 Aloha and welcome to Think Tech Hawaii's Hawaii Together. I'm your host Kaley Ikeena, president of the Grassroot Institute. We've got such a beautiful place here in Hawaii, lovely people, wonderful climate, wonderful visitors as well from across the world. But very few people focus on the fact that we're in massive debt as a state. Currently, we owe $88 billion over the next 30 years that we just don't have the money to pay for. Who's going to pay for it? How are we going to solve that problem? What can we do about it? Well, I've got with me an expert today who has some answers to these tough questions. His name is Dan Mitchell. He's an economist with the Center for Freedom and Prosperity based in Washington, D.C. He's a former senior fellow at Kato Institute and also at Heritage Foundation. And we're going to pick his brain because he understands this situation across the nation that states are facing in terms of some of their fiscal dilemmas. So please welcome to the program today Dan Mitchell. Dan Aloha and welcome to the program. I'm glad to be with you and I'm looking forward to coming to Hawaii again. Well, we're looking forward to hosting you here soon. Dan, what gave you the interest in the first place of taking a look at fiscal conditions of various states? Of all the things you could study as an economist, what's attracted you to that? My main job over the last several decades has been working on fiscal policy in Washington. But in terms of studying fiscal policy in Washington, I'm often reading the academic literature, the policy studies, and so much of what you see in that world is comparisons happening with different countries, but also what's happening with different subnational forms of government. And of course, inside the United States, that means looking at what's happening with state governments. And what you find, whether you're looking at the international evidence, whether you're looking at what's happening in Washington, or whether you're looking at the state level, or even for that matter, I just wrote a column about what's happening in Chicago. There's almost a universal tendency on the part of politicians to spend more money than they have. There's a tendency to spend money today or commit to spend money today without knowing what the future revenue streams are to finance those spending commitments. It's sort of the classic issue of what's called public choice economics. Politicians like making themselves popular. And in many cases, you make yourself popular by buying votes with other people's money. Well, you talk about buying votes. I think that's part of the problem. Would you say that politicians have short term cycles? They're up for reelection every two or four years. And so they don't have to think much beyond that. And they're thinking in terms of the goodies they can promise in order to get reelected. Now, spending may not always be a bad thing if we have the money. But is it the case, as it is in Hawaii, is it the case across the nation that spending is taking place in a way that outpaces the money that is coming into state coffers? That's the fundamental challenge that exists. Any time you have any sort of bump in the economy, a recession, what happens? Revenues fall. Well, spending commitments don't fall. They continue on and on. And so you get sort of what I call this boom bust ratchet effect with the state fiscal finances because usually there's some form of balanced budget requirement. And so when the economy is growing and revenues are expanding, maybe 6, 7, 8, 9 or even 10% a year, what happens? State governments increase spending 6, 7, 8, 9 or 10% a year. But when there's a recession and all of a sudden your revenues might drop by 5%, then politicians with that sort of balanced budget requirement that they at least nominally want to obey or at least think they have to obey, they then turn to higher taxes as sort of their first answer. So with state government finances, this is how they're different from the federal government. The federal government never worries about balancing its budget. It just increases spending in good times and it increases spending in bad times. States have a different challenge than Washington, but that challenge doesn't lead them to adopt better policy. It's still a question of spend as much as you can, whenever you can. And then when there's a recession, that's your excuse to raise taxes. You're also in those situations that want to be fair. That's usually when states tighten their belt somewhat and spending either gets frozen or doesn't grow as fast. So they do respond to economic downturns with some spending restraint. But also, that's when they get the permanent tax increases. And those permanent tax increases then create a higher revenue trend line that exacerbates the underlying spending problem in the first place. Here in Hawaii, we have $14 billion of unfunded liabilities in our employee retirement system. And when it comes to the health care programs for state retirees, that's $12.6 billion. So right there, just for our public employees, that's $26 billion that we owe to our pensioners, people who've worked for the state, that we simply don't have. How does that compare