The Feudal Future Podcast .
Hello and welcome to another episode of the Feudal Future Podcast . I'm Marshall Toplansky , I'm Joel Kotkin , and today we're going to be tackling a really interesting question of financial deficits across the states , a little bit of a special focus on California .
And to help us do that we have two eminent guests Steve Malanga , who is the senior fellow at Manhattan Institute and senior editor for the City Journal publication that they publish , and former state senator , former Orange County treasurer and Orange Orange County supervisor , john Morlock , who's lived this live in his lifetime in Orange County .
Gentlemen , welcome , joel . You want to kick us off ?
Yeah , I'll start off with you , Steve . I've been reading your stuff in City Journal for a long time . This financial crisis that's affecting states and cities has been going on for a long time . Is your sense that it's ? It's getting worse and sort of the debt is inexorable ?
Well , you know , at this point , the COVID , you know , inserted itself , if you will , into the whole picture and in ways that nobody anticipated .
When COVID first , when the lockdowns first began , people thought , you know , the states were just going to just go , you know , just going to go bankrupt , because they were already sitting on all this debt , including pension debt . Instead , several things happened .
The first thing is that , starting with the Trump administration , then the Biden administration , they sent hundreds of billions of dollars to states and cities and school districts and local governments . At the same time , they sent a lot of money to people , and so the savings rate in America , the household saving rate , actually rose as a result of all this .
What was supposed to be budget deficits turned into actually a lot of budget surpluses , including in California just a couple of years ago , in the middle of COVID . Now , a lot of people warned that the problem was that a lot of this was one-time government money .
In fact , it was money the government was kind of printing , or the electronic version of printing , and that when it went away , state budgets would be in trouble , and municipal budgets and school budgets , especially around the country . That is exactly what we're starting to see right now . What we've seen ?
A tremendous decline in tax collections at the state level , particularly economically sensitive taxes . What I mean by economically sensitive like income taxes , corporate income taxes and individual income taxes . In 2023 , in the aggregate , state income tax collections declined by about 11 percent . Corporate income taxes also declined .
What didn't go down were things like property tax collections , because , of course , you know they they kind of roll over in a number of years .
At the same time , a lot of states spent all the money that Trump and then Biden had sent them and , as a result of that , at this point we see a lot of states struggling with deficits of varying degrees , although California just blows everybody else out of the water , which is something I'm sure we'll talk about .
So that's where we are kind of right now and we're back to . You know , all that debt never went away and a lot of states took this government money and they spent it to do things like paper over deficits . And now you know the fiscal reckoning that people suggested was going to come after . Covid is here .
Well , John , how does that square with how you see things here in the great golden state of California ?
Well , marshall and Joel , it's great to be with you and it's a real honor to see Steve . We've talked over the years , so thank you for joining us . But Steve hit it right on the nose . In California we saw rising revenues year after year since Gavin Newsom came into office . He started with a budget that Jerry Brown , his predecessor , governor Brown .
His Brown's last budget was at $126.5 billion and in the last five years Gavin Newsom has taken it up to $240.1 billion . So it's almost doubled . But Newsom has sort of been living the normal life where people think that yesterday is today , is tomorrow , and if my revenues went up 20% this year and last year , they're going to go up 20% the next year .
And Hubris kicks in and he had just been spending all this money and he didn't take any of it and reduce debts . He didn't reduce the pensions , he didn't reduce OPEB or we call it retiree medical or other post-employment benefits . But worse off is that he did not reduce the debts with borrowings from the federal government to pay for unemployment benefits .
So another problem we have in California is that we don't have a good accounting system . We spend over a billion dollars for software and we still can't get a financial statement out in time . Every state has to prepare an annual comprehensive financial report .
It should be out within six months , usually December , and we just got the the June 30 financial report audit for California for June 22 . We just got it in April of 24 .
And what it revealed is that we picked up another $47 billion in debt for unemployment benefits or , you know , paying those out from the federal government , which is really remarkable because , as Steve pointed out , every state got CARES Act money , lots of it and they all improved .
47 of the 50 states improved their financial situation by reducing either their unrestricted net deficit or improving their unrestricted net assets . But California dropped $47 billion more than 20% . So we've had such an amazing case of mismanagement here in California .
Now , when you add in hold on just a second when you add in the obligatory spending on pensions for public employees to this new level of debt from the CARES Act and from other new indebted areas , how do the lines ever cross ? I mean , how do they ever get rid of this ? Are there any solutions to solving this problem ?
