How to Think About Debt

Summary:  Balancing the budget is a good idea and receives a lot of press. However, the budget is far less important than the steady growth of debts, unfunded obligations, and entitlements. These items are stealthy future deficits. To really understand whether or not we have financially sustainable government budgets, we have to go to the balance sheet, where debt is recorded. There are a lot of misconceptions about debt. In the interest of simplifying a complex subject, this report focuses on government debt, but the primary concepts discussed apply to all debt, public and private. They are all claims against future income.

What about California’s debts, state and local, and unfunded obligations? Are they large enough to affect the state’s growth rate? It’s hard to tell. Our recent study for the California Policy Center, “Calculating California’s Total State and Local Government Debt” (April 2013) summarized the state’s debts and unfunded pension and retiree healthcare obligations as follows:

Estimated Total California State and Local Government Debt
As of June 30, 2012   ($=B)

Fletcher_20121210_CA-Debt

California’s total state and local government debts and unfunded obligations are about $18,000 to $23,000 per citizen depending upon what investment return assumption you use in valuing unfunded pension obligations. This data is for 2011 and 2012 and debts and unfunded obligations are higher today. This only refers to California’s state and local debt and does not include any estimate of entitlement obligations for welfare and Medicaid, or the private debts of companies and individuals. U.S. federal debt now exceeds $17.0 trillion or about $54,000 per citizen. This doesn’t include unfunded liabilities for Medicare, Social Security, or Medicaid.

When do these debt and other obligations become a serious problem?

The Debt Supercycle

We are at the end of a 30-year debt supercycle. How will it end? All debts and entitlements can’t be paid. Who gets stuck with the bill? So far, we’re leaving the check on the table and pretending the dinner was free.

Will all this debt come due with a bang one day or will it dissipate slowly over time?

Fletcher-20121210-2

The debt cycle begins when debt levels are fairly low. The government determines that they can stimulate economic growth by adopting policies to encourage people to borrow to increase consumption and investment. The Federal Reserve facilitates this process by keeping interest rates low and taking other actions to avoid slowdowns in the economy. As debts increase, so does the cost of servicing these debts, interest and principal payments. At some point it becomes crucial to maintain low interest rates to make it easier for private and public debtors to service their debts and avoid bankruptcies.

Low interest rates and easy credit further stimulates economic growth as well as excessive speculation such as in housing and the stock market. These assets increase in value beyond what they would be worth without easily available credit at low interest rates.

These overvalued assets are used as collateral to secure additional borrowing that increases debt burdens even more. As debt levels grow, it takes more and more borrowing and other stimulus to keep the economy growing, and to maintain asset prices.

At some point, debt burdens become unsustainable in spite of low interest rates and easy credit, and investors lose confidence that future growth of the economy and asset prices can be sustained. We then have a market correction or recession such as the 2008 mortgage bubble collapse. The triggering event may be the collapse of the Lehman Brothers investment bank or some other event. However, the house of cards that collapsed was assembled over many years.

When the economy contracts in a recession and incomes fall, the debts and other obligations remain.

Shouldn’t we be mainly concerned about the deficit, and balancing the budget? Who looks at balance sheet entries anyway?

Balancing the budget is a good idea and receives a lot of press. However, the budget is far less important than the steady growth of debts, unfunded obligations, and entitlements. These items are stealthy future deficits.

To really understand whether or not we have financially sustainable government budgets, we have to go to the balance sheet, where debt is recorded. That is where the bodies are buried. This is further complicated by the fact that some obligations aren’t reported at all and are largely ignored on official government financial statements.

The real problem is the steady under reported growth of debt at the federal, state, and local level, the growth of unfunded pension and retiree healthcare obligations at the state and local level, and the seemingly out of control growth of entitlement obligations for welfare, Social Security, and government provided medical care, Medicare and Medicaid.

These are balance sheet items and can’t be fully grasped by looking at annual budgets. GASB, the Government Accounting Standards Board, will improve reporting of unfunded pension obligations starting with the fiscal year beginning in June 2014. However, this is only a start in honestly reporting these obligations. Reporting of unfunded pension obligations is inadequate in that pension funds such as CalPERS are still free to use optimistic investment return assumptions in calculating unfunded obligations. They assume an average investment return of 7.5% per year. If actual returns average less than 7.5%, unfunded pension obligations will be larger than reported under the new GASB regulations. For example, as shown on the first table above, if average returns to the pension funds are 5.5% instead of 7.5%, the unfunded liability increases by over $200 billion, from the officially recognized $128.3 billion to $328.6 billion. For much more on how changes in rates-of-return affect California’s total state and local unfunded pension obligation, refer to the CPPC study “How Lower Earnings Will Impact California’s Total Unfunded Pension Liability.”

Retiree healthcare expenses are largely unfunded and must be fully paid out of future tax revenues. GASB doesn’t currently require this future obligation to be reported.

Why can’t we just write off debts we can’t pay?

Debt forgiveness is a fiction. Someone always pays in full.

According to the economist Michael Pettis, author of “The Great Rebalancing,” “Debt always matters because it must always be paid for by someone –even if the borrower defaults, of course, the debt is simply “paid” by the lender… It must cause a reduction in demand elsewhere, most probably in household consumption. This reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.”

What’s the relationship between debt and growth?

Borrowing increases the rate of GDP growth (gross domestic product) on the way up and reduces GDP growth on the way down. Debt stimulates growth when it’s spent and depresses future growth when it is paid back. Debt is essentially borrowing future consumption.

Over-indebtedness is probably the main reason that the world’s major economies are growing slowly. This is in spite of massive efforts by the U.S. Federal Reserve and other central banks to stimulate their economies by keeping interest rates very low and adding to bank reserves to stimulate borrowing.

When we were adding to our debts, borrowed money allows a higher level of consumption than could have been supported based on the earnings of individuals and corporations alone. This effect may have added as much as 0.5%/year to GDP growth over many years. However, this is stealing consumption from the future when the debt has to be serviced (make the principal and interest payments).

So, on the way up, if we assume that the economy would grow about 3.0%/year without increasing debt, we’d get 3.5%/year growth instead. On the way down, we’d have to subtract the negative effects of servicing high debt loads and deleveraging (paying off debts) to reduce debt burdens. A guess is that we’d see growth of 2.5%/year or so (3.0%/year normal growth less something like 0.5%/year due to debt service and deleveraging). Interestingly, the U.S. real GDP growth rate was 3.4%/year on average until the 2008 recession, and an average of 2.3%/year since the recovery started in mid-2009. This could be a coincidence.

According to the economist Gary Shilling, the U.S. economy is likely to have low growth for another five years or so before deleveraging reduces debt loads enough to allow the economy to grow at its normal long-term average rate. So far, all the deleveraging has occurred in the private sector, companies and individuals reducing what they owe, while government debts continue to grow.

Is there good debt and bad debt?

There are several broad types of debt, some good and some bad. The form of the debt is less important than what it is used for. The California Policy Center’s debt study listed several broad categories of debt:

Good debt is:

1. Debt that is an investment in an asset that generates a future income by way of taxes or fees sufficient to pay the interest and principle on the debt. A toll road or water treatment plant would be examples.

Debt to fund investments that grow the economy with a corresponding growth in tax revenues sufficient to service the debt also qualifies as good debt. However, not all debt-financed investments qualify. Government debt requires tax increases or fees to service the debt and these tax increases and fees reduce funds available for consumption and investment in the private sector, the source of tax revenues. Both of these effects need to be considered in deciding if a government expenditure funded by debt is worthwhile.

2. Debt that is an investment in a long-lived asset such as a new highway or government building that would be used by the future taxpayers who are responsible for paying the interest and principle on the debt by way of taxes or fees.

Bad debt (and unfunded obligations) is debt that is used to cover current expenses but paid for by future taxpayers. This form of debt is essentially deferred taxation and passes a current expense to future taxpayers, inter-generational theft.

Are growing unfunded obligations the same as debt?

They are similar with some differences.

The growing future cost of paying for unfunded obligations takes funds that could have been used for future consumption and investment and has the same effect as servicing or paying down debts.

Some entitlements are responsible and desirable transfers to those who need help from those who can afford to help. This can include publicly funded K-12 education to welfare and Medicaid payments. However, we shouldn’t spend more than the economy can support.

All entitlements, current and future are different from debt in that changes in laws and regulations might be able to reduce these future costs while the cost of debt service can’t be altered without a bankruptcy or mutually agreed restructuring of debt. Future entitlements, because they aren’t funded, qualify as debt to the extent we are not setting aside enough money today to pay for them in the future. These unfunded liabilities for future entitlements are particularly troubling with respect to pension benefits that are difficult to modify even in bankruptcy.

In some ways, entitlements and unfunded pension and retiree healthcare obligations are a bigger problem than debt. Debt typically is for a fixed amount to be repaid at a specific interest rate over a specific time period. Entitlements are open-ended obligations such as for unemployment, welfare, or medical care for low-income families. The taxpayer, via the government, is obligated to pay whatever the formula for the entitlement says is due without regard to ability to pay. Timing can also be a problem. In a recession, unemployment and welfare payments go up as more people lose their jobs at a time when tax revenues are declining.

The future cost of underfunded pension obligations and retiree healthcare expenses are hard to predict. If pension funds suffer investment losses such as during the 2008 recession, or if investment returns are less than assumed, the taxpayer is responsible for any shortfall. Retiree healthcare expenses are largely unfunded and have to be paid out of future tax revenue.

It’s the authors’ opinion that post retirement benefits should be fully funded while the employee is working and providing a public service to taxpayers. To the extent that these benefits aren’t fully funded, we are asking future taxpayers to pay for current expenditures that they are not gaining any benefit from, the equivalent of bad debt.

Entitlements such as Social Security, Medicare, and Medicaid are promises of future payments that are totally the responsibility of future taxpayers since these entitlements are not funded. Even Social Security is not funded even though there is a Social Security trust fund. Social Security payments in excess of current benefit payouts are spent by the federal government. The government deposits an IOU in the trust fund to offset the amount taken. When these IOUs are due in the future, they will have to be paid for out of future taxes or by additional borrowing by the government.

What’s the relationship between debt, inflation, and deflation?

Debt is future consumption denied as taxes have to be increased and other spending has to be cut to service the debt. Ditto for entitlements and unfunded obligations. Servicing debt is deflationary. It depresses future consumption by the amount of the debt service.

The cost of servicing a high level of debt or paying down your debts takes funds that could have gone to consumption, the major portion of GDP, or private sector investments needed to grow the economy. In the U.S., consumption makes up almost 70 percent of GDP. This loss of consumption leads to lower prices and slower GDP growth. Lower prices, overall, constitutes deflation.

If the cost of servicing debt is high enough, demand is so depressed that the economy could experience a depression, chronic negative growth with falling prices, high unemployment, and ongoing budget deficits – possibly a deflationary spiral that is very hard to break out of to get the economy growing again. This is Japan today, and possibly countries such as Greece, Spain, and Italy.

Why is growth so important?

By far, the best way to reduce indebtedness is to increase tax revenues by growing the economy faster. However, high levels of debt work in the opposite direction as we’ve seen and lead to lower, not higher growth of the economy. If debts are too high, one can enter a death spiral where debts are growing faster than tax revenues so that debt service costs continue to grow as a percent of GDP. This could also be caused by interest rates increasing to exceed the rate of revenue growth, or by having to add to already high levels of debt to fund a budget deficit or increasing entitlements.

When lenders lose confidence in the ability of a government to service its debts, they can stop lending or increase the interest rate they charge to account for the risk of non-payment. If the interest rate exceeds the country’s growth rate, their debts will continue to grow faster than their economy and tax revenues and become an ever-increasing burden.

Can’t governments avoid repaying their debts or reduce what’s owed?

Governments, national, state, or local can take steps to reduce their debt burdens. However, they can’t make their debts disappear. They can only transfer part or all of their debts to others either publicly or secretly if they can get away with it. Special interests such as large financial institutions also try to transfer their debts to others, often with government help.

Not surprisingly, the prime target to receive the unpaid government debt is the taxpayer who is not well represented in the transaction. Savers and high-income taxpayers are best because they at least have some money.

Growing the economy faster to increase tax revenues would be a positive way to reduce debt burdens. However, governments that have high debt levels usually have other problems that prevent them from being able to grow their economies faster, or lack the political will to make hard choices in favor of policies that promote growth.

Some favorite alternatives to transfer debts to others are:

1. Financial repression:  This is underway in the U.S., Europe, Japan, and China. The central bank takes actions to keep interest rates below their normal long-term averages to make it easier for debtors to service their debts. Savers pay the difference via lost income between normal interest rates and the lower repressed rates they are earning on their savings. These low interest rates also make it more difficult for pension funds to meet investment targets.

Financial repression and inflation are essentially hidden taxes on savers and bondholders. It’s estimated that financial repression is costing savers about $400 billion/year in lost interest income. This discourages savings and reduces the amount that people can save making them more dependent on the government in old age. This is not a policy objective of financial repression but is an unintended consequence.

2. Inflation:  Inflation reduces the value of a currency and makes it easier for governments to repay their debts in cheaper currency. Who pays? The saver whose savings and interest and dividend payments lose value due to inflation. Also, consumers who have to pay higher prices for goods and services.

3. Default:  This isn’t very practical for major economies. However, it’s not inconceivable that countries such as Greece or even Italy could be forced to default at some point. Banks and other lenders will get stuck with the bill and will have to be bailed out by their governments if their losses are large enough to threaten their solvency.

4. Restructuring:  Under the threat of default, sometimes a borrower can convince lenders to revise the terms of the debt to stretch out payments and reduce the interest rate. Again, the lender pays the difference between what they would have received in interest and principal payments and what they get under the new terms.

5. Devaluation:  An outright default can be replaced by efforts to devalue, lower the value, of a county’s currency. This doesn’t work for those countries using the Euro because they don’t control the value of their currency. Other countries such as Argentina frequently resort to devaluations to pass on their debts to foreign lenders.

6. A wealth tax:  Why not tax wealthy persons’ assets, not just their income? Why not, for example, impose a one-time tax of 5 to 10% of a person’s net worth in excess of $1.0 million? It would all be “applied” to debt reduction and the government would promise to do this only once. This would be a very destructive and unfair tax in that a persons’ wealth was already taxed when the money was earned or inherited. However, this idea was suggested recently by the International Monetary Fund (IMF) and could have some appeal to desperate politicians and voters who would be in favor of more taxes on those with substantial savings.

What did Keynes really say?

Shouldn’t the government increase spending during recessions even if that leads to deficits and increases debt? They have to make up for the slack in the private sector.

People forget what Keynes said. They remember that, according to Keynes, during recessions you should increase government spending even if that results in deficits and increased debt. What they forget is that during good times you need to run a surplus and pay off the debt.

Unfortunately, it’s easy for politicians and others to agree to run deficits (such as for “stimulus” spending) and increase debts during recessions but impossible for them to agree to run a surplus in good times. During recessions we run deficits, during good times we spend it all and sometimes a lot more.

Another crucial point made by Keynes was the importance of incurring “good debt” when stimulating the economy during recessions. Good debt, well exemplified by the many projects undertaken by the U.S. government in the 1930’s – dams, highways, rural electrification – is investment in infrastructure that yields long-term economic returns to society.

“Keynes, as opposed to some of his interpreters and predecessors, did not recommend constant budget deficits. Instead, he advocated cyclical deficits, counterbalanced by cyclical budget surpluses. Under such a system, government debt in bad times would be retired in good times. However, Keynes’ original proposition was bastardized in support of perpetual deficits, something Keynes himself never advocated.”  –  Hoisington Investment Management report

Can you solve your debt problem by taking on more debt?

Many governments are trying to solve their problems by adding debt to fund budget deficits, and entitlement spending, and public works projects. They are using deficit spending to attempt to stimulate their economy to grow faster. They are digging a bigger hole on the assumption that their economies will eventually grow fast enough to service their growing debts. Some are probably cynically assuming that they will be able to default or devalue their currency sometime in the future and never have to repay what was borrowed. It won’t work.

What if the borrower can’t pay, defaults?

The borrowed funds have already been spent and will never be recovered. The lender can wait forever to get paid. It will not happen. In this case the lender can pay off the bad debt slowly over time via lost income or recognize this loss immediately and write down the bad debt, taking the loss all at once. Some may avoid a write down hoping for a government bailout or are waiting to leave the problem to a successor.

Can’t we sell assets to pay off debts?

This works if there sufficient valuable to assets sell. Examples could be drilling permits for oil and gas, or public land. This can work for some countries that, for example, have state owned companies that can be sold to the public or to a private company. However, this is usually not a practical solution since what can be sold is greatly exceeded by what’s owed.

How will it end?

Nobody knows for sure.

Will we have inflation or deflation? It is quite possible we will experience deflation over the next several years as debt burdens become unsustainable and as some defaults become inevitable. This could be followed by inflation if central banks can’t unwind the massive bank reserves they’ve created, and if governments remain addicted to deficits and growing debts, unfunded benefits, and expanding entitlements.

Have central bank actions actually done some good following the 2008 mortgage bubble collapse and given economies time to heal? Or, are they just postponing inevitable harsh adjustments when governments are forced to live within their means? It is generally agreed that aggressive action by the Federal Reserve following the collapse of the Lehman Brothers investment bank in 2008 prevented a credit crisis and an even more severe recession.

A concern is what are the practical limits of what the Federal Reserve and other central banks can do to stimulate growth. Will the Federal Reserve be out of bullets when the next recession hits?

In the U.S., fiscal policy, the use of budgets, taxes, and spending to deal with the situation is not available due to gridlock in Washington D.C. We don’t need another stimulus bill anyway. The last one, The American Recovery and Reinvestment Act of 2009, was sold as being for “shovel ready” projects but was later determined to be primarily for entitlements and aid to state governments. The full burden of dealing with the situation falls on the central bank, the Federal Reserve, and their tools to influence money supply, borrowing, and interest rates.

Will fiscal or monetary stimulus help much anyway? Are we just avoiding the real work associated with real reforms that make a difference? Are we trying to get an out of shape athlete to run faster by loading him up with Red Bull? To grow the economy faster and create more jobs and tax revenue, we need to make changes to taxes and regulations at all levels of government to lower the cost of doing business, to promote private sector investment in the economy, and to encourage business growth and new business formation. We also need reforms to improve job training and education. We are in competition with workers, companies, and governments around the globe. There isn’t any place to hide.

Genuine investments in public infrastructure could help. These investments would qualify as good debt if they made real improvements that lowered costs and improved productivity, or were for essential public works projects such as rebuilding levees to avoid flooding. However, our ability to add debt has already been compromised and we’d need to carefully consider any additions even if it is good debt.

Politicians are in denial when it comes to dealing with deficits, debts, and unfunded pension benefits and entitlements.

*   *   *

About the Authors:

William Fletcher is an experienced business executive with interests in public finance and national security. He retired as Senior Vice President at Rockwell International where most of his career was spent on international operations and business development for Rockwell Automation. Before joining Rockwell, he worked for Bechtel Corporation, McKinsey and Company, Inc., and Combustion Engineering’s Nuclear Power Division, and was an officer and engineer in the U.S. Navy’s nuclear program. His international experience includes expatriate assignments in Hong Kong, Europe, the Middle East, Africa and Canada. In addition to his interest in California’s finances, he is involved in organizations dealing with national security and international relations. Fletcher is a graduate of Tufts University with a BS degree in Engineering and a BA degree in Government. He also graduated from the U.S. Navy’s Bettis Reactor Engineering School.

Ed Ring is the executive director for the California Policy Center. Before joining the CPPC, he worked in finance and media, primarily for start-up companies in the Silicon Valley. As a consultant and full-time employee for private companies, Ring has done financial modeling and financial accounting for over 20 years, and brings this expertise to his analysis and commentary on issues of public sector finance. Ring has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Los Angeles: Will the City of the Future Make it There?

When I arrived in Los Angeles almost 40 years ago, there was a palpable sense that here, for better or worse, lay the future of America, and even the world. Los Angeles dominated so many areas — film, international trade, fashion, manufacturing, aerospace — that its ascendency seemed assured. Even in terms of the urban form, L.A.’s car-dominated, multipolar configuration was being imitated almost everywhere; it was becoming, as one writer noted, “the original in the Xerox” machine.

Yet today the nation’s second-largest city seems to have fallen off the map of ascendant urban areas. Today’s dynamic cities in terms of job and population growth are the “new Los Angeleses,” such as Houston, Dallas, Phoenix or Charlotte; at the same time L.A. lags many more traditional “legacy” cities in job creation and growth, notably New York, Boston and Seattle. Worst of all, L.A. has lost its status as the dominant city on the West Coast; that title, in terms of both economic and political power, has shifted to the tech-heavy Bay Area.

With a weak economy and little media outside Hollywood, the city has lost much of its cachet. A Businessweek survey last year ranked San Francisco asAmerica’s best city to live in. Los Angeles was 50th, behind such unlikely competitors as Cleveland, Omaha, Tulsa, Indianapolis and Phoenix. In another survey that purported to identify the top 10 cities for millennials, Seattle ranked first, followed by Houston, Minneapolis, Dallas, Washington, Boston and New York. Neither L.A. nor Orange County made the cut.

L.A.’s relative decline reflects a collective inability to readjust to changing economic conditions. Some of this has to do with the end of the Cold War, but also with the loss of the headquarters of many of the area’s top defense contractors, such as Lockheed and, most recently, Northrop Grumman. In 1990, the county had 130,100 aerospace workers. A decade later, that number dropped by more than half to 52,400. By 2010, the county’s aerospace jobs numbered 39,100.

With the exception of drone technology, the region’s aerospace industry, as one analyst put it, has become “dormant,” a victim of a talent drain and a difficult business environment. This decline has weakened the metro area’s standing as an industrial center — L.A. has lost almost 20% of its manufacturing jobs since 2007. Meanwhile STEM employment in the Los Angeles-Santa Ana area is still stuck below its 2002 levels; once arguably the world’s largest agglomeration of scientists and engineers, the region has now dipped below the national average in the proportion of STEM jobs in the local economy.

In contrast to the Bay Area, whose tech community also was largely nurtured by defense contracts and NASA, L.A.’s defense and aerospace industries never pivoted into the vast civilian market. Capital, too, has played a role. The L.A. area has lots of rich people, but a relatively weak venture capital community. For example, the Bay Area was a recipient of roughly 45% of U.S. venture capital investment in the third quarter of 2013, while far more populous Los Angeles-Orange County took in under 6.5%.

The growth of VC-financed companies is one reason why L.A. has been less able to produce high wage jobs than its northern rival. According to a recent projection by Economic Modeling Specialists Inc., high-wage jobs will account for only 28% of L.A.’s job growth from 2013 through 2017 compared to 45% in the Bay Area.

Far greater problems can be seen further down the economic food chain. The state’s heavy industry — traditionally the source of higher-paid blue-collar employment — entirely missed the nation’s broad manufacturing resurgence. In the first decade of the 2000s, according to an analysis by the Praxis Strategy Group, L.A. lagged all but 10 of the nation’s 51 large metro areas in creating manufacturing jobs.

Two other once-unassailable economic niches in L.A., its port and entertainment, also are under assault. The expansion of the Panama Canal has increased the appeal of the Gulf ports, as do plans for expanded port facilities in Baja, California.  These shifts threaten many of the roughly 500,000 generally well-paid blue-collar jobs in the local logistics industry.

Then there’s the slow but steady erosion of L.A.’s dominance in its signature industry, entertainment. Motion picture employment is down 11,000 since 2001. In the same period New York has notched modest gains alongside growth in New Orleans and Toronto. New announcements of industry expansions and an uptick in production in L.A. show that Tinseltown is far from dead, but challenges continue to mount from overseas and domestic competitors.

Perhaps most shocking has been the tepid response to this relative decline among L.A.’s business and political leaders. Once local entrepreneurs imagined great things, like massive water and port systems, dominated the race for space and planned out the suburban dreamscapes of Lakewood, Valencia and the Irvine Ranch.

Arguably the signature achievement of this past decade, and the one getting the most attention in the media, has been the revival of downtown as a residential and cultural hub. Having essentially abandoned the model of a multipolar city, L.A. has poured billions in infrastructure and subsidies into a half-baked attempt to turn Los Angeles into a faux New York. This is something of a fool’s errand since barely 3% of area residents work downtown, and most cultural consumers live far away on the westside or in the San Fernando Valley.

New Mayor Eric Garcetti is also a density advocate, and is placing huge bets on the massive building of high-end high-rise housing, all this despite weak job and population growth. In his campaign he emerged as the candidate of developers who want to densify the city, including Hollywood, over sometimes fierce grassroots opposition.

Compared to his inept and economically clueless predecessor, Antonio Villaraigosa, Garcetti represents something of an upgrade. He at least knows jobs matter at least as much as development deals for contributors. Yet he remains pretty much a creature of the failed leadership culture of L.A., which is dominated by public employee unions, subsidy-seeking developers and greens, largely from the city’s affluent westside.

Can L.A. turn itself around? The essential ingredients that drove the city’s ascendency remain: its location on the Pacific, its near-perfect climate and spectacular topography. The key now is for the region to build an economic strategy that allows it to use its assets, and build around its increasingly immigrant-dominated grassroots economy. Innovation in music, fashion and food continue at the grassroots level, with much of the inspiration coming from the city’s increasingly racially diverse mestizo culture.

What L.A. needs now is not a slick media campaign, but a concerted effort to tap this neighborhood-centered energy. The city of the future needs to reinvent itself quickly, before it fades further behind its competitors on the coasts and in Texas. Successful cities such as  Boston, San Francisco, Seattle  and Houston all managed to find ways to nurture new industries to supplement their traditional ones. Los Angeles should be able to do the same, but only if it seizes on its fundamental assets can it again become a city with a future.

About the Author:  Joel Kotkin is executive editor of NewGeography.com and Distinguished Presidential Fellow in Urban Futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA. This story originally appeared at Forbes.com and is republished here with permission.

Union Controlled Classrooms – What Happened to Public Education in the U.S.

The United States spends more per pupil on public education than any other country in the world, about one trillion dollars annually, but it is at the bottom of the class. In 2009, 15-year old American students ranked 17th in reading, 23rd in science and 32nd in mathematics in the PISA international assessment of academic achievement. In 2000, they ranked 18th in math and 14th in science. 500,000 students from 34 OECD nations participated in each assessment.

A glance at the final exams given in 1895 and 1912 to 8th grade students is a striking example of how far we have fallen as a nation. [1, 2] 12-year old students in Salina, Kansas in 1895 had to pass the five-hour exam to qualify for admission to high school. Sample questions include:

–  Name the parts of speech and define those that have no modifications.
–  If a load of wheat weights 3942 lbs., what is it worth at 50 cents per bushel, deducting 1050 pounds for tare?
–  Relate the causes and results of the Revolutionary War.
–  Write 10 words frequently mispronounced and indicate correct pronunciation by use of diacritical marks and by syllabication.

How many adults in 2013 could pass this test?

The decline in scholarship of America’s students parallels the unionization of public education. Teachers unions did not exist in the 17th, 18th and 19th centuries when student achievement in the Unites States was the envy of the world. They are a fairly recent development.

Founded in 1857 by 43 teachers as a professional association, the National Education Association became a labor union in the social chaos of the 1960’s. Their metamorphosis into a union has negatively impacted the course of public education and the character of educators.

At its 50th anniversary, the NEA had a membership of 5,000. By 1960, the number had increased to 700,000. At its 150th anniversary in 2007, membership had ballooned to 3.2 million. The annual costs for public education during this period also ballooned, from $13 billion to $900 billion. [3]

Annual per student spending in constant 2011-2012 dollars rose from $3,648 in 1960 to $9,941 in 1995. In 2000, the average cost was $8,854. [4]  Today, it exceeds $10,000. In New York and the District of Colombia, the cost is $20,000, yet DC students have the lowest scores in this country as well as in all 34 of the countries in the OECD. [5]

There is an inherent structural flaw in the motives and priorities of a labor union being entrusted with the academic health and welfare of the nation’s young citizenry. In the transformation from a professional association to a union, its primary focus has shifted to the needs and welfare of the 3,500,000 teacher members, not the 55,000,000 young students placed in their care. [6]

The change in identity from a professional association to a labor union has had profound political, sociological and psychological consequences. These effects are linked to the decline in public education and academic scholarship and on the quality and performance of teachers. In their wake, America has become a global embarrassment. It is important to distinguish between teachers and teachers’ unions. Americans respect and trust teachers. They do not view unions in the same light. The difficulty lies in the lack of awareness of the union’s control over teachers and schools by the American public.

The NEA is dedicated, first and foremost, to the extent of its own power and political influence. Although unions claim to exist for the good of their members, they exist mainly for their own self-interests. The interests of the teachers are secondary. Those of the fifty-five million public school students are dead last.

With more than $1.5 billion in annual revenue from the mandatory dues of its 3.5 million members, the NEA has become a major player on the national political landscape. It is the largest contributor to the Democrat Party. [7]  The NEA can muster vast sums of money and numbers of votes for candidates in local, state and national elections or to defeat ballot initiatives that threaten its monopoly in public education.

To protect their interests, teachers unions have bludgeoned the citizens of California time and again at the ballot box. In 1993, the CTA spent $17 million to defeat Proposition 174 for school choice and $26 million in 2002 to defeat Proposition 38, a similar school voucher initiative.

They mortgaged their own headquarters in 2005 to raise the $56 Million that was needed to defeat the school reforms proposed by Governor Schwarzenegger. Had the CTA needed even more funds, its parent organization would have covered the shortfall with the staggering war chest the NEA has made available to any of its state affiliates. [8]

The continual increase in federal investment in public education and corresponding decrease in class size has not produced an increase in student performance. Quite the opposite has happened. The rate of literacy in our armed forces has steadily declined throughout the 20th century from 96% in WWII, to 81% in the Korean War to 73% in Viet Nam. [9] Thirty percent of current Navy recruits can’t read at a 9th grade level, the minimum required as a precaution in order to comprehend equipment instructions and operate them safely. [10]

Among high school graduates, the statistics are far worse. 75% of freshmen in 2-year colleges and 40% in 4-year colleges require remediation in reading and math. The US itself ranks 49th among the nations of the UN in its literacy levels. After 12 years of education in the nation’s public schools at a cost of $120,000 per student, America has an embarrassingly small return on its investment.

The 1895 and 1912 8th grade exams are a troubling reflection of the corrosive effects unionization has had on educators, students, the curriculum and the nation itself. Most teachers of that early era in our history had only a basic education. A high school education in the 1890’s provided a more solid understanding of mathematics, geography and literature than does most college degrees today.

Classes were large and often shared by students from several different grade levels. The curriculum was rigorous and every student was expected to master the Three R’s. The Bible, world atlas, US Constitution and the McGuffey Readers were often the only textbooks available. Strict rules promoted learning and kept disruptiveness to a minimum.
Public education in America was once among the nation’s greatest achievements. Its schools produced many of the world’s greatest minds (Thomas Edison, Alexander Graham Bell and Henry Ford) until the sixties. That remarkable achievement appears to have been lost since the intrusion of the powerful teachers’ unions, a footnote in our national history.

The NEA also changed the character of educators. Images in newspapers and on TV of angry teachers in the streets of Chicago and New York with placards demanding higher wages while their students are locked out of their schoolrooms for days stand in stark contrast to the well-dressed, soft-spoken teachers of our childhood.

Mob thuggery has inserted itself into public education. The educators who march and chant in favor of unions are often very emboldened and brutish. Although many teachers disagree with this unseemly and unprofessional behavior and would never voluntarily abandon their students, they are voiceless within the union.

The NEA has co-opted the teaching profession. Teachers have become members of a union, not of a highly esteemed profession. In its wake, the NEA damaged our schools, our students and our educators. There has been a dumbing down of our teachers, 41% of math teachers and 51% of those in chemistry and physics lack even a minor in their area of specialization and a correspondent dumbing down of our students, 23rd in science and 32nd in math on international assessment of academic competence.

Public education in America is literally on its deathbed. The only treatment to save its life is radical reform. There are no other options. Absolute control must be wrested from the teachers union.

Solutions to Revitalize Public Education in the United States:

(1) The Right to Work policy should be implemented in all states as should the right to opt out of mandatory dues and agency fees.

(2) Seniority, step increases in salary and automatic tenure after two or three years are rules that should be revoked.

(3) Assessment of teacher performance, disciplinary matters and design of the curriculum should be under district control with continual input from the community as should hiring and firing of teachers.

(4) Charter schools, single-sex schools and parental choice should all be made widely available.

It is time America took back control of the education of its future citizens. The purpose of this series will be to examine the effects of unionism on U.S. public education and academic achievement, quality of the teachers and the curriculum being taught by them and of the massive fraud of the federal monopoly in education.

It is our hope that exposure of the malignant effects of the unions on public education and the threat for the nation’s future will provide some direction for a much-needed public discussion about an issue that may be among the most critical for our continued survival as a world leader.

R. Claire Friend, MD, is a retired psychiatrist and frequent commentator on the psychological dimensions of education and social welfare policies.

Footnotes:

1. http://www.rootsweb.ancestry.com/~kssvgs/school/8th_exam_exp.html

2. http://blogs.smithsonianmag.com/smartnews/2013/07/no-youre-probably-not-smarter-than-a-1912-era-8th-grader/#ixzz2bEdfZHU3

3. http://nces.ed.gov/pubs2009/2009020.pdf

4. http://www.econlib.org/library/Enc/Education.html in constant 1995 dollars

4. http://nces.ed.gov/programs/digest/d12/tables/dt12_213.asp in constant 2011-2012 dollars

5. Eric Hanushek, Paul Peterson and Ludger Woessman, Endangering Prosperity, p. 50

6. http://www.census.gov/newsroom/releases/archives/facts_for_features_special_editions/cb11-ff15.html

7.

8. http://www.followthemoney.org/database/topcontributor.phtml?u=20205&y=0

9.

10. https://www.google.com/#q=percent+of+US+navy+recruits+who+are+illiterate

Additional Notes:

Annual cost per student by state:
http://www.npr.org/blogs/money/2012/06/21/155515613/how-much-does-the-government-spend-to-send-a-kid-to-school

Annual cost per student in constant dollars:
Eric A. Hanushek, “Deconstructing RAND,” Education Next 1, no. 1 (2001), online edition: http://www.educationnext.org/2001sp/65.html.

Record Corporate Profits vs. New Firm Creation

Corporate Profits Are at a Historic High

The economic malaise characterizing the years after the financial crisis has largely bypassed corporate America. Corporate profits are currently at a historic high of 11 percent of GDP (see fig. 1 below). Expert speculation abounds as to the causes and implications of this trend. Many commentators, seeing these record profits as another sign of growing inequality and concentrated wealth, blame an increase in corporate power. There is, however, another explanation – little discussed but worthy of analysis – for this trend: fewer new firms are entering the market.

Fig 1  –  Corporate Profits as a Percentage of GDP

Bruneau-1

The Economic Process that Has Traditionally Controlled Corporate Profits Has Broken Down

Basic economic theory holds that as sectors of the economy heat up, new entrants, enticed by the prospect of high profits, will move into the sector, capturing profits for themselves, and driving down average profits. In other words, new firms serve to check supranormal corporate profits. The restaurant and technology industries provide great examples of this process. The influx of new firms to profitable sectors of the economy has traditionally kept corporate profits at approximately 6 percent of GDP – around half what it is now.

But this process has broken down over the past several years with fewer new firms entering the market despite the existence of profit signals that would traditionally entice them. At around 750,000 per year, the number of new firms (“establishment births” in Bureau of Labor and Statistics lingo) entering the market is at nearly the same level it was 20 years ago.

When taking into account that the number of working Americans has risen by over 46 million, or 24 percent, over this period, the trend becomes even more pronounced: There are now approximately 3.2 new firms per year per one thousand working age Americans, down from a historical average of about 3.8 (see fig. 2 below).

Fig 2  –  New Firms (Absolute and per 1000 Working-Age Population)

Bruneau-2

The number of new firms entering the market per year over the number of those exiting (“births/deaths”) is back in positive territory after several years during which more firms exited the market than entered it. However, new firms are not only fewer than usual but also smaller, employing fewer people. New firms now cumulatively employ around three million Americans, down from a historical average of around 4.75 million in the 1990s (see fig. 3 below).

Fig 3  –  New Firms over Exiting Firms and Employment at New Firms

Bruneau-3

What Could Be Causing Fewer New Firms to Enter the Market?

So why is it that fewer new firms than usual are entering the market at a time of record corporate profits? There is no shortage of speculation across the ideological spectrum. Some experts claim the problem is structural. For example, Tyler Cowen, head of the Mercatus Center, argues that having already harvested “the low-hanging fruit” – that is, the economic opportunities inherent to the country – that new firms could have otherwise tried to exploit, the United States is going through a “Great Stagnation.” Now, because of technology and other structural shifts, the economy is entering a new, more challenging landscape that offers fewer opportunities for new firms – or the middle class.

A more basic explanation for this trend could be that Americans do not face the right incentives to start new businesses. Traditionally, a leading factor preventing entrepreneurial expansion has been economic uncertainty. The National Federation of Independent Businesses ranks “uncertainty over economic conditions” and “uncertainty over government actions” as dominant concerns. The idea that uncertainty is detrimental is shared by other global economic bodies including the International Monetary Fund, which concluded that uncertainty is a primary cause of recent weak economic growth, claiming that it “weighs heavily on the outlook.”

This uncertainty can be quantified: Using an algorithm based on newspaper coverage, expiring tax code provisions, and disagreement among economic forecasters, economists Baker, Bloom, and Davis created the Economic Policy Uncertainty Index. This index reveals that economic uncertainty has remained at historic highs since the financial crisis (see fig. 4 below). Potential new firms may understandably be hesitant to enter such a climate of uncertainty

Fig 4  –  Economic Policy Uncertainty Index

Bruneau-4

Increased Regulation May Also Be a Culprit

Reams of academic research suggest that regulations disincentivize new business formation. Klapper, Laeven, and Rajan’s findings that “costly regulations hamper creation of new firms, especially in industries that should naturally have high entry” are representative of the research on the topic. As the research indicating a link between regulations and business formation increases, so, too, does the American regulatory burden. The total number of federal regulations has surpassed one million, according to data from the Mercatus Center. In its latest Global Competitiveness Report, the World Economic Forum ranks the United States 80th place in the world in terms of regulatory burden, down from 23rd place just seven years ago. The Fraser Institute’s Economic Freedom of the World report for 2013 shows the U.S. falling from 2nd place to 17th place in this category over a similar period.

In an attempt to quantify the country’s regulatory burden, Clyde Wayne Crews Jr., of the Competitive Enterprise Institute, has been tracking the Federal Register’s number of outstanding “economically significant” rules (those with a negative economic impact of $100 million or more) as well as its number of pages devoted to “final rules.” His research indicates an unprecedentedly high number in both categories, with over 200 outstanding economically significant rules and 25 thousand pages devoted to final rules, since the financial crisis (see fig. 5 below).

Fig 5  –  Economically Significant and Final Regulations

Bruneau-5

As experts examine the reasons for and implications of historically high corporate profits, they should also consider the causes and effects of fewer new firms on this trend.

Jordan Bruneau is a policy analyst for the Economic Freedom Project, focusing on issues of free trade, economic freedom, and well-being. (c) Charles Koch Institute, republished with permission.

How Regulations Favor Monopolies and Big Government

Before discussing how Big Food operates today, let’s take a moment to look back at how agriculture operated in the US South in the late 19th and early 20th centuries. Viola Goode Liddell, daughter of a cotton salesman, described the system:

When an [Alabama] Black Belt farmer sent his cotton down river to Mobile, he . . . had to take what he was given and be satisfied. . . . The big cotton dealers [had financed him and] the weighing . . . and grading of the cotton was . . . at their discretion. . . . Furthermore, these cotton kings either bought  outright or went into partnership with fertilizer houses, feed and implement stores, and wholesale groceries, so that [the growers] . . . had to buy everything they needed for running their farms and for advancing their tenants from specified concerns. . . . The tenant farmer and sharecropper [were at the bottom of the chain] . . . but . . . the landlord . . . had the same kind of rope around his neck that was about the tenant’s, except it was bigger and stronger and more likely to choke him to death.

As this passage attests, agriculture was a controlled market in the late 19th and early 20th century South, and it remains controlled today, although the system is not the same. Control now lies in the hands of the government and its private, industrial farming and food processing cronies, today’s equivalent of yesterday’s “big dealers.”

These cronies, including Monsanto and other giant food concerns, dominate food and farm policy at the White House, USDA, FDA, and EPA. The regulators seem to prefer big firms because they are easier to manage than thousands of little family farms and businesses. Besides, they provide lucrative jobs, other emoluments, and campaign contributions. The giant food firms in turn like the system because new and small competitors are ill-equipped to handle legal and lobbying expenses and uncertainties, not to mention often hostile regulators intent on preserving monopolies and quasi-monopolies for their friends.

More than in other industries, prices are government controlled, even though economists on both right and left sides of the political spectrum agree that direct price controls are counter-productive. For a quarter century beginning in 1958, the government did not allow Safeway to reduce food prices. That eventually changed, but some retail food prices are still directly controlled, notably milk.

Have dairy farmers benefited from this? It would seem not. Most dairy farmers over the years have been driven out of business, and the pace of dairy farm failure accelerated after 2008. USDA rules and regulations, especially the Pasteurized Milk Ordinance (PMO), have both stifled innovation and concentrated production into huge factory farm dairies, many located in California, whose arid climate makes it easier to pack thousands of animals into a small space. As a direct result, milk is less and less available locally and must be shipped across the country. This is not only costly and wasteful of energy; it also means the milk must be ultra-pasteurized for long shelf life, which makes it less nutritious. It is also illogical to concentrate dairy, which requires prodigious amounts of water, in the waterscarce West.

Over the years, tightening government regulations have shut down most local, small slaughter houses. It is more convenient for USDA inspectors to visit a few giant operations. This and other policies have also encouraged the growth of huge factory farms for chickens, eggs, hogs, and other animal products. These operations, usually called Confined Animal Feeding Operations (CAFOs), squeeze animals into smaller and smaller spaces, creating pitiful conditions, mountains of excrement, and uncontrollable sanitation problems. Contamination and outbreaks of food-borne illnesses are invariably traced to these CAFOs, but when the government responds, it does so by creating new regulations and expenses for small, local operations, which are not the source of the problem, so that even more of them are driven out of business.

The latest government spasm along these lines was the Food Safety Act of 2011, a bill that was passed by legislative legerdemain. A bill passed by the House was taken up by the Senate, the old language excised, the new Senate food safety legislation dropped in, in order that the Senate could pretend to be acting on a House bill, as required by procedure. Both chambers ultimately approved the new language. The Act as initially written called for sizable fees payable to government by even tiny food operations. This did not survive, but for the first time the FDA got direct legal authority over individual family farms. Prior to this legislation, farmers of all sizes had to answer (only!) to the USDA, Defense Department Corps of Engineers, EPA, and state regulators.

The FDA knows little or nothing about farming. But this new authority may eventually put FDA inspectors on the farm, and if so the agency will want farms to be large scale and limited in number. This is the FDA’s pattern. For a time, the Agency banned the import of French cheeses that were not heavily pasteurized, a step inconsistent with making the finest cheese. Then a few very large French cheese makers were allowed to export to the US. Smaller, family, and artisanal cheesemakers were not.

Among the regulations that small farmers already face are Clean Water Act requirements governing waterways and wetlands. The Act exempts agriculture. That sounds simple, but it is not. If a farmer wants to build a pond, he had better get the Corps of Engineer’s permission. This can be enormously costly and time consuming.

There is not even a settled, legal definition of a wetland. One Corps office may advise to file form X; another may say, no, file form Y. What if the farmer later wants to sell fishing rights to the pond? No, that is not farming. The Corps can hit you with massive fines and require both the removal of the pond and restoration of the landscape just as it was. Almost any step a small farmer or rancher takes may be creating serious legal liabilities. Who has the money or legal assistance to sort it all out or the paperwork to prove compliance? Once you have made a mistake, the government can threaten jail.

The US Department of Labor in 2011 decided to ban children working on family farms. Faced with criticism, they said they would exempt “family” farms. But what exactly did they mean by that? They meant, it turned out, farms directly owned by the child’s parents in their own name. Farms held in a family partnership or LLC were not deemed “family” farms. Finally in 2012, USDL backed off, but the secretary said she was disappointed at this outcome and the Agency might return to the issue in the future.

If the US government really wants to protect children, why did it approve pizza as a vegetable under the School Lunch Program? Why does it also dump into school lunches poor quality meat that has been irradiated (nuked) to eliminate bacterial contamination? Why did Congress specifically override efforts to restrict greasy french fries in school lunches? In each case, the reason was that powerful food companies wanted to sell pizza or potatoes, and the government wanted to dump its own surplus meat, and school children were an easy target. Producers of sugar-laden food even pay “rebates” (subsidies) to food service companies supplying school lunches in order to encourage processed over fresh food.

For years the federal government advised people to stop smoking, but subsidized the growers of tobacco. That only ended by paying tobacco allotment holders lump sums to buy them out. Now the government warns people to cut back on sugar consumption, but supports sugar growers with price supports and tariffs against foreign sugar. The Fanjul family of Florida owns much of the domestic sugar production; members of the family are well known political donors who have contributed more than $1.8 million to politicians over the years. The Fanjuls’ sugar, sucrose, which appears on kitchen shelves, is actually far less ubiquitous than the high fructose syrup derived from corn which the government also heavily subsidizes. This is an important product of Archer Daniels Midland (ADM), another largescale source of federal of political campaign funds ($495,000 2011–August 20, 2012).

Government farm subsidies are notoriously skewed toward larger farm operators: $1 dollar of every $2 dollars goes to the top 4%; $ 8 dollars of every $10 to the top 15%. Some of these subsidies even go abroad. In order to avoid trade sanctions under World Trading Organization (WTO) rules, the US government pays $147 million a year to Brazilian cotton producers, so that it can continue to subsidize US cotton producers. There is also the usual toll from fraud or inattention. Over the first ten years of the 2000s, more than $1 billion was paid to deceased farmers, a fifth of them dead for at least seven years.

Payments are not only highly concentrated in terms of recipients. They are also highly concentrated by crop: 90% went to support just five crops: corn, wheat, soybeans, cotton, and rice; 30% to corn alone. US PIRG, a consumer organization, noted about this:

We’re handing out taxpayer subsidies to big agribusinesses to help subsidize junk food. Huge, profitable corporations like Cargill and Monsanto are pocketing tens of billions in taxpayer dollars, and turning subsidized crops into junk food ingredients including high fructose corn syrup . . . at a time when one in three kids is overweight or obese, and obesity-related diseases like diabetes are turning into an epidemic. .

If [federal] agricultural subsidies went directly to [taxpayers] to allow them to purchase food, each of America’s 144 million taxpayers would be given $7.36 to spend on junk food and 11 cents with which to buy apples each year—enough to buy 19 Twinkies but less than a quarter of one Red Delicious apple apiece.

US PIRG’s chose this example because most of the subsidized crops are found in Twinkies, but among fresh produce, the only significant subsidy goes to apples.

In the summer of 2012, severe drought in the US Midwest drove up the cost of corn, and even threatened to create animal feed shortages. But there was no real shortage of feed corn. Because of the government’s ethanol mandate, over 40% of annual corn production is diverted into car fuel. In a normal year, only 36% goes for animal feed, and even less, 24%, for human consumption. Moreover, no one—other than corn producers—likes the ethanol mandate. Environmentalists have long documented that ethanol fuel produces more carbon and smog, not less.

2012 corn animal feed shortages provided the perfect opportunity for the Obama administration to pull the ethanol mandate and subsidy. At the time, this mandate was driving up the cost of corn, the cost of fuel, the cost of animal feed, and would shortly drive up the cost of meat. What did the president actually do? He traveled to Iowa in August of the election year to announce that the federal government would buy up $100 million worth of pork, $50 million of chicken, and $20 million of lamb and catfish. So, an additional federal subsidy was piled on top of all the existing ones, with very little likelihood that it would actually help the meat producers.

Does the government really think it should be interfering with meat prices in order to correct the mess it has made in corn prices? If so, perhaps the old Soviet central planners should be brought in to give us some advice about how to go about it?

Crony-Capitalism-in-America

About the Author: Hunter Lewis is co-founder of AgainstCronyCapitalism.org. He is co-founder and former CEO of global investment firm Cambridge Associates, LLC and author of 8 books on moral philosophy, psychology, and economics, including the widely acclaimed Are the Rich Necessary? (“Highly provocative and highly pleasurable.”—New York Times) He has contributed to the New York Times, the Times of London, the Washing­ton Post, and the Atlantic Monthly, as well as numerous websites such as Forbes.com and RealClearMarkets.com. This post is an excerpt from Chapter 12 of his most recent book, Crony Capitalism in America: 2008–2012.

Ideological Battles Divide Both of America's Major Political Parties

To our progressive friends, it seemed like a century of advocating for government-sponsored universal health care reached fruition when the Affordable Care Act became the law of the land. But triumph turned to tragedy when Progressivism’s signature accomplishment blew up on the launch pad. Not only did this make a shambles of our wounded president’s governing philosophy, it sent the most vulnerable Democratic officeholders scurrying for cover, leaving damage control to a few befuddled party elders.

Far-left true believers, putting their faith in hope over experience, are insisting that Obamacare’s woes were brought about by compromise, and are demanding what they wanted all along and expected to get when Obamacare ultimately went bankrupt: single-payer, nationalized health insurance. To lead the charge, they will recruit their newest champion, Elizabeth Warren, anti-banking demagogue and untiring defender of unsustainable middle class entitlements.

The populist professor recently made headlines with the extraordinary claim that Social Security is $2.7 trillion in surplus and could easily provide increased benefits. She will have no trouble doubling down on the hoary promises her fellow progressives so fervently promote. As for the math? Who cares! It’s greedy insurance companies, Republican sabotage, and the wicked one percent who are really to blame for the Obamacare fiasco. Keep your focus on the enemies of the people and all will be well.

Old-bull Democrats, determined to recreate the glory days of the 1990s, will rally around their presumptive presidential nominee, Hillary Clinton. Hillary has been doing her level best to stay out of the line of fire as the wheels come off her former rival’s presidency, leaving it to Bill to prick Obama’s balloon whenever the opportunity arises. Watch these two old hands try to triangulate their party back to the center, perhaps even reaching across the aisle to old-bull Republicans as Clinton Inc. tells an angry and frightened electorate that things will surely get better if adults are put back in charge.

Old-bull Republicans, fearing a Tea Party insurgency even more than the Clinton campaign steamroller, will seek to strike a grand bargain on … well, everything. Remember the good old days when Tip and the Gipper could deliver both guns and butter while maintaining a respectful professional rivalry. So what if this means spending the country into oblivion? Politics is the art of the possible, which makes winning elections more important than defending principles. And wouldn’t life be better if Washington insiders could get back to scratching each other’s backs without having to worry about primary challenges?

And the Tea Party? These Constitution-thumping reactionaries will remain the wild card, biding their time, picking off the weakest of the old bulls, and preparing for the moment when America is finally forced to make hard choices. That moment will come when our QE besotted fiat currency system begins to totter, threatening to take the too-big-to-fail banks down with it. Will they convince America to hit the reset button—scrapping the bankrupt entitlements and crony capitalist policies that are sucking the life out of our economy? Or will they be driven back to their survival cabins to impotently watch the country sink into permanent Eurosclerosis?

Oddly enough, one solution to the Obamacare mess that could produce a stable political outcome is to give both extremes what they want—a government funded, owned, and operated national healthcare service freely accessible by the needy and a deregulated, privately insured health care delivery market where people of means can avoid the poor quality of care a public service will surely deliver. How to unwind the disastrous attempt to glue public and private systems together in an effort to disguise the underlying income redistribution will be the story of the next three years. And figuring out how to honestly pay for a new public healthcare service on top of Social Security and Medicare will force a conversation about means-testing that may eventually get the middle class off the dole, future generations off the hook, and Ponzi entitlement schemes out of bankruptcy.

About the Author:  In the 35 years since Bill Frezza graduated from MIT with degrees in electrical engineering and biology he has been a scientist, an engineer, a product manager, a salesman, a consultant, an entrepreneur, an author, a technology evangelist, and a venture capitalist. His early career on high-tech’s bleeding edge included the development of first generation electronic newspapers, home banking, home shopping, cable modems, multi-user videogames, wireless LANs, and wireless email, all of which became a success – for someone else a decade later. His 15 years as a venture capital investor working with early stage telecom, semiconductor, and biotech startups taught him humbleness, risk aversion, and the ability to identify ten fatal flaws out of five in any startup business plan. Frezza is a frequent guest on CNBC, FOX, and CBN News where he is challenged to reduce complex economic and policy issues into thirty second sound bites. More writing by Frezza can be found at BillFrezza.com. This article originally appeared in Forbes and appears here with permission from the author.

Ways to Grow California's Economy: A Checklist for Discussion

There is no substitute to growing California’s private sector economy. Growing the economy has substantial benefits:

  • The private sector economy is the only source of jobs and tax revenues.
  • It’s better for everyone to raise tax revenues by growing the economy rather than through tax rate increases and new taxes.
  • A growing private sector economy also reduces unemployment and welfare expenses, as well as making these expenses more affordable.
  • State government can’t create private sector jobs.  However, it does create a climate that encourages or discourages business formation and the investments needed to grow the economy.
  • California is in competition with other states and other countries for businesses and jobs needed to grow the state’s economy.
  • Is California becoming more like New York?  New York has a slow growing economy.  New York City is affluent due to the highly profitable financial services industry.  Smaller, upstate cities such as Buffalo, Syracuse, and Rochester are in decline.  Industry and agriculture are losing jobs.  Sound familiar?

NON-FARM EMPLOYMENT GROWTH, FOUR LARGEST STATES  (1990 = 100)
Source:  U.S. Bureau of Labor Statistics

Fletcher-EconGrowth-1b

CALIFORNIA NET BUSINESS FORMATIONS  (2001-2010)
Source:  EMSI

Fletcher-EconGrowth-2d

WAYS TO GROW CALIFORNIA’S ECONOMY:  A CHECKLIST FOR DISCUSSION

1. California needs to substantially reduce the cost and complexity of doing business in the state to compete with other states and other countries for businesses and jobs:

  • The state is losing businesses and taxpayers to other states, out migration.
  • California has the highest income tax, sales tax, and gasoline tax rates in the country.
  • At 8.7% the state has the fifth highest unemployment rate in the country.
  • It has the only state “cap and trade” tax in the country.
  • The business tax climate is the third worst behind New Jersey and New York.
  • The legal environment is anti-business.
  • The state is ranked by CEOs as the worst state to do business in for the ninth year in a row.

2.  California needs to reform public employee pay and retirement benefits to control the cost of government:

  • The growth of salaries and funded and unfunded pension and healthcare benefits for public employees is a growing burden on present and future taxpayers.
  • Many cities, counties, and school districts are cutting back on essential services and employment to cover unaffordable pension and retiree healthcare costs.  Some cities and counties face bankruptcy because of these costs.
  • Pay and benefits for public employees are too generous and should be based on the private sector (aka taxpayer) equivalents for similar positions.
  • Unfunded pension and healthcare liabilities need to be eliminated.  These costs should not be passed on to future taxpayers, a form of inter-generational theft.  These benefits should be fully funded during employees’ years of employment.
  • The pension system needs to be reformed to be less dependent upon defined benefit plans where the taxpayer is stuck with the bill for any underfunding due to poor investment performance or the use of overly optimistic investment assumptions.
  • If it isn’t funded, is it real?  Will future taxpayers and politicians be willing to raise taxes and cut spending to pay for unfunded pensions and retiree healthcare?  Or, will they look for ways to renege on these obligations?  Would today’s generous benefits have been awarded in the first place if their true costs were disclosed when they were awarded?

3.   It should be obvious that the state has been underinvesting in its infrastructure:

  • The state’s roads, airports and other infrastructure have been neglected and need to be upgraded and expanded to support a growing economy.
  • We pay for our infrastructure either way.  We can pay explicitly to upgrade and maintain the state’s infrastructure, or we can pay the hidden costs associated with inadequate infrastructure such as through increased traffic congestion, higher transportation costs, and slower economic growth with the associated loss of personal income, tax revenue, and jobs.
  • Spending on infrastructure is being crowded out by welfare spending and growing public employee pay and benefits.
  • The state needs to strike a better balance between essential infrastructure investments and other expenses.

4.  Financial reporting for state and local governments needs to be improved:

  • More meaningful reports for state and local finances are needed to include, for example, long-term trends and performance metrics.
  • Statements of actual expenditures are needed along with other data at the close of each fiscal year, the equivalent of annual reports, not just budgets for the next fiscal year.
  • Reporting of debts and unfunded liabilities should be improved along with forecasts of these expenses.
  • The state needs to publish timely consolidated reports for local governments, school districts, and special districts with some measures of financial performance and solvency.
  • Much better reporting of public employee pension and retiree healthcare costs is required including actual payouts, fund contributions, and unfunded liabilities using more realistic investment return assumptions.

5.  Education needs substantial improvements:

  • We shouldn’t give our students low-tech educations in a high-tech, global economy.
  • Our students have to compete with their peers around the globe, not just in California or the U.S.
  • As such, school performance should be measured based on international, not just U.S., standards.
  • The education system at all levels needs to be opened up to more innovation, to provide more choice to students and parents, and to allow more competition.
  • More vocational training is needed to give workers the skills needed to qualify for better paying jobs and to help grow the state’s economy.
  • California’s colleges and universities need to find ways to reduce (not freeze but reduce) the cost of a vocational training and a college education.  Make education more affordable for everyone.
  • The state needs to spend more on education.  However, more funding without reforms will probably not improve much.  How does California with the highest state tax rates in the U.S. also have below average per pupil spending for K-12 education?

6.  Welfare needs to be reformed to reduce costs and promote self-sufficiency:

  • We shouldn’t promise more than we can afford.
  • We need more job growth and better education to reduce welfare spending.  If there aren’t enough jobs or well-educated workers, we’ll get more unemployment and welfare spending.
  • California can’t afford to be more generous than other states with similar per capita incomes, or compared to national averages.
  • There is no substitute to helping everyone be self-supporting with incentives to get a job, improve skills and education, and save for the future.

7.  Healthcare is too expensive and bureaucratic and needs a big overhaul:

  • We should be in favor of good, basic healthcare for everyone even if they can’t pay.
  • Don’t confuse health insurance with healthcare.  They are not the same.
  • The present system is unaffordable, and may not be sustainable.  More government bureaucracy, mandates, rules, and cost reduction programs won’t make it work.
  • Pharmaceuticals, medical devices, and diagnostics are using the latest technology.  However, the rest of healthcare is way behind leading customer-oriented businesses such as Walmart or Amazon in using information systems and technology to be more efficient, more productive, more customer-friendly, and to lower costs.
  • A better system would use insurance to manage risk and protect people who need expensive procedures or require expensive, long-term care.  Routine medical expenses should be covered by health savings accounts, supplemented by vouchers or tax credits for those who have low incomes.  Tax deductions aren’t equitable.  They are most valuable to those who have above average taxable incomes.
  • A better system would include more innovation, more choice, and more competition across state lines.
  • To lower costs, we need to get most people to make healthier lifestyle choices.

About the Author:  William Fletcher is a business executive with interests in public finance and national security. He retired as Senior Vice President at Rockwell International where most of his career was spent on international operations and business development for Rockwell Automation. Before joining Rockwell, he worked for Bechtel Corporation, McKinsey and Company, Inc., and Combustion Engineering’s Nuclear Power Division, and was an officer and engineer in the U.S. Navy’s nuclear program. His international experience includes expatriate assignments in Hong Kong, Europe, the Middle East, Africa and Canada. Fletcher is a graduate of Tufts University with a BS degree in Engineering and a BA degree in Government. He also graduated from the U.S. Navy’s Bettis Reactor Engineering School.

Principles of a Good Tax System

Editor’s Note: This article by Jason Mercier outlines the principles of optimal tax policies in Washington state. It should be of interest to Californians because it offers a useful perspective on our own tax policies. Washington has succeeded in one key area, “balance and reliability,” because their three primary tax revenues, based on sales, gross business receipts (B&O tax) and property, are not likely to fluctuate much from year to year. This is in stark contrast to California, currently enjoying an alleged “surplus” thanks in large part to capital gains driven by recent IPOs. Washington also does well in “competitiveness,” being a relatively low tax state. It would be interesting to see an informed assessment of what might be an optimal tax system for California, and the principles outlined by Mercier provide a template. Any takers?

The Washington State House Finance Committee held a work session last week reviewing the state’s tax structure and how it compares nationally. I had the opportunity to present on the principles of a good tax system. I encouraged the committee to focus its tax reform efforts around the following fundamental building blocks of a good tax structure:

Simplicity  –  Current challenges:  B&O (business & occupation) tax and 1,800 taxing districts.

Accountability  –  Current challenges:  More public notice of tax bills and hearings needed and additional transparency of numerous taxing districts.

Economic Neutrality  –  Current challenges:  B&O tax, some of the highest sin taxes in the country, and predictability of tax policy.

Equity and Fairness  –  Current challenges:  Selective B&O tax relief and compounding impact of voter approved sales and property tax levies at local level on overall tax burden for low income.

Complementary  –  Current challenges:  Cost shifting of programs from state to local (unfunded mandates) and new taxing authority for local without adequate taxpayer protection (high vote threshold or voter approval).

Competitiveness  –  Based on various state ranking comparisons and net-migration of population to Washington, the state is doing well on competitiveness though our estate tax is out of the norm for states without an income tax.

Balance and Reliability  –  Realizing there is no such thing as a recession proof tax structure Washington does relatively well on balance and reliability when measuring the volatility of the sales, B&O, and property tax base.

A 2010 study by the St. Louis Federal Reserve Bank (State Tax Revenue Growth and Volatility) found that Washington’s tax structure resulted in the 4th least volatile tax revenues. The reason for this is Washington’s three major tax sources (sales, gross receipts, and property) are among the least volatile taxes. Progressive income and capital gain taxes, however, are the most volatile taxes.

According to the St. Louis Federal Reserve Bank:

“As mentioned, the retail sales and gross receipts tax is a very significant revenue source for state and local governments . . . it grows moderately relative to other tax revenues and is also reasonably stable . . .

The property tax is mainly used to finance local government. Its combination of high growth and low volatility make it a very attractive revenue source . . .

The corporate income tax is especially problematic in state budgeting because of its high volatility. Interestingly, its high volatility is not associated with a high growth rate. From a similar point of view used to analyze financial markets, this is a high-risk revenue source without compensation provided by higher expected growth . . .

As mentioned, individual income taxes also constitute a very important source of revenue for state and local governments. Their growth rate exceeds that of the retail sales and gross receipts taxes. It is also much more volatile. This volatility is undoubtedly the source of many of the current budgeting challenges faced by state and local governments.”

The relative stability of Washington’s tax structure has also been noted by Standard & Poor’s. From S&P’s July 2013 bond rating for the state:

Sales tax-based revenue structure that exhibits sensitivity to economic cycles but to a lesser degree than those of states that rely primarily on personal and corporate income taxes . . . The state’s reliance on retail sales and business and occupation (gross receipts) taxes for a combined 69% of general fund tax revenues (on a budgetary basis) typically affords more revenue stability than other states enjoy because many of them rely on personal income tax revenues.

Since you can’t tax your way out of the business cycle, for budget peace of mind when the economy recovers, states need to use a “three-legged stool” of sound budgeting:

  • Meaningful spending limit to avoid overextending in the good times;
  • Protected 10% reserve account (so you don’t have to resort to tax increases or deep spending cuts in the bad times); and
  • Limiting base expenditures to core functions within the revenue forecast when in the good times.

So what are the benefits of a low tax burden based on sound tax principles?

  • Faster economic growth
  • Greater wealth creation
  • End micromanagement and political favoritism
  • Increased civic involvement

As previously noted, a couple of areas that need more improvement are the transparency of the state’s tax system and the B&O tax.

On tax transparency, individuals and business owners should be able to quickly and easily learn about how much officials in each taxing district add to their total tax burden. This is especially true when considering there are nearly 1,800 taxing districts in the state.

To improve tax transparency an online searchable database of all tax rates in the state should be created and modeled after the state’s searchable budget website (fiscal.wa.gov). The online tax database should be set up to allow users to find their state and local tax rates (such as property and sales taxes) by entering their zip code, street address, or by clicking on a map showing individual tax district boundaries. An online calculator should also be included to allow citizens to calculate what their potential total tax burden is and know which of their elected officials are responsible for which parts of it.

A bill was proposed in 2009 to do this but it was not adopted (SB 6105: Concerning transparency in state and local taxation). At the work session yesterday, however, Rep. Carlyle noted that improvements to the Department of Revenue’s database authorized in the current budget should allow the state to start to move in this direction.

About the Author: Jason Mercier is the Director of the Center for Government Reform at Washington Policy Center. He serves on the Executive Committee of the American Legislative Exchange Council’s Tax and Fiscal Policy Task Force and is a contributing editor of the Heartland Institute’s Budget & Tax News. Jason is also a columnist for Seattle PostGlobe.org and serves on the board of the Washington Coalition for Open Government and was an advisor to the 2002 Washington State Tax Structure Committee. He received a B.A. in Political Science from Washington State University.

Why Are the Medical Insurance Companies Silent?

Editor’s Note: This essay by John Goodman makes explicit, in the context of the federal passage of the Affordable Healthcare Act, a phenomenon that is alive and growing in California. We usually call it corporatism, or crony-capitalism, but the endpoint of the trends, usually described using euphemisms, is economic fascism. Where communism might be correctly defined as a government takeover of the private sector, economic fascism is more of a joint-venture between business and government, with government as the senior partner. In California, public sector unions control the government, and most corporations do what they’re told, in order to secure favorable legislation (and avoid retaliatory legislation), as well as to win government contracts and subsidies. Along with practical suggestions for how to grow California’s economy, isn’t it time for a theoretical discussion regarding exactly what sort of political economy California’s got, and what might be more truly in the interests of working families?

What exactly are they afraid of?

John Goodman, the leading medical care analyst in the country, asked this question a few weeks ago. His piece was entitled: None Dare Call It…. The missing words were economic fascism.

Economic fascism, the system developed by Italian dictator Mussolini and later adopted by Hitler, is a highly developed form of crony capitalism. It has its own code of silence, not unlike the oath of omerta associated with the Mafia.

Private interests and government officials make their deals behind closed doors and are then not supposed to talk about them. To break the oath of silence is considered a grave offense.

In the past, medical insurance companies have been regulated by the states. They enjoyed their crony capitalist deals, but principally with state officials and regulators.

The federal government could not easily bring the insurers to heel, despite periodic efforts to do so. They were quick to put up ads defending their interests. They were not the least bit silent.

For example, when Hillarycare was first proposed during the early years of the Clinton administration, the largest insurance companies came out in loud opposition. They spent huge sums advertising against it on television.

The Clintons were furious, but unable to do much about it. In the end, the insurance companies succeeded in humiliating the Clintons: Hillarycare couldn’t even get through a Democratic controlled Congress.

Perhaps remembering this history, President Obama took a very different approach to developing Obamacare.

First he announced that there would be a game-changing new federal program. Insurers knew this would make or break medical insurance company profits. The president then assembled at the White House  the major medical players, including the hospitals and the American Medical Association as well as the insurers, in order to offer them a deal.

Out of hearing of press or public, the president in effect told the big special interests: You can help us craft the legislation, but if you later oppose it, you will be dead meat.

Only one insurance company failed to keep this “deal.” It was threatened with both Senate and Justice Department retaliation and quickly fell into line.

The medical equipment manufacturers alone failed to sign on to the deal at all. They were punished with a stiff new tax on medical equipment.

President Obama is now trying to shift the blame for millions of canceled policies onto the insurance companies. You would expect them to defend themselves. But they don’t, either because they are too deep in the deal or too intimidated– or both.

Thanks to Obamacare’s passage, the federal government has much more control over them than during the Clinton administration. They have in effect become government sponsored and controlled entities, and the days of their speaking out publicly against their federal overlords are over.

Do the insurance companies like the crony capitalist arrangements they have become party to, or do they think they have no choice but to go along?

No one can be sure. As Breitbart’s Wynton Hall pointed out, the medical insurers are enjoying both record profits under this administration and buoyant stock prices.

The S&P 500 healthcare stock index has so far this year gained 37.5%, making it the top performing sector. All public shares have benefited from the Federal Reserve’s money printing spree, but medical insurance companies are doing especially well, at least for now.

There is, however, a potential fly in the ointment. The new Obamacare policies are really bad medical insurance policies.

They are bad because they severely restrict your choice of doctor and hospital and often pay the doctor barely more than Medicaid. Paying so little means that doctors may not want you as a patient or will give you very little time.

Medicaid patients are familiar with not being able to find a doctor who will take them. Obama exchange policy holders will now often find themselves in the same boat.

These exchange policies are not private insurance in the traditional sense. As John Goodman says, they are “Medicaid Lite.”

Eventually the public will catch on to all this. There will be a lot of anger. At that point, the crony partners, government and business, will fall out, and insurance profits will be anything but safe.

For now and for the forseeable future, government remains the dominant crony. It is not the private interests controlling government, as much as they would like to. It is the government controlling private interests.

Growing government dominance of crony capitalist arrangements is also documented in a new book by Peter Schweizer called Extortion.

About the author:  John C. Goodman is a libertarian economist and the founding president of the Dallas-based, free-market think-tank the National Center for Policy Analysis and Research Fellow at the non-partisan, scholarly Independent Institute. Goodman received his Ph.D. in economics from Columbia University. He is the author of ten books, including the 2012 release, Priceless: Curing the Healthcare Crisis, which provides a concrete alternative to Obamacare; Patient Power: The Free-Enterprise Alternative to Clinton’s Health Plan; and Leaving Women Behind: Modern Families, Outdated Laws, with Kimberley A. Strassel and Celeste Colgan.

Too-big-to-fail Banks Will Kill the Global Economy

Editor’s Note: Anyone who is still wondering whether or not California’s trillion dollars of state and local government debt is a problem, or, by extension, whether or not the $15 trillion of federal government debt, or the $50+ trillion of total market debt in the U.S., is invited to read the following article. While reading, they are invited to reflect upon California’s version of financially too-big-to-fail; Wall Street enabled public sector pension funds and public sector bond debt. When public sector union spokespersons indignantly insist that concerns about government deficits or unfunded public sector pensions are merely shibboleths promulgated by “right-wing extremists,” they are ignoring this fact: The global economy is in the terminal phases of a long-term debt cycle that virtually guarantees, at the least, severe and ongoing financial challenges to the solvency of our public institutions. How these financial challenges might be overcome is not within the scope of this particular essay, but exploring solutions is the charter of the Prosperity Forum. To visualize solutions, you must appreciate the problem.

There are not many things on which Harvard professor-turned-Massachusetts Senator Elizabeth Warren (D-MA) and I agree. Yet, to her credit, she has been sounding the alarm about the threat that “Too Big To Fail” (TBTF) banks represent to our economy. However, that is where our agreement ends. Like most progressives, she vastly overestimates the efficacy and wisdom of regulatory bodies that invariably become captive to the corporations they are supposed to regulate as that great revolving door refreshes the influence of crony capitalists regardless of who is voted into office.

In fact, the regulatory policies she proposes would increase the TBTF behemoths’ threat to the economy by further entrenching the alliance of Wall Street bankers, the Fed, the Treasury Department, the White House, and congressional enablers from both parties that brought us to this point. Until we figure out how to unravel this single biggest threat to our prosperity, the best we can hope for the next time the TBTF house of cards comes tumbling down is for the ensuing violence and privation to be contained long enough to avoid the emergence of totalitarian regimes both here and around the world.

Sound apocalyptic? Think our problems can be solved with a regulatory nip here and a fiscal tuck there? Believe that our fiscal and monetary challenges can be overcome if we just get “the rich” to pay their “fair share?” If you answered “yes” to any of the above, then you are part of the problem, playing into the hands of the interests you believe you can control through the ballot box. Because the people who are driving this particular runway trainnever have to run for office.

Let’s take it from the top.

1) The global currency system is headed for collapse.

This will be unlike any currency collapse we have ever seen. It will not be geographically containable, and will leave no safe havens. For the first time in history, central banks around the world are debauching their currencies in unison. Even the normally prudent Swiss are so afraid of the threat currency appreciation poses to their export industries that they have joined the madness.

Stable exchange rates and the fact that Consumer Price Index (CPI)-based measures of inflation remain muted have calmed alarm bells. Meanwhile, the swelling asset bubble created by this unprecedented monetary expansion is being explained away — and in some quarters even welcomed — as some sort of stimulus-driven economic recovery.

Hurrah, look at the booming stock market! Look at rising housing prices! Look at the expansion of consumer credit! Keynesianism works! The so-called “wealth effect” will awaken animal spirits and kindle aggregate demand, which will revive the real economy, backfilling the value already priced into the stock market. Real economic growth will return, mass unemployment will abate, and all will be forgiven.

Unless it doesn’t. And to date, it hasn’t. The remedy for that? Print even more money!

2) The perceived elimination of counterparty risk is financial crack cocaine.

The subprime mortgage meltdown gave us fair warning of what happens when investors believe they will be protected by government intervention when parties with whom they do business fail. The most egregious case is the backdoor bailout of Goldman Sachs and others through AIG, whose debts from reckless derivatives trading were paid out to creditors by U.S. taxpayers at 100 cents on the dollar. By refusing to allow AIG, Fannie Mae, Freddie Mac, and other failed financial institutions on the losing side of subprime mortgage bets to go through normal bankruptcy (which would have paid off creditors at pennies on the dollar), Washington was essentially telling the financial institutions on the winning side of those bets that they never have to hedge or discount their positions for counterparty risk.

This has profound consequences on trading behavior, as it distorts the incentives that should inform institutional risk management. Individual traders’ winning positions can grow without bound, matched by losing positions held by counterparties. Meanwhile, no parties have to worry about which side they will end up on because Uncle Sam will be there with a bailout, either way. And the bonus band plays on.

3) There is no safe exit from ZIRP.

Future historians will puzzle in amazement about how otherwise sophisticated people allowed the entire global monetary system to come crashing down because some Princeton professor got his hands on a printing press. Fed Chairman Ben Bernanke’s unshakable commitment to a Zero Interest Rate Policy (ZIRP) has impoverished savers, driven investors dangerously out along the risk curve, and baked a ticking time bomb into the federal budget cake. The last feat is quite an accomplishment considering we haven’t evenhad a federal budget for almost four years. But when and if Congress finally does its constitutional duty, the Fed cannot even contemplate a return of real interest rates to historical norms because interest payments on the federal debt compounded at 4 or 5 percent will be fatal.

And so, our money printing policy is in a Red Queen’s race where, “It takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast!” There is only one way for this race to end. We have seen it in the Weimar Republic and, more recently, Zimbabwe.

4) We only await our Archduke Ferdinand moment.

No one knows what will trigger the panic that wipes away the unfounded confidence upon which our entire fractional reserve banking system is perched. Will it be the inevitable exit of Greece from the euro? Sovereign debt repudiation by Prime Minister Beppe Grillo? An Iranian nuclear weapons test that draws a military response from Israel, followed by a seize-up of oil markets? There are so many potential triggers to choose from. We will know that the moment is near when the smart money starts heading for the sidelines, to be followed by everyone else.

Except that it is always too late for everyone else. By the time global equity markets finish imploding over a few days of carnage, the well-connected insiders that caused the mess will be licking their chops totaling up their short positions, safe in the belief that when their counterparties go down, governments will somehow make good with yet another round of freshly printed money. Whether this is provided through bailouts or nationalization is immaterial. The damage will have been done.

What happens next? That is impossible to call. No one can predict what the collapse of the TBTF banking system will lead to when impoverished people in country after country begin clamoring to be rescued by a man on a horse.

About the Author:  In the 35 years since Bill Frezza graduated from MIT with degrees in electrical engineering and biology he has been a scientist, an engineer, a product manager, a salesman, a consultant, an entrepreneur, an author, a technology evangelist, and a venture capitalist. His early career on high-tech’s bleeding edge included the development of first generation electronic newspapers, home banking, home shopping, cable modems, multi-user videogames, wireless LANs, and wireless email, all of which became a success – for someone else a decade later. His 15 years as a venture capital investor working with early stage telecom, semiconductor, and biotech startups taught him humbleness, risk aversion, and the ability to identify ten fatal flaws out of five in any startup business plan. Frezza is a frequent guest on CNBC, FOX, and CBN News where he is challenged to reduce complex economic and policy issues into thirty second sound bites. More writing by Frezza can be found at BillFrezza.com. This article originally appeared in the Huffington Post and appears here with permission from the author.

Exploring a Prosperity Policy Agenda for California

The People of California want prosperity but most are not getting it. The California Policy Center has established this new website, the Prosperity Forum, to explore the reasons why Californians are not as prosperous as they once were. By making prosperity the primary focus, other objectives, which sometimes dominate our State’s politics, can be placed in perspective. Maybe it is possible for prosperity to coexist with them.

Californians have an urgent need to have prosperity considered from this perspective because politicians rarely do. It is no secret that Sacramento is run by special interests. Public sector unions and corporations outspend every other campaign donor type for the loyalty of our State Legislators, assuring that when they need to have a law enacted to further a specific item on their agendas, they will have the votes to make it happen. The same holds true for single-issue advocates. Because special interests and single issue advocates force politicians to focus narrowly on the benefits conferred by their specific proposals, laws are often enacted in California without any consideration given to the broader economic consequences of those laws. Who suffers most? Working families and the poor.

Most people are aware that California is not as prosperous as it once was. The elites in Hollywood and the Silicon Valley are doing fine in their coastal communities. But common families in the Central Valley and the inner cities of Los Angeles and San Francisco are far from prosperous. Unemployment persistently exceeds the national average as manufacturing jobs have moved elsewhere, and a once thriving middle class diminishes, leaving even the hope for prosperity an empty promise for the working class. To return the people to prosperity requires economic growth for the benefit of all. With prosperity comes hope for a brighter future and an equal opportunity to succeed.

Applying this People-first perspective, the Prosperity Forum proposes to explore issues that affect the prosperity of Californians with a bias towards economic growth. Following are some examples.

1. Energy and the Environment

Shale oil makes all Californians rich. This is because the oil sleeps beneath land owned by the State. Californians are like Saudi Princes who may collect fees from others for oil extracted from their land. The State, of course, is run by the politicians in Sacramento; though elected by the people, as long as they are in office, the politicians tell the people whether they get to prosper or not from this unique asset. But if the politicians decide to let the people’s oil flow, there is little doubt that the people would prosper in a big way.

A USC study reports that California has over two-thirds of the total shale-oil reserves in the United States. Shale-oil has become accessible because of recent developments in an old technology known as “fracking”. According to an article republished in September’s Prosperity Forum by respected author Chris Reed, “By 2020, fracking could create up to 2.8 million jobs, increase the state’s total economic output by up to 14.3 percent, boost state and local tax revenue by $24.6 billion annually, and increase aggregate state personal income by up to 10 percent. Even a relatively tentative foray into fracking could generate hundreds of thousands of middle-income jobs that don’t require college degrees.”

So why not go after it? North Dakota, with far smaller shale-oil reserves, began large scale fracking over 10 years ago, and its unemployment rate is down to 3.2%. Texas and Pennsylvania have also seen economic improvement after fracking was begun in those states.

The principal objection comes from environmentalists. So far, it has been these objections that have been delaying prosperity in California from energy development. The Prosperity Forum will conduct an ongoing analysis of these objections to determine whether prosperity and environmental interests can co-exist. The answer may turn on which environmental interests one is talking about—concern about local contamination or concern about possible worldwide impacts on climate change.

a. What Are The Risks Of Local Pollution Associated With Fracking?

In every state where shale-oil and shale gas has been accessed through fracking, concerns have been raised about the possibility that groundwater might become contaminated locally. Objections have also been raised about the potential for methane gas to be released at the surface as a result of fracking, which could lead to an explosion hazard. As explained by investigative reporter Chris Reed in his article “Fixing California: Will Fracking Bonanza Be Allowed?,” fracking has been carried out successfully for years in other states without significant harm to the local environment. There are some differences between California shale oil and other kinds, and objective study is, of course, required. But unless something surprising is uncovered, it seems likely that any risks of local contamination that might arise from fracking would be outweighed by the prosperity to be gained from it, especially the opportunity to be gained by working families who have been left out of California’s economic abundance for far too long.

b. What are the risks to climate change from fracking?

An official website of the Governor’s Office of Planning & Research, entitled “Just The Facts,” which is devoted to an objective discussion of climate change, recently reported on the September 2013 release of the first part of the report of the Intergovernmental Panel on Climate Change’s (IPCC) report updating the science of climate change. The California website reported that the IPCC found “that evidence of warming is ‘unequivocal’ and that it is ‘extremely likely’ that human influence has been the dominant cause of that warming.” Also, “changes . . . are already underway.” Explaining the climate science, the California website reports that the future “far-reaching consequences” of “greenhouse gas emissions, particularly carbon dioxide (CO2)” escaping into the atmosphere will be “increasing global temperatures and extreme events” such as “sea level rise, with related flooding and erosion of coastal areas,” “more frequent and hotter heat waves,” a “declining snow pack, with very significant implications for agriculture  and California’s water users,” and “more frequent and higher intensity wildfires.”

The majority of Californians agree with this assessment. Consequently, California is among the leaders in laws and regulations that limit greenhouse gas emissions from power plants, automobiles and other sources throughout the State. Indeed, Californians are proud to have met or exceeded nearly ever contaminant limit set by its regulatory agencies. In addition, California has adopted a cap and trade program administered by its Air Resources Board that is the envy of advocates for greenhouse gas restrictions throughout the United States.

Still, some say that California must do more when it comes to shale oil. Even if it is eventually determined that the risk of local pollution from fracking is acceptable, there are those who urge Sacramento to require working families to forego the opportunity for prosperity that shale oil affords because, they say, climate change science demands it. This solution is not, however, advocated on the Governor’s Planning and Research website, Just the Facts. Nor is it advocated in any of the U.N.’s IPCC reports.

Given the extensive set of laws already in place in response to the threat of climate change, there is reason to wonder whether the direct benefits of leaving shale oil in the ground outweigh the prosperity to be attained from taking it out of the ground and selling it. While California still allows cars to use oil-based fuel in the form of gasoline, under current law, shale-oil certainly could not be used to increase the amount of emissions coming from hydrocarbon-based fuels being used in California. Prosperity will come from selling shale-oil to people who use it outside of California. Californians might disapprove of those who buy their shale-oil, but history shows that they will purchase it from someone. So one question to be answered in the Prosperity Forum is whether a policy of leaving shale-oil in the ground would result in a material reduction in direct greenhouse emissions, and if not, why should working families be required to forego the prosperity that comes from allowing it to be extracted and sold?

Some argue that leaving shale-oil in the ground sends a message to the world that those who do not do their share to prevent climate change need to change their practices. Whether diplomacy of this nature will achieve a net benefit is open to debate. Californians should have that debate because 2.8 million jobs are at stake. Since the Governor’s website, Just The Facts, omits any discussion of these and other consequences of leaving shale-oil in the ground, Prosperity Forum is here to explore the issue in depth. California’s working families deserve no less.

Shale-oil belongs to everyone. Absent a compelling reason, it is time for Sacramento to start selling it so that all may prosper.

2. Education

Everyone deserves a fair start in life. Isn’t that, after all, the reason we have public schools? Yet, California’s public school system no longer provides a fair start for most students. Especially in the inner cities, drop-out rates are high, and many students never learn how to read properly. For California to prosper it must first need a workforce through an expanded economy, but then it needs to have a workforce that is at least moderately competent to make the economy work properly.

A few years ago, a blockbuster documentary, Waiting for Superman, was produced by Davis Guggenheim, the academy award winning director and producer of An Inconvenient Truth. It portrayed the plight of students who were trying to be accepted into charter schools, where only a few openings were available each year. The huge demand for these places compared to the public schools the students were trying to escape spoke volumes about the difficulties being faced by students trying to escape a difficult environment and get a fair start in life. The film provided insight into the role of the teachers’ unions in creating a system where education was no longer focused on teaching children as much as protecting teachers, many of whom were not good at their jobs.

In response to Waiting for Superman and a number of similar films and books exposing the corruption in our public schools, California politicians have done nothing. It is not a coincidence that the California Teachers’ Association is consistently the largest single donor to political political campaigns in California. When a teacher in El Monte was caught taking pornographic photos of his students with blindfolds so that they could not see that he was putting his bodily fluids onto objects, such as cookies, that they were holding, the school had to pay him to resign instead of firing him because of procedures negotiated by the CTA, and when a local legislator tried to enact a law to make it easier to fire teachers like him, the CTA made sure its favorite legislators did not allow the proposed law to get out of committee.

Things are bad in California education, but they can get better. Prosperity Forum intends to explore all of the ways that Californians can make it so.

3. Regulations

Last June, the CEO of CKE Restaurants, Andy Puzder, gave a mostly upbeat interview to the Wall Street Journal.  CKE is a California-based company, whose founder, Carl Karcher, began the predecessor to his Carls Jr. restaurant chain as a street vendor in 1941. Puzder’s company is expanding, he said. “It has 3,300 restaurants in 42 states and 28 foreign countries. There are 248 sites in the Middle East.” “Business-friendly places like Texas, where the company plans to open 300 new restaurants by the end of the decade” are the easiest states in which to grow, says Puzder, noting that restaurants in Houston and San Antonio hold records for highest first-week sales. “All those records used to be in California,” Puzder noted, but CKE no longer opens new restaurants in California.

What makes Texas “business-friendly” and California not? Puzder gave an example: “Consider how long it takes for one of his restaurants to get a building permit after signing a lease. It takes 60 days in Texas, 63 in Shanghai, and 125 in Novosibirsk, Russia. In Los Angeles, it’s 285.”

In that example, Puzder summed up the link between government regulations and prosperity: for California’s working families that translates into “no jobs at Carl’s Jr. in Los Angeles, but people like us are getting entry level jobs in Texas, Shanghai and Novosibirsk.” Why? Because time is money.

Imagine a working family of 6 in California who has worked hard and believes they have saved just about enough to start their own business. Because all of them have, at one time or another, worked in a fast food restaurant, they decide to start a fast food franchise, such as a Carl’s Jr. They are taking a sizable risk by investing all of their savings and giving up other work opportunities to open the business, but that’s what entrepreneur’s do, and if the risk pays off, as they hope it will, they will fulfill a dream of being their own boss.

The imaginary California working family spends much of its savings paying a franchise fee, a down payment on the mortgage to purchase the property, equipment for the restaurant, insurance, and expenses for lawyers, accountants and other professionals to make sure they are compliant with various regulations, including the new federal health care law. They have obtained a construction loan and can start construction as soon as the building permit is approved. So far, so good. Then they wait. And they wait. It takes 285 days, over nine months before their permit comes through—and that’s only if they are lucky enough to be treated like average citizens.

Our imaginary family likely has counted on a time when they will receive their building permit, build their restaurant, and, at last, the new restaurant will generate revenue. As a Carl’s Jr. franchisee, they look forward to the day when they will be able sell Six Dollar Burgers, Western Bacon Cheeseburgers, and some sweet potato fries and collect a small profit on each sale, and when those small profits add up, they plan to start paying off their debts so that one day, they will own their business or start another one just like it for their grandchildren. But while they wait for those revenues to start flowing in, they still must pay expenses whether the new restaurant opens or not. Waiting is expensive.

Texas gets it. We know their bureaucracy is friendly to business because they deliver the building permit in 60 days, shortening the time before building can begin and revenues can start coming in. But California, evidently, does not care a whit about our working family; its bureaucracy takes 225 days longer than Texas. During the 285 days our family waits for a permit, it must pay interest on its mortgage, fees for security, interest on a swing loan for supplies, not to mention lost wages for family members who quit their jobs to work on the new business project. Before they even start, the money runs out, the family has to default on its mortgage, and it gives up its dream of business ownership. People in their neighborhood who had hoped to work at the new restaurant look for work elsewhere. That’s why CKE Restaurants does not build new restaurants in California anymore. And that’s one of the reasons why California is no longer prosperous.

Reports and analysis posted on the Prosperity Forum will study such regulatory logjams. Politicians are responsible for the regulations that slow down the birth of businesses that provide jobs, and they are responsible for the performance of the bureaucracy that delivers such long wait times. Perhaps they have good reasons for causing these long delays. Prosperity Forum plans to ask them. California’s working families deserve to know, at least, why it is that their politicians are making decisions that place this economic burden on them. It might help them decide how to vote.

Bob Loewen is a member of the board of directors of the California Policy Center.

Are Annual Contributions Into CalSTRS Adequate?

Preface: Earlier this year the California Policy Center published a study evaluating the Orange County Employee Retirement System (OCERS) to explore this same question: Are Annual Contributions into OCERS Adequate? That study adopted a unique focus, evaluating contributions into OCERS not based on percent of payroll, but by looking at the actual amount of cash being contributed each year. In particular, the study evaluated how much cash each year was being contributed to reduce the unfunded liability. This report performs the exact same analysis, using the exact same template. Different numbers; same story. Pension analysts and pension activists are encouraged to download the spreadsheets (CalSTRSOCERS) used in both of these studies, and use them to perform similar analysis for whatever pension systems they are concerned about. For whatever pension fund they choose to analyze, it is quite likely they will find that the amount of money being contributed to reduce the unfunded liability is alarmingly low.

Summary: For the fiscal year ended 6-30-2012 the California State Teachers Retirement System, CalSTRS, collected $5.8 billion from employees and employers to invest in their pension fund. Of this $5.82 billion, $4.7 billion was the so-called “normal contribution,” which was a payment to cover the present value of future pensions earned during FYE 6-30-2012 by actively employed participants. The other $1.1 billion that was collected and invested in the fund was a “catch-up” payment to reduce the unfunded liability, which as of 6-30-2012 was officially estimated to be $71.0 billion.

Using evaluation formulas and unfunded liability payback terms recommended by Moody Investor Services in April 2013, this study shows that if the “catch-up” payment is calculated based on a level payment, 20 year amortization of the $71.0 billion unfunded liability – still assuming a 7.5% rate-of-return projection – this catch-up payment should be $7.0 billion per year. The study also shows that if the CalSTRS pension fund rate-of-return projection drops to 6.20%, the unfunded liability recalculates to $107.8 billion and the catch-up payment increases to $9.6 billion per year. At a rate-of-return projection of 4.81%, the unfunded liability recalculates to $154.9 billion and the catch-up payment increases to $12.2 billion per year.

This study also finds that the $4.7 billion normal contribution into CalSTRS for FYE 6-30-2012 was based on a rate-of-return assumption of 7.5%. The study shows that lowering the rate-of-return projection from 7.50% to 6.20% would require the normal contribution to increase by another $1.1 billion; lowering it from 7.50% to 4.81% would require the normal contribution to increase by another $2.5 billion. The rate of 6.2% represents the historical performance of U.S. equity investments (including dividends) between 1900 and 1999. The rate of 4.81% is the Citibank Pension Liability Index rate as of July 2013, which is the lower risk rate recommended by Moody’s Investor Services for pension liability forecasting.

The conclusion of this study is that CalSTRS relies on optimistic long-term earnings projections and very aggressive unfunded liability repayment schedules in order to pay the absolute minimum into their pension fund. If CalSTRS is required to even incrementally lower their rate-of-return projections – something that market conditions may eventually dictate – their funded ratio which is already only 67.0% will fall precipitously. Unless extremely favorable market conditions occur for the next several years without interruption, in order for CalSTRS to remain solvent, they need to dramatically cut retirement benefits, or increase their annual contributions by 50% or more per year.

*   *   *

INTRODUCTION

The purpose of this brief study is to assess whether or not the $5.82 billion contributed during the fiscal year ended 6-30-2012 into the CalSTRS pension fund was sufficient to ensure the long-term solvency of the fund. Using methods recommended in July 2012 and finalized in April 2013 by Moody’s Investor Services, and elucidated in a recent CPPC study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County,” this study will perform what-if scenarios, estimating the size of the CalSTRS unfunded liability at various rates of return.

This study will also discuss whether or not the current contributions, both normal and catch-up, add sufficient assets to the CalSTRS fund to ensure solvency, and how much contributions would need to increase using more conservative assumptions regarding return on investment and payback periods. Finally, throughout this study an attempt will be made to discuss and explain key concepts of pension finance, in keeping with the CPPC’s mission to inform and involve more people in discussions of sustainable public finance. The tables in this study were produced on an Excel spreadsheet that can be downloaded here:

DOWNLOAD SPREADSHEET:  Analysis-of-CalSTRS-Pension-Liability-and-Contributions.xlsx

The officially recognized amounts for key variables used in this study, including the total contribution to the pension fund, normal contribution, “catch-up” contribution to reduce the unfunded liability, as well as the total assets, total liabilities, and unfunded pension fund liability, were all drawn from publicly available CalSTRS financial reports.

*   *   *

HOW MUCH WAS CalSTRS UNDERFUNDED AS OF 6-30-2012?

The underfunding of any pension fund is calculated by subtracting from the amount of the total invested assets the present value of the liability to pay pensions in the future. Because these future pension obligations are intended to be paid sometime between next year and 50-60 years from now, the liability today is calculated by adding up the net present values of the estimated payments to be made for each year in the future. If the total value of the pension fund’s invested assets is equal to the present value of all future pension payments, the fund is said to be 100% funded.

Using data from the CalSTRS “Defined Benefit Program Actuarial Valuation as of June 30, 2012,” here are the officially recognized amounts for CalSTRS assets, liabilities, and underfunding at the end of last year [1]:

  • Actuarial accrued liability (AAL) = $215.19 billion
  • Valuation value of assets (VVA) = $144.23 billion
  • Unfunded Actuarial Accrued Liability = $70.96 billion

*   *   *

HOW MUCH WAS CONTRIBUTED INTO CalSTRS IN FYE 6-30-2012?

Again using data from CalSTRS “Comprehensive Annual Financial Report, FYE 6-30-2012,” the total contribution into the pension fund in 2012, via direct payments by participating employers and withholding from participating employee paychecks, was $5.82 billion [2].

Annual pension fund contributions have two components, the “normal contribution,” and the “unfunded contribution,” which is the amount paid towards reducing the plan’s unfunded liability. The “normal contribution,” simply stated, needs to be an amount equal to the present value of future pension payment obligations earned in the current year.

Normal Contribution: The total employer and employee normal cost for FYE 6-30-2012 was $4.69 billion as documented on page 15 of the Milliman actuarial report for CalSTRS, “Defined Benefit Program Actuarial Valuation.” [3].

Unfunded Contribution: The amount paid into the CalSTRS pension fund during their FYE 6-30-2012 to reduce their unfunded liability is not explicitly disclosed on official documents. But logic dictates the total unfunded contribution to be the difference between the total contribution, $5.82 billion, and the normal contribution, $4.69 billion, or $1.13 billion.

  • Total contribution = $5.82 billion
  • Normal contribution = $4.69 billion
  • Unfunded contribution = $1.13 billion

The remainder of this report will consider whether or not this level of contributions is adequate by estimating required contributions based on more aggressive payback terms, as well as more conservative rate-of-return projections. The first step is performing these what-ifs is to estimate how the unfunded liability is affected by changes to the rate-of-return projections.

*   *   *

HOW DO LOWER RATES OF RETURN AFFECT CalSTRS UNFUNDED PENSION LIABILITY?

To be 100% funded, a pension plan must have invested assets equal to the present value of all future pension payments. For every participating employee, whether they are active or retired, actuaries estimate their salary growth, their year of retirement, their initial pension, their subsequent pension payouts based on COLAs, and their life expectancy. The present value of all these future payments is how much a fully funded pension plan’s assets must be worth.

The rate at which these future payments are discounted per year must be equivalent to whatever rate the pension fund managers believe they will earn interest, on average, over the life of the fund. The theory is that if no future work were performed, and no future pension benefits were earned, and no additional money were contributed to the fund, the assets currently invested in a fully funded plan would earn enough interest to support every future pension payment until the last participant died of old age.

Since the amount of assets in a pension plan is a known, objective quantity, the debate over how much unfunded liability a plan may have centers on what assumptions are used to estimate the present value of the future payments, i.e., the “Actuarial accrued liability (AAL),” which CalSTRS valued as of 6-30-2013 at $215.2 billion. In order to assess whether or not that amount is overstated or understated, we can use a short-cut formulated by Moody’s Investor Services in their July 2012, “Moody’s Adjustments to US State and Local Government Reported Pension Data.”

In order to revalue a pension fund’s liabilities without having access to every actuarial calculation from every fund, what Moody’s does is estimate the midpoint of the future payments stream. They select 13 years into the future, which is quite conservative. Using a longer duration than 13 years will greatly increase the sensitivity of the liability to changes in the projected rate-of-return. Here is their rationale [4]:

“To implement the discount rate adjustment, we propose using a common 13-year duration estimate for all plans. This is a measure of the time-weighted average life of benefit payments. Each plan’s reported actuarial accrued liability (“AAL”) is projected forward for 13 years at the plan’s reported discount rate, and then discounted back at 5.5%. This calculation results in an increase in AAL of roughly 13% for each one percentage point difference between 5.5% and the plan’s discount rate. For example, a plan with a $10 billion reported AAL based on a discount rate of 8% would have an adjusted AAL of $13.56 billion, or 35.6% greater than reported.

We recognize this duration estimate may be higher than warranted for some plans and lower than warranted for others. Each pension plan has a unique benefit structure and demographic profile that affects the time-weighted profile (duration) of future benefit payment liabilities. However, plan durations are not reported, and calculating duration individually for each plan is not feasible. Our proposed 13-year duration is the median calculated from a sample of pension plans whose durations ranged from about 10 to 17 years. Plans with shorter durations usually are closed or have a preponderance of older or retired members.”

Here is the formula that governs this readjustment:

Adj PV = [ PV x ( 1 + official %i ) ^ years ] / ( 1 + adjusted %i ) ^ years

Table 1, below, shows how much the CalSTRS unfunded liability will increase based on two alternative rate-of-return projections, both of which are lower than the official rate of 7.50% currently used by CalSTRS. Here they are:

Case 1, 6.2%  –  here is the rationale for this rate-of-return, excerpted from the report “Pension Math: How California’s Retirement Spending is Squeezing The State Budget” [5] authored by Joe Nation, a Ph.D., Stanford Institute for Economic Policy Research, and former California Democratic assemblyman: “This 6.0 to 6.5 percent figure is based on the performance of a hypothetical fund containing 80 percent equity and 20 percent income instruments between 1900 and 1999. It assumes an equity rate based on the 20th-century Dow Jones industrial annual average of 5.3 percent, plus 2 percent in dividends, less 0.5 percent in fees. Combined with income instruments with a net rate of return of 4.5 percent, this hypothetical fund would have earned an average annual rate of 6.2 percent.”

Case 2, 4.81%  –  the rationale for this rate-of-return comes from Moody’s Investor Services “Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data,” released in April 2013 [6]“For adjustments to pension data, Moody’s will use the Citibank Pension Liability Index (Index) posted on the date of the valuation instead of its original proposal to apply a single rate for all plans each year.” Citigroup Pension Discount rate as posted by the Society of Actuaries in July 2013 was 4.81% [7].

Table 1 makes the revaluation method specified by Moody’s transparent. To download the spreadsheet that contains all of these tables, click here:  Analysis-of-CalSTRS-Pension-Liability-and-Contributions.xlsx, and refer to the first tab “unfunded liability.” To make the logic of these calculations as plain as possible, the spreadsheet cells where assumptions are input are shaded in yellow, and the result cells at the bottom are shaded in green. Column 1 shows the baseline case, using the official projected interest rate of 7.50%, meaning the end result is unchanged. Column two uses the “case 1″ lower rate of 6.20%, column three uses the “case 2″ rate of 4.81%. The first three rows show how the officially reported unfunded liability is calculated. The first four rows of the second second section, “Revaluation of Unfunded Pension Liability,” projects the liability forward 13 years to develop a future value at the official rate of return, 7.50%. The final three rows of the second section then calculate the present value using the baseline rate of 7.50%, the case 1 rate of 6.20%, and the case 2 rate of 4.81%.