to the conditions of other states? If you look at some of the national rankings of public pension debt in terms of unfunded liabilities on a per capita basis or as a share of state economic output, Hawaii ranks in the bottom 10 in every one of the rankings that I've seen. Now, obviously, when you're looking at these long-run forecasts, they are sensitive to what interest rates you assume for your discount rate, what is the cost of a $5 billion obligation 10 years from now, how you measure that depends on your assumptions. You also have assumptions that states use in terms of their pension funds and any money that they might be setting aside for care. What sort of returns are they assuming? In most states, of course, they put in very optimistic assumptions. They think, oh, we'll earn 7% on whatever money we're investing forever, which, okay, if that happens, that's great, but I think it's more responsible to have more cautious assumptions because it's better to have a happy surprise than to be caught short of money because you were basing your budgets on a wish and a prayer instead of common sense and prudence. Now, that's different than Washington. Washington doesn't really have a problem with bureaucrat pensions. Yes, they're expensive, yes, they're there, but we actually did reforms during the Reagan years that removed that as a major fiscal problem for Washington. Our problems in Washington, of course, are the giant entitlement programs, Medicare, Medicaid, Social Security, but federal government bureaucrat pensions are a relatively minor manageable issue because they did the reforms. And they said federal bureaucrats, of course, get very generous benefits, but for the most part, they're required to basically pay as you go for those in terms of setting aside money, in terms of having a pension system that is actually reasonably reasonable in terms of its assumptions. So Washington, I usually never say Washington is a good role model, but we did do some decent reforms in the 1980s where the bureaucrat pensions and other obligations are not a major issue. It looks like states need to follow that. Now, here in Hawaii, in addition to the $26 billion of unfunded liabilities related to our public employees, we've also got a total altogether, economists tell us now, of $88 billion when you factor in the essential infrastructure needs and emergency needs that are predicted for the next 30 years. That's a huge amount of money. I mean, we're a state of only $1.4 million in population, and that means every man, woman, and child has an extraordinary amount of debt, and every child is born with at least $20,000 of debt if they're born in Hawaii. What is the problem that we face? What's the precariousness of our situation now to have that much debt hanging over the heads of the state? You have to look at that $88 billion and probably dissect what's in that number. Sometimes when people put together these numbers, they put in a wish list. The construction lobbyists might say, oh, well, we have an expansive list of things we want to do in terms of highway spending and mass transit and things like that, and if you take a more jaundice look at that, maybe you could get that number down. So you'd have to look at what's inside that $88 billion figure. The one thing that is contractually obligated now depends, of course, on the state constitution and how firm it is, but usually the promises that are made to state government workers, and for that matter, maybe local government workers are in that number as well, those are contractual obligations that you can't break in certain states. I don't know whether Hawaii is in this category, but in my mind, if a state has that kind of limit, at the very least, you're in a whole stop digging. Many states in America have done reforms where, OK, maybe you don't touch the contractual obligations that have been made to existing government workers or current retired government workers, but at the very least for new hires, for new people coming into the system, put them in a more of a 401K type of system, what's called defined contribution, where they're saving money, it's their basically personal property, they don't have to rely on some pension fund making investments. They can in effect direct the investments themselves or usually just turn it over to some financial professional. There are certain prudent steps that can and should be taken at the very least to keep the unfunded liabilities from growing in size. Well, to its credit, the state has taken the first steps toward some form of reform and we're hopeful that they will stay the course. We've had a very strong defined benefit system and the state is looking at ways we can transition to a defined contribution system so that we're not merely making promises and then having to pay for them without actually earning the money. But we'll come back to that after we take a quick break, but I wanted to throw out a figure to you. For the past 30 years, the state of Hawaii has increased its annual spending by 5%. You're an economist and you know what charts look like in terms of curves. That's extraordinary. What are your thoughts about that and how sustainable is that kind of spending? You've