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Friday, May 25, 2012

California Budget Death Spiral can be fixed before it is too late.

I was listening to KFI-AM talk show hosts John and Ken yesterday and they were discussing Detroit's budget deficit and how it appeared as if their budget was in an economic "death spiral".  

The concept behind a city or state's budget death spiral is interesting. As one cuts certain areas of the city or state budget, less critical services are provided resulting in more blight and less economic interaction.  

As the city or state budget is further cut, pension fund payments become a greater and greater percentage of the remaining budget. The result is a budget "death spiral" in which sacred cow portions of city or state budgets become all that the city can afford to support. The resulting loss in quality of life for all citizens causes personal safety and actual home equity values to keep dropping.

The loss in home equity values further reduces city and state income levels as property tax revenue drops, causing the sacred cow portions of the budget (including pensions) to become a bigger and bigger portion of the overall budget, thus accelerating the budget death spiral cycle.

The city and state budget death spiral is further exacerbated as the loss of home equity values also INCREASES consumer debt to personal collateral ratios. It's one thing to owe 10,000 dollars if one has 20,000  dollars in wealth, it's quite another to have that 20,000 dollars in home equity suddenly nosedive to 7,500 dollars yet still have that same 10,000 dollars of debt. 

Less overall wealth drives down wages while the ongoing interest rate charges on existing consumer debt reduces the opportunity to spend money locally. Hence, the 2008 stock market crash that then caused home values to plummet almost overnight dramatically increased the ratio of overall consumer debt to home equity values.

All of these economic conditions have led to the beginning of a state budget death spiral funneled from several different but intersecting sources, the key now is to find a force that can offset the budget death spiral.

The solutions to stopping a budget death spiral are amazingly simple. 

The first step is to Incentivize consumer debt with a consumer debt paydown program that slashes interest rate charges on existing debt to virtually zero percent, AS LONG AS THE CONSUMER IS ACTUALLY REDUCING THEIR OVERALL DEBT EVERY MONTH.

The benefits of consumer debt reduction through interest free pay down incentives is far superior to either debt forgiveness or telling people to either get a job or get a second job. 

Consumer debt reduction should occur in as efficient manner as possible otherwise it can create additional economic stress on  resources raging from petroleum, electricity, to water, because working additional hours simply to service an interest rate charge on a debt requires the use of valuable resources.  Valuable resources should only be used to PAY DOWN an existing debt, NOT to simply tread water.

The second step involves linking pension fund guarantees to a specific percentage of the overall state budget. I don't know what that pension percentage cap should be, but I would assume more than 10% to 15% of the city or state budget going towards pension plans or pension payrolls would help initiate a city or state's budget death spiral.
So here are the two solutions,
One, incentivize consumer debt paydown with zero percent interest rate charges for those who pay down their overall debt every month (because this means in short time they actually have more liquid income to spend locally, which is good for city and state tax revenue). 

Two, limit pension fund obligations to a specific percentage of overall city and state total tax income. 
If this reduces pension payouts to those already promised pensions, offer perks to make up the difference such as severely reduced pricing for special events, reduce property tax payments to the level they were when the original pension promise was made, offer low interest rate incentives for car purchases. 
Give perks to those with state pensions as a way to offset pension payment reductions if the present pension payout is suffocating the overall ability of the state and city to offer basic, fundamental services that are valued and relied upon.
Do these two things and the state and city budget death spirals can be fixed before they spiral out of control.

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