COV-19, the recession, and state budgets: What are our choices?

Richard F. Keevey

This week on EJB Talks Stuart Shapiro sits down with Bloustein School Senior Policy Fellow and former New Jersey Budget Director Richard Keevey, who reflects on his years of budgeting at both the state and national levels. Mr. Keevey gives his take on how the pandemic, and the ensuing economic downturn, have put enormous pressure on state governments. The pandemic has increased the needs of residents, while the recession has dramatically decreased the revenue sources that the state government relies upon. Given the magnitude of New Jersey’s fiscal crisis, what options do the state’s leaders have for making spending cuts without negatively affecting those who need services the most?

Stuart Shapiro
Welcome to another episode of EJB Talks. I’m Stuart Shapiro, the Associate Dean of the Faculty at the Bloustein School. And the purpose of this podcast is to talk with my colleagues and our alumni about issues affecting people in New Jersey, the United States, and the world.

COVID-19 and the ensuing economic downturn have put enormous pressure on state governments. Simply put, COVID has increased the needs of the residents, while the recession has decreased the revenue sources that the state government relies upon. Richard Keevey is the former New Jersey budget director and comptroller appointed by governors from each political party. He was also the Deputy Undersecretary for Finance at the Department of Defense and the Chief Financial Officer at the Department of Housing and Urban Development. And lucky for us, he teaches budget and finance at the Bloustein School. Rich, thanks for joining us.

Richard Keevey
Thank you for inviting me. Glad to be here.

Stuart Shapiro
We’ll focus primarily on New Jersey today. Can you talk a little bit about the magnitude of the fiscal crisis that New Jersey in particular faces?

Richard Keevey
Sure. As a the result of the virus, current estimates are that we’re going to be losing $10.1 billion of revenue over the next 6 to 18 to 24 months. So that’s quite a drop of funds.

Stuart Shapiro
Right.

Richard Keevey
The budget of the state is on an annual basis, approximately $40 billion. And I would say that this is an unprecedented situation. I happen to have been the budget director under Governors Kane and Florio, and both of them had big problems when they assumed office. We looked at $3 billion problems that could face the state and we addressed with a series of budget cuts and increases in taxes and we “weathered the storm” so to speak. But this level is dramatic. $10 billion is a huge number. And the task is going to be how do we provide as many services as we can and somehow get through this budget shortfall and the virus. So it’s going to be a real challenge for the governor and the legislature. And they need to make sure that whatever they’re doing to solve the current problem, they don’t bury themselves or bury the state in the future. So that’s my quick take on the plight of New Jersey.

Stuart Shapiro
Yeah, that’s a good assessment of the magnitude. I mean, 25%, almost, of revenue, it sounds like… going away.

Richard Keevey
I should point out that, you know, we’re not unique in this situation. There are many states that have the same problem. Especially the bigger states. California, New York, Virginia, Michigan, Ohio. All are facing similar kinds of problems.

Stuart Shapiro
Right. So this is a discussion an issue that has nationwide implications, even though we’ll focus on New Jersey.

Richard Keevey
Right.

Stuart Shapiro
When I think about budgets, and I think when most people think about their household budget or their personal budget, I think about it in two parts. You have money coming in, and you have money going out. So let’s start with the first. Are there ways to offset the decreases in revenue for what I think is going to be a recession that lasts several years at a minimum?

Richard Keevey
Basically, there are two ways of doing it. One, raise more revenue, increase taxes, or what I like to say reduce the amount of tax expenditures in the budget–and we can get back to that later–or cut programs. They are the two fundamental, basic ways of doing it. Now, incidentally, our governor has proposed at the moment that he may want to issue bonds to fill in the shortfall. He’s talked anywhere between $5 to 10 to $12 billion of bonds to fill in the gaps. We can talk about this in more detail later. But from my point of view, that is a big mistake. Because, once you issue those bonds for one year, what do you do when the next year comes around? Right. You have to fill that gap that was filled. So fundamentally, from my point of view, you’ve got to raise new revenue and cut programs. Very difficult decisions.

Stuart Shapiro
Now you’ve mentioned reducing tax expenditures. Can you explain for the audience what that means?

Richard Keevey
Well, there’s a lot of tax credits and deductions built into the tax code that gives certain people and certain corporations benefits. Some of the more easily understood ones are, when you file for New Jersey income tax and you’re a senior or a veteran, you get certain tax deductions. Or, certain items are not taxed. For example, in New Jersey, we do not tax food and clothing. I lived for a time in Virginia, they tax food and clothing. So from the taxpayer’s point of view, they like that, and the overall tax structure, that might be okay. But, if we tax food and clothing, for example, the state would have another $3.5 billion without raising any rates.

Stuart Shapiro
Wow.

Richard Keevey
The ways in which the revenues and taxes can be altered or changed are not easy decisions to make. Can you imagine if you’re a taxpayer and you say, “Oh, my word! You mean, we now have to pay sales tax on food and clothing? We never did that before!”