As can be seen, even with what is probably an unrepresentative duration of only 13 years, if the pension fund is only projected to earn 6.2% instead of 7.50%, the unfunded liability estimate jumps from $70.0 billion to $107.8 billion, and at a projection of 4.81%, more than doubles to $154.93 billion. These are not implausible scenarios.

TABLE 1  –  RECALCULATING CalSTRS UNFUNDED PENSION LIABILITY

CalSTRS_solvency_analysis_Nov2013_table01a

*   *   *

HOW DO LOWER RATES OF RETURN AFFECT CalSTRS UNFUNDED CONTRIBUTION?

Table 2, below, shows how much CalSTRS should be paying back each year to reduce their unfunded liability if they were to pay it back using the terms of a conventional amortized loan with level payments each year. And this “level payment” method is what has been adopted by Moody’s Investor Services in their Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data, “Moody’s adjusted net pension liability will be amortized over a 20-year period on a level-dollar basis using the interest rate provided by the Index.” [8]

When reviewing Table 2, bear in mind that the payment made in FYE 6-30-2012 into the CalSTRS pension fund towards reducing their unfunded liability was $1.13 billion. As the baseline case in column 1 shows, if this payment were calculated using a level payment, 20 year term as recommended by Moody’s Investor Services, they would have had to pay $6.96 billion during 2012, more than six times as much. This observation merits repetition: By applying repayment terms that Moody’s Investor Services – the largest credit ratings agency in the world – has recommended public sector pension funds adopt, and without changing the return-on-investment assumptions that many analysts (including Moody’s who recommend using the Citibank Pension Index rate which typically is under 5.0%), CalSTRS is underpaying their unfunded contribution by a factor of more than six times.

Columns 2 and 3 in Table 2 help illustrate why it isn’t excessive to specify a 20 year, level payment plan to eliminate a pension plan’s unfunded liability. Because the amount of the unfunded pension liability, the principle being repaid, will fluctuate according to how much fund managers think the invested assets are going to earn. And as Table 1 shows, the amount of the unfunded liability is extremely sensitive to these changes.

In column 2, case 1 shows the impact of a 6.20% rate of return projection for the CalSTRS pension fund. The unfunded pension liability increases from the official $70.0 billion to $107.8 billion, which more than offsets the using the lower 6.20% rate to calculate the required payments. In case 1, a 6.20% projected rate of return for the CalSTRS pension assets will equate a $9.55 billion annual payment to reduce their unfunded liability. In case 2, a 4.81% projected rate of return for the CalSTRS pension assets will equate a $12.2 billion annual payment to reduce their unfunded liability.

Note: The first table in the Appendix to this report shows more detail on how CalSTRS is currently incurring negative amortization, i.e., how the unfunded pension liability will increase each year if only $1.13 billion is paid annually toward reducing that liability, as well as how the unfunded pension can be eliminated within 20 years using the higher payments calculated using the level payment method.

TABLE 2  –  RECALCULATING CalSTRS UNFUNDED CONTRIBUTION

CalSTRS_solvency_analysis_Nov2013_table02a

*   *   *

HOW DO LOWER RATES OF RETURN AFFECT CalSTRS NORMAL CONTRIBUTION?

No discussion of whether or not sufficient funds were contributed to CalSTRS during FYE 6-30-2012 would be complete without considering the “normal contribution,” which was $4.69 billion. The normal contribution is defined as how much future pension obligations were earned by actively employed participants during the current year, in this case, during the 12 month period ended 6-30-2012. If a pension plan is considered to be 100% funded, the normal contribution is the only payment necessary.

Table 3, below, revalues the normal contribution using methods recommended by Moody’s Investor Services. Again, a shortcut of this type is necessary because it is impossible with publicly available information to apply various rates of return to estimated future annual pension payments accrued during 2012 according to the actuarial profile for every actively employed participant in CalSTRS. Instead, the normal payment, representing the present value of the entire stream of future pension payments earned by actively working participants in the most recent year, is recalculated, using the official rate-of-return projection, 7.50%, at a future value set 17 years from now, representing the average remaining service life of active employees. This future value is then discounted back to present value using the lower rate-of-return, in our cases, at 6.20% and 4.81%. This process will yield a higher required normal contribution. Here’s how Moody’s describes this method in their July 2012 proposal “Moody’s Adjustments to US State and Local Government Reported Pension Data.” [9]

“The ENC [employer’s normal cost] adjustment reflects the lower assumed discount rate and the use of a 17-year active employee duration estimate for all plans – i.e., each plan’s normal cost is projected forward for 17 years at the plan’s reported discount rate, and then discounted back at 5.5% [based on the Citibank Pension Liability Index, as Moody’s specifies, which has dropped subsequently dropped to 4.81% – this study uses two lower rate scenarios, 6.20% and 4.81%], after which employee contributions are deducted to determine the adjusted ENC. The 17-year duration assumption reflects our estimate of the average remaining service life of employees based on a sample of public pension plans. We acknowledge that this is a simplifying assumption that may be too long or too short for different plans. Using this approach, a reported ENC payment of $100 million based on an 8% discount rate would grow to $149 million based on a 5.5% discount rate.”

As case 1 and 2 show on Table 3, lowering the CalSTRS pension fund’s rate-of-return projection from 7.50% to 6.20% increases the normal contribution by $1.1 billion; if it is lowered from 7.50% to 4.81% the normal contribution increases by $2.5 billion.

TABLE 3  –  RECALCULATING CalSTRS NORMAL PENSION CONTRIBUTION

CalSTRS_solvency_analysis_Nov2013_table03b

*   *   *

CONCLUSION

Using evaluation formulas and unfunded liability payback terms recommended by Moody Investor Services in April 2013, this study shows that if the CalSTRS “catch-up” payment is calculated based on a level payment, 20 year amortization of the $70.0 billion unfunded liability – still assuming a 7.50% rate-of-return projection – this catch-up payment should be $6.96 billion per year, rather than the $1.1 billion unfunded payment that was actually made. The study also estimates that if the CalSTRS pension fund rate-of-return projection drops to 6.20%, the unfunded liability recalculates to $107.8 billion and the catch-up payment increases to $9.6 billion per year. At a rate-of-return projection of 4.81%, the unfunded liability recalculates to $154.9 billion and the catch-up payment increases to $12.2 billion per year.

This study also estimates that the $4.7 billion normal contribution into CalSTRS for FYE 6-30-2012, based on a rate-of-return assumption of 7.50%, would have to increase to $5.5 billion based on lowering the rate-of-return assumption to 6.20%. Further, the study shows that by lowering the rate-of-return assumption from 7.50% to 4.81% would require the normal contribution to increase to $6.9 billion.

The 2nd table in the appendix, “Required rate-of-return at various levels of underfunding,” shows why underfunding is a slippery slope by illustrating how much higher rates have to be just to keep the underfunding from getting worse. Pension spokespersons have consistently stated that annual earnings in any mature fund will always greatly exceed annual contributions. On the table, the 5th column “baseline” shows how much earnings have to increase at CalSTRS current official level of 67.02% funded. At that level of funding, as can be seen, just in order for the unfunded liability to not increase, CalSTRS currently has to earn an annual return of 11.2%. At that sustained rate-of-return, the surplus earnings beyond the projected 7.50% do not reduce the unfunded liability at all, they merely prevent it from getting larger.

To recap, for the fiscal year ended 6-30-2012, here are some CalSTRS financial highlights as determined in this study:

  • Lowering the earnings projection to 6.20% increases the normal contribution by $1.1 billion per year; lowering it to 4.81% increases the normal contribution by $2.5 billion per year.
  • The unfunded “catch-up” contribution of $1.1 billion did not lower the officially recognized unfunded liability of $71.0 billion, in fact, it grew by $4.2 billion (ref. Appendix 1, baseline case).
  • If the earnings projection is lowered from 7.50% to 6.20% the unfunded liability increases from $71.0 billion to $107.8 billion; if it is lowered to 4.81% the unfunded liability increases to $154.9 billion.
  • At the official return projection of 7.50%, if the unfunded liability is paid back according to 20 year level payment amortization terms, the annual catch-up payment would have been $6.9 billion.
  • Using 20 year level payment amortization terms, at a return projection of 6.20% the annual catch-up payment should have been $9.6 billion; at 4.81%, it should have been $12.2 billion.
  • An annual return projection of 6.20% represents the long-term appreciation of equities [5], an annual return projection of 4.81% represents the Citibank pension liability index rate as of July 2013 [7].

The conclusion of this study is that CalSTRS relies on optimistic long-term earnings projections and very aggressive unfunded liability repayment schedules in order to contribute the absolute minimum each year into their pension fund. As a result, their unfunded liability increased during FYE 6-30-2012 by over $4.0 billion. If CalSTRS is required to even incrementally lower their rate-of-return projections further – something that market conditions may eventually dictate – their funded ratio which is already only 67.0% will fall precipitously. Unless extremely favorable market conditions occur for the next several years without interruption, in order for CalSTRS to remain solvent, they need to dramatically cut retirement benefits, or increase their annual contributions by 50% or more per year.

*   *   *

FOOTNOTES

(1)  CalSTRS Defined Benefit Program Actuarial Valuation as of June 30, 2012, page 32, Table 8

(2)  CalSTRS “Comprehensive Annual Financial Report, FYE 6-30-2012, page 41, “Statement of Changes in Fiduciary Net Assets.”

(3)  Milliman: Defined Benefit Program Actuarial Valuation, as of June 30, 2012, page 15, Section 4 “Actuarial Obligation, Normal Cost.”

(4)  Moody’s Adjustments to US State and Local Government Reported Pension Data, request for comment, July 2nd, 2012, page 6.

(5)  Pension Math: How California’s Retirement Spending is Squeezing The State Budget, Stanford Institute for Economic Policy Research, page 13, December 2011.

(6)  Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data,” ref. “The Adjustments,” item 1, April 2013.

(7)  Citigroup Pension Discount Curve, Society of Actuaries, July 2013

(8)  Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data, ref. “The Adjustments,” item 3, April 2013.

(9)  Moody’s Adjustments to US State and Local Government Reported Pension Data, ref. page 8, section four, part one “New discount rate applied to normal cost.”

*   *   *

APPENDIX  –  TABLE 1  –  UNFUNDED LIABILITY AMORTIZATION SCENARIOS

CalSTRS_solvency_analysis_Nov2013_appendix01a

APPENDIX  –  TABLE 2  –  REQUIRED RETURN AT VARIOUS LEVELS OF UNDERFUNDING

CalSTRS_solvency_analysis_Nov2013_appendix02a

Fixing California: The Green Gentry’s Class Warfare

Historically, progressives were seen as partisans for the people, eager to help the working and middle classes achieve upward mobility even at expense of the ultra-rich. But in California, and much of the country, progressivism has morphed into a political movement that, more often than not, effectively squelches the aspirations of the majority, in large part to serve the interests of the wealthiest.

Primarily, this modern-day program of class warfare is carried out under the banner of green politics. The environmental movement has always been primarily dominated by the wealthy, and overwhelmingly white, donors and activists. But in the past, early progressives focused on such useful things as public parks and open space that enhance the lives of the middle and working classes. Today, green politics seem to be focused primarily on making life worse for these same people.

In this sense, today’s green progressives, notes historian Fred Siegel, are most akin to late 19th century Tory radicals such as William Wordsworth, William Morris and John Ruskin, who objected to the ecological devastation of modern capitalism, and sought to preserve the glories of the British countryside. In the process, they also opposed the “leveling” effects of a market economy that sometimes allowed the less-educated, less well-bred to supplant the old aristocracies with their supposedly more enlightened tastes.

The green gentry today often refer not to sentiment but science — notably climate change — to advance their agenda. But their effect on the lower orders is much the same. Particularly damaging are steps to impose mandates for renewable energy that have made electricity prices in California among the highest in the nation and others that make building the single-family housing preferred by most Californians either impossible or, anywhere remotely close to the coast, absurdly expensive.

The gentry, of course, care little about artificially inflated housing prices in large part because they already own theirs — often the very large type they wish to curtail. But the story is less sanguine for minorities and the poor, who now must compete for space with middle-class families traditionally able to buy homes. Renters are particularly hard hit; according to one recent study, 39 percent of working households in the Los Angeles metropolitan area spend more than half their income on housing, as do 35 percent in the San Francisco metro area — well above the national rate of 24 percent.

Similarly, high energy prices may not be much of a problem for the affluent gentry most heavily concentrated along the coast, where a temperate climate reduces the need for air-conditioning. In contrast, most working- and middle-class Californians who live further inland, where summers can often be extremely hot, and often dread their monthly energy bills.

The gentry are also spared the consequences of policies that hit activities — manufacturing, logistics, agriculture, oil and gas — most directly impacted by higher energy prices. People with inherited money or Stanford degrees have not suffered much because since 2001 the state has created roughly half the number of mid-skilled jobs — those that generally require two years of training after high-school — as quickly as the national average and one-tenth as fast as similar jobs in archrival Texas.

In the past, greens and industry battled over such matters, which led often to reasonable compromises preserving our valuable natural resources while allowing for broad-based economic expansion. During good economic times, the regulatory vise tended to tighten, as people worried more about the quality of their environment and less about jobs. But when things got tough — as in the early 1990s — efforts were made to loosen up in order to produce desperately needed economic growth.

But in today’s gentry-dominated era, traditional industries are increasingly outspent and out maneuvered by the gentry and their allies. Even amid tough times in much of the state since the 2007 recession — we are still down nearly a half-million jobs — the gentry, and their allies, have been able to tighten regulations. Attempts even by Gov. Jerry Brown to reform the California Environmental Quality Act have floundered due in part to fierce gentry and green opposition.

The green gentry’s power has been enhanced by changes in the state’s legendary tech sector. Traditional tech firms — manufacturers such as Intel and Hewlett-Packard — shared common concerns about infrastructure and energy costs with other industries. But today tech manufacturing has shrunk, and much of the action in the tech world has shifted away from building things, dependent on energy, to software-dominated social media, whose primary profits increasingly stem from selling off the private information of users. Servers critical to these operations — the one potential energy drain — can easily be placed in Utah, Oregon or Washington where energy costs are far lower.

Even more critical, billionaires such as Google’s Eric Schmidt, hedge fund manager Thomas Steyer and venture firms like Kleiner Perkins have developed an economic stake in “green” energy policies. These interests have sought out cozy deals on renewable energy ventures dependent on regulations mandating their use and guaranteeing their prices.

Most of these gentry no doubt think what they are doing is noble. Few concern themselves with the impact these policies have on more traditional industries, and the large numbers of working- and middle-class people dependent on them. Like their Tory predecessors, they are blithely unconcerned about the role these policies are playing in accelerating California’s devolution into an ever more feudal society, divided between the ultra-rich and a rapidly shrinking middle class.

Ironically, the biggest losers in this shift are the very ethnic minorities who also constitute a reliable voter block for Democratic greens. Even amid the current Silicon Valley boom, incomes for local Hispanics and African-Americans, who together account for one-third of the population, have actually declined — 18 percent for blacks and 5 percent for Latinos between 2009 and 2011, prompting one local booster to admit that “Silicon Valley is two valleys. There is a valley of haves, and a valley of have-nots.”

Sadly, the opposition to these policies is very weak. The California Chamber of Commerce is a fading force and the state Republican Party has degenerated into a political rump. Business Democrats, tied to the traditional industrial and agricultural base, have become nearly extinct, as the social media oligarchs and other parts of the green gentry, along with the public employee lobby, increasingly dominate the party of the people. Some recent efforts to tighten the regulatory knot in Sacramento have been resisted, helped by the governor and assisted by the GOP, but the basic rule-making structure remains, and the government apparat remains highly committed to an ever more expansive planning regime.

Due to the rise of the green gentry, California is becoming divided between a largely white and Asian affluent coast, and a rapidly proletarianized, heavily Hispanic and African-American interior. Palo Alto and Malibu may thrive under the current green regime, and feel good about themselves in the process, but south Los Angeles, Oakland, Fresno and the Inland Empire are threatened with becoming vast favelas.

This may constitute an ideal green future — with lower emissions, population growth and family formation — for whose wealth and privilege allow them to place a bigger priority on nature than humanity. But it also means the effective end of the California dream that brought multitudes to our state, but who now may have to choose between permanent serfdom or leaving for less ideal, but more promising, pastures.

Joel Kotkin is executive editor of NewGeography.com and Distinguished Presidential Fellow in Urban Futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA. This essay was originally published in The Daily Beast and appears here with permission from the author.

California's "Open Enrollment Act" Empowers Students to Transfer Out of Underperforming Schools

Have you ever wanted to know if your child is attending a chronically underperforming school?

Well, start spreading the word: the list is out. Due to a law I wrote while serving in the California Senate, the 2010 Open Enrollment Act identifies the 1,000 chronically underperforming schools in California and empowers parents of kids enrolled in these to be able to seek enrollment in any higher performing California public school. The Act is particularly important for the hundreds of thousands of students who are trapped in chronically failing schools – yet their own school officials fail to exert turnaround efforts.

I wrote the bill because year after year I continued to see unpublicized lists of schools identified as underperforming. Yet, nothing was ever done. Even worse, parents of kids attending these schools had no knowledge of their school’s status. Unless a parent is wealthy and can send their child to a private school, most parents are forced to stay in their government assigned school – even when state officials have identified it as a chronically underperforming school.

But what happens when some schools are nothing more than dropout factories and school officials dare not restructure the contracts of the adults employed in them? Where else do we use geographic assignment – ZIP code – in vital aspects of American life?

Racial restricted housing covenants were barred long ago, freeing us to buy homes in any neighborhood. It’s unthinkable that a “local” health department official would assign your child to a “local” dentist based on your address. Have you ever driven across town to worship at the church or temple of your choice – imagine if your ZIP code was checked at the entrance? As families, we can pack up the car or get on the bus and go to any park we choose for a Sunday outing. Imagine the controversy if officials barricaded the entrance, telling you that this was not your “local” park: admission denied!

Yet in our American education system, a government bureaucrat who does not know you or your child, each school year designates your child to a school based on five digits – your ZIP code – regardless if it’s been failing for years. Even when school bureaucrats know that a school to which a student is assigned is failing, kids, and unknowing parents, keep being assigned to them. Indeed, ZIP code is the new five degrees of separation that can influence whether a child today will be one of tomorrow’s doctors or drop outs, inventors or illiterates.

The just released “Romero” Open Enrollment List for the 2014-15 school year can be viewed at 1000schools.org. The new Foundation for Parent Empowerment will work with parents to teach them about the law. The current list identifies schools from 515 school districts – some with an Academic Performance Index as low as 374 (the state targeted goal is 800). Almost every Orange County school district has schools listed. Some schools, due to formulaic pressures, should be excluded; many are “repeat offenders” necessitating radical transformation.

Romero-2HOct2013

In writing the law, I didn’t just want to “name names.” But absent a spotlight on failing schools, too many have simply been abandoned. Compilation of the list is a revealing opportunity for Californians to begin to publicly identify chronically underperforming schools and finally exert pressure to use existing state and federal laws to transform them.

Automatic assignment by ZIP code is the complete absence of parental choice. Parents now have the choice: keep waiting for change, like the fictional characters Vladimir and Estragon wait endlessly and in vain for the mythical Godot, or they can empower themselves and begin to vote with their feet and enroll their child in a school of their choice. That’s parent power – and it’s now the law.

Gloria Romero is an education reformer from Los Angeles. Romero served in the California Legislature from 1998 to 2008, the last seven years as Senate majority leader. This article originally appeared in the Orange County Register and is republished here with permission.

Bipartisan Solutions for California

When examining policy options that might help restore a financially sustainable public sector, reformers tend to focus on what may be politely referred to as austerity programs. And no effective package of reforms can ignore austerity measures; cutting government programs, cutting government staff, and cutting government employee compensation. At the same time, an essential element in such an austerity program would be new rules to change the political landscape – in particular, legislation to curb the power of public sector unions whose agenda intrinsically favors bigger government.

Focusing on austerity alone, however, not only condemns many useful government programs and virtually all government workers to an unpalatable fate, but it is insufficient to revitalize overall economic growth. Accompanying any package of austerity measures must be a package of prosperity oriented measures. These include, predictably, creating a more business-friendly regulatory environment. But they also should include public/private infrastructure projects, strict new laws designed to break up monopolies and promote competition among very large corporations, and a relaxed permitting process for land, energy and resource development. All of these prosperity measures must share a common priority – to lower the cost of living. This not only makes austerity measures affordable, but it frees up public capital to reduce debt and make smart infrastructure investments, and it frees up private capital to innovate and invest in entirely new industries.

Here, in more detail, are solutions for California that combine both austerity and prosperity:

(1) Balance State and Local Government Budgets:

(a) Lower the wages of all state and local government workers by 20% of whatever amount they make in excess of $50,000 per year. Lower the wages of all state and local government workers by 50% of whatever amount they make in excess of $100,000 per year. Include in “wages” ALL forms of compensation.

(b) Solve the financial crisis facing pensions by imposing special tax assessments on state and local government pensions in the amount of 50% of all pension payments in excess of $60,000 per year and 75% of all pension payments in excess of $100,000 per year. Adopt the same reformed  financial rules governing pension liability estimates that already apply to private sector pension plans.

(c) Require 75% of all K-12 and Community College employees to be teachers in a classroom.

(d) Faithfully implement the federal welfare reforms already adopted by most other states in 1996 during the Clinton administration.

(2) Change the Rules in Sacramento:

(a) Implement fundamental curbs on the rights of public sector unions, including:  Grant all public sector workers the right to opt-out of union membership and payment of any union dues including agency fees. Prohibit government payroll departments from collecting union dues. Allow all public sector employees to negotiate their own wages and benefits and not be bound by collective bargaining terms if they wish. Prohibit public sector unions from negotiating over long term benefits, and require all current wage and benefit agreements to expire at the end of the term for the elected officials who approved the agreements. Prohibit public sector unions from engaging in political activity of any kind.

(b) Discontinue California’s “CO2 auctions,” which are nothing more than a way to redistribute money from middle class ratepayers to bankers, crony green entrepreneurs, and public sector payroll departments. Repeal AB32. Crucially, lift the crippling burden of land use regulations that keep the prices of homes and commercial property artificially high in California.

(c) Revisit all business-friendly recommendations made by business associations such as the bipartisan California Chamber of Commerce. This would not include compromise positions in support of public sector unions and crony capitalist environmental regulations. This would include banning mandatory project labor agreements or requiring union only contractors on government funded projects.

(3) Use government surpluses to engage in public works, and streamline permitting for private infrastructure investments, that LOWER the cost of living for everyone:

(a) Rebuild California’s aqueducts and develop additional aquifer and surface storage for runoff harvesting. Build desalination plants on the southern California coast. Upgrade existing dams and pumping stations. Permit farmers to contract with California’s urban water districts to sell their water allocations. Create water abundance and make water cheap.

(b) Build new power stations. Whether this is a joint project with Nevada to establish nuclear power stations in the vicinity of Yucca Mountain, or building new natural gas fired power plants, the immediate establishment of an additional 20%+ of generating capacity in California would result in significant lowering of utility rates and make California a net exporter of electricity.

(c) Permit development of offshore oil and gas using slant drilling from land. It is no longer necessary to develop offshore drilling rigs to extract energy reserves. There are cost-effective ways to bring this energy onshore without the risk of an oil spill from an offshore platform.

(d) Permit development of natural gas and shale oil reserves in California.

(e) Permit development of new mines and quarries in California.

(f) Build additional pipeline capacity into California to import and export natural gas to and from elsewhere in North America.

(g) Permit development of a liquid natural gas terminal off the California coast. Get California onto the global LNG grid to import and export natural gas and further diversify sources of energy and income. Create energy abundance and make energy cheap.

(h) Upgrade existing roads, bridges, and freeways. Begin working on “smart lanes” that will facilitate cars and mass transit vehicles driving on autopilot.

(i) Instead of developing a bullet train – something that might be worth experimenting with once everything else on this list is done and Californians have surplus money – upgrade California’s existing freight and passenger rail infrastructure. When practical, integrate passenger and freight service on common rail corridors in large cities where high population densities make passenger rail economically viable. Increase the speed of intercity passenger rail to 100+ MPH, which can be done on upgraded but already existing track. Improve the interstate rail links emanating from the ports of Los Angeles and Long Beach, to help them remain competitive.

Implementing policies designed to lower the cost of living is a perilous undertaking. Because it involves increasing the supply of all basic commodities and services including housing, energy, water and transportation, it can lower asset values and profits in those sectors and can contribute to a deflationary economy. But by lowering the cost of living, despite how pay and benefit cuts may affect public sector workers, and despite existing downward pressure on compensation that affects private sector workers employed by corporations competing in the global economy, the overall standard of living may actually improve.

During the 21st century there are two competing models of economic growth. The path California is on involves artificially inflating the prices of all basic commodities. Staying on this path will reduce global competition, empower entrenched global elites, and consolidate the power of public sector unions, monopolistic corporations, and global bankers. Economic growth will be slower, and in terms of genuine productivity, it will be an anti-competitive age of control by the few over the many, and a sad utilization of the great technological advances we have seen in recent decades.

