A Washington That Can Say No

Will state governments respond to President Obama's proposed freeze on a portion of discretionary spending by learning some fiscal discipline?

At Jon Fleischman's essential Cal politics blog Flash Report, Jason Clemens looks at how the loss of an amiable credit market will force politicians to dismantle the Golden State's bloated, wealth-destroying government:

Along the way lenders begin to notice the accumulation of debt and demand higher interest payments to accommodate them for the added risk. This means even higher interest costs, which means even less resources available for a given set of resources. The spiral is now self reinforcing – more spending leads to more borrowing, which leads to more debt and higher and increasing interest costs, which leads to more borrowing, and the cycle begins anew.

In many ways California has already entered this cycle. For instance, according to the U.S. Census Bureau's annual survey of state government finances, interest costs as a percent of revenues has nearly doubled since 2000. Put differently, nominal interest costs in California have more than doubled from $2.6 billion in 2000 to $5.7 billion in 2008.

Some may argue that California is too big an economy for lenders to worry about risk. Such people would be ignoring the fact that California's debt is already the most risky (lowest bond rating) of any state. Indeed, Standard and Poor recently reduced the state's bond rating once again…

The choice for California is not whether to reform. The choice is whether legislators will enact meaningful reforms in a thoughtful, proactive way, or whether reforms will be imposed on us from the outside, probably in the not-so-distant future.

California's budget in 2009 was $25 billion smaller than its budget in 2008. The state's balanced budget law and supermajority requirement for tax increases do not do a perfect job of producing balanced budgets or reining in taxation, but they are useful in times of economic hardship. (This is in a state that can't even come to terms on a piddling reform like privatizing the lottery.)

Last week Obama responded to Gov. Arnold Schwarzenegger's disgraceful attempt to shake another $6.9 billion out of D.C. with an offer of only $1.5 billion in the budget proposal. There are no new sources to drain. And federal aid to states—including ARRA-related stimulus funds and the $25 billion blown on Medicaid in the budget—provides only limited support for state budgets, because those dollars tend to come committed to particular boondoggles.

States can't print their own money, but the federal government can. So far there is no evidence that cautious bond buyers are willing to say no to U.S. government debt. During his audience with Jake Tapper Sunday, Treasury Secretary Tim Geithner made countless variations on the phrase "Again, remember where we were just a year ago." But when asked about the possibility that Moody's might lower the federal government's bond rating, Geithner said U.S. Treasury notes will remain strong because they were strong a year ago:

Absolutely not. And that will never happen to this country. And again, if you step back and look at what has happened throughout this crisis, when people were most worried about the stability of the world, they still found safety in Treasuries and the dollar. You're still seeing that every time. People are reminded again about the many challenges you see around the world.

Never's a long time, but it must be said that the decline in demand for federal debt is a seeming inevitability that continues not to happen.

The Obama Administration has never seen a hundred billion dollars it didn't want to flush down a low-flow toilet, but the California experience suggests even the threat of reducing aid to states (Schwarzenegger and the California congressional delegation have all vowed to keep fighting for a larger chunk of federal pork) can make states reduce spending, if not to accept a great Californian's truer-than-ever assessment of the role of the state: