During his tenure as governor of Indiana from 2005 to 2013, Daniels worked to steadily improve Indiana’s financial condition and make the state more attractive to businesses and individuals. Formerly the head of the Office of Management and Budget under President George W. Bush, Daniels talks about state competitiveness the same way CEOs talk about sales prowess: “It has become a market share game because America is not growing.”21 While some states offer up-front cash incentives to lure businesses away from other states, Daniels refused to do so. In direct contrast to Illinois—which has repeatedly resorted to cash or tax incentives just to keep businesses from leaving—Indiana has attracted businesses through its strong balance sheet, lower taxes, and right-to-work law. That didn’t come easy. At the end of 2006 Indiana had $19 billion of debt outstanding. In 2010 state debt was worked down to $14 billion. On an individual basis, Indiana had a debt burden per capita—inclusive of unfunded pension and benefit costs—of $2,455 in 2010, the third lowest in the nation.22
What made the Daniels administration even more unusual was its commitment to using current revenues to pay for current expenses. By doing so, Indiana steadily reduced its debt and improved its balance sheet so dramatically that the state eventually earned the highest bond rating from all three major credit-rating agencies. Indiana’s triple-A rating is actually a notch better than that of the U.S. government. What’s most remarkable about the Indiana story is how fast the transformation happened. Knowing he was competing for jobs with other states, Daniels operated with a sense of urgency. “How long does it take to turn around a state?” he said in an interview with me, repeating my question. “I don’t know, I was in a hurry.”23
Florida Versus Connecticut
In 2011 Florida governor Rick Scott phoned his old friend, billionaire investor Eddie Lampert, and asked him a question: Why are you still living in Connecticut? Lampert owned a vacation home in Florida, and Scott wanted to know why Lampert and his hedge-fund firm—ESL Investments, owner of Sears and Kmart and a firm with $10 billion under management—would choose to remain in a state that had corporate taxes 60 percent higher than Florida’s and a median personal income tax of 5.75 percent, versus zero in Florida. Soon Lampert was asking himself the same question, and in 2012 he moved his home and his business from Greenwich to Miami. Governor Scott didn’t stop with Lampert. Scott continues to make phone calls to other business leaders in Connecticut, New York, New Jersey, and Illinois. What Governor Scott understands is that the more businesses and the more wealth he can attract to Florida, the more jobs will be created and the less pressure he’ll face to raise taxes or cut spending.24
From the private sector himself—he was a venture capitalist and before that the CEO of the Columbia/HCA hospital chain—Scott understood how important speed of execution is to business. He also appreciated the looming threat of the housing bust to Florida’s overall economy. Among the first things he did upon taking office was shrink government agencies, push through a bill that removed the state from local planning and development decisions, and streamline the permitting process for developers and other businesses. “Every rule costs money—just the fact that you have to research to find out if you’re in compliance,” Scott told the Tampa Bay Times.25 He made jobs his priority and argued that his most important role was to get people back to work. I asked him whether he approached things any differently as chief executive of a state than he did as a chief executive in the private sector. “No difference,” he replied, barely even pausing to consider the question.26
In contrast to Florida, Connecticut was the only state to raise income taxes in fiscal year 2012. Prior to 1992 the state had no income tax and attracted businesses and individuals from New York and New Jersey specifically because of its advantageous tax environment. And while Connecticut still offers lower taxes than New York and New Jersey today, the gap is narrowing, and all three states rank near the bottom (or near the top, if you like taxes) in terms of state and local tax burdens as a percentage of personal income. Because the tax-arbitrage opportunities within the Tri-state region are so marginal—it just doesn’t pay enough nowadays to move from New York City to Greenwich, Connecticut—rich people like Eddie Lampert and businesses like Pilot Pen Corporation of America (which relocated from Trumbull, Connecticut, to Jacksonville, Florida, in 2008) are not moving just regionally.27 They are moving hundreds or thousands of miles to states like Florida and Texas. The exodus from Connecticut is likely to continue because the state simply cannot afford to cut taxes. At $18,981, Connecticut’s per-capita tax burden is now the third highest in the nation—seven times higher than Florida’s.28
Texas Versus California
