Beyond the official federal debt, there is another $2.5 trillion or so in state and local debt, according to Federal Reserve figures. Why so much? A lot of that debt comes from spending that is extraordinarily stupid and wasteful, even by government standards. Because state and local authorities can issue tax-free securities — municipal bonds — there’s a lot of appetite for their debt on the marketplace, and a whole platoon of local special-interest hustlers looking to get a piece. This results in a lot of misallocated capital: By shacking up with your local economic-development authority, you can build yourself a new major-league sports stadium with tax-free bonds, but you have to use old-fashioned financing, with no tax benefits, if you want to build a factory — which is to say, you can use tax-free municipal bonds to help create jobs, so long as those jobs are selling hot dogs to sports fans.
Also, local political machines tend to be dominated by politically connected law firms that enjoy a steady stream of basically free money from legal fees charged when those municipal bonds are issued, so they have every incentive to push for more and more indebtedness at the state and local levels. For instance, the Philadelphia law firm of Ballard, Spahr kept Ed Rendell on the payroll to the tune of $250,000 a year while he was running for governor — he described his duties at the firm as “very little” — and the firm’s partners donated nearly $1 million to his campaign. They’re big in the bond-counsel business, as they advertise in their marketing materials: “We have one of the premier public finance practices in the country, participating since 1987 in the issuance of more than $250 billion of tax-exempt obligations in 49 states, the District of Columbia, and three territories.” Other Pennsylvania bond-counsel firms were big Rendell donors, too, and they get paid from 35 cents to 50 cents per $1,000 in municipal bonds issued, so they love it when the local powers borrow money.
So that’s $14 trillion in federal debt and $2.5 trillion in state-and-local debt: $16.5 trillion. But I’ve got some bad news for you, Sunshine: We haven’t even hit all the big-ticket items.
One of the biggest is the pension payments owed to government workers. And here’s where the state-and-local story actually gets quite a bit worse than what’s happening in Washington — it’s the sort of thing that might make you rethink that whole federalism business. While the federal government runs a reasonably well-administered retirement program for its workers, the states, in their capacity as the laboratories of democracy, have been running a mad-scientist experiment in their pension funds, making huge promises but skipping the part where they sock away the money to pay for them. Every year, the pension funds’ actuaries calculate how much money must be saved and invested that year to fund future benefits, and every year the fund managers ignore them. In 2009, for instance, the New Jersey public-school teachers’ pension system invested just 6 percent of the amount of money its actuaries calculated was needed. And New Jersey is hardly alone in this. With a handful of exceptions, practically every state’s pension fund is poised to run out of money in the coming decades. A federal bailout is almost inevitable, which means that those state obligations will probably end up on the national balance sheet in one form or another.
“We’re facing a full-fledged state-level debt crisis later this decade,” says Prof. Joshua D. Rauh of the Kellogg School of Management at Northwestern University, who recently published a paper titled “Are State Public Pensions Sustainable?” Good question. Professor Rauh is a bit more nuanced than John Boehner, but he comes to the same conclusion: Hell, no. “Half the states’ pension funds could run out of money by 2025,” he says, “and that’s assuming decent investment returns. The federal government should be worried about its exposure. Are these states too big to fail? If something isn’t done, we’re facing another trillion-dollar bailout.”
The problem, Professor Rauh explains, is that pension funds are used to hide government borrowing. “A defined-benefit plan is politicians making promises on time horizons that go beyond their political careers, so it’s really cheap,” he says. “They say, ‘Maybe we don’t want to give you a pay raise, but we’ll give you a really generous pension in 40 years.’ It’s a way to borrow off the books.” The resulting liability runs into the trillions of dollars.