Well , let's attack two issues . One is pension debt and the other is other post-employment benefit debt . So California gives lifetime medical benefits to its retirees . That's created an unfunded actuarial accrued liability of over $90 billion . So let me give a personal story .
When I was elected supervisor for the County of Orange , the unions the public employee unions said we want raises . And so we said fine , what are you going to give us ? How about if we modify our retiree medical plan ? It's at 1.4 billion underwater . And so we negotiated .
We changed so many parts of the terms in the deal I don't want to get into the specifics , but the unions agreed to those terms and we reduced the unfunded liability from $1.4 billion to $400 million 71% . And as a senator , when I was on the Budget and Finance Committee , I kept repeating to the Department of Finance why don't we work on reducing the OPEBs ?
Here's what we did in Orange County , and they always blew me off . But if we had done that at the state of California , at the state level , we could remove what ? $63 billion from our balance sheet ? The other is the pension debt . The pension debt .
In 1999 , a bill passed , sb 400 that improved pension benefits by 50% , and the California public employee retirement system doesn't do math very well .
So instead of having a two-tier system where you say , okay , after this is adopted , we prospectively give you a new formula after this date and you stay with the old formula , they decided to make it retroactive to the date of hire . So when you have a fully funded pension plan in 1999 , when the dot com boom is in place , and you're 100% funded .
But if you improve benefits by 50% overnight , you become two-thirds funded . So here we are , literally a quarter century later , and we're still at 71% . We have not picked up or retired that debt and so you're paying all this additional interest 7% and it's just been an onerous thing . So how do you address that ?
Well , governor Brown said okay , new formulas for new hires . Some states have gotten a little more aggressive . I'll give the case of Wisconsin , where they said we're going to go to a shared risk defined benefit pension plan . So if you look at any rankings of pensions of states , you'll always see Wisconsin at the top .
And what a shared risk defined benefit plan does is it says to the employees if we don't earn what we're supposed to earn , then you have to increase your contributions . We will share the risk as opposed to the state and the taxpayers be completely so . there are remedies .
Usually you can implement something like Wisconsin did if you're in bankruptcy court , but states can't go into bankruptcy court .
Steve , are we seeing the same things , or is California uniquely horrible ?
Well , it's funny you say that because , as you were talking about this , I was thinking of the New York State budget .
In New York State , when things got so terrible after the so-called Great Recession of 2008 , 2009 , andrew Cuomo and local leaders like Mike Bloomberg , who was the mayor at the time of New York City , actually did pension reform in New York State very similar to what you're talking about in California , because the New York State Constitution protects the benefits of
everyone already working . But what they did was they rolled back , they lessened the benefits for new employees . Now it takes a long time for those kinds of savings to accrue , but it has been a long time and New York State is now getting those kinds of savings . So what's going on now ?
In this latest budget , the employee unions are fighting essentially to roll back those reforms that they're using a very kind of obscure argument which essentially says that if public employees don't belong to Social Security and they don't have to , unlike those of us in the private sector if they don't belong to Social Security , then their pension system has to at
least equal Social Security .
Now they're trying to claim that their pension system now does not equal even Social Security benefits , which , believe me it more than does , and I won't go into all of the financial machinations here , but we're already seeing this in New York and there's pushback in New Jersey also , although there I think the governor is aware that they're on such thin ice already
, even compared to places like California , that any attempt to do anything like that will really get them in trouble . So , yes , welcome to 2024 .
And the state of California did something very unique when Jerry Brown was governor . He sat down with Janet Napolitano , the chancellor for the University of California system , and said if you want more funding from Sacramento , then you're going to have to implement a defined contribution plan for new hires .
In other words , when someone comes onto the faculty of University of California , they have a choice either to go in the defined benefit plan or a defined contribution plan , which is like a 401k .
Versus a pension just to help . Well it is a pension .
But it's what the private sector has adopted . And what they found is that 27% or more of new hires said we'll take the DC because it's portable , we're not going to be here for a long time , We'll take it with us . Well , when I was in the Senate on the budget committee , I was one of two Republican senators where we met with the assembly .
They tried to eliminate that plan every year because unions find defined contribution plans anathema .
Steve . Yeah , what I was going to say is we actually at the Manhattan Institute did some surveys of teachers , for instance . A lot of teachers , most teachers in blue states at least they have these defined benefit pensions .
The thing is there's a lot of turnover in education and many teachers leave or leave the system they're in after 10 years Under a defined benefit plan . They don't do very well because they're not portable . You can't take them somewhere else . The money and during the first 10 years in a defined benefit plan you don't really accrue a lot of benefits .
It's not like we're going to put 6% a year in every year under a defined benefit plan .