The federal government has spent $800 billion more this year than it received in revenue. The full fiscal year deficit is expected to be about $1.5 trillion (which is even higher than last year’s). Surprise, the new health care law will cost $150 billion more than estimated just a few months ago.

Frankly, this is all you need to know, visualized for your viewing pleasure:

Debt doom

I’m reminded of a quote from my favorite political economist, Frederic Bastiat, from the mid 19th century:

Self-preservation and self-development are common aspirations among all people. And if everyone enjoyed the unrestricted use of his faculties and the free disposition of the fruits of his labor, social progress would be ceaseless, uninterrupted, and unfailing.

But there is also another tendency that is common among people. When they can, they wish to live and prosper at the expense of others. This is no rash accusation. Nor does it come from a gloomy and uncharitable spirit. The annals of history bear witness to the truth of it: the incessant wars, mass migrations, religious persecutions, universal slavery, dishonesty in commerce, and monopolies. This fatal desire has its origin in the very nature of man — in that primitive, universal, and insuppressible instinct that impels him to satisfy his desires with the least possible pain.

Man can live and satisfy his wants only by ceaseless labor; by the ceaseless application of his faculties to natural resources. This process is the origin of property.

But it is also true that a man may live and satisfy his wants by seizing and consuming the products of the labor of others. This process is the origin of plunder.

Now since man is naturally inclined to avoid pain — and since labor is pain in itself — it follows that men will resort to plunder whenever plunder is easier than work.

History shows this quite clearly. And under these conditions, neither religion nor morality can stop it.

When, then, does plunder stop? It stops when it becomes more painful and more dangerous than labor.

It is evident, then, that the proper purpose of law is to use the power of its collective force to stop this fatal tendency to plunder instead of to work. All the measures of the law should protect property and punish plunder.

But, generally, the law is made by one man or one class of men. And since law cannot operate without the sanction and support of a dominating force, this force must be entrusted to those who make the laws.

This fact, combined with the fatal tendency that exists in the heart of man to satisfy his wants with the least possible effort, explains the almost universal perversion of the law. Thus it is easy to understand how law, instead of checking injustice, becomes the invincible weapon of injustice. It is easy to understand why the law is used by the legislator to destroy in varying degrees among the rest of the people, their personal independence by slavery, their liberty by oppression, and their property by plunder. This is done for the benefit of the person who makes the law, and in proportion to the power that he holds.

From the Detroit News: Landscapers find workers choosing jobless pay

But B&L Landscaping in Oak Park finds the labor pool is noticeably weaker and less motivated, director Richard Angell said, even though the company still gets 80 to 100 applicants per week.

“We’re just getting people coming in, filling out paperwork, hoping they won’t get hired,” Angell said. “… We’re having a hard time finding quality applicants.”

I will quote extensively from his comments and bold the comments that I believe are important to note. This financial report is extremely relevant to the upcoming income tax increase on the ballot May 4th. For more information on that subject, see my posts on the income tax increase (Grand Rapids Tax Increase: It’s the Pensions Stupid, and Grand Rapids Fires Police, Firefighters, Keeps Parking Lot Sweepers).

By approving this tax increase, the taxpayers of the city will simply be kicking the can down the road one more year. As I’ve already demonstrated, if the tax increase passes, the city will be forced to come back again next year for even more money because the pension plans are killing the city’s budget.

Here are CFO Scott Buhrer’s comments. I know it’s long, but reading it is a must for all city residents:

Today it is obvious that the U.S. economy has far more capacity to produce goods and services than the demand for those goods and service. So any increase in demand will result in little price change. This will be the case until our underemployment rate of over 17% (the U6 measure) drops by a considerable amount and we begin to use our factories well above our current 72% utilization rate. In his book The Return of Depression Economics and the Crisis of 2008, Paul Krugman, winner of the Nobel Prize in Economics, correctly predicted that monetary policy (i.e. zero interest rates) would not lead us out of this financial crisis, and subsequently, as a columnist for the New York Times, Krugman has written of his belief that much more federal stimulus funding is required. But, at the end of the day, can you solve a problem that at its very heart emanates from excessive debt by continuing to fuel demand underwritten by government debt?

Over the last year I have provided assessments of National, State, and local economies. On September 15th I reported that the federal government had spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the United States last year (i.e. Gross Domestic Product, or GDP).

Which brings us to today. Irrespective of whether the economic recovery has begun or not, the United States (and much of the rest of the industrialized world for that matter), will face a long and difficult stretch of time as we deal with the excessive debt levels that have been accumulated over the past two decades.

