Sunday, December 26, 2010

Has George Will Tripped on Federalism?


Today George Will praises the proposed Public Employee Pension Transparency Act, the title of a bill introduced by Congressman Devin Nunes (R-California). As Will describes it, the bill would perform two main functions. First, the Act would enhance the transparency of state and local pension systems, by requiring states to disclose the full extent of their pension liabilities as well as the nature of the financial assumptions used to calculate those liabilities. Second, the Act would, Will says "stipulate that state and local governments are entirely responsible for their pension obligations and the federal government will provide no bailouts."

As Will points out, states and localities together labor under nearly $4 Trillion in unfunded pension liabilities. Given these facts, encouraging fiscal responsibility by spendthrift states is a laudable objective. At the same time, there are two possible objections to the bill as Will has described it.

First, Congress cannot, as a matter of Constitutional Law, bind future Congresses not to bail out insolvent states, even states whose insolvency is the result of reckless spending. So, for instance, the new incoming Congress could not enact a tax cut and at the same time provide that "no future Congress shall repeal this reduction in tax rates." Allowing one Congress to bind future Congress's would entrench the decisions of today's representatives, and the people they represent, depriving citizens of their ability to alter the course of national policy by electing different representatives in the future.

Hence, while it might make sense as a matter of policy in this particular instance for Congress to bind itself in this manner, future Congresses would properly feel perfectly free to ignore such an effort and thereby address any request for a bailout "on the merits" of such a request. I hasten to add that, like George Will, your humble blogger cannot imagine an instance in which the national government should bail out a state that has become insolvent due to its own fiscal profligacy.

Second, some might wonder why the National Government should be attempting to induce states to disclose additional information to their own citizens about pension liabilities. In particular, devotees of federalism can justly ask why Will, a prominent conservative, would advocate such national interference with states' inner political workings. As this blog has previously noted, in a federal system, states compete with each other for citizens and capital; states that adopt inefficient rules will lose capital and citizens to other states. Moreover, presumably a state's own citizens have a greater interest in that state's solvency than citizens in other states. Given these assumptions, there is no apparent reason why a national government would be in a better position to determine the appropriate level of public pension transparency than state governments subject to these competitive and democratic constraints. It should also be noted that individuals, including large institutional investors, have significant incentives to ascertain the actual liabilities of states and localities that issue debt before purchasing such debt, with the result that states that decline to provide such information my find themselves paying higher rates of interest, other things being equal, than those that do.

Will and, for that matter, Congressman Nunes, have anticipated such an objection. For, as Will points out, the Act would not require ANY state to adopt the sort of disclosure he describes. Instead, the Act would "merely" encourage states to do so by withdrawing the tax exemption for interest on debt issued by those states that decline to comply. In other words, states that declined to comply with the Act's disclosure provisions would be placed at a competitive disadvantage in the capital market compared to those states that did, in fact comply.

To be sure, subsidizing the issuance of state debt via exempting its interest from taxation is questionable practice. Moreover, withdrawl of a tax exemption is not equivalent to the outright coercive imposition of such rules. Moreover, Congressman Nunes should be praised for showing some sensitivity to federalism concerns. At the same time, use of the tax system to induce states to pass legislation they otherwise would not enact still, in the view of this blogger, requires some showing of a national interest that justifies such attention to the disclosure practices of individual states. While there may be such an interest, Will has not provided one, leaving the case for such legislation as of yet unproved.