Charles Hugh Smith "Of Two Minds" blog takes a look at the coming crisis in state and local government finances. As he puts it, "Strangely enough, every easily foreseeable financial crisis is presented in the mainstream media as one that “nobody saw coming.” No doubt the crisis visible in these three charts will also fall into the “nobody saw it coming” category." The first chart may tell the whole story, or at least most of it:
At some point, borrowing becomes impossible (or prohibitively expensive) and the only trick left is to raise some taxes. Unfortunately, that well is empty, too. Taxes have gone up at essentially the rate of GDP growth: 75% instead of 77%.
Wages and salaries are barely keeping up with inflation, real household incomes are down 8.5% since 2000 and state and local government taxes and spending are rising at twice the rate of inflation--where does this lead to?State and local governments have to balance budgets, but they're not all in strong financial shape. What we have here is another one of those situations that just can't keep going the way that it has been going. Continuing to spend more than income is the very definition of unsustainable. And we all know things that can't go on won't go on.
1. The bond market may choke if state and local governments try to "borrow our way to prosperity" as they did in the 2000s.
2. If state and local taxes keep soaring while wages stagnate and household income declines, households will have less cash to spend on consumption.
3. Declining consumer spending = recession.
4. In recessions, sales and income taxes decline as households spending drops. This will crimp state and local tax revenues.
5. This sets up an unvirtuous cycle: state and local governments will have to raise taxes to maintain their trend of higher spending. Higher taxes reduce household spending, which reduces income and sales tax revenues. In response, state and local governments raise taxes again. This further suppresses disposable income and consumption. In other words, raising taxes offers diminishing returns.
At some point, local government revenues will decline despite tax increases and the bond market will raise the premium on local government debt in response to the rising risks.
When borrowing become prohibitive (or impossible) and raising taxes no longer generates more revenues, state and local governments will have to cut expenditures. Given their many contractual obligations, these cuts will slice very quickly into sinews and bone.