The 19th-century British journalist Walter Bagehot claimed that during each speculative upturn merchants and bankers “believe that the prosperity they see will last always, that it is only the beginning of greater prosperity.” A boom in U.S. stocks in the early 1900’s was remembered by Alexander Dana Noyes, the financial editor of the New York Times in the 1920’s, as “the first of such speculative demonstrations in history which based its ideas and conduct on the assumption that we were living in a New Era; that old rules and principles and precedents of finance were obsolete; that things could be done safely today which had been dangerous and impossible in the past.” This mode of wishful thinking has continued up to the present day.

Instead of providing beneficial warning, economists have more often played the role of enablers during each successive New Era. The noted and early neoclassical economist whose work is perhaps more respected now than when he was alive, Irving Fisher of Yale, notoriously opined in September 1929 that stocks had reached a “permanently high plateau,” justifying this view with the claim that Prohibition had enhanced worker productivity and that businesses were employing new “scientific” management practices.

More recently, just a few short years ago, Federal Reserve Chairman Ben Bernanke and a number of other academic economists hailed the “Great Moderation,” arguing that rising institutional debt levels were tolerable, thanks to better monetary policy and better risk reducing financial innovations. During the boom years, Mr. Bernanke pronounced that rising house prices were a sign of improved economic fundamentals rather than speculative excess. It turns out that the Great Moderation was, in fact, a trap – a time of overindulgence of borrowing and risk-taking that would eventually destroy wealth rather than create it. Financial catastrophe is invariably preceded by periods of prosperity and New Era rationalizations.

The same Irving Fisher first highlighted the fact that an economy’s debt level could have harmful impacts on the economic growth, if it is excessive. In 1933 Fisher published his debt deflation theory that pointed out that the contraction of debt levels (which is currently occurring) usually results in prolonged economic distress. Borrowing binges invariably unwind, often quite precipitously, with sharp declines in asset prices, consumption, and high unemployment.

Housing prices are a remarkably accurate predictor of banking crises. Banking crises often follow periods of financial liberalization or deregulation. For all its “this-time-is-different hubris”, the United States has proved no exception. Rapidly rising housing prices should have set off alarm bells. Especially when the cumulative real price (i.e. inflation adjusted) increase in the United States between 1995 and 2006 rose 92%, more than three times the 27% gain for the preceding 100 or so years – and the total value of mortgages reached 90% of GDP. In 2005 alone, at the height of the bubble, real housing prices rose more than 12%, which was six times the rate of GDP growth.

International institutions (e.g. the International Monetary Fund) might help avert crises by promoting greater transparency in reporting financial data. Although it’s better than most, the United States government “runs an extraordinarily opaque accounting system.” In the past two years, the federal government (including the Federal Reserve) added huge off-balance-sheet guarantees and trillions of dollars of difficult-to-price assets to its books – and to date the Federal Reserve has refused to disclose details about these assets to the U.S. Congress. Bloomberg (a media company providing business and financial news and information) has sued in an attempt to compel disclosure.

What we do know is that Congress authorized up to $300 billion to bail out Fannie Mae and Freddie Mac. Quietly, on Christmas Eve, Treasury pledged unlimited support for the two agencies, without any additional Congressional approval.

Financial over-indulgence knows no boundaries and has no expiration date. Human nature is at the heart of the financial disasters. A recurring theme: investors, lenders and policymakers repeatedly delude themselves during economic booms into thinking that business cycles have been repealed and that the good times will go on and on. Indeed, after the recent financial collapse, 140 banks failed in 2009. If you think banking failures are declining and the financial crisis is over, consider this: the Federal Deposit Insurance Corporation’s (FDIC) board recently voted to approve the 2010 budget, which includes $2.5 billion for staffing to resolve failed banks taken over by the agency. That does not include the cost of winding up the affairs of these failed banks, which is almost impossible to estimate. That FDIC budget for staffing to resolve the affairs of the failed institutions is up 92% from $1.3 billion in 2009. The hiring plans will bring the number of FDIC employees to 8,653. Sheila Bair, Chairman of the FDIC, said the budget approved for 2010 “will ensure that we are prepared to handle an even larger number of bank failures next year, if that becomes necessary and to provide regulatory oversight for an even larger number of troubled institutions.” The number of problem banks on the FDIC’s confidential list as of September 30th more than doubled to 552 – the highest level in 16 years – up from 250 at the start of the year.

Three important factors pertain to the present situation in the United States and the world.

