In yesterday's article I talked about how Tea Party efforts are misdirected at public sector workers in Wisconsin instead of the banks on Wall Street who created the recession. However, it does not change the fact that the budget deficit in Wisconsin does exist. So I want to set aside for a moment how Governor Walker is choosing to attack the deficit and instead look at what would happen should nothing be done to fill the deficit gap by cut spending or increasing revenue.
How governments finance deficit spending
The way governments finance their deficit spending is by selling bonds backed by the treasury of the state or local government to private institutions and individuals, the government then pays back the principal plus a fixed interest rate that is determined by the government institutions credit rating and the time it takes the bond to mature. The bond revenue for the state of Wisconsin from July 1 2009 to June 30 2011 is $3,581,172,100, which makes up 5.4% of the state's budget.
A rule of thumb in the bond industry is that a drop from a AAA rating to a AA rating (the rating the state of Wisconsin currently has) can mean an increase from .25% to .50% percent paid in interest on the bond. So using very rough numbers the credit rating drop would mean if (for the sake of simplicity) the deficit was to be financed with 10 year bonds instead of paying 3.25% on the bonds Wisconsin has to pay 3.75% an increase of $18 million dollars just on the interest. So the idea is to endure short term pain in order to squash the deficit that Wisconsin has been carrying year to year and thereby improve the state's credit rating, which will lessen the burden on the taxpayer in the long run. This would allow for the state to comfortably reduce the tax burden on individuals and businesses thereby theoretically reducing unemployment to a tolerable 3-4%.
Governor Walker is proposing to refinance the bonds that are set to mature on March 16th, pushing the bonds maturity off of Wisconsin's balance sheet for the next two years. The idea being not to raise revenue through increasing tax rates but by broadening the tax base by improving the business climate in the state. This is a more solid long term strategy considering the budget shortfall can be traced by almost exclusively to a drop in income tax revenue because of the rise in unemployment.
Government Bond Market: The next bubble to pop
This increase in bond yield rates is creating a bubble in the bond market, because while there is increased risk, it is not taken all that seriously in the financial sector and many are looking upon the increased yields as easy money. However if local and state governments begin to default on the bonds they owe it will result in a financial disaster, leaving only commodities and hard assets as safe places to park capital. This would drive prices through the roof at the pump and on the shelves.
Wisconsin and Governor Walker had several options, cut spending, raise revenues through tax and fee increases or default on the bonds. The choice was an easy one for Governor Walker his conservative ideology and backing of the RNC. As Robert Barro pointed out in his excellent column in the Wall Street Journal yesterday, putting harsh limits on collective bargaining is the only long term solution to preventing the same budget problems down the road.
If Walker would do nothing eventually Wisconsin would be in the same position as California with a A- credit rating a forced to implement draconian measures like drastically cutting welfare and medicaid which California is cutting by $3 billion dollars and forcing massive layoffs by way of slashing funding for programs across the board. And this is Democratic Governor Jerry Brown!
About the Author: Shaun Booth is editor of MilwaukeeStory.com.