The alternative economic model for California is to adopt policies that dismantle monopolies, nurture competition, and encourage new development of land and resources. If costs for basic commodities are lowered instead of raised, capital is released to finance completely new industries, from robotics and space commercialization to life-extension and other fundamental advances in medicine. This will cause rapid and sustainable economic growth, unprecedented per-capita prosperity, and even faster technological advancement. Because California enjoys so many gifts – natural resources of almost unparalleled abundance and diversity, and an economy that is the technological leader in the world – the solutions described here, though painful, may ensure California survives and thrives during what are sure to be challenging years ahead.

The Next Climate Debate

In his second inaugural address, President Obama promised to “respond to the threat of climate change, knowing that the failure to do so would betray our children and future generations.” The crowd roared. “Environmentalists Hail Obama Climate Change Focus,” proclaimed an Associated Press headline.

Three weeks later, in his State of the Union address, the president highlighted his efforts to reduce U.S. carbon emissions, called for cap-and-trade legislation, and committed to taking executive action aimed at further reducing emissions. The “centerpiece” of this agenda, according to the New York Times, will be “action by the Environmental Protection Agency to clamp down further on emissions from coal-burning power plants.” But of the 35 gigatons of carbon dioxide emitted around the world this year, U.S. coal plants will account for only two. Even if the EPA were to shut down those plants instantly, global emissions would still be much higher this year than they were the year President Obama took office.

As members of the movement for unilateral nuclear disarmament did in the past, climate-change activists have clothed plainly ineffectual policies in the language of moral necessity. Disarmament was rejected across the political spectrum and never achieved credibility. But equally unserious emissions-reduction schemes have become decidedly mainstream, thanks in part to conservatives’ focus on questioning the science of climate change rather than the policy prescriptions that have been offered to address it. The time has long since passed for them to accept climate science and focus on the policy response — terrain on which they have a decisive political advantage and on which U.S. action can be steered more constructively.

The math of U.S. carbon dioxide emissions is straightforward: We are responsible for less than six of those 35 global gigatons, and our emissions are expected to remain relatively flat for the foreseeable future. Meanwhile, worldwide emissions are increasing rapidly, thanks to 10 percent annual increases in countries such as India and China, and will surpass 50 gigatons by 2050. Over the past decade, China alone has added new annual emissions equivalent to the total annual emissions in the U.S., and it will do so again in the coming years. Even the complete elimination of U.S. emissions would be quickly offset by increases elsewhere.

Furthermore, the threat of climate change is based on a “stock,” not a “flow.” Because carbon remains in the atmosphere for a long time, what matters is not the amount emitted in a given year but the total amount that has built up. Lower U.S. emissions do not ultimately reduce the threat of climate change; they simply postpone some portion of it. If the U.S. completely eliminated its emissions, reducing long-run global emissions by 10 percent, the result would not be a 10 percent reduction in climate change; rather, it would take 10 percent longer to end up with virtually the same amount of carbon in the atmosphere. What would formerly have happened in 50 years would now take 55 instead.

In the face of this reality, activists (including the ironically named “Do the Math” movement) make the same arguments that supporters of unilateral disarmament made in the past. If the U.S. shows leadership, other nations will follow. We have a moral obligation to act. Even if we can’t solve the problem, we have to do what we can. From there it is only a short and illogical stumble to the ad hominem conclusion: Anyone who does not support our approach must be too stupid to understand the problem or too rich/insensitive/reckless to care about it.

Unfortunately, U.S. “leadership” is of little value when other nations have strong incentives to pursue a different course. The developing world has billions of people to lift out of a poverty whose depth we can barely imagine; if ameliorating poverty through economic growth creates a risk of catastrophic climate change, that is a risk they will take. And if we choose to drive up our own energy costs in order to cut our emissions, they will gladly take our manufacturing jobs, too.

As with an American decision to unilaterally disarm, unilateral reductions in U.S. emissions would sacrifice our best bargaining chip in exchange for nothing. A reduced or eliminated U.S. nuclear arsenal might well have triggered greater proliferation around the world and increased the likelihood of conflict with the Soviet Union. Likewise, U.S. emissions cuts achieved by increasing U.S. energy costs will likely drive energy-intensive industrial activity and the associated emissions to less energy-efficient economies.

Still, somehow, this obsession with reducing U.S. carbon emissions is at the heart of the environmental movement and the top of the self-congratulatory liberal agenda. Solemn pronouncements on the issue guarantee fawning media coverage and are the height of fashion on college campuses.

The president has touted a range of ineffectual policies whose impact on U.S. emissions would be so small as almost to defy measurement. His Corporate Average Fuel Economy (CAFE) standards for the auto industry mandate a doubling of average fuel efficiency by 2025. The resulting total reduction in carbon emissions, according to the government’s own analysis, will be 4.7 gigatons. Not annual; total. The atmospheric carbon concentrations anticipated for January 2040 will be postponed until . . . February 2040.

Other measures will achieve even less. The Utility MACT, an EPA regulation aimed at shutting down old coal-burning power plants, is projected to reduce emissions by 0.015 gigatons per year — less than three one-thousandths of total U.S. emissions. An EPA regulation aimed at preventing the construction of new coal plants is expected to reduce emissions by exactly zero.

And then there are the president’s ongoing efforts to block the proposed Keystone XL pipeline. Environmental activists oppose the pipeline because it would bring oil from Canadian sands to the U.S. market, and this oil would result in slightly higher carbon emissions than oil from other sources. In August 2011, after more than three years of study, the State Department concluded that the project would have no influence on global carbon emissions because Canada will develop the oil sands regardless of whether the pipeline is built. The report also looked specifically at U.S. emissions and concluded that use of oil from the Canadian sands would increase annual carbon emissions in the U.S. by 0.003 to 0.021 gigatons as a result of the higher-carbon Canadian oil’s supplanting oil imported from other nations.

Despite the report’s finding that the pipeline would have virtually no climate impact, thousands of protesters encircled the White House to oppose its construction, and President Obama postponed its approval. A final decision has subsequently been postponed, and postponed again. In late January, the State Department announced that it would miss yet another deadline and would reach a decision in April at the earliest. In February, thousands of protesters gathered again in Washington, D.C. Sometime soon, carbon emissions from the protests may actually exceed those that would result from construction of the pipeline.

In defense of an incrementalist approach to reducing emissions, the administration has attempted to put a value on the prevention of a ton of carbon emissions. Perhaps reductions in U.S. emissions will not solve the global problem, the argument goes, but surely they will have some benefit. However, valuing carbon ton by ton makes as little sense as valuing nuclear stockpiles warhead by warhead because, in each case, the dangers are extremely non-linear. In theory, every reduction in the world’s stockpile of nuclear weapons would offer some mitigation of risk. In practice, no one much cares about the damage done by the 400th weapon launched, let alone the 4,000th. So it is with climate change. Every reduction in U.S. emissions does technically mean less carbon dioxide pumped into the atmosphere. But no plausible U.S. action changes the overall trajectory of emissions and warming or the nature of the potential impact. This is doubly true given the stock-not-flow dynamic at work. Activists who in one breath promise the collapse of civilization absent dramatic worldwide emissions reductions insist in the next that minor actions will make an important difference. Both claims cannot be true.

Unfortunately, economists take this approach to carbon emissions very seriously. They argue that the damage from carbon emissions represents a “negative externality” and that efficient policy would therefore put a “price” on it, ideally through a carbon tax or at least a cap-and-trade system. While this makes perfect sense on a chalk-drawn supply-and-demand chart, it breaks down upon contact with the real world. As with unilateral regulatory efforts, reducing emissions by charging a higher price for each gallon of gas or kilowatt-hour of coal-generated electricity here in the United States makes no significant dent in the trajectory of the atmospheric carbon concentration. If emissions are still rising, and the threat remains as large as ever, there is no “efficiency” to be gained by imposing a higher price on them. Individual Americans get taxed, but society sees no benefit.

There is one legitimate rationale for unilateral U.S. action on climate change: innovation. The U.S. cannot force the rest of the world to reduce its carbon emissions, but if it develops breakthrough technologies that are more economically attractive than conventional fossil fuels, the rest of the world will presumably adopt them by choice. Here the disarmament analogy breaks down, and unilateral action has value.

But the debate has too often conflated the objectives of technological innovation with those of emissions reductions, treating them as somehow interchangeable or additive when they are not. CAFE standards offer a helpful illustration. The fuel-economy requirements they establish, while aggressive relative to the current performance of automobiles in the U.S., are not much higher than standards in Europe and Japan today. In other words, the standards are not actually aimed at developing new technology at all; they are aimed at imposing a particular (expensive) lifestyle on American consumers that is already available to those who want it. Other policies commonly characterized as promoting a “clean-energy future” turn out upon careful scrutiny to have similarly tenuous links to promoting innovation. Blocking the Keystone pipeline, for instance, does nothing but redirect U.S. consumption to other sources of oil.

How then should we evaluate the carbon tax as a method for spurring innovation in alternative-energy industries? Once the goal of correcting for a negative externality and reducing consumption is stripped away, the “value” of a reduced ton of emissions no longer offers a guide for setting the price. The tax would presumably have to be massive. After decades of huge subsidies to the wind and solar industries for the purpose of producing economically viable alternatives to fossil fuels, even the industries themselves insist that the subsidies remain necessary. If a subsidy worth half the wholesale price of electricity has not succeeded in making the industry competitive, how high would a tax have to be to create a sufficient market distortion?

Any such tax would be extraordinarily regressive, with higher energy prices disproportionately affecting lower-income families and blue-collar professions. It would send a signal to heavy industry to locate elsewhere. And as politicians attempted to remedy these flaws through increasingly complicated regulatory and redistributive schemes, the supposedly “efficient” and “market-based” approach would quickly become a big-government labyrinth of new agencies, rules, and handouts. If a tax on carbon is truly the best way to promote innovation, its proponents have a long way to go in making the case.

President Obama has not even attempted to make it, and has instead ignored the goal of technological innovation in favor of a purely economic claim that his climate-change policies will produce the “green jobs” of the future. In congressional testimony supporting the Waxman-Markey cap-and-trade legislation, for instance, EPA administrator Lisa Jackson acknowledged that “U.S. action alone will not impact world CO2 levels” but then asserted that the proposal was “a jobs bill.” Perhaps a massive, economy-wide regulatory scheme designed to drive up energy prices is the right way to create jobs, perhaps not; an intriguing debate, to be sure. Regardless, claims about tackling climate change had mysteriously vanished from the conversation.

Chastising the president for this bait-and-switch, the editors of MIT Technology Review rejected his administration’s line of reasoning and asserted that “we must [adopt non-fossil fuels] to reduce carbon dioxide emissions and begin stabilizing our climate. It’s time to acknowledge that green jobs were always just political cover for that motive.” Except that reducing U.S. emissions will not even begin to stabilize the climate. And around and around the policy rationales go.

Unilateral nuclear disarmament never gained traction. Even radical student groups hesitated to call for much beyond preliminary steps. Britain’s Labour party did incorporate unilateral disarmament (for Britain) into its platform during the 1980s, but abandoned it after the party’s leadership concluded that the position was blocking its path to power. In U.S. politics, unilateral disarmament was so clearly out of the mainstream that George McGovern took pains to explicitly disavow the position in announcing his run for the presidency in 1984. During their 1980 debate, Ronald Reagan criticized President Carter for making unilateral concessions in negotiations with the Soviets. Carter’s response, citing his 13-year-old daughter, Amy, and addressing the issue in moralizing terms that ignored the actual policy options, is considered one of the worst answers in the history of presidential debates. Americans had no difficulty understanding both that nuclear weapons were a grave threat and that unilateral U.S. efforts to eliminate that threat would be fruitless.

Yet equally flimsy arguments for emissions reductions have become mainstream because they stand unopposed. Conservatives have allowed the debate to be framed as a binary choice between “climate activism” and “climate skepticism,” and they have associated themselves with the latter — a position that becomes less and less tenable as more and more scientific evidence accumulates. This has been a serious mistake.

In fact, the climate debate encompasses a broad range of questions. On some of these the science has produced a consensus deserving of respect, on some the science continues to evolve, and on some the science has little to offer. Starting at the start: Is the atmospheric carbon concentration increasing? Everyone seems to agree that it is. Is there a “greenhouse effect” through which increased carbon concentrations lead to a warmer climate? Here, too, there is an overwhelming consensus that the answer is yes. That is the view of, among others, the American Meteorological Society, the American Physical Society, the American Geophysical Union, the American Association for the Advancement of Science, and the National Academy of Sciences.

While there is always the possibility that a scientific consensus will turn out to be wrong, on no issue besides climate change do conservatives allow a lack of absolute certainty to stand in the way of making the best decisions possible in response to the risks as they are currently understood. Unless the scientific community is perpetrating an unprecedented hoax, the existence of such a widespread consensus indicates at least a significant likelihood of a real danger, which presents policymakers with an actual risk deserving of serious consideration.

Accepting the science does not, however, require one to accept the liberal policy prescriptions. Science is only an input to any policy discussion, and nowhere is this truer than in the case of climate change, where the scientific consensus resolves remarkably little. More carbon in the atmosphere leads to warming, but how much warming? Scientists speak in terms of “climate sensitivity” — how sensitive is the climate to some increase in carbon dioxide? Here there is very little agreement. For instance, the models run by the U.N.’s Intergovernmental Panel on Climate Change (IPCC) in its landmark 2007 report produced ranges of predicted future warming whose high estimates were nearly three times their low estimates. The best case showed warming by 2100 of anywhere from 1.1°C to 2.9°C. The worst case showed a range from 2.4°C to 6.4°C. More recent research suggests that climate sensitivity is likely toward the lower end of previously estimated ranges.

A further question is, For a given level of warming, what damage will result? How much will the sea level rise? How much will weather patterns shift? If storms become both stronger and less frequent, what will the net impact be? Again, the projections vary widely.

Only after the full range of scientific predictions is taken into account does the policy discussion even begin. The world in 2100 will have a level of wealth and technology that we can predict no better than the drivers of the first Model Ts could predict the world of today. How capable of adaptation will such a world be, and how much should we spend today to reduce damage then? Finally, for each specific proposal, what are the actual costs and anticipated benefits?

These are the questions on which conservatives should focus. And it is on this playing field, not in a fight over the basis of the science, that they will prevail. Of course, where dangers are exaggerated or distorted in pursuit of a political agenda those excesses must be confronted. But ultimately, the Left’s policy ideas for unilaterally reducing U.S. carbon emissions are not bad ones because there is no potential threat; they are bad ones because they are unresponsive to the potential threat. By accepting the credibility and good faith of the underlying science, conservatives can ask of every policy proponent: Have you run your idea through the climate models, and are any risks averted or materially reduced? The answer to the latter question in every case will be no.

Reagan did not question whether Soviet nuclear weapons were capable of causing explosions. To the contrary, he declared in his second inaugural address that “we seek the total elimination one day of nuclear weapons from the face of the earth.” And then he eviscerated those who wished to leap from that goal to absurd and self-defeating policy responses.

The difficulty of precisely quantifying the climate-change threat does not offer an excuse for doing nothing. Indeed, the risks of climate change look in many ways like those of nuclear proliferation: a likelihood of significant damage somewhere in the world with fallout that might make some regions unlivable, a fear of potential devastation to an American city, and even some possibility of civilizational disaster. Regardless of how probable any of these scenarios is, the elimination of each risk should at least in principle be a goal.

But in each case we should dispassionately consider what can and cannot be achieved, add up the potential costs and benefits, and chart a pragmatic course forward. This means unreservedly acknowledging the threat and the challenge, while aggressively rejecting self-righteous preening and opposing the pretextual pursuit of ineffectual policies that oh-so-conveniently align with liberal priorities. It also means offering a substantive agenda focused on supporting research and innovation, the only tools with the potential to solve the problem.

Funding for basic and applied research in energy technologies should be the top priority. Government has shown that it can effectively address a real market failure at the pre-commercial stage. Some mechanism for subsidization should be up for discussion. There is value in supporting promising alternatives to fossil fuels at the cusp of commercialization. An ideal subsidy would be technology-neutral (i.e., available to any approach that met broadly defined criteria), tied to production rather than investment, and time-limited. Climate research should also be generously funded, not mocked, so that the many uncertainties become less uncertain over time. Adaptation measures should be developed and tested. And we should investigate various geoengineering strategies instead of reflexively shunning them.

Nuclear power should be part of every conversation. The technology that environmentalists have for decades opposed more aggressively than any other is, ironically, the only one that has displayed any potential to produce carbon-free energy at the price and scale we need. A permanent waste repository should be established. Immediate reforms to the Nuclear Regulatory Commission should aim to accelerate the nuclear-permitting process and encourage new approaches to plant design. Broader regulatory reform should aim to ensure that technologies of all kinds can reach the market as smoothly as possible.

Finally, we should take a new approach to international engagement. Global climate conferences that emphasize posturing over action have earned the scorn they receive. Hard-headed, bilateral discussion between the U.S. and China, by contrast, would at least establish clear markers for where the sides stand and why. It might even identify areas for mutually beneficial cooperation, starting with technology, as U.S.-Soviet negotiations on arms control did once upon a time. Instead of today’s strategy of giving away every bargaining chip we can think of, we should exploit every leverage point we might have.

This agenda offers no guarantee of success. But the question is whether it has greater potential to spur breakthrough innovation and eventually achieve global emissions reductions than the Left’s potpourri of taxes, regulations, subsidies, handouts, conferences, and protests. It is a question conservatives should welcome.

Oren Cass was the domestic-policy director of Mitt Romney’s presidential campaign. This was originally published in the National Review in March 2013 and is republished here with permission from the author.

Unreformed Welfare: California's Armegeddon

Welfare in America is a classic example of government failure. The combined federal, state and county welfare programs have had enormous destructive economic, social and moral consequences. In the absence of significant change, the Heritage Foundation projects their cost at $10.6 Trillion over the next decade. [1]

The initial beneficiaries of government aid were widows and orphans who had been left without means of support after the war. The annual cost for the program was about $1 Billion. [1] The War on Poverty Act of 1964 widened the net considerably. Welfare applications exploded as did illegitimate births. Marriage rates plummeted. By 1970 the cost had risen to $27 Billion.1,2 Four years after the 1986 amnesty and reunification legislation, the cost had ballooned to $170 Billion. [1]  By 2000, it was $228 Billion. [1]

A decade later, it was $994 Billion. [1] By 2012, it exceeded $1.3 Trillion. [1], [2] According to Heritage, the total cost for Medicaid and welfare amount to 70% of the federal budget. [2] The study warns, in the absence of cuts, welfare and interest on our national debt will consume 92 cents of every dollar of revenue by the end of the next decade.

In 1996 Congress proposed a series of welfare reform measures to stem the financial juggernaut. The bill signed by President Clinton imposed a 5-year lifetime benefit limit as well as a work requirement to receive aid. Caseloads in many states were halved within four years except in California which had resisted enforcing the federal requirement. [3]

Federal and state politicians have gradually expanded the welfare net and the costs.3 Excluding Social Security and Medicare recipients, over 100 million Americans currently receive monthly government support. [2], [4]

Instead of temporary assistance, as Temporary Aid Needy Families deceptively suggests, welfare has become a way of life for almost half the country’s population. Illegal immigration has had significant effects on these costs. Traditionally immigrants were ineligible for welfare benefits. The 1986 amnesty and reconciliation included eligibility for benefits.

The Center for Immigration found 43% of all immigrants in the United States for at least 20 years were still receiving welfare benefits. [5] In California, 70% of illegal immigrants and their families are enrolled in at least one federal and state welfare programs. [2], [5] The total in cash and benefits a welfare recipient in California receives from the 80+ federal and state programs is equivalent to a $17.87 per hour job. [6]

Welfare is linked to illegitimacy, poverty, addiction and crime. It is a disincentive to education, work and marriage. Welfare has turned tradition, morality and civilized society on their head. Welfare is the proverbial free lunch St. Paul abjured.

In 1996 the government was forced to reform welfare. The measure included a five-year lifetime limit and a work requirement. California resisted the federal guidelines for lifetime caps in aid. The state passed its own reforms in 1997 which included time limits and work requirement but never implemented them. [3]

In California today, if a parent exceeds the five-year federal limit, child-only benefits under the Safety Net Program allow the children to receive welfare until age 18. [3], [4], [5] Despite the federal work requirement, only 22% of California’s welfare recipients have jobs. [3], [5]

Politics and demographics are the major reasons for the continuing resistance. California has for many years been a single-party Democrat-controlled state with a population of legal and undocumented immigrants that is among the highest in the country. To-date, the overwhelming majority of immigrant voters support Democratic candidates.

A substantial percentage of undocumented immigrants are women with native-born children. 70% of these families receive welfare. [5]  Mike Antonovich, longtime Los Angeles County Supervisor, recently announced that welfare payments in 2013 for LA County’s 100,000 children of 60,000 illegal parents will exceed $1.6 Billion. He noted this did not include the hundreds of millions spent annually for education. [7]

The changes to the current welfare system proposed by Governor Brown include reducing the time limits to two years. [4] Without eliminating the child-only program, this will have only minimal effects on the 550,000+ cases and 1 million children receiving monthly CalWorks benefits. [8] Moreover, as previously noted, similar rules were imposed in 1997 but never implemented. [3]

California has a long list of costly, overlapping programs that provide benefits to individuals with incomes of 200% above the poverty line. [9] Nash Keune labels California “America’s Welfare Queen.” [4] The state has 12% of the population but 33% of the nation’s welfare recipients. The financial burden to fund these programs falls on the middle class which is now taxed at a higher rate than millionaires in 47 other states. [10] Not unsurprisingly, 4 million middle-class families and business owners have fled the state for Texas, Nevada, Florida and Tennessee. This has left a huge vacuum in the state’s tax base.

Without substantive reform, there can be no significant change in the social or fiscal calculus. Benefits for undocumented immigrant parents and their children must be reexamined. Time limits for temporary aid must be shortened and enforced. So must work requirements. Out of wedlock childbirth must not be rewarded and subsidized. Is it possible to compel individuals who have become inured to having someone else support them to support themselves? Ask your parents and grandparents. The following chart produced by the Pennsylvania Dept. of Public Welfare illustrates the degree to which the welfare state has come to dominate the U.S. economy:

Friend-Welfare-2HOct13

Child rearing offers a heuristic model for welfare reform. Parents impose external limits to promote self-discipline in their children. Homework and chores instill a work ethic and personal responsibility. These traits are the hallmark of adulthood. Welfare aborts this normal process. It obviates the need to grow up and become independent. It fosters permanent babyhood. Welfare has nurtured a dependent class of individuals who have been sustained by an overly indulgent and tolerant citizenry.

There is, of course, an alternative. Parents encourage and reward good behavior as much as they discourage and punish its opposite by using limits and punishment. Children fight discipline and rules, the means used to guide them into adulthood. Most youngsters learn the wisdom of obeying the rules. They behave and follow in the footsteps of their parents. Most move out before their 21st birthday to make their own way in life.

Young children size up the rule makers and instinctively know how to game them. Unfortunately welfare recipients have the same incentives to game the system. The public has accepted millions of capable unmarried twenty- or thirty-year old daughters with two or three young children refusing to move out for ten, fifteen or twenty years. In addition, they expect to be housed, fed, clothed, educated without having to pay for anything.

This is the new family portrait of the United States of Welfare. It is the height of insanity to tolerate, much less to extol the virtue of a system that has proven itself to be morally and fiscally bankrupt. Welfare has brought out the worst, not the best in its beneficiaries. The system was designed by politicians for their own self-interest, not public benefit.

Millions of mothers birthed earlier generations of Americans in conditions we would consider poverty, yet they nurtured and raised their young to become productive, successful adults without any government support. It is the mother’s love, hard work and sacrifice that constitute a healthy internal model for moral virtue in life. Welfare has corrupted this process and generations of mothers and millions of their offspring as well. A glance at Chicago, Detroit, Philadelphia, New York or Los Angeles is all it takes if proof is needed.

Thoughtful recommendations to reform welfare include limiting low-skill immigration, restore the work requirement for Temporary Aid to Needy Families and apply them to all federal welfare programs, reduce welfare spending to pre-recession levels, then limit future growth to the rate of inflation, provide a portion of welfare assistance as loans rather than grants, end the marriage penalty and encourage marriage in low-income neighborhoods.  These ideas should be carefully studied and debated. Meanwhile, if California were to merely emulate the other 49 states to faithfully implement the bipartisan federal reforms passed in 1996, it would go a long way towards restoring sense and sustainability to California’s welfare policies.

R. Claire Friend, MD, is a retired psychiatrist and frequent commentator on the psychological dimensions of education and social welfare policies.

Footnotes:

1. http://www.heritage.org/research/reports/2010/06/confronting-the-unsustainable-growth-of-welfare-entitlements-principles-of-reform-and-the-next-steps

2. http://www.heritage.org/research/reports/2012/02/2012-index-of-dependence-on-government

3. http://www.caltax.org/member/digest/feb2001/feb01-6.htm

4.

