Tax Increases, Rationalization and Bankruptcy

Today we discuss the alternative routes available for insolvent public entities. Think of this as a road trip and  the alternatives as "use toll roads" or "avoid toll roads" or "the scenic route."  The philosophers might call these routes “Pick your poison" or “Chickens coming home to roost.” Pragmatists would just say, “It’s about time!”

The tax increase route has one very sound, intellectual foundation for being chosen. It is necessary to pay for what you get. That is a fundamental. There is no free ride. There is no free lunch. So, whatever you are getting from government must be paid for. Raise taxes to the level needed to pay for government. Public employee unions are really big supporters of this alternative. If you are not a government employee, you have two alternatives. One, settle for less or two, get what you want/need from others sources for less. Otherwise, pay up. Someone has to pay for those union wages, benefits and generous retirement programs and payments and, of course, all the fancy entitlement programs.

Rationalization. This term is a fancy word which when applied to a business situation refers to reduction in employees, employee benefits and pensions and other business costs. The rationalization route usually occurs under dire circumstances but can also be enacted as part of an ongoing evaluation and productivity producing activity. Can rationalization work? Absolutely. There are many successful business examples where cost cutting, employee reductions, changing retirement plans from defined benefit plans to defined contribution plans all helped build a strong foundation for future economic growth and increased competitiveness in the marketplace. Unfortunately, there are few examples of where rationalization has been enacted successfully with public entities such as state and local governments. Why is that you ask? Mostly the answer lies in the overused and over abused word – “POLITICS.” What do we mean? In business the vote lies with the consumer; the purchaser; the end user. If consumers don’t buy; the business fails. In government there is no consumer because consumer implies choice. So, the market force of consumer choice is replaced with politics. The politician wants to be elected or reelected. He/she plays to several audiences including many entrenched government employees. She/he wants a compromise. A resolution. He/she wants to move on. Not engage in lengthy fights over wages and benefits and pensions. Doesn’t want or have the spine to cut back on programs and activities. She/he also knows that prolonged fights with government employees and strikes and shutdowns will cost them some voter support. So he/she gives in. She/he doesn’t fight because they survive by not fighting; the exact opposite of the business person who must fight to survive.

There are two other back road routes of rationalization in the public sector. One is to privatize services. Seek bids from private suppliers/vendors to provide services and goods. Usually a great idea. Introduces competition which is usually the best form of maintaining both quality and value. Also, gives the public entity the ability to provide certain services/goods without making a permanent investment in personnel and equipment. Privatization should be an ongoing part of any good government agency; not something to turn to when the money runs out. A second route is asset sales. There is an old expression, “don’t eat or sell the seed corn.” Well politicians don’t quite think the same way most farmers think. A number of municipalities and states have either sold assets or are contemplating a sale of assets. Chicago wants to sell its airports. It already sold a toll road. And it irritated almost every one by a bad deal in selling its parking meters. Greece has become adept at mortgaging its infrastructure in this manner.  Selling earning assets to pay current expenses is a sure sign of a failing entity. TheFundamentals advises against purchasing the debt of any entity which is now taking this route.

Now there are some more learned voices out there proposing a combination of the above alternatives. Raise taxes, cut spending and all will be cured. For the aforementioned reasons, TheFundamentals sees no likelihood of sustainability in either choice. As our readers know, TheFundamentals has addressed the benefits of the bankruptcy route (see: TheFundamentals, February 9, 2010.) There are many candidates in America for bankruptcy. There are many public entities that should embrace bankruptcy. Bankruptcy is to the financially promiscuous as redemption (or the Tiger Woods clinic) is to the sexually promiscuous. We support bankruptcy for several notable reasons: financial insolvency is best dealt with now and not postponed; bankruptcy brings finality to financial problems; bankruptcy is the only route to eliminating unpayable known and contingent liabilities with finality; bankruptcy processes and resolutions are well accepted in the US; bankruptcy is the only route to eliminating contractual obligations with employees and vendors that are a massive economic burden on the taxpayers of these insolvent entities. Bankruptcy is the preferred route for these reasons and we encourage all insolvent entities to immediately examine its applicability to their situation. No one wants to be first on this scenic route but you sure don’t want to be last.