First, when debt becomes excessive, regardless of whether the government or the private sector is accumulating the debt, countries lose the ability to grow their way out of the problem; they must go through the time consuming and often painful processes of debt repayment and increased savings.

Second, whether the debt is owed externally or internally is not as critical as the excessiveness of the debt. Economic damage occurs as a result of extreme over-leverage, whether the barometer of performance is economic output, the labor markets, or asset prices.

Third, government actions, even involving sizable sums of money, are far less helpful than they appear. Further increasing government debt to solve the problem of over-indebtedness in the private sector only leads to greater systemic risk and general economic underperformance.

The question that is currently being debated is “are we headed for massive inflation or deflation”? As is widely feared here in the U.S., many countries have had the right
circumstances and mechanisms to inflate away their debt overhang, and, in fact, have done so by debasing their currency. This approach poses the most risk to those individuals who are on fixed incomes. Those particular circumstances, however, are not currently present in the United States, not with underemployment in excess of 17% and industrial capacity utilization at 72%.

I view the present inflationary environment as benign because: 1) the U.S. economic system is overleveraged and academic research confirms that this circumstance leads to deflation; 2) monetary policy is, and will continue to be, ineffectual as efforts to spur growth are thwarted by declining asset prices, loan destruction, and adverse regulatory influences; and 3) the federal government’s stimulus spending will ultimately lead to increased taxes and governmental borrowings must inevitably rise, further stunting any economic growth. These factors ensure that inflation will remain contained. Interest rates easily can and do rise for short periods, but remaining elevated in a disinflationary environment is contrary to the historical experience. If we do see higher interest rates it could be coupled with stagflation.

Fisher’s 1933 “Debt-Deflation Theory of Great Depressions” and modern “quantitative” methods have now essentially confirmed this conclusion: over-indebtedness and major contractions, particularly those that involve geographical regions (or in the present situation, extend worldwide) lead to deflation, not inflation.

The U.S. response and the world-wide response to the financial crisis have been remarkable.

But, we may find that at the end of the road, the cure could be as deadly as the illness. In 2009 the book This Time is Different – Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff compiled a database by looking at over 250 financial crises in 66 countries over a period of 800 years. The common theme in explaining the crises is that debt was excessive relative to national income (GDP). They make the compelling case that this old rule still applies and this time is not different. After studying data spanning 800 years, Reinhart and Rogoff characterize the current financial crisis as the “ Second Great Contraction.”

Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises such as the one that we are currently experiencing, share three characteristics:

First, asset market collapses are deep and prolonged. Declines in real housing prices average 35% stretched out over six years, whereas equity price collapses average 56% over a downturn of about three and a half years.

Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of seven percentage points during the down phase of the cycle, which lasts on an average more than four years. Output falls (from peak to trough) more than 9% on average, although the duration of the downturn, averaging roughly two years, is considerably shorter than that of unemployment.

Third, the amount of government debt tends to explode; it rose an average of 86% (in real terms, relative to pre-crisis debt) in the major post-World War II episodes. The main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. The upper-bound estimates of the banking bailout costs pale next to actual measured increases in public debt. The biggest driver of the governmental debt increase is the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions.

The Reinhart and Rogoff book is very sobering. It provides extensive empirical data that supports my belief that we have a lot of pain left to experience because of the bad choices our nation has made. We, in this case, is the entire developed industrialized world, and the emerging world will suffer, too, as we go through it. It is not a matter of pain or no pain. There is now no way to avoid it. It is simply a matter of when and over how long a period. The lesson of history, then, is that even as the economy and financial institutions improve, there will always be a temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be.

Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant. No careful reader of Friedman and Schwartz will be surprised by this lesson about the ability of governments to mismanage financial markets, a key theme of their analysis. As for financial markets, we have come full circle to the concept of financial fragility in economies with massive indebtedness.

All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. This time may seem different, but all too often a deeper look shows it is not. Deficit spending only provides a transitory boost to the economy. It initially raises GDP, as it did in the second half of 2009, but then the effect dissipates and later is reversed, as financial resources available to the private sector are reduced.

Conclusion

The enormous amount of federal borrowing and stimulus programs are likely to serve to restrict long-term economic growth. The slow U.S. economic growth environment will obviously lead to continuing budget challenges for the City and the State. If we continue to push expenses into future years it will assure that our future will be challenging even if the economy improves.

Why is this issue important? Because the state will eventually have to repay this borrowed money. We’re talking about billions of dollars.

