Goldmark: The pain of shrinking local gov't

An important sector of our economy is faltering, when it should be at the center of our efforts at economic recovery.

That sector is state and local government.

It's a large slice of the pie -- more than 10 percent of gross domestic product. It employs about 19 million people, or around 15 percent of our total non-farm work force. And it is responsible for critical service areas from law enforcement to education.

The blunt truth is that the federal government has never paid much attention to how the three levels of government interact economically. The feds were "stimulating" the economy in 2009-10, while state and local governments were laying people off despite some direct federal aid. The feds crowed about putting money into "shovel ready" projects while state and local governments cut back on maintenance and new capital projects.

Today the best available figures for the two years after the crash of 2008 suggest that the contractionary effects of the state and local governments seriously undermined efforts of the federal government to move the economy forward.

Let's look at four critical dimensions of this puzzle.

First is employment. We don't want state and local governments firing people when we're trying to speed up the recovery. But that's what most state and local governments are doing. Gov. Andrew M. Cuomo showed the right path by striking a deal in 2011 whereby state public unions gave up wage increases in return for no layoffs. That keeps paychecks flowing to families, and forces state and local governments to limit costs by making their operations more efficient with existing staff.

The second subject is Medicaid. It is the heaviest load state and federal governments share, and its costs historically rise far faster than the cost of living. Medicaid costs borne by state and local governments in New York are the highest in the country. Eventually the feds will probably have to give each state a block grant for Medicaid and let states decide how to meet local needs. Today Medicaid is administered jointly by the feds and the states on a fee-for-service reimbursement basis -- a recipe for little accountability and lots of cost escalation. The federal government should say to the states: If you save money by eliminating inefficiencies or increasing productivity, you can keep 75 percent of what you reduce below last year's expenditures. This would set off a scramble by states to streamline services and weed out waste.

Third, we need to have the traditional state-and-local function of building and maintaining our infrastructure moving at top speed as an engine of economic recovery. But state and local governments aren't spending much because of the budget squeeze they face: escalating demand on one side and declining property and sales tax revenues on the other. President Barack Obama proposed a national infrastructure bank to facilitate and backstop the issuance of state-and-local debt to rebuild our capital plant and to create new jobs. But Republicans in Congress are paralyzed in the grip of ideologically driven "no-to-everything." So don't hold your breath for them to approve new investment in infrastructure.

The fourth subject is public-sector pensions, which pose the biggest danger of a gigantic financial hole -- and where many state and local governments are participating in massive disguised borrowing. New York is actually borrowing from its pension funds to make payments to those same funds. The pension problem does not need to be solved overnight. But in the next few years, pension benefits for new employees need to be cut back to affordable levels. And post-employment benefits not guaranteed by contract -- primarily health care -- need to be reconfigured. This will be tough medicine. But the time to start is now. Every year we delay makes the budget hole deeper.

Peter Goldmark, a former budget director of New York State, is a member of the State Budget Crisis Task force, co-chaired by Paul Volcker and Richard Ravitch.