Within the high-tech world, there are no bigger California success stories than Apple and eBay. Yet in 2012, when Apple was deciding where to invest $300 million and add 3,600 new sales and accounting jobs, it chose to build in Austin, Texas, instead of near its Cupertino, California, headquarters.29 When San Jose–based eBay and its PayPal subsidiary were looking to add 1,000 new jobs, eBay also chose Austin, Texas.30 Where jobs go, taxpayers follow: According to the Manhattan Institute for Policy Research, of the 1.1 million Californians who left the state in the 2000s, 225,000 of them moved to Texas, making it far and away the most popular destination for ex-Californians.31
From 2005 to 2009 Texas accounted for just 1.5 percent of migration out of California. By 2010, in just one year, that number had jumped to 12 percent.32 This attracted so much attention from California politicians that in 2011 they sent a delegation, led by Lieutenant Governor Gavin Newsom, to Texas to learn “best practices” and find out why so many were leaving California for Texas.33 They should have saved themselves the trip because the answers were fairly obvious. California has the second-highest unemployment rate in the country, among the highest corporate and individual tax rates in the nation, and a regulatory climate businesses consider onerous. In 2012 a survey of CEOs by Chief Executive magazine deemed California the worst business climate in the country for the eighth consecutive year.34 By early 2012 personal income was growing 71 percent faster in Texas than in California. Dallas Federal Reserve president Richard Fisher proudly shows a graph (any and every chance he can) of spectacular job growth in Texas and how it has outpaced that of any other regional Federal Reserve district for the last three decades.35
For a young person just graduating from college and now wondering which part of the country offers the best opportunity and quality of life, knowing where the jobs are being created is essential. Governor Scott of Florida often says that what people care about most are education, jobs, and a low cost of living. What state offers the best education programs for children? Which state offers the best job opportunities so people can provide for themselves and their families? A state’s commitment to a quality education system matters. Its commitment to well-paying jobs matters. And when it comes to pay, what really counts isn’t so much gross salary earned but the after-tax, take-home pay actually deposited in a breadwinner’s bank account. The quality and cost of living are also critical variables. Not only is it easier to find a job in Texas than in California, there are no income taxes in Texas, and the average home price is 60 percent less expensive in Texas than in California.36 In other words, you can get twice as much house for your money in Texas than in California.
Business migration foreshadows economic and employment growth. California’s unemployment rate is already twice that of Texas and Oklahoma, and there’s a clear connection between their relative unemployment rates and the fact that Texas and Oklahoma have both benefited from California-based companies like Google, Facebook, and eBay building new facilities in their states. Like a young planet whose gravitational pull becomes stronger as it gains mass, states like Texas and Oklahoma will only become more attractive to tech companies and tech workers over time. (Indeed, Priceline.com CEO Jeffery Boyd told Fortune that one reason he’s kept the online travel company headquartered in Connecticut is the absence of competitors who might pilfe
r his employees or bid up their pay.)37
Job creation, corporate migration, stronger consumer balance sheets, stronger state balance sheets, and a relatively muted impact from the credit crisis are powering the central-corridor states ahead of their coastal counterparts. Sure, there may be nothing in Texas comparable to driving the Pacific Coast Highway with the top down, but when a California home costs three times as much and the taxes are three times higher, a move to Texas starts looking mighty attractive—even if you have to make a yearly trip back to visit family and friends. Indeed, famed economist Arthur Laffer often tells the story of purchasing his home in Tennessee with his first-year tax savings from leaving California.38
The United States is already in the process of rebalancing itself demographically based upon opportunity and standard of living. Historically these shifts have taken decades to play out. But in a fast-moving, digital economy like today’s, change is happening fast. Central-corridor states don’t have the deep scars of the overconsumption, excess spending, and debt racked up over the past twenty-five years. Compared with their coastal rivals, these states now appear nimble and competitive to businesses that need every advantage possible to succeed. No politician wants to raise taxes, but when the mismatch between revenues and expenses hits an inflection point—when simply cutting costs won’t close the gaps—raising taxes becomes a last resort. States like California, Illinois, and Connecticut are all raising taxes and cutting programs, while states like Oklahoma and Indiana are cutting taxes and investing in infrastructure and education. Growth rates are just higher and will be for years to come in the central corridor.