5. http://www.cis.org/immigrant-welfare-use-2011

6. http://dailycaller.com/2013/08/20/study-welfare-pays-more-than-work-in-most-states

7. http://losangeles.cbslocal.com/2013/09/16/undocumented-la-county-parents-projected-to-receive-650m-in-welfare-benefits/

8. http://www.ppic.org/main/publication_show.asp?i=888

9. http://en.wikipedia.org/wiki/Welfare_in California

10. http://online.wsj.com/news/articles/SB10001424052702304444604577340531861056966

Unaffordable California – It Doesn't Have To Be This Way

Here’s a documented comparison of California taxes and economic climate with the rest of the states. The news is bad, and getting worse. But the state and local government policies that created an unaffordable California can be reversed:

PERSONAL INCOME TAX:  Prior to Prop 30 passing in Nov. 2012, CA already had the 3rd worst state income tax rate in the nation. Our 9.3% tax bracket started at $48,942 for people filing as individuals. 10.3% started at $1 million. Now our retroactive (to 1/1/2012) “millionaires’ tax” rate is 13.3% – including capital gains (CA total CG rate now the 2nd highest in the world!). 10+% taxes now start at $250K. CA now has by far the nation’s highest state income tax rate. We are 21% higher than 2nd place Hawaii, 34% higher than Oregon, 47.8% higher than the next 2 states, and a heck of a lot higher than all the rest – including 7 states with zero state income tax. CA is so bad, we also have the 2nd highest state income tax bracket. AND the 3rd. Plus the 5th and 7th.
http://taxfoundation.org/sites/taxfoundation.org/files/docs/ff2013.pdf, Table #12

http://tinyurl.com/CA-2nd-CG

SALES TAX: CA has the highest state sales tax rate in the nation. 7.5% (does not include local sales taxes).
http://taxfoundation.org/article/state-and-local-sales-tax-rates-january-1-2012

GAS TAX:  CA has the nation’s highest gas tax at 71.9 cents/gallon (July, 2013). National average is 49.5 cents.
http://www.api.org/statistics/fueltaxes/
(CA also has the nation’s 3rd highest diesel tax – 77.0 cents/gallon. National average 54.8 cents)

PROPERTY TAX:  California in 2009 ranked 15th highest in per capita property taxes (including commercial) – the only major tax where we are not in the worst ten states. But CA property taxes per owner-occupied home were the 10th highest in the nation in 2009.
http://www.taxfoundation.org/taxdata/show/251.html
http://www.taxfoundation.org/taxdata/show/1913.html (2009 latest year available)

“IMPACT FEES” ON HOME SALES:  Average 2012 CA impact fee for single-family residence was $31,100, 90% higher than next worst state. 265% higher than jurisdictions that levy such fees (many governments east of the Sierras do not). For apartments, fee averaged $18,800, 290% above average outside state. The fee is part of the purchase price, so buyer pays an annual property tax on the fee!
http://www.newgeography.com/content/003882-california-homes-require-real-reach

“CAP AND TRADE” TAX:  CA has now instituted the highest “cap and trade” tax in the nation – indeed, the ONLY such U.S. tax. One study estimates the annual cost at $3,857 per household by 2020. Even proponents concede that it will have zero impact on global warming.
http://tinyurl.com/WSJ-CA-cap-and-trade

SMALL BUSINESS TAX:  California has a nasty anti-small business $800 minimum corporate income tax, even if no profit is earned, and even for many nonprofits. Next highest state is Oregon at $150. A few others under $100, with most at zero.
http://tinyurl.com/CA-800-tax

California small businesses failed in 2011 at a rate 69% higher than the national average — the worst state in the nation.
http://money.cnn.com/2011/05/19/smallbusiness/small_business_state_failure_rates/index.htm (based on Dunn & Bradstreet study)

CORPORATE INCOME TAX:  CA corporate income tax rate (8.84%) is the highest west of the Mississippi (our economic competitors) except for Alaska.
http://taxfoundation.org/article/2013-state-business-tax-climate-index
Table #1 – we are 5th highest in nation in per capita collections.

BUSINESS TAX CLIMATE:  California’s 2013 “business tax climate” ranks 3rd worst in the nation – behind New Jersey and anchor-clanker New York state.
http://taxfoundation.org/article/2014-state-business-tax-climate-index

LEGAL ENVIRONMENT:  The American Tort Reform Association now ranks CA the “worst judicial hellhole” in U.S. – extremely anti-business. But the U.S. Chamber of Commerce ranks CA higher – “only” the 4th worst state (unfortunately, sliding from 7th worst in 2008).
http://tinyurl.com/CA-worst-judicial-hellhole
http://www.instituteforlegalreform.com/states/california

FINES AND FEES:  CA tickets are incredibly high. Red-light camera ticket $490. Next highest state is $250. Most are around $100.
http://reason.org/blog/show/red-light-cameras-and-the-enigmatic

CA needlessly licenses more occupations than any state – 177. Second worst state is Connecticut at 155. The average for the states is 92.
http://cssrc.us/publications.aspx?id=7707

CA has the 3rd highest state workers compensation rates, up from 5th in 2010. CA has a 3.4% rate increase scheduled for 2013.
http://www.cbs.state.or.us/external/dir/wc_cost/files/report_summary.pdf
http://tinyurl.com/2013-CA-rate-increase

OVERALL TAXES:  Tax Foundation study ranks CA as the 4th worst taxed state. But if counting ONLY in-state and local taxes, we are arguably the 2nd highest.
http://taxfoundation.org/article/annual-state-local-tax-burden-ranking-2010-new-york-citizens-pay-most-alaska-least

UNEMPLOYMENT:  CA has the 5th worst state unemployment rate (August, 2013) – 8.9%. National unemployment rate 7.3%. National unemployment rate not including CA is 7.1%, making the CA unemployment rate 25.7% higher than the average of the other 49 states (one of the better performances we’ve managed in several years). http://www.bls.gov/web/laus/laumstrk.htm

Using the 2nd quarter 2013 U-6 measure of unemployment (includes involuntary part-time workers), CA is the 2nd worst at 18.3% vs. national 14.3%. National U-6 not including CA is 13.8%, making CA’s U-6 33.0% higher than the avg. of the other 49 states.
http://www.bls.gov/lau/stalt.htm

EDUCATION:  CA public school teachers the 4th highest paid in the nation. CA students rank 48th in math achievement, 49th in reading.
http://www.lao.ca.gov/reports/2011/calfacts/calfacts_010511.aspx, page 36
http://www.cde.ca.gov/fg/fr/sa/cefavgsalaries.asp

California, a destitute state, still gives away community college education at fire sale prices. Our CC tuition is the lowest in the nation. How low? Nationwide, the average community college tuition is more than double our California CC’s.
http://trends.collegeboard.org/college-pricing/figures-tables/state-tuition-and-fees-state-and-sector-2012-13-and-5-year-percentage-change

This ridiculously low tuition devalues education to students – often resulting in a 25+% drop rate for class completion. In addition, up to 2/3 of California CC students pay no net tuition at all!
http://tinyurl.com/ygqz9ls

Complaints about increased UC student fees too often ignore one crucial point — all poor and many middle class students don’t pay the “fees” (our state’s euphemism for tuition). There are no fees for most California families with under $80K income.
http://www.universityofcalifornia.edu/blueandgold/

WELFARE AND POVERTY:  1 in 5 in Los Angeles County receiving public aid.
http://www.latimes.com/news/local/la-me-welfare22-2009feb22,0,4377048.story

California’s real poverty rate (the new census bureau standard) is by far the worst in the nation at 23.5%. We are 55.7% higher than the average for the other 49 states. The CA poverty rate is 19% higher than 2nd place Florida.
http://www.huffingtonpost.com/2012/11/14/california-poverty_n_2132920.html

California has 12% of the nation’s population, but 33% of the country’s TANF (“Temporary” Assistance for Needy Families) welfare recipients – more than the next 7 states combined. Unlike other states, this “temporary” assistance becomes much more permanent in CA.
http://www.utsandiego.com/news/2012/jul/28/welfare-capital-of-the-us/?print&page=all

California ranks 48th worst for credit card debt and 49th worst for percentage of home ownership.
http://riderrants.blogspot.com/2013/02/more-dismal-california-economic-rankings.html

GOVERNMENT INSOLVENCY:  California now has the 2nd lowest bond rating of any state – Basket case Illinois recently beat us out for the lowest spot. We didn’t improve our rating – Illinois just got worse.
http://www.calwhine.com/great-news-california-no-longer-has-worst-credit-rating/1554/

California prison guards highest paid in the nation.
http://www.caltax.org/caltaxletter/2008/101708_fraud1.htm

HOUSING COSTS:  Of 100 U.S. real estate markets, CA contains by far the least affordable middle class housing market (San Francisco). PLUS the 2nd, 3rd, 5th, 6th and 7th. San Diego is #5 (w/homes avg. 1,056 sq. ft.)
http://riderrants.blogspot.com/2013/10/the-us-least-affordable-housing-market

TRANSPORTATION COSTS:  CA has 2nd highest annual cost for owning a car – $3,966. $765 higher than the national average.
http://tinyurl.com/lmxnucs

WATER & ELECTRICITY COSTS:  California residential electricity costs an average of 39.6% more per kWh than the national average. CA commercial rates are 58.3% higher. For industrial use, CA electricity is 71.8% higher than the national average (June, 2013). NOTE: SDG&E is even higher than the CA average! http://www.eia.gov/electricity/monthly/epm_table_grapher.cfm?t=epmt_5_06_a

A 2011 survey of home water bills for the 20 largest U.S. cities found that for 200 gallons a day usage, San Diego was the highest cost. At 400 gal/day, San Diego was third highest.
http://www.circleofblue.org/waternews/wp-content/uploads/2011/05/allstats590.jpg

BUSINESS FLIGHT:  In 2012, our supply of California businesses shrunk 5.2%. In ONE year. NOTE: That’s a NET figure – 5.2% fewer businesses in CA in 2012 than were here in 2011. Indeed, in 2012, CA lost businesses at a 67.7% higher rate than the 2nd worst state!
http://riderrants.blogspot.com/2013/07/in-2012-ca-lost-businesses-at-677.html

736 top U.S. CEO’s surveyed rank California “the worst state in which to do business” for the 9th straight year (May, 2013).
http://chiefexecutive.net/best-worst-states-for-business-2013

From 2007 through 2010, 10,763 industrial facilities were built or expanded across the country — but only 176 of those were in CA. So with roughly 12% of the nation’s population, CA got 1.6% of the built or expanded industrial facilities.
http://podcasts.odiogo.com/city-journal/podcasts-xml.php (California Manufacturers and Technology Association podcast)

OUT-MIGRATION:  California is now ranked as the 2nd worst state to retire in. Only basket-case Illinois is worse. We “beat” NY, RI and NJ.
http://www.topretirements.com/blog/great-towns/our-worst-states-to-retire-list.html/

Consider California’s net domestic migration (migration between states). From 2000 through 2009, California lost a NET 1.5 million people. Net departures slowed in 2008 only because people couldn’t sell their homes. But more people still leave each year – in 2011 we lost about 100,000 net people to domestic out-migration. Again, note that this is NET loss.
http://www.newgeography.com/content/002585-new-census-data-reaffirms-dominance-south
http://tinyurl.com/2011-CA-migration

They are primarily the young, the educated, the productive, the ambitious, the wealthy – and retirees seeking to make their nest-eggs provide more bang for the buck.

Richard Rider is the chairman of San Diego Tax Fighters, a grassroots pro-taxpayer group. Rider successfully sued the county of San Diego (Rider vs. County of San Diego) to force a rollback of an illegal 1/2-cent jails sales tax, a precedent that saved California taxpayers over 14 billion dollars, including $3.5 billion for San Diego taxpayers. He has written ballot arguments against dozens of county and state tax increase initiatives and in 2009 was named the Howard Jarvis Taxpayers Association’s “California Tax Fighter of the Year.” Rider updates this compilation of statistics on California every month.

Announcing the Prosperity Forum

One of the overwhelming challenges facing fiscal conservatives is how to cut government spending without harming economic recovery. It may seem obvious that governments eventually have to stop relying on borrowing to finance their deficits, but eliminating government spending deficits can only partly rely on spending cuts. Economic growth is the other essential element.

To explore and catalog worthy prescriptions for economic growth, the California Policy Center has launched a new project, the California Prosperity Forum. We seek informed and constructive policy ideas and analysis from any source, guided by our core belief that prosperity and opportunity will return to California through a combination of common sense reforms in Sacramento, greater freedom for the private sector, and innovation in our public schools.

Opponents of austerity are not only concerned about the potentially negative impact of reduced government spending on the economy, but also the ability of individual government workers or beneficiaries of government entitlements to pay their bills. This concern is particularly acute in California, which has the highest overall cost of living in the United States. But the way to address this concern is not to abandon a measured reduction in excessive pay and benefits for government workers, but to simultaneously enact policies designed to lower the cost of living for all Californians.

To this end, another core belief that must inform any prosperity oriented policy forum is competition. To accelerate innovation and lower prices requires competition between businesses in a free market. California’s Silicon Valley coined the phrase “better, faster, cheaper,” to describe spectacular advances in information technology. But that phrase applies to innovation throughout history, describing how lowering the cost of living has continuously raised the standard of living for humanity.

Lowering the cost of living in California through competition requires dramatic shifts in policy priorities. For example, lowering the cost of energy requires responsible development of California’s massive shale oil and shale gas reserves. Lowering the cost of housing requires easing California’s draconian restrictions on land development. And lowering California’s overall cost of living also requires California to step back from having the highest tax rates of any state in the U.S. And to propel these reforms through California’s state and local governments will mean taking on powerful monopolies who benefit from high prices and minimal competition.

The theme of fostering competition to rejuvenate California’s economy applies to commerce, but applies equally to education. California’s former Senate Majority Leader Gloria Romero has called the inadequate performance of public schools the civil rights issue of our time. Educational outcomes have been consistently found to improve when students and their parents have alternatives. When students can opt-out of attending a failed school, this not only immediately benefits those students, but impels the failed school to try new solutions and make tough decisions to improve. Needless to say, improved education translates into a more employable workforce.

Critics of free-market policies often point to the Wall Street meltdown of 2008 and the growing wealth of the so-called “one-percent” as an indictment of free market capitalism. But they are mingling together what are two very distinct versions of capitalism. Productive capitalism, the ecosystem of corporations, entrepreneurs, investors and inventors who compete and collaborate to create affordable products and services that improve our lives, is the engine that has produced virtually all of the material amenities we enjoy today and take for granted. Speculative capitalism – for want of a better term – is a globalized casino of high-frequency trading and market manipulation that produces nothing. In its currently grossly overbuilt iteration, speculative capitalism is an economic parasite. It may be comforting to equate productive capitalism with speculative capitalism, but they are vastly different.

Successfully advancing a prosperity policy agenda requires championing productive capitalist efforts. It requires unlocking California’s vast reserves of energy and land, rescuing our public schools, and restoring California as a business-friendly state. But a prosperity policy agenda also requires opposing the monopolistic financial interests who make billions issuing bonds to finance state and local government deficits. It requires opposing the financial interests who make billions in commissions and management fees to collect and invest unsustainable public sector pension funds.

Austerity should appeal to any fiscally responsible citizen as tough, necessary medicine. But prosperity is the other side of the coin. It deserves equal if not greater attention from anyone determined to see California recover its historic reputation as a land of great opportunity and promise. To that end, we offer the California Prosperity Forum.

*   *   *

Ed Ring is the executive director of the California Policy Center.

California's New Feudalism Benefits a Few at the Expense of the Multitude

California has been the source of much innovation, from agribusiness and oil to fashion and the digital world. Historically much richer than the rest of the country, it was also the birthplace, along with Levittown, of the mass-produced suburb, freeways, much of our modern entrepreneurial culture, and of course mass entertainment. For most of a century, for both better and worse, California has defined progress, not only for America but for the world.

As late as the 80s, California was democratic in a fundamental sense, a place for outsiders and, increasingly, immigrants—roughly 60 percent of the population was considered middle class. Now, instead of a land of opportunity, California has become increasingly feudal. According to recent census estimates,  the state suffers some of the highest levels of inequality in the country. By some estimates, the state’s level of inequality compares with that of such global models as  the Dominican Republic, Gambia, and the Republic of the Congo.

At the same time, the Golden State now suffers the highest level of poverty in the country—23.5 percent compared to 16 percent nationally—worse than long-term hard luck cases like Mississippi. It is also now home to roughly one-third of the nation’s welfare recipients, almost three times its proportion of the nation’s population.

Like medieval serfs, increasing numbers of Californians are downwardly mobile, and doing worse than their parents: native born Latinos actually have shorter lifespans than their parents, according to one recent report. Nor are things expected to get better any time soon. According to a recent Hoover Institution survey, most Californians expect their incomes to stagnate in the coming six months, a sense widely shared among the young, whites, Latinos, females, and the less educated.

Some of these trends can be found nationwide, but they have become pronounced and are metastasizing more quickly in the Golden State. As late as the 80s, the state was about as egalitarian as the rest of the country. Now, for the first time in decades, the middle class is a minority, according to the Public Policy Institute of California.

The Role of the Tech Oligarchs.

California produces more new billionaires than any place this side of oligarchic Russia or crony capitalist China. By some estimates the Golden State is home to one out of every nine of the world’s billionaires. In 2011 the state was home to 90 billionaires, 20 more than second place New York and more than twice as many as booming Texas.

The state’s digital oligarchy, surely without intention, is increasingly driving the state’s lurch towards feudalism. Silicon Valley’s wealth reflects the fortunes of a handful of companies that dominate an information economy that itself is increasingly oligopolistic.  In contrast to the traditionally conservative or libertarian ethos of the entrepreneurial class, the oligarchy is increasingly allied with the nominally populist Democratic Party and its regulatory agenda. Along with the public sector, Hollywood, and their media claque, they present California as “the spiritual inspiration” for modern “progressives” across the country.

Through their embrace of and financial support for the state’s regulatory regime, the oligarchs have made job creation in non tech-businesses—manufacturing, energy, agriculture—increasingly difficult through “green energy” initiatives that are also sure to boost already high utility costs. One critic, state Democratic Senator Roderick Wright from heavily minority Inglewood, compares the state’s regulatory regime to the “vig” or high interest charged by the Mafia, calling it a major reason for disinvestment in many industries.

Yet even in Silicon Valley, the expansion of prosperity has been extraordinarily limited. Due to enormous losses suffered in the current tech bubble, tech job creation in Silicon Valley has barely reached its 2000 level. In contrast, previous tech booms, such as the one in the 90s, doubled the ranks of the tech community. Some, like UC Berkeley economist Enrico Moretti, advance the dubious claim that those jobs are more stable than those created in Texas. But even if we concede that point for the moment,  the Valley’s growth primarily benefits its denizens but not most Californians. Since the recession, California remains down something like 500,000 jobs, a 3.5 percent loss, while its Lone Star rival has boosted its employment by a remarkable 931,000, a gain of more than 9 percent.

Much of this has to do with the changing nature of California’s increasingly elite—driven economy. Back in the 80s and even the 90s, the state’s tech sector produced industrial jobs that sparked prosperity not only in places like Palo Alto, but also in the more hardscrabble areas in San Jose and even inland cities such as Sacramento. The once huge California aerospace industry, centered in Los Angeles, employed hundreds of thousands, not only engineers but skilled technicians, assemblers, and administrators.

This picture has changed over the past decade. California’s tech manufacturing sector has shrunk, and those employed in Silicon Valley are increasingly well-compensated programmers, engineers and marketers. There has been little growth in good-paying blue collar or even middle management jobs. Since 2001 state production of “middle skill” jobs—those that generally require two years of training after high-school—have grown roughly half as quickly as the national average and one-tenth as fast as similar jobs in arch-rival Texas.

“The job creation has changed,” says Leslie Parks, a long-time San Jose economic development official. “We used to be the whole food chain and create all sorts of middle class jobs. Now, increasingly, we don’t design the future—we just think about it. That makes some people rich, but not many.”

In the midst of the current Silicon Valley boom, incomes for local Hispanics and African-Americans, who together account for one third of the population, have actually declined—18 percent for blacks and 5 percent for Latinos between 2009 and 2011, prompting one local boosterto admit that “Silicon Valley is two valleys. There is a valley of haves, and a valley of have-nots.”

The Geography of Inequality

Geography, caste, and land ownership increasingly distinguish California’s classes from one another. As Silicon Valley, San Francisco, and the wealthier suburbs in the Bay Area have enjoyed steady income growth during the current bubble, much of the state, notes economist Bill Watkins, endures Depression-like conditions, with stretches of poverty more reminiscent of a developing country than the epicenter of advanced capitalism.

Once you get outside the Bay Area, unemployment in many of the state’s largest counties—Sacramento, Los Angeles, Riverside, San Bernardino, Fresno, and Oakland—soars into the double digits. Indeed, among the 20 American cities with the highest unemployment rates, a remarkable 11 are in California, led by Merced’s mind-boggling 22 percent rate.

This amounts to what conservative commentator Victor Davis Hanson has labeled “liberal apartheid,” a sharp divide between a well-heeled, mostly white and Asian population located along the California coast, and a largely poor, heavily Latino working class in the interior. But the class divide is also evident within  the large metro areas, despite their huge concentrations of affluent individuals. Los Angeles, for example, has the third highest rate of inequality of the nation’s 51 largest metropolitan areas, and the Bay Area ranks seventh.

The current surge of California triumphalism, trumpeted mostly by the ruling Democrats and their eastern media allies, seems to ignore the reality faced by residents in many parts of the state. The current surge of wealth among the coastal elites, boosted by rises in property, stock, and other assets, has staved off a much feared state bankruptcy. Yet the the state’s more intractible problems cannot be addressed if growth remains restricted to a handful of favored areas and industries. This will become increasingly clear when, as is inevitable, the current tech and property boom fades, depriving the state of the taxes paid by high income individuals.

The gap between the oligarchic class and everyone else seems increasingly permanent. A critical component of assuring class mobility, California’s once widely admired public schools were recently ranked near the absolute bottom in the country. Think about this: despite the state’s huge tech sector, California eighth graders scored 47th out of the 51 states in science testing. No wonder Mark Zuckerberg and other oligarchs are so anxious to import “techno coolies” from abroad.

As in medieval times, land ownership, particularly along the coast, has become increasingly difficult for those not in the upper class. In 2012, four California markets—San Jose, San Francisco, San Diego, and Los Angeles—ranked as the most unaffordable relative to income in the nation. The impact of these prices falls particularly on the poor. According to the Center for Housing Policy and National Housing Conference, 39 percent of working households in the Los Angeles metropolitan area spend more than half their income on housing, as do 35 percent in the San Francisco metro area—both higher than 31 percent in the New York area and well above the national rate of 24 percent. This is likely to get much worse given that California median housing prices rose 31 percent in the year ending May 2013. In the Bay Area the increase was an amazing 43 percent.

Even skilled workers are affected by these prices. An analysis done for National Core, a major developer of low income housing, found that prices in such areas as Orange County are so high that even a biomedical engineer earning more than $100,000 a year could not afford to buy a home there. This, as well as the unbalanced economy, has weakened California’s hold on aspirational families, something that threatens the very dream that has attracted  millions to the state.

This is a far cry from the 50s and 60s, when California abounded in new owner-occupied single family homes. Historian Sam Bass Warner suggested that this constituted “the glory of Los Angeles and an expression of its design for living.” Yet today the L.A. home ownership rate, like that of New York, stands at about half the national average of 65 percent. This is particularly true among working class and minority households. Atlanta’s African-American home ownership rate is approximately 40 percent above that of San Jose or Los Angeles, and approximately 50 percent higher than San Francisco.

This feudalizing trend is likely to worsen due to draconian land regulations that will put the remaining stock of single family houses ever further out of reach, something that seems related to a reduction in child-bearing in the state. As the “Ozzie and Harriet” model erodes, many Californians end up as modern day land serfs, renting and paying someone else’s mortgage. If they seek to start a family, their tendency is to look elsewhere, ironically even in places such as Oklahoma and Texas, places that once sent eager migrants to the Golden State.

Breaking Down the New Feudalism: The Emerging Class Structure

The emerging class structure of neo-feudalism, like its European and Asian antecedents, is far more complex than simply a matter of the gilded “them” and the broad “us.” To work as a system, as we can now see in California, we need to understand the broader, more divergent class structure that is emerging.

The OligarchsThe swelling number of billionaires in the state, particularly in Silicon Valley, has enhanced power that is emerging into something like the old aristocratic French second estate. Through public advocacy and philanthropy, the oligarchs have tended to embrace California’s “green” agenda, with a very negative impact on traditional industries such as manufacturing, agriculture, energy, and construction. Like the aristocrats who saw all value in land, and dismissed other commerce as unworthy, they believe all value belongs to those who own the increasingly abstracted information revolution than has made them so fabulously rich.

The  ClerisyThe Oligarchs may have the money, but by themselves they cannot control a huge state like California, much less America. Gentry domination requires allies with a broader social base and their own political power. In the Middle Ages, this role was played largely by the church; in today’s hyper-secular America, the job of shaping the masses has fallen to the government apparat, the professoriat, and the media, which together constitute our new Clerisy. The Clerisy generally defines societal priorities, defends “right-thinking” oligarchs, and chastises those, like traditional energy companies, that deviate from their theology.