According to the web site Pro Publica, Michigan is the number two borrower of federal funds to pay unemployment benefits (behind California). The negative balance of the state’s unemployment fund now stands at $3.429 billion. This negative balance is rising almost exponentially. In December alone, the state paid out $243 million more than it collected in unemployment taxes from employers.

2009′s “stimulus” law contained a provision that allowed states to avoid interest payments through 2011, but the bill will eventually come due. The kicker is that higher unemployment taxes on employers will be imposed to attempt to pay this shortage back, but that will just serve to kill more jobs as businesses are saddled with even more costs of doing business.

As the private sector has collapsed under the weight of debt saturation, government has begun to take on the debt load.This won’t end well.

The problem is that so many people are now dependent on government handouts, the political will to fix the situation will be almost impossible to come by. The entitlement  culture will only be curtailed where there is no other choice. And that may be sooner than we think.

We see our own microcosm of this with the crushing pension costs in Grand Rapids. The city’s commission is asking for an income tax increase, 100% of which will go to pay pension costs. And that’s just for the first year. They will have to come back to taxpayers to cover the tens of millions more they will need to pay just to keep the pension fund solvent. Let me repeat, just so it’s clear. This income tax increase will do nothing to improve or prop up city services. It will go only to pay for pensions.

Multiply this by all the cities in Michigan by all the states in the nation by all the people on federal benefits.

Just to illustrate, please observe the national debt’s growth rate:

National Debt Doom

That’s called a parabola. It will fail. Nature doesn’t tolerate exponential growth rates.

• Raise the minimum wage from $7.40 an hour to $10 an hour and remove exceptions in the law that allow employers to pay less than minimum wage to some workers.
• Cut utility rates by 20 percent.
• Require all employers to provide health coverage or pay a fine.
• Increase unemployment benefits by $100 a week, extend benefits by six months and make all workers eligible for unemployment. The maximum unemployment benefit is now $387 a week.
• Impose a one-year moratorium on home foreclosures.

It’s frankly a bit stunning and just goes to show the complete and total ignorance of basic economics apparently held by the state’s Democratic Party leadership. The Republicans in the state have actually taken a bit of initiative to propose budget cuts to close the widening state budget deficit, but Republicans long ago gave up the ghost on having any credibility when it comes to walking the walk.

Anyways, perhaps the Democrats have not gotten the memo that the overwhelming evidence shows that a higher minimum wage increases unemployment (or decreases employment). Perhaps 15.2% isn’t high enough for them. Why does the minimum wage increase unemployment? Because it prices those out of the market with the least skills. Look at it from an employer’s perspective. If you were to hire someone at $10 an hour, would you hire a teenager or someone with little to no skills, or would you hire someone with some skills or prior experience? Of course you would hire the person with prior experience. The higher the minimum wage goes, the less likely that employers will hire people with lower skill sets. This is why, due to our complete and utter failure of public school systems in urban areas in this state, unemployment among teens, African-Americans, and unskilled laborers is close to all-time highs. A higher minimum wage will simply exacerbate this problem. It ends up harming people, not helping them.

Requiring all employers to provide health insurance or pay a fine is another killer of jobs, primarily jobs provided by small businesses. I know someone who recently started a small business and it has done extremely well. He has hired about ten people, all part time. These are ten people who are happy to have any job at all. If he had to pay for health care for these employees, he would probably have to lay about half of them off, depending on the cost. It would degrade the service he provides by being required to provide the same service with fewer people, and it would surely drive up prices.

Oh, and instituting a one year moratorium on home foreclosures would further encourage the moral hazard of walking away from one’s home. Heck, I would even consider walking away if I got a year of free rent. House prices in the Grand Rapids area have already dropped 25-30% in the last couple of years. Anyone who has purchased in the last five or so years is probably underwater. It makes simple business sense to stop paying the mortgage, save the payment for a year in a savings account, and walk away with thousands of dollars in savings.

Way to go Democrats! There’s nothing like pouring gasoline on a fire to try and put it out!

The revenue collected from Michigan’s General Fund and School Aid Fund earmarked taxes totaled $1.3 billion in May, which was down 13.4% from last year’s level.  This marked the  fourth consecutive month  that tax collections have declined in excess of 10.0%.  While  collections for almost all of the major taxes experienced declines in May from their year-ago levels, the most significant declines were experienced by the sales, use, and income taxes.   Compared with the Senate Fiscal Agency’s monthly breakdown of the revised consensus estimates for FY 2008-09, May collections fell below the monthly estimate by $62.0 million and this shortfall was due primarily to weaker-than-expected sales and use tax collections.