Stuart Shapiro
Right. That’s going to be politically challenging. I would imagine.

Richard Keevey
I should point out, there are three basic taxes in New Jersey to support the state government. And it depends upon what you want to go into but they are the income tax, the sales tax, and the corporation tax. That’s almost 70% of all of our revenue. If something goes wrong in the economy it’s going to affect those three taxes. And that’s the problem we’re facing. That’s where the $10 billion shortfall comes about.

Stuart Shapiro
Is there room for talking about increases in tax rates?

Richard Keevey
Well, prior to the disaster facing the country, our governor wanted to increase the rates on the wealthy. We have a pretty, very progressive tax rate in New Jersey. And people in the lower-income and middle income pay relatively low rates. As you work your way up towards a million dollars, you pay a higher rate. Now what the governor wanted to do was increase the rate for people over $1 million. So that’s always a possibility. And of course, you could increase the rate on the sales tax. Instead of paying 6.75%, we could move it up to 7 or 7 and a half or 8. So there are all kinds of options, if you will if revenues were the solution.

Stuart Shapiro
Right. Well, let’s go to the other side of the ledger now. Where are the places, in your view, that the budget can be cut and the harm from those cuts would be the smallest?

Richard Keevey
Let me start out by saying, 72% of the New Jersey budget expenditures go outside of the state government. In the forms of either state aid to municipalities, counties and school districts–almost $18 billion in that category. So the state raises money and sends it back down to help local jurisdictions. And we have a whole series of grants that also leave the state government. The biggest one being Medicaid. Where we are reimbursing nursing homes and doctors and pharmaceuticals to care for those indigent folks who don’t have their own coverage.

Other big areas are in the grant area–higher education. We provide aid to Rutgers and all the other colleges in the state. Transit subsidies and a whole myriad of nonprofit groups that provide direct services to clients. So those two. And the biggest part of the state aid is school aid. About $15 to $17 billion goes back to school districts. The remaining money in the budget, if you will, paying for state services, are mostly taken care of or spent for institutional care. Almost, the majority of employees in the state are tied in one way or another with institutions; correction, mental hospitals, centers for the developmentally disabled.

So, the point I want to make is a lot of the money leaves the state. And it’s for programs that if you could think about what I just said, do we cut higher education? Do we cut aid to school districts?

Stuart Shapiro
Right.

Richard Keevey
Do we cut aid to municipalities? It’s a very difficult choice. Sometimes people say, “Oh, it’s easy to cut the state budget, just get rid of all the fluff.” (laughing) Well, there is some fluff, I’m sure, but my point would be, it could be very difficult and challenging to make sizable cuts to address the problem.

Stuart Shapiro
Yes, I was struck as you were listing those areas off. I mean, Medicaid, schools, mental hospitals, etc. We’re talking about groups of people that we, as a society, many of us think at least, should be the focus of government effort and government expenditure. And then when you add in COVID-19, and the fact that more people are unemployed as a result of the recession, the need of these people is even greater. So it strikes me that on the budget cut side, there’s almost nothing that’s not painful. I mean, it’d be nice that there was some waste, fraud, and abuse in there. But like you said, I don’t think it’s a lot. Most of the money is going to people that probably need it.

Richard Keevey
I think that’s true. And that’s why the challenge to me as a former budget director was always, how do you make these cuts without affecting negatively the people who need it? Even things that people take for granted. Motor vehicle operation, state police, filling up cracks on the road, building new roads, etc, etc. All take up some money, and it’s hard to make cuts. However, you know, the general public is suffering problems. So there’s no doubt that the state needs to make cuts. For example, there’s a salary increase built-in for all state employees beginning next year. My view says, well, you know, you can’t get it. The problems are so big we can’t possibly be giving you salary increases when your fellow New Jerseyans are losing their jobs. Another big area which we might get to later is the pension problems, how do we fund them properly in the face of losing all this money? So these are challenging areas for making reductions. I always say to folks, the person who says, “Oh, just cut the budget and that solves the problem,” really doesn’t focus on where the money’s going and who it’s going to affect.

Stuart Shapiro
Yes, it’s much easier to do that from the safety of your keyboard.

Richard Keevey
Absolutely!

Stuart Shapiro
…than actually have decisions to make. Alright, well, you mentioned the pension. So let’s go there now. You’ve described the pension fund as the 10,000-pound elephant in the room for New Jersey. What do you mean by that? And why do pensions pose a particular problem for New Jersey?

Richard Keevey
New Jersey, it depends upon what report you read, is either the worst-funded pension system in the country or next to the worst.

Stuart Shapiro
Who’s our rival?

Richard Keevey
Illinois.

Stuart Shapiro
That’s what I thought!

Richard Keevey
Of course, Illinois is our rival in everything. I mean, (laughing) I digress a little bit. We’re not even in the same league with Illinois–they are so bad that it’s amazing. And if we could ever solve our pension problem, we, as a matter of fact, aren’t in that bad shape.

Stuart Shapiro
Right.

