection fees, dog licenses, car registration fees, some times you pay a fee to use your state or local parks and so on. Then there are those fees we all love to hate - parking tickets, fines for local code violations and you can even go down the list to fines or penalties you may pay for breaking the law. All told, it's pretty much a grab bag of income sources. It is volatile to be sure. Consider that revenues from income and sales taxes are going to be directly impacted by the employment rate and volume of sales. When those things go down, so too do the monies derived from them.

Recall the different scenarios I laid out in The Hows and Whys of budgeting for individual incomes. Some of us have a stable income, some of us do not. Do you remember what I said you would need to do if you have a variable (unstable) income?
But if you own your own business or have a job, like sales, where the pay tends to rise and fall with the season, you'll want to consider your total yearly income.
That's right, you need to average your income over time to come up with a realistic budget. For a municipality that has the potential for huge swings in income, historical averaging is a good way to plan for the future. Any city, county or state that has been around for more than 10 or 15 years has been through at least one boom and bust cycle. That's plenty of time to see where the peaks and valleys are in terms of income. This information ought be used to average out what the effective income and outflow can be safely assumed to be.

So, for example, if I am the mayor of Anytown and I know that our tax revenues bottomed out at $1.2 million in 2001 and peaked at $3.4 million in 1999 and just a while back in 2009 we again saw a dip down to $1.5 million, I have a pretty good scatter chart to work with to establish a trend line. The trend line will describe my average projected income year over year. The trick for me as mayor is to keep my expenses BELOW that line each year. Like a smart individual, anything that comes in above and beyond that line is going into the savings fund for future down-turns in the economy. Just because we have an off-year, I still want to be able to keep my fire and police and emergency services running, the streets lit and repaired and so on. If I plan carefully, I'll be able to do this. If I have a short term view of things, however, or decide to spend all of my income each year, I leave nothing for when the economy goes in the tank and have a hard choice to make: cut services or take on debt.

Unfortunately, many state and local governments over the past several decades have chosen to take on debt all too often (in my opinion - you can decide for yourself if you agree - I suggest looking at how many of these are filing for or about to file for bankruptcy and default on their debts though). There are actually two nasty things about debt. We already know about the interest, but the worst bit is the over-reach it allows. Over-reach is when you buy or establish more legacy services than you can realistically sustain. This is made easy by cheap credit (low interest) and the willingness to borrow. It's politically very expedient and easy for me to agree to any terms, as mayor, that any of my public service unions bring to the table if I'm willing to over-reach. It takes some discipline, though, to have to say no to expansions in expenses and resist credit and the pain it brings later.

So - what can we afford? Only so much as we have coming in and/or have saved for.

What do we have to do when we run out of money? Stop spending or borrow - which is really just more spending. The obvious answer is stop spending.

Can a government just pull the plug on critical services? Emphatically, no. And that's the problem with over-reaching. Once you establish a level of service, especially in the public sector, you are going to have hell-to-pay to roll any of it back. It can be politically damaging to do so. But, if your goal is to keep your town, village or state from totally defaulting on its debts (making any future borrowing VERY expensive), cuts have to be made.

Some recent history illustrates the drastic side of this. In the State of Michigan, Flint and Detroit have had such a dramatic down turn in their local economies that they have had to actually SHRINK the size of the cities to keep basic services up and running. By reducing the extents of the city limits, they are reducing the miles of roads they maintain, the numbers of parks they keep in operation and the number of street lights they keep on all night, but they also remove some far flung properties from the property tax pool. It's a delicate balancing act trying to keep the city viable while providing a reasonably decent level of service.

Anyway, there you go. I hope that aids your understanding a bit without being too leading in terms of opinion. There are some (not as fiscally literate as you, since you read this blog) who think running up debt or even defaulting on debt is OK as long as there are no job cuts, pay cuts or reductions of services. The trouble with that is the same as for an individual in terms of credit worthiness... if you default on your debt, getting future credit when you REALLY need it becomes impossible. Just to put it in context, if a state can't agree to cut some public union jobs today and insists on keeping everyone to the point where they have to take on debt and persist till the debt is defaulted on, the next time the economy sours unexpectedly, that government body will not be able to get a loan. Then it won't be whether you cut a job or not, it will be time to shut the lights off and lock the doors... the government is out of business. Not exactly ideal for a whole host of reasons. That's why fiscal conservancy is important all the time. If you fail to plan for the future, the future will have you for lunch.

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