When the Senate Fiscal Agency met in mid-May, they estimated the revenues for the remainder of the fiscal year. Despite the fact that they updated their estimates at that time, actual revenues for May declined by $62 million. In other words, in the matter of a few weeks, their estimates were already off. The budget is deteriorating that quickly.

More:

Sales tax revenue totaled $406.6 million in May, which was down a sharp 22.2% from the year-ago  level.   A consistent historical monthly series for the sales tax is available back to FY 1984-85 and the decline in May marks the largest percentage decline  in monthly sales tax collections during this 24-year period.

. . .

Tobacco tax revenue totaled $84.0 million in May, which was down 5.9% from last year’s level.  Most of  this decline is likely due to the large increase in the Federal tobacco tax that went into effect on April 1.  The Federal tax increase is having a negative impact on Michigan’s $2-per-pack cigarette tax because it boosted the price of cigarettes and therefore is having a negative impact on cigarette sales and Michigan’s tax receipts.

That last quote is vitally important. It perfectly exemplifies the power of taxation. It’s common sense, but the politicians in Lansing don’t seem to get it. The more you tax something, the less of that “something” you’re going to get. Clearly, the more cigarettes are taxed, the fewer cigarettes that will be sold. The same goes for businesses. The more you tax businesses, the fewer businesses there will be, and hence the fewer jobs there will be. Gosh, it’s pretty simple, but our tax-hiking pals in Lansing and elsewhere don’t seem to get it.

Finally, the $406 million of sales tax revenue in May was the lowest monthly level of sales tax collection I could find, going back at least until 2005. Michigan is hurting, folks, and it’s only going to get worse, as exemplified by the state’s skyrocketing 14.1% unemployment rate.

Read a little about how California’s government is collapsing because of that state’s inability to enact any rational level of reform: California Collapsing.

Oh, and remember our post about how the stimulus won’t do a damn thing? Below is the Federal Government’s chart, formulated back in January, which attempted to scare people into passing the gigantic wasteful bloated stimulus plan. They wanted to show how bad things would get without the stimulus and how much better things would be if the stimulus did pass. Guess what. Things are much worse than either prediction. The red dots are actual unemployment since January. Just another reason not to believe any of the bilge coming out of Washington when it comes to economics.

While tax collections in February were expected to fall below last year’s level, due primarily to the impact of the economic recession, the decline was much worse than expected . . . In addition, tax collections fell short of the estimate for February by almost $100.0 million.  Combined with the equally weak level of collections in January, tax collections so far in FY 2008-09 are about $200.0 million below the January 2009 consensus revenue estimate.

Interestingly, tax collections in the current fiscal year (which began in October 2008) were doing fairly well, until now. Last month, however, state tax revenue was down 31% from last year’s February level. Sales tax revenue, a good proxy for economic strength, was down 17% year-on-year in February, while real estate transfer tax revenue was down 41%. Stunning. This indicates (along with Michigan’s highest-in-the-nation unemployment rate of 11.6%) that the economic downturn is actually accelerating. 

This sets the stage for several possible outcomes. Although the structural budget problems aren’t as bad in Michigan as in California, we are heading in California’s direction in terms of budget meltdown, if the current trends continue. The politicians are in a tight spot here. They will almost certainly have to propose additional tax increases as well as budget cuts. The question becomes how does the Republican-majority State Senate react? They caved to last year’s massive tax hike – will they do it again? How do they sell a tax increase when over 1 in 10 Michiganders doesn’t have a job? When the Detroit Three continue to contract and lay people off in massive numbers? When house prices continue to decline, making it more and more attractive to simply walk away from mortgages?

Gimme more. Gimme more. Gimme gimme gimme more.

Today it was announced that Michigan’s unemployment rate hit 11.6%. What is governor Granholm’s reaction? She announces her support for an increase in gas taxes! Great idea! She has already succeeded in increasing the income tax by 12% and increasing business taxes by 22%. That seems to be working out really well. Not.

Her insatiable appetite for more of your money won’t be quenched until no one in Michigan is left with a job.

“In five years, you’re going to be blown away by the strength and diversity of Michigan’s transformed economy.” – Governor Granholm, State of the State address, January 25, 2006 (unemployment rate was 6.2%).

By contrast, France, which historically has always had extremely high unemployment due to bloated government, high taxes, and constantly-striking unions, has an unemployment rate of 7.5%. That’s right. We’ve beat France.