The costs of fiscal failures: Atlantic City and Puerto Rico

Puerto Rico has defaulted on its bond interest payments. Atlantic City says it can’t make any further payments. What's the endgame?

Atlantic City promotional Image, courtesy

WASHINGTON, May 6, 2016 — Once again, Puerto Rico has defaulted on its bond interest payments after failing to pay $400 million due May 1. Atlantic City just made a $1.8 million interest payment on its debt, but says it can’t make any further payments. Are these isolated instances, or are they the tip of the iceberg?

American government has a serious debt problem at every level. Locally, there are a number of cities that are carrying heavy debt loads. Many states require a balanced budget. But even with that, some states are also burdened with heavy debt. On the federal level, the total national debt now exceeds $19 trillion.

Cities like Detroit have already filed for bankruptcy and Detroit, having finally re-emerged from that situation, is now trying to rebuild. Other cities, such as Atlantic City, are likely to follow its path. All this negative action is leading to a debt crisis at virtually every level of government. Will the State of New Jersey bail out Atlantic City? Will the federal government bail out Puerto Rico?

In addition, if they are bailed out, will that lead to more government entities seeking help from the next level of government? That question is weighing heavily on the minds of elected officials who must make the final decision.

How did the U.S. get in this position?

Government provides a service to the citizens that are paid for by the taxpayers. Services are by definition labor intensive, which means the majority of the cost of government is for labor’s wages, benefits and pensions. Historically, government workers were paid lower salaries than equivalent workers in the private sector, but were offered better job security and better than average benefit packages to offset this.  People worked in government because they generally were dedicated to serving the public good. They were not organized into unions.

Then in 1962, President Kennedy signed an executive order giving public employees the right to bargain collectively. At the time, government workers generally earned about 30 to 40 percent less than workers in comparable private sector positions. The right to bargain collectively, however, gave public workers the ability to seek higher wages, even better benefits and generous pensions, all of which they proceeded to procure.

While this greatly improved economic conditions for public employees, the additional cost to government had to be paid by taxpayers. In addition, beginning with President Kennedy’s spending increases on social programs, followed by President Johnson’s Great Society spending increases, resulted in the federal government running deficits in 51 of the next 54 years.

Since the federal government said that it was acceptable to spend more money than is being raised in tax revenue, the states and cities followed suit, generally failing to factor in the increased fixed costs. After more than 50 years of increased government spending for employees, who now earn about 30% more than their private sector counterparts, all of which created huge deficits and debts, we have reached a near-crisis situation.

A basic lesson in business finance is that incurring debt to finance assets, especially income producing assets, is acceptable, while incurring debt to pay expenses is not. Our current government debt problem is a result of borrowing to pay expenses.

In Atlantic City, after gambling was approved in 1976, the city saw tremendous growth. There were plenty of good paying jobs and the casinos generated enough tax revenue for the city to enable it to pay generous salaries, offer generous benefits and give generous pension packages to city employees. The city’s spending exploded.

Then in 2007, increased national competition and a looming recession cut casino revenue from the $5.2 billion reported in 2006 to just $2.6 billion collected last year. Casinos claimed their assessed value and their tax bills were too high based on the lower levels of income being generated. After successful tax appeals and negotiations, Atlantic City saw more than a 50 percent decrease in tax revenue. Spending, however, continued to increase.

Today Atlantic City has more than $500 million in debt and an annual budget deficit of $100 million. They have been unable to reduce their spending which is now over $262 million per year. AC now faces either a bankruptcy or a state takeover.

Just like households, government must learn to live within its means.  For too many years politicians just kicked the can down the road. Today we are at the end of that road.

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