The numbers already bear out the regional shift. Since 2008 consumer-spending growth in the Midwest has outpaced that in the West by 30 percent, and that trend shows no signs of abating. Consumers in Midwest states are more likely to be employed, more likely to have manageable amounts of revolving credit-card debt, and certainly likely to be paying lower taxes. All this leads to higher relative levels of disposable income—a magnet for retailers and service providers. From 2008 to 2010 Wyoming, North Dakota, Texas, Iowa, Indiana, and Colorado all showed strong positive GDP growth, while New Jersey, California, Florida, Arizona, and Nevada all experienced declines. In fact, many of these coastal and Sun Belt economies are reporting lower GDPs today than in 2007, while other parts of the country keep hitting all-time highs. It is exactly due to the economic paralysis of the coasts and the Sun Belt that the overall U.S. economy can’t break out of its snail’s-pace, sub–2 percent growth. After all, California, Florida, Arizona, and Nevada still account for 21 percent of the total U.S. economy. While that is down from the 2007 peak of 22 percent, the housing-bust states remain a huge drag, diminishing the chances of a vigorous national recovery.39
With so many businesses now requiring proximity to little more than a highway, an airport, and a high-speed data network, the nation’s business and industrial hubs have never been more vulnerable to poaching by rival states with better services and lower taxes. The history books offer one ominous analogy for the poachees: New York City. Between 1950 and 1980 high taxes, declining schools, rising crime, and political lunacy (culminating in the 1975 fiscal crisis) contributed to a New York City population decline of 800,000—from 7.9 million to 7.1 million people. It took twenty years before New York City recouped those population losses.40
In 1950 the city of Detroit boasted a population of 1.8 million people. Just 60 years later its population has been reduced to a mere 600,000. Why? Jobs exodus, political and social instability, and steeply reduced social services create a self-perpetuating downward spiral that many cities find impossible to escape. This is how Detroit, once America’s sixth-most-populous city, devolved into a welfare city—another American ghost town.41 The contexts may be different, but stories like Detroit’s are playing out all over the country. Population is declining in the Las Vegas metro area. Even Florida saw its population decline in 2009. The loss of business and jobs always leads to reduced tax revenues, reduced services, and more incentive for residents to leave. What’s different today is causation. Governments are no longer helpless victims of business loss but the catalysts for it. Businesses and families are leaving because they cannot afford the taxes now needed to pay out-of-control debt service. It’s why America’s central corridor—the heartland, the Midwest, the onetime flyover states, the golden triangle within the center of the country—will be the foundation of economic growth for years to come.