Richard Keevey
But having said that, pensions are about 54% funded. That means that we do not have enough money set aside to pay for commitments that we’ve made to current and future retirees who have entered into a contract with the state that they would receive these pensions. Part of the problem is because for many years, prior governors failed to put into the budget, the amount of money that the actuary said should be put into the budget, if you’re going to have a properly funded system. So over the years with shorting of the appropriations, it created this long-range problem. And I also want to point out, and folks sometimes don’t focus on this, but when we talk about funding as a pension system, it’s not only the state employees, but the state pays for the local government that…I’m sorry, the school district share. So all teachers who are retiring, their school district doesn’t pay for their pension, the state does.

Stuart Shapiro
I see.

Richard Keevey
So, the same with health benefits. I digress a little bit, but most people think about pensions and also talk about retirement health benefits. The state pays for the Teachers Retirement Fund. The state contributes to the higher education retirement system. So you add all those together and we’re talking about really big numbers. If we were funding the pension system properly, we would have to put in six and a half-billion dollars in this year’s budget.

Stuart Shapiro
Wow.

Richard Keevey
We’re not near that number. The governor, before the disaster hit, was looking at about $4.2 billion, which is pretty good. That would have been a good increase compared to 5, 6, 7 years ago. So I did phrase this as the 10 pound, 100 pound, 1000 pound, million-pound gorilla (laughing) because it is really a problem for the state. We’re not unique, but we lead the league.

Stuart Shapiro
And these are contractual obligations? I mean, we, it’s not like we can say, “oh, we’re not going to pay you.” I mean, eventually these obligations are going to have to be paid.

Richard Keevey
That’s correct. Now we can change pension law, that is not a negotiable item. Health benefits is negotiable.

Stuart Shapiro
Okay.

Richard Keevey
So pensions could be changed. In fact, Governor Christie made a proposal to make these changes. Senate President Sweeney has made proposals to make these changes. Now, Sweeney’s proposals would affect only new employees. We would change the pension system to what’s called a defined contribution system as opposed to a defined benefit. But, I’d be getting into the weeds if we went further than that, other than to say, this is a big problem.

Stuart Shapiro
Yeah, if you do something that just helps new employees, they’re not going to retire and get their pensions for a long time. And, we have a problem much before they face retirement. So let me touch on…I mean, one thing that could help the state would be the feds. Certainly in Washington, much of the debate over another stimulus package involves help to the states. Is that something the feds should be doing or do the feds have other concerns that they need to be watching as they think about budgets? Unlike New Jersey, the feds can print money.

Richard Keevey
That’s right. We have no loss of revenue, or, no loss of debt in this country. We have… long term debt is quite large. But yes, I think the federal government has got to step in. Tod date, they’ve provided New Jersey with about $2.8 billion to help with the costs associated with the virus. And they provided some almost $400, $500 $600 million to New Jersey Transit. And they’ve provided some minimal amounts to municipalities and to school districts. But to solve the problem that New Jersey has, and many other states, I’m of the idea that they need to issue some more debt and provide direct state aid to municipalities and states across the country. In any given number, New Jersey would wind up with maybe 3, 3.5 percent of the total amount that’s allocated. So to fill in these gaps, I think federal aid is critical and that Congress has to step up in the next month or two, to provide that money. They can’t wait around. As you know, from the beginning of our discussion, we’re running into problems right now.

Stuart Shapiro
Right. I mean, just doing quick math if the feds decided to provide $100 billion in state aid and New Jersey got 3% of it. That’s $3 billion towards our problems.

Richard Keevey
Right. Correct.

Stuart Shapiro
It seems to me that, you know, one always hates to have the “well let’s look to Washington for answers as our solutions,” but it does seem in this case, and you can correct me if I’m wrong, that that’s got to be an important component of however we get out of this crisis.

Richard Keevey
That’s correct. They can legitimately print money. States, in my point of view, should only be borrowing for capital purposes. Now, on that issue, Stuart, remember I mentioned to you if we sell bonds…

Stuart Shapiro
Right.

Richard Keevey
Say, we sold $5 billion of bonds and drop that money into the next budget. The following year, that $5 billion, isn’t there. So what do we do the next year?

Stuart Shapiro
Right.

Richard Keevey
And that’s why I argue for no sale of bonds. Solve the problem now, raise some taxes, if necessary, cut some spending, maybe even defer additional contributions into the pension system and then pick up the problem later. But these are troubling times.

Stuart Shapiro
Indeed, indeed, they are. Rich, thank you very much for coming on with us today, it’s has been a very educational discussion. One that I think our listeners, many of whom are New Jersey residents, will profit from hearing. So thank you.

Richard Keevey
You’re quite welcome. I enjoyed it.

Stuart Shapiro
I’d also like to give a big thank you to our production team, Tamara Swedberg, Amy Cobb, and Karyn Olsen. We’ll be back next week with another talk from another expert at the Bloustein School. Thanks for listening and have a great Fourth of July. Or hope you had a great Fourth of July because by the time you listen to this, it will probably have passed. Happy Independence Day.