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Nobel Prize Winner Gary Becker reminds us that it is not pretty. Here is a small excerpt:

The disturbingly large present and prospective fiscal deficits of the federal government receive much attention, and deservedly so. Yet the financial situations of many state and local government finances are also in bad shape, and in many respects they are far more difficult to solve than are the federal fiscal problems.

California provides a dramatic example. It has a current annual budget deficit of over $20 billion, which amounts to about 20% of its annual spending. My home state of Illinois is not far behind, with a fiscal deficit also of about 20% of total spending. States like Nevada even have much bigger deficits. Many cities, like Chicago and New York, also face dismal fiscal futures. Some states, like Texas, have much better fiscal health, either because they have had greater fiscal discipline, or because the Great Recession has a smaller impact on their tax revenues.

As bad as their present fiscal situation is, the long-term picture for state and local government finance is even more dismal. The vast looming problem is the huge level of unfunded liabilities for pensions and health care to retired government employees. Recent estimates place the present, or discounted, value of state and local government unfunded liabilities at over $3 trillion. This amounts to about 22% of American GDP, and it is more than 150% of annual state and local government spending. Unfunded liabilities are so large because of several factors.

Fiscal adjustment by states and cities is further complicated by the heavy unionization of their employees. Whereas unionization in the private sector declined drastically during the past several decades to only about 7% of the private labor force, unionized state and local government employees grew dramatically to about 40% of all these employees. Government unions, like the teachers unions, are powerful and entrenched, and would battle fiercely against efforts to greatly reduce any part of their total compensation.

One way or another, cities and all states with the most serious unfunded liability problems would eventually be forced to either lower their spending or raise their taxes. Either way that would reduce their competitiveness against other states. It is hard to come away with much optimism for the economic futures of the states and cities with the greatest fiscal problems.

Have a lovely weekend.

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