Chapter 9
David Takes On Goliath: New Political Precedents
When I first wrote about the threat that state and local budget crises pose to the overall U.S. economy back in September 2010, I assumed the first stories to make headlines would involve heavy pressure on the mayors and governors in housing-bust states to cut expenses and, more important, cut payroll. The outcry would arise from social-contract defaults—in the form of citizens receiving reduced services for higher taxes. This first phase would continue until the pain got so acute that taxpayers and voters stepped in to stop the bleeding. Voter outcry would then initiate phases two and three—cuts to public-employee pensions and refusals to make good on municipal-bond payments. To my surprise, the outcry that deafened all others involved the mere mention of municipal-bond defaults, let alone sizable ones. The loudest complaints were from the municipal-bond dealers, who shouted back that widespread municipal-bond defaults had not happened since the Great Depression and therefore could not and would not happen again. Needless to say, this argument reminded me of those who contended that home prices would never go down because they hadn’t since the Great Depression. They also argued that municipal bonds couldn’t default because most bonds were backed by the full faith and credit—the guaranteed taxing authority—of the state and local governments that had issued them. Of course, so too did pension obligations. It was never clear to me why muni-bond folks thought there could be defaults on some tax-guaranteed obligations—i.e., pensions—but not on municipal bonds. When a pension contract is renegotiated, isn’t that a default? And while not explicitly guaranteed by taxes, how are essential state services like education and infrastructure morally subordinate to bondholders? The issue wouldn’t come down to the ability to pay. State and local governments may be technically able to meet their tax-guaranteed obligations, but only if they sacrifice significant services and infrastructure investment. And remember, tax guarantees are only as good as the taxpayers willing to honor them. The bigger and more inflammatory issue would be willingness to pay. So long as willingness to pay was an issue, reform and compromise would be critical.
Reform will be difficult, especially given the outsized political influence wielded by public-employee unions. Ironically, however, many of the early success stories of pension reform come from largely Democratic locales. Voters in San Jose, for example, approved some of the most aggressive pension reform yet in the United States by a margin of nearly 70 percent to 30 percent.1 San Jose passed reforms that doubled the amount new employees contribute to their pension plans, increased the retirement age, capped the cost-of-living adjustment, and altered the calculation upon which benefits were determined by averaging salaries over the last three years of employment (instead of using just the last year). For existing employees the reforms also restricted benefits, either by requiring higher employee contributions or by transferring benefits to a lower-cost plan with reduced benefits.
Why did Mayor Chuck Reed of San Jose get such widespread support for pension reform, which is typically unpopular? How did this come about? The voters of San Jose had reached an inflection point, saying, “Enough is enough.” Since taking office in 2007, Reed had done everything within his power to improve the city’s finances, yet the city could not escape budget shortfalls. Just like most states, San Jose is required to balance its budget, but doing so required cutting programs and reducing services. So in the summer of 2012, after the city cut more than a thousand jobs and cut salaries by over 10 percent—and all the while not
properly funding its heath-care programs—the community took a stand, with 69 percent of voters approving a rollback in pension benefits.2
Elected in 2006, Reed says he was not asked one question about pensions in fifty-eight mayoral debates. Today he is the go-to guy across the state of California—and lately across the country—on pension reform. Unwilling to undermine public safety further by reducing the number of police officers and firefighters on the job, Reed focused on the fastest-growing expense in the city’s budget: pensions. He began to focus on the importance of bringing down the costs of future accruals. When he took office, Reed’s budget staff warned him that annual retirement costs could soar from $155 million to $650 million within five years. Reed kept his message simple: Pension expenses had grown faster than any other single expense in the city, and if they were not addressed, there would literally be no money left for public protection and services. “Taxpayers are paying for services,” said Reed. “They should get those services. . . . It’s just going to get worse if we don’t get control of these costs.”3
The Bankruptcy Option
Bankruptcy is the last resort for any individual, business, or government. Filing for Chapter 9 bankruptcy is supposed to give a financially distressed government the time and fiscal breathing room required to develop and negotiate plans for reorganizing debt while protecting the government from its creditors. However, while the option may seem enticing, Chapter 9 bankruptcy can be an expensive and time-consuming process with an uncertain outcome. Any municipality choosing to file for Chapter 9 faces a certain negative impact in the credit market, resulting in increased borrowing costs in the future. Indeed, when Orange County declared bankruptcy in 2004, the municipal-bond market punished not just the county but the entire state, demanding higher interest payments from all California issuers of municipal bonds.
Fate of the States: The New Geography of American Prosperity Page 14