The New SerfsIf current trends continue, the fastest growing class will be the permanently property-less. This group includes welfare recipients and other government dependents but also the far more numerous working poor. In the past, the working poor had reasonable aspirations for a better life, epitomized by property ownership or better prospects for their children. Now, with increasingly little prospect of advancement, California’s serfs depend on the Clerisy to produce benefits making their permanent impoverishment less gruesome. This sad result remains inevitable as long as the state’s economy bifurcates between a small high-wage, tech-oriented sector, and an expanding number of lower wage jobs in hospitality, health services, and personal service jobs. As a result, the working class, stunted in their drive to achieve the California dream, now represents the largest portion of domestic migrants out of the state.

The YeomanryIn neo-feudalist California, the biggest losers tend to be the old private sector middle class. This includes largely small business owners, professionals, and skilled workers in traditional industries most targeted by regulatory shifts and higher taxes. Once catered to by both parties, the yeomanry have become increasingly irrelevant as California has evolved into a one-party state where the ruling Democrats have achieved a potentially permanent, sizable majority consisting largely of the clerisy and the serf class, and funded by the oligarchs. Unable to influence government and largely disdained by the clerisy, these middle income Californians are becoming a permanent outsider group, much like the old Third Estate in early medieval times, forced to pay ever higher taxes as well as soaring utility bills and required to follow regulations imposed by people who often have little use for their “middle class” suburban values.

The Political Implications of Neo-Feudalism

As Marx, among others, has suggested, class structures contain within them the seeds of their dissolution. In New York, a city that is arguably as feudal as anything in California, the  emergence of mayoral candidate Bill de Blasio reflected growing  antagonism—particularly among the remaining yeoman and serf class— towards the gentry urbanism epitomized by Mayor Michael “Luxury City” Bloomberg.

Yet except for occasional rumbling from the left, neo-feudalism likely represents the future. Certainly in California, Gov. Jerry Brown, a former Jesuit with the intellectual and political skills needed to oversee a neo-feudal society, remains all but unassailable politically. If Brown, or his policies, are to be contested, the challenge will likely come from left-wing activists who find his policies insufficiently supportive of the spending demanded by the clerisy and the serfs or insufficiently zealous in their pursuit of environmental purity.

The economy in California and elsewhere likely will determine the viability of neo-feudalism. If a weaker economy forces state and local government budget cutbacks, there could be a bruising conflict as the various classes fight over diminishing spoils. But it’s perhaps more likely that we will see enough slow growth so that Brown will be able to keep both the clerisy and the serfs sufficiently satisfied. If that is the case, the new feudal system could shape the evolution of the American class structure for decades to come.

Joel Kotkin is executive editor of NewGeography.com and Distinguished Presidential Fellow in Urban Futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA. This essay was originally published in The Daily Beast and appears here with permission from the author.

Fiscal Responsibility Starts with Main Street

Two events in the past month have caused me extreme concern that one of our greatest economic errors as a nation is being repeated.

I refer to the five-year anniversary of the Lehman Brothers bankruptcy filing we just observed and to the decision of the Federal Reserve to defer the “tapering” of their gigantic quantitative easing project (tapering refers to slowing down the quantitative easing, and the quantitative easing refers to the act of buying bonds with money that does not exist). The great economic error I refer to is the cult-like mentality surrounding homeownership in our society that brought our entire economic system to its knees in the fall of 2008. Five years later, what exactly have we learned?

I am not one who will say that the economic system is not better off than it was during the peak of the crisis. It is. Bank leverage has been dramatically reduced and significant asset write-downs amongst the American financial institutions have completely recalibrated the balance sheet disaster we faced just five years ago. However, has the underlying mentality on Main Street changed? Has the government’s coddling of the housing market changed? It would seem to me that between Wall Street, Main Street and government policy, the only institution actually behaving and acting differently is Wall Street. You won’t see that uttered in the mainstream press.

In taking three months to flat-out tell the market they were going to begin “tapering” their bond-buying program, the Fed built into the market the expectation that some of the excessively easy monetary policy they were providing would begin to unwind. Then, to the shock of every single market participant and analyst, they announced that they would not begin tapering and provided the most dovish overtone to their present mood we have heard from them yet.

Why? Why would the Fed know that the capital markets were fully prepared to absorb a $10 billion tapering of this bond-buying, and then not even do that? It is not merely my opinion that at some point they have to stop this – it is their opinion! Chairman Ben Bernanke has said so repeatedly. This was a golden opportunity to begin some very, very mild restoration of sound monetary policy. So why would they do this?

Their coddling of the housing market is dumbfounding. I would assume there is extreme pressure from Fannie Mae and related policymakers to sustain the steroids the Fed had injected into the housing market prior to the summer of 2013. The mere expectation of modestly higher rates slowed this momentum enough that I believe the Fed chickened out. This is disappointing, because the Fed knows that the day of reckoning has to come. No “housing recovery” can be considered real when it cannot even sustain the modest tapering of a bizarre Fed bond-buying program.

Five years after the most severe economic crisis since the Great Depression, what has become of the cult of homeownership in American society? Has it been squashed or is it larger than ever? Can you name one political candidate, political party or economic ideology with the courage to speak out against a “real estate recovery”? What is a “real estate recovery”? Intrinsic value needs no prayer for recovery – it just plain happens. When supply and demand are aligned the way they are supposed to, prices move the way their supply-and-demand characteristics dictate.

Today, we do not have people praying for a substantive real estate recovery – we have people praying for their house to go up in value so they can trade it. We do not have a culture, five years after the economy was brought to its knees, looking to repel the culture of debt that created the crisis – we have a movement to give this culture fresh life.

The family value of homeownership is a noble and worthwhile goal, but I see no evidence five years later that Main Street has disposed of its culture of short-termism, speculation, indebtedness and instability for a culture of value, fundamentals and stable community living. The covetousness that destroyed Lehman is the same covetousness that raged throughout Main Street.

I know five years later what effects the crisis has had on Wall Street. Leverage has been reduced and capital raised with reckless abandon. Many of the firms who played such a huge role in the crisis are gone. Can the same be said of Main Street? How we look at the crisis in another five years is not going to depend on what is happening with Wall Street; it will depend on the American culture’s ability to learn the great moral lesson of 2008 – a culture that begins with Main Street.

David L. Bahnsen is a managing director at a large Wall Street firm, where he runs a large wealth management practice. He is a certified financial planner and certified investment management analyst. He and his family reside in Newport Beach.

Fixing California: Will Fracking Bonanza Be Allowed?

Seven years ago, the California unemployment rate was virtually the same as the national rate — under 5 percent. The Golden State had seen some downs during the broad economic growth enjoyed across America since the 1980s, especially after the end of the Cold War hollowed out the defense industry in the early 1990s. But by and large, California generally fared well for a generation, its economic health paralleling that of the U.S.

Now, in 2013, the state unemployment rate remains well above the nation’s for the fifth straight year — 8.9 percent in August vs. the U.S. rate of 7.3 percent. Using a joblessness measure that is based on those who want full-time work but can’t find it, California has the second-worst rate in the nation: 18.3 percent. Between elevated unemployment and the high cost of living, the Golden State now has the highest effective poverty rate of any state.

This explains why state leaders have for years spoken in a general sense about the urgent need to create good middle-class jobs. Nevertheless, Gov. Jerry Brown, Senate President Darrell Steinberg and Assembly Speaker John Pérez have not championed any initiatives or passed any legislation that offered broad hope of helping the state’s economy.

Until this month. On Sept. 20, the governor signed SB 4, a bill meant to comprehensively regulate hydraulic fracturing, better known as “fracking,” in energy exploration.

Fracking uses underground water cannons to blast away rocks blocking access to oil and natural gas reserves. It has been a staple of energy exploration for 60-plus years. In the past decade, however, energy companies have made the process vastly more efficient. They’ve come up with better formulas for the small amounts of chemicals added to the water cannons to loosen up rock formations; they’ve paired fracking with horizontal drilling techniques that enabled access to previously inaccessible reserves.

However, the most transformative change in hydraulic fracturing has come courtesy of the information-technology revolution. Energy explorers are now able to take the equivalent of massive MRIs of vast swaths of underground. This enables far more precise drilling.

SB 4 and related legislation mandate that permits be approved before fracking can be used and that the environmental effects of fracking, particularly on groundwater, be monitored.

Given that fracking has occurred for decades without any disaster remotely equivalent to Three Mile Island, oil companies had cause to criticize SB 4 as unnecessary regulation. Instead, their opposition was muted, reflecting their eagerness to get on with fracking in California.

That’s because fracking has the potential to vastly boost oil companies’ bottom lines while transforming California’s economy. The Golden State is home to enormous oil reserves in sedimentary rock formations thousands of feet below ground known as shale. The Monterey Shale formation, beneath the Central Valley and a coastal and offshore chunk of the Los Angeles Basin, contains more than 15 billion barrels of oil that can be accessed using fracking, according to a 2011 U.S. Energy Information Administration analysis. That’s nearly two-thirds of the total oil shale reserves in the entire nation.

A University of Southern California study released in March concluded that were energy companies allowed to develop the Monterey Shale in the central part of the state and an area east of Santa Barbara, it could lead to a vast economic boom. By 2020, fracking could create up to 2.8 million jobs, increase the state’s total economic output by up to 14.3 percent, boost state and local tax revenue by $24.6 billion annually, and increase aggregate state personal income by up to 10 percent. Even a relatively tentative foray into fracking could generate hundreds of thousands of middle-income jobs that don’t require college degrees.

This amounts to a geologic gift to all Californians, a chance for the state to regain its economic vitality and rebuild its middle class. But to realize this opportunity, it’s likely that Democratic leaders like Brown, Steinberg, Perez, Lt. Gov. Gavin Newsom and Sen. Dianne Feinstein will have to stand up to environmentalists within their party who continue to depict fracking as the equivalent of strip mining. Even though SB 4 was billed as the most comprehensive fracking regulations adopted by any U.S. state, the Sierra Club and other groups wanted it vetoed in favor of a full moratorium on the process.

20130930_Reed_CA-Shale-map

Their most consistent claim — that fracking is a profound risk to water supplies — runs against common sense. Fracking typically occurs a mile or more beneath the surface, thousands of feet below the water table.

The warning from greens that is arguably most credible — raising the possibility that fracking releases dangerous amounts of methane, a far more concentrated greenhouse gas than carbon dioxide — was undercut by a peer-reviewed study released this month that was jointly sponsored by the Environmental Defense Fund and nine petroleum companies.

Decades of supporting evidence explain why Democrats like Colorado Gov. John Hickenlooper, former Pennsylvania Gov. Ed Rendell and President Barack Obama see fracking as just another heavy industry — one with risks that can be addressed with regulation.

If California environmentalists wanted to have a demagoguery-free debate on fracking, that would be helpful. It would focus on their traditional view that the world should leave fossil fuels behind as rapidly as possible because of climate change and broader pollution concerns. Such an argument retains the central flaw of laws like AB 32, which are premised on the idea that the rest of the world will follow the Golden State’s lead in switching to cleaner-but-costlier energy. Still, it would certainly beat the debate that greens want to have that builds on a premise rejected by the Obama administration — fracking is the devil — and a “fact” that’s just not true — fracking is new and unknown.

But if their concerns can’t be addressed, much less resolved, then the Golden State’s leaders have a fateful decision ahead of them. Do they vigorously pursue the oil bonanza that is just around the corner? Or do they let a powerful faction of the state’s dominant political party — affluent urban greens — use courts and delay tactics to prevent the creation of hundreds of thousands of middle-class jobs?

The fracking economic miracle is real and on full display in North Dakota, Montana, Texas, Ohio, Pennsylvania and Colorado — without the accompanying degradation warned of by greens. If this basic fact is given the weight it deserves, millions of struggling California families can finally catch a break.

But that’s a big “if” — even after our state’s years of doldrums.

Chris Reed is an editorial writer for U-T San Diego. Before joining the U-T in July 2005, he was the opinion-page columns editor and wrote the featured weekly Unspin column for The Orange County Register. Reed was on the national board of the Association of Opinion Page Editors from 2003-2005. From 2000 to 2005, Reed made more than 100 appearances as a featured news analyst on Los Angeles-area National Public Radio affiliate KPCC-FM. This article originally appeared in the San Diego Union-Tribune and is republished here with permission.

California can protect the environment while sharing in an energy bonanza

Hydraulic fracturing — fracking — has been used to extract oil and natural gas from shale rock for decades. But technological improvements in recent years have made the process far more efficient. It’s expanded use in states like North Dakota, Texas, Ohio, Pennsylvania and Colorado has sparked an energy revolution that is pushing the United States toward energy independence. It has also sparked major controversy over environmental concerns, nowhere more so than in California. On Sept. 20, Gov. Jerry Brown signed legislation regulating fracking. In this essay below, Colorado Gov. John Hickenlooper, like Brown an environmentally oriented Democrat, makes the case that energy development and environmental protection are not mutually exclusive.

A 21st-century oil and natural gas industry in Colorado is recognizing that more rigorous regulations translate into broader citizen acceptance. This evolution, and the joining of innovations like horizontal drilling with long-accepted practices like hydraulic fracturing, is moving America toward energy independence.

In the process, we are improving the quality of the air, as well as beginning to fight back against climate change.

Colorado has a proud history of leadership and innovation in the deployment of clean energy technologies. We have laws in place that require utilities to produce as much as 30 percent of their electricity from renewable sources by 2020.

Natural gas has emerged as a valuable complement to renewable energy. Because gas-powered utility plants can readily ramp up and down over short periods in response to fluctuating energy demands, it makes for a strong marriage with renewables. Wind energy continues to grow as an important resource in Colorado and at times provides more than half of the electricity generated by our state’s largest utility, Xcel Energy.

Greater deployment of natural gas is also the source of dramatic reductions in carbon emissions. In fact, due largely to the shift from burning coal to gas for electricity generation, the United States is more than halfway to the Kyoto Protocol goals of reducing carbon emissions to 1990 levels. In Colorado, Xcel Energy has reduced its carbon emissions 11 percent from 2005 levels and recent legislation will lead to greater shifts from coal to gas. If climate change is a serious threat, then these facts make a persuasive case for the cleaner attributes of natural gas.

Using natural gas in power plants and, increasingly, in vehicle and truck fleets also reduces a wide array of air pollutants that affect public health and accumulate in the natural environment. Generating power with gas in place of coal, for example, reduces emissions of nitrogen oxides by nearly 80 percent. It cuts sulfur dioxide to nearly zero and it eliminates mercury, a toxin that builds up in the fish that we eat. It slashes the emissions of tiny particulates that can damage our respiratory systems.

The public rightly wants assurances that oil and gas development can be conducted safely, especially as newly accessible reserves sometimes exist under neighborhoods, parks and schools. Extracting these resources must be done without harm to groundwater supplies or unacceptable impacts to the air we breathe. In Colorado, we are addressing these matters with a steady flow of new rules dating to 2007.

With extensive involvement from interested parties, including environmental groups and industry representatives, we’ve developed a suite of rules. These rules provide public disclosure of fracturing chemicals, dramatically expanded requirements for groundwater sampling before and after drilling occurs, and major new steps to reduce impacts when wells are drilled near homes and businesses.

We continue to aggressively address air pollutants associated with oil and gas development. We’ve ratcheted up requirements that operators reduce the compounds that contribute to the formation of unhealthy ground-level ozone. We’ve required “closed-loop” drilling in proximity to homes so chemicals are captured and stored to reduce emissions and odors. We were one of the first states to require “green completions,” a process that dramatically reduces the venting of methane that can occur when new wells are completed. We were also the first state to begin implementing new EPA rules designed to reduce emissions, rules that themselves were modeled in part on what Colorado was already doing.

Colorado’s been at this a while. In 2008, the General Assembly did the important job of remaking the oversight board that regulates oil and gas development so that it reflects a far broader range of Coloradans and interests, and makes protecting public health, the environment and wildlife a mission on par with facilitating the safe development of mineral rights.

Even as we point to these accomplishments, we recognize the need to adapt to new information as part of an ever-evolving regulatory approach. We are participating in developing new data, partnering with academic scientists at Colorado State University and our own health department to better understand the dispersal of emissions resulting from oil and gas development and whether any specific pollutants and exposures present risks to public health.

Coloradans understand the challenges associated with a sustainable water supply. We see water as a precious resource that must be managed with great care. Hydraulic fracturing depends on water, and significant volumes can go into a single well. In context, we also understand that it’s a small fraction of the water used in our state, about a tenth of one percent. Industry shares our desire to conserve water. People in oil and gas development love Colorado no less than anyone else, and we’re encouraged by the rapid innovations designed to significantly reduce and recycle the water required for hydraulic fracturing.

We’ve shown that strong regulations, responsible operators and an engaged public combine to make hydraulic fracturing a safe and critical part of our energy picture.

Even as we champion the environmental advantages, it’s important to consider the economic benefits. A recent study from international consulting firm IHS found unconventional oil and gas accounted for 77,000 jobs and $5.9 billion in labor income in Colorado 2012. The same study also found the industry in Colorado provided nearly $3 billion in public revenues through tax payments, with about half of that to state and local governments. Those dollars and jobs have been especially critical as we emerge from a crushing recession and lingering unemployment challenges.

The same kind of impact on employment and economics is true nationally. The industry is supporting 1.7 million jobs. The ability to develop shale gas has changed the country’s energy security picture right before our eyes. Our nation’s dependence on unstable regimes for energy is dwindling as we become one of the world’s leading producers.

This ability to produce our own low-cost, cleaner energy is drawing manufacturing back to the United States and making us more competitive worldwide. Foreign investment in electricity-intensive industries is also flowing into the country and keeping household utility rates low and stable.

The benefits of cleaner, cheaper energy to the environment, economy and national security are clear. Developing natural gas resources reduces impacts on climate and improves air quality, all while making it easier to incorporate renewable energy into the mix of supplies. Hydraulic fracturing is thoroughly regulated with state-level oversight that can quickly adapt to new information. The industry continues to innovate at a rapid pace in ways that reduces the footprint of development, reduces environmental impacts and relies on less water to generate these resources. We must all continue to push to accelerate these improvements.

John Hickenlooper, a Democrat, is the governor of Colorado. This article originally appeared in the San Diego Union-Tribune and is republished here with permission.

The Best Way to Help the Poor is to Grow the Economy

We have heard a lot from the Obama administration about the growing gap between the rich and poor among us. Less discussed by the Left however, is how middle-income families have done under this administration. What is their record? The fact is that median household income has fallen by 7% since 2007, with most of the decline coming on President Obama’s watch. Liberals are quick to find villains on Wall Street and in “Benedict Arnold” corporations while ignoring how their anti-growth policies and rhetoric are making the problem worse for those struggling to reach the middle class.

The U.S. economy is not a “fixed pie” entrusted to Washington elites to slice up in the way they see fit, but is instead a dynamic and adaptive system, the likes of which the world has never seen. It is a system capable of growing quickly and lifting the prospects of all in it, if we don’t screw it up. Yet nobody in this administration has seemingly considered the cost, in terms of slower growth, the myriad of new regulations implemented, and the higher tax rates and the general climate of uncertainty companies operate in today. Taken together these actions are preventing us from growing as fast as we otherwise would and robbing citizens of improvements in living standards. This failure to live up to our growth potential has harmed our country and our middle class.

Since the depth of the recession in 2009 our economy has averaged slightly over 2% growth. This compares to growth of over 5% in a similar period following the deep recession of the 1980s. Had our economy grown at a 5% rate over this period it would today be close to $2 Trillion larger and since 2009 would have created about $4 Trillion more output.

Had this been the case, our national debt would be smaller, our deficit more reasonable and far more philanthropic money would support hospitals, charities, churches and other non-profits. Lives would have been improved and more than likely saved as additional research projects funded by the larger economy would have benefited our society. Additionally, greater demand for workers created by the larger economy would have driven higher wages up for the middle class and lower our unemployment rate.

Why was this not the case? Why has the rebound from this recession been the weakest from a major recession on record? The answers lie significantly in the President’s stifling policy agenda since taking office in 2009. Following the recession of the 1980s the Reagan administration fostered a business-friendly climate by, among other things, passing two significant tax reform acts, reducing the regulatory burden placed on businesses and spurring business success. Conversely the last several years have seen massive increases in regulation, increased tax rates, significant uncertainty around “what’s next” and the fostering of a climate that equates business success with greed.

I can think of few better growth-killing measures than telling employers that they face far greater costs when they grow beyond their 49th employee or when they ask a worker to work their 30th hour of the week, yet this is exactly what this administration has done in Obamacare. I can think of few better ways to limit private investment and risk-taking than by increasing taxes on long-term investments by over 50%, yet that is what this administration has done. I can think of few better ways to limit corporate investment than to create massive uncertainty through fiery rhetoric and the implementation of expensive regulations outside of the legislative process. Increased risk and lower returns means fewer projects, less investments, fewer jobs and stagnant or decreasing wages.

Greater income equality may indeed be a moral issue, certainly the development of a growing thriving middle class is. We must consider though that growth is moral as well. Growth saves lives, growth feeds starving children, growth lifts wages and pulls people out of poverty. The next time you hear a new regulation or tax discussed I would ask that you consider the entire cost. Not just the cost to an individual’s or company’s time to comply, or someone’s reduced take home income. I would ask you consider the cost of having a smaller economic pie in the future for us all to share.

Pat Maciariello is a businessman and free-market advocate running for Congress in California’s 45th Congressional District.

How Should Technological Advances Affect the Role of Government?

“Robots will steal your job, but that’s ok.”
Federico Pistono

Anyone who has recently driven through Mountain View, in the heart of Silicon Valley, is likely to have had the memorable experience of sharing the road with a car that has nobody inside. Google’s “autonomous cars” are being tested there, and apparently they drive better than people do – they are smart, safe, sober, and tireless. They have the potential to eliminate 3.6 million full-time jobs in the United States.

Anyone purchasing materials at a Home Depot store, or their local grocery chain store, without interacting with a human cashier, has seen the future of retail employment. According to the Bureau of Labor Statistics, there are 3.4 million people working as retail cashiers in the United States. Most of those jobs are also at risk.

What about agriculture? New robots are coming that can do anything a farm worker can do. As noted in this report, “Robot harvests on the horizon; farm owners predict machines will revolutionize costs,” a machine is now being tested that can thin lettuce shoots, a job that requires extraordinary precision and finesse. If machines can thin lettuce, they can do anything on the farm.

Manufacturing? Old news. Robots are on track to completely take over manufacturing. What about journalism? Can robots displace reporters? Read your local newspaper’s high school sports reports – but don’t be too sure a human composed the story, because many newspaper chains have already automated routine reporting. They crowd-source the data gathering with mobile phone applications, and let software applications produce more consistent, more comprehensive written coverage. By the way, how much would you like to bet on whether or not a robot can cook a better Big Mac?

Enough already. If you don’t think technology and automation in this era represents a fundamentally new phenomenon compared to the pace and impact of technological advances in previous centuries, I’ve got a bridge to sell you. Jobs are being relentlessly eliminated via automation. This is throwing highly skilled workers alongside semi-skilled and unskilled workers into a labor market where most of them will not find a new job that comes anywhere close to paying them what they used to earn in the job they lost.

And this is why, now more than ever, public sector unions should be illegal.

The mega-trends of automation, globalization, plummeting birthrates and an aging population are not immoral or happening by design, they are simply parts of an inevitable phase of human evolution at which we find ourselves today. The stratification of wealth that attends these trends is the effect of them, not the cause.

How governments, America’s in particular, midwife today’s epochal transformations of human civilization must not be distorted by a government class who exempt themselves from the challenges facing everybody else. If government workers, through their unions, are permitted to make a separate bargain with the shrinking pool of wealthy global elites who benefit from automation and globalization, it will be mutually corrupting. Whatever political economy must emerge to enfranchise those billions who will otherwise become dispossessed by automation and globalization, it is not feudalism, nor fascism. The growing alliance between government employee unions and the ultra-rich is a recipe for both.

Despite preaching the opposite, public sector unions, by definition, undermine the empathy that government workers feel for private sector workers. Because empathy between the government and the governed can only exist if every taxpayer funded entitlement, whether it is retirement security, or health security, or protection of civil liberties, is implemented and earned according to formulas and incentives that apply to every citizen equally – regardless of who they work for. To cite just one pertinent example, currently in the United States there are more total liabilities in the public employee pension funds – representing 17% of the workforce – then there is in the entire Social Security fund, representing everyone else. This is not a formula for empathy. This is not a valid social contract. And it is the result of collusion between powerful financial interests and public sector unions.

The technological advances that eliminate jobs at the same time as they empower the government and the super-rich raise profound questions:  How will government evolve to enable or encourage improved economic security for all citizens? How will government evolve to craft and enforce environmental edicts? How will government evolve to combat crime and terrorism? What policies are adopted and how citizens accept them will depend in great part on whether or not government employees are making the same sacrifices and following the same rules.

To paraphrase Federico Pistono, robots will not only steal your job, they will watch you. The capacity of government to employ robots for police and military applications is without practical limits. Do Americans want a government – empowered beyond any historical precedent – that is unionized and protects the interests of its members. Or do Americans want a government staffed by people who are personally experiencing the same challenges as the citizens they serve? Which government might be more likely to equitably navigate the seismic, perilous, wondrous currents of this age?

Ed Ring is the executive director of the California Policy Center.