Monday, January 24, 2011

Financial Crisis in the Government

I'm at JFK, about to catch a 12-hour nonstop flight to Riyadh, Saudi Arabia tonight to attend the Global Competitiveness Forum (a mini-Davos I've heard; tomorrow through Tuesday, followed by two days in Abu Dhabi and Dubai.  It's my first visit to the Arab world since a holiday in Egypt right after college in December 1989, when I was helping Wendy Kopp start Teach for America.  Should be interesting…


I'm dedicating this entire email to what I think will be the single biggest issue in education reform for the foreseeable future: the financial crisis at all levels of government, which is placing enormous and growing pressure on unions representing public sector workers, most notably the teachers' unions.  The outlook for them is, at best grim, at worst, catastrophic.


Given my day job as a money manager, I've done quite a bit of work on this topic and I'm convinced that the crisis is NOT a short-term phenomenon that will quickly melt away as the economy recovers.  Though things may get somewhat better if we get a strong economic recovery, this will be offset by the rising payouts for healthcare and pension promises (for example, an editorial in today's NYT ( notes that "The city's pension costs have jumped from $1.5 billion in 2001 to $7 billion this year. Mr. Bloomberg rightly argues that the city can't afford to go on this way.")  In many states and cities – indeed, nationwide – governments made long-term promises to unions that were not properly accounted or reserved for and will, in many cases, prove to be unaffordable, so the era of belt-tightening is here to stay.


At is a report by the Center on Budget and Policy Priorities that lays out the ugly details, state by state.  To be sure, many states are in decent shape, but many of the biggest ones – most notably, IL, NJ, NY, and CA, which collectively account for 25% of the U.S. population – are effectively bankrupt (the only reason this isn't more widely recognized is lousy accounting, which has been a major contributor to the problem).  Here's the summary of the report:

As governors across the country prepare their budget proposals for the coming year, they continue to face a daunting fiscal challenge.  The worst recession since the 1930s has caused the steepest decline in state tax receipts on record.  State tax collections, adjusted for inflation, are now 12 percent below pre-recession levels,[1] while the need for state-funded services has not declined.  As a result, even after making very deep spending cuts over the last several years, states continue to face large budget gaps.  

To date some 44 states and the District of Columbia are projecting budget shortfalls for fiscal year 2012, which begins July 1, 2011 in most states. These come on top of the large shortfalls that states closed in fiscal years 2009 through 2011.  States will continue to struggle to find the revenue needed to support critical public services for a number of years, threatening hundreds of thousands of jobs.

A survey of state fiscal conditions suggests that:

·         2012 is shaping up as states' most difficult budget year on record.  Thus far some 44 states and the District of Columbia are projecting budget shortfalls totaling $125 billion for fiscal year 2012. 

While states are anticipating significant shortfalls in the coming year, their options for addressing those shortfalls are dwindling.  Federal assistance for states, which has been enormously helpful in allowing states to avert some of the most harmful potential budget cuts, will be largely gone by the end of fiscal year 2011, the current fiscal year.  Nearly one-half of the nation's governors have now released their budget proposals for fiscal year 2012, and their proposals reflect this grim fiscal reality.  A number of these proposals contain deep cuts to state services on top of the substantial cuts that states have already made since the start of the recession.

·         There are signs that state finances will start to stabilize after next year, but recovery will be slow.  The list of states that need to close mid-year budget gaps for the current year is far shorter than in the last two years.  Thus far only 11 states and the District of Columbia have reported new shortfalls emerging in their 2011budgets.  In fiscal year 2010, by contrast, some 45 states saw new shortfalls emerge after they enacted their budgets.  This trend may indicate that state revenues are stabilizing and that state finances will begin to recover along with the broader economy. 

·         Despite modest signs of improvement, states continue to face a long road to recovery.   Already, some 22 states are projecting shortfalls totaling $70 billion for FY 2013 (the year that begins 17 months from now).  Once all states have prepared estimates, this total is likely to grow.  Thus, significant state shortfalls are expected to persist into the future.

The shortfalls that states are projecting for fiscal years 2012 and 2013 are in addition to the over $430 billion in shortfalls that states have already closed in fiscal years 2009, 2010, and 2011 combined.

The primary implications of this permanent financial crisis for all public sector unions are twofold: 1) in the short term, widespread layoffs; and 2) in the longer term, a renegotiation of pension and healthcare promises, certainly for new employees and, likely, historical promises as well.  These go to the heart of what the unions have fought for over the past century, so they are rightly panicked (and if they're not, they should be!).


(Incidentally, I am not celebrating this.  While the unions have, to some extent, brought it upon themselves by becoming corrupt, shorts-sighted, and/or inflexible, I think the decline in unionization over the past 40 years is troubling and has led to a host of social ills/inequalities.)


I am not sure what this means for education reform.  On the downside, it means that the 100+ year bull market in education funding is likely over.  Every year, almost without fail, K-12 education spending in the country has risen faster than inflation and there have been huge windfalls in places like Kansas City, the Abbott districts in NJ, and the Campaign for Fiscal Equity money in NYC.  Much of this extra money was wasted, but where reform-minded leaders were in place, it was critical to grease the wheels of reform.  For example, it's much easier to get charter laws passed and charter caps lifted if schools losing students to charter schools can keep all or most of the money for those students.


But belt tightening can also have an upside, as it forces issues to the fore.  For example, layoffs are forcing an urgent debate over the horrible and immoral practice of last-hired, first-hired, irrespective of quality.


The budget crises will also have a huge but uncertain impact on the teachers' unions.  Going forward, in many places they are going to feel (and behave) as if they're under attack and fighting for their lives (because they will be!).  It's not clear to me if this is good for reform or not.  On the one hand, a trapped, wounded animal can lash out in a reckless, harmful and unpredictable way.  On the other, the pressure they're under could cause them to be willing to strike deals on issues they consider to be less important, like charter caps or teacher evaluations, in order to get what they want in terms of preserving jobs and pensions.  We reformers are going to have to be VERY clever, open-minded and flexible.

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