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Commentary By Steven Malanga

Where's the Government's Fiscal Reform Bill?

Governance, Economics Tax & Budget

As members of our two houses of Congress reconcile their differing financial regulatory bills into one piece of legislation that they hope will bring more transparency and supervision to Wall Street, you have to wonder: Where is the debate about reforming the fiscal practices of government?

If one thing is clear as the world financial situation proceeds from one crisis to another, it is that politicians have been as crafty in their fiscal maneuvers as any Wall Street trader, as opaque in the deals they construct as any maker of swaps contracts, and as motivated by short-term self interest as any investment banker who puts together a complex security likely to explode shortly after he’s peddled it.

By now, for instance, many people understand that Greek politicians kept two sets of books for some time in order to hide the true nature of their deficits, and to give workers a higher standard of living than the country could actually afford.

Less well understood, perhaps, is how the rest of the European Union encouraged that bad behavior when it allowed banks to load up on the debt of Greece and other EU nations by not requiring the bankers to carry this national borrowing on their books in quite the same way they account for other loans, because of course countries don’t default on their debt (except when they do). The capital charade helped make a farce of the EU’s guidelines on national deficits. It also made it necessary for Germany to bail out Greece because Germany was really bailing out its own banks.

But why pick on Europe when we have so much glaring fiscal malfeasance in the U.S.? Last month, for instance, David Crane, an advisor to California’s governor, explained in the Wall Street Journal how board members of the state’s giant pension fund justified a huge new set of benefits for public employees in 1999 by claiming the pension fund could pay for the new benefits out of investment gains. To do this the fund projected an average annual rate of return in the stock market that was so unrealistic that the Dow would have to be at somewhere around 25,000 right now for taxpayers to have been held harmless.

Instead, the state and many local governments have been slammed by the new pension enhancements, which legislators willingly voted for even though they knew Calpers was hardly an independent voice. Taxpayers have had to pony up some $12 billion in additional pension contributions this decade.

If you advocate reforming such practices, don’t bother bidding for government work. Last year, when Montana’s public employee pension funds were searching for an actuarial firm, the request for proposals specified that if a firm believed in valuing public pension funds based on realistic projections of how the market will perform, it need not apply. Only firms willing to accept the state’s benchmark, which projects an unrealistic average annual return of 8 percent, were eligible to bid for the business.

Faced with shrinking tax revenues, state and local politicians have employed all sorts of fiscal evasions to kick problems down the road, where some future set of office holders will have to deal with them (presumably with some new set of maneuvers). In Washington State last year, lawmakers helped balance the budget by ignoring the fact that public employees are living longer and the state should be contributing more to pension funds to account for that. Disregarding demographic reality allowed the state to scrimp on contributions.

Lawmakers justify some fiscal evasions on the grounds that they are one-time maneuvers designed to tide governments over till tax revenues rebound. But once politicians get a taste of these techniques, they become addicted to them. New York, for instance, helped to solve a budget crisis during the early 1990s by selling the infamous Attica prison to a state agency for $200 million. Then the state continually refinanced the bonds it used for the purchase, so that it still owes $300 million on the prison after having already paid out $254 million to bondholders. If he’s elected, perhaps Democrat Andrew Cuomo, who’s running for New York Governor on a platform of fiscal reform, will finally pay off the bonds that his father Mario floated 20 years ago.

Remarkably, such shenanigans only seem to encourage other states. Arizona sold its state capitol and other buildings and then leased them back last year to balance its budget. The one-shot left the state scrambling for new revenues this year as the downturn continued, and lawmakers pulled out another gimmick: pledging future lottery proceeds to back $450 million in borrowing to plug this year’s budget. You wonder how many different ways Arizona can mortgage its future.

You also have to marvel at how audacious governments have become at simply usurping the law. Jersey politicians absconded with proceeds from the state’s unemployment fund back when joblessness was low, leaving employers in the state now on the hook for hundreds of millions of dollars in new taxes. New Hampshire tried to raid a private medical malpractice fund but was only turned back by the courts, which ruled that politicians had no right to money. Last year, voter outrage forced Ohio politicians to return money they had grabbed from a fund to prevent blindness and funneled into the state’s general accounts to help close a budget gap.

Because the federal government can run deficits, it doesn’t resort to quite the same evasions as states and cities. Instead, as the deficit grows and becomes more politically unpalatable, Washington just tries to mislead taxpayers about the consequences of its actions. The recently passed health reform legislation, requiring 10 years of taxes to pay for six years of services, is a textbook example.

The bill is filled with little fiscal landmines waiting to explode in our faces. Washington has allocated just $5 billion for new high risk pools to cover the uninsured and chronically ill until 2014, when new health exchanges begin operating, but that money is woefully inadequate and will run out in a year or two. Congress also passed the bill with a massive cut in Medicare reimbursement rates that Congress privately pledged to rescind in exchange for support from doctors for the legislation. Additional cost of not making the cuts: $276 million over 10 years.

Politicians like to say that taxpayers prefer such maneuvers during tough times to budget cuts or tax increases. But politicians ultimately get hooked on such practices and rarely wind up making things right when times are good and tax revenues are plentiful. Instead, the fiscal tricks and evasions are just piled on top of one another until they become unsustainable.

Where is the legislation that will force politicians to be more transparent about their financial maneuverings, more realistic in their projections, and more orthodox in the ways they account for the consequences of their actions? It awaits action.

This piece originally appeared in RealClearMarkets

This piece originally appeared in RealClearMarkets