put your finger on what is the key fiscal variable. How fast over time is government growing relative to the productive private sector of the economy because what is the private sector? That's the tax base. If your nominal GDP or nominal economic output of the state is growing at say 4% a year and your state spending is growing at 5% a year, that's a very, very bad situation to be in over time because this wedge effect where you gradually have a bigger and bigger gap, that's probably explains a lot of why there's this $88 billion figure that people are talking about. What you want in terms of fiscal responsibility, maybe I'm just a moderate at heart on some of these issues but I don't really care whether the budget is balanced every year. What I care about is making sure that the long-term trend line of government spending is certainly no higher than the long-run trend line growth of private sector GDP and ideally it should be maybe 1% point or more below that so that you're actually sort of freeing up some resources for private sector growth and economic expansion but you really have put your finger on the key issue, the growth of state spending in the long run if it's too rapid compared to the private sector that's basically the recipe that got Greece in trouble. You look back over the last several decades before they hit their financial crisis in 2009, 2010, the problem was is they had government growing too fast. Now in many of those years, they even had budget surpluses. So it's not a question whether the budget is balanced or not in any given year, it's is government growing over time faster than the private sector? That is a very, very bad trend to be on for a state or for that matter a nation. Well, those are some good insights and I like the fact that you're not linking the solution merely to balancing the budget and I'm gonna ask you a bit about that when we come back from a quick break. My guest today is economist Dan Mitchell and when we come back, I'm gonna ask him what the solution is. He's talked about bringing spending down as one of the directions we need to go. Are there mechanisms for it? We've heard of spending caps, we've heard of balancing the budget. What's the best practice out there that will help Hawaii? I'm Kayleigh Akina on the Think Tech Hawaii Broadcast Network will be right back in one moment. Don't go away. Aloha, I'm Lillian Cumick, host of Lillian's Vegan World, the show where we talk about veganism and the plant-based diet located in Honolulu, Hawaii. I'm a vegan chef and cooking instructor and I have lots of information to share with you about how awesome this plant-based diet is. So do tune in every second Thursday from 1 p.m. Aloha. Aloha, I'm Daelyn Yanagita, one of our hosts of our Business in Hawaii talk show on the Think Tech Hawaii. The theme of Business in Hawaii is to share with you stories of local businesses by local people and our guests share with us their journey to building a successful business right here at home. We are streamed live on Think Tech weekly at 2 p.m. on Thursdays. Thank you so much for watching our show. I am Daelyn Yanagita and we'll look forward to seeing you then. Welcome back to Hawaii Together on the Think Tech Hawaii Broadcast Network. I'm Kayleigh Akina, your host and president of the Grassroot Institute of Hawaii. My guest today is economist Dan Mitchell who's talking to us about our state's fiscal crisis and what can be done about it. We're gonna bring him right back on now. Dan, thanks for standing by. Dan, we've been talking about the fact fundamentally that spending is just not a good practice to keep doing over and over again, especially when you don't have the money and that has gotten us into hot water. So as you look across the nation, what is the best way to deal with such a situation? I think the best fiscal policy is to have some sort of constitutional spending cap. We have that in the state of Colorado. It's called TABOR, the Taxpayer Bill of Rights. Technically it's not even a spending cap, it's a revenue cap. Revenues can't grow faster than population plus inflation. Any revenue above that trend line automatically gets rebated to the taxpayers. But when you look at that, revenue cap combined with their balance budget requirement it gives them, of course, indirectly a spending cap. And that spending cap inflation plus population seems to work very, very well. Texas also has a spending cap, but it's linked to personal income. And of course personal income, especially in a fast growing state like Texas, that grows a lot faster than population plus inflation. So I'm not a big fan of the Texas spending cap. I just don't think it works as well. Now, of course, you can't really complain that much about Texas. Their economy's doing so well. So I guess if you start in a very good spot like Texas, I guess you can allow spending to grow 6% a year. If your personal income's growing 6% a year, at least you're not deteriorating because you started strong. Colorado I think is a better role model though, especially for states like Hawaii that do have a long run problem with government spending and government debt. So if Hawaii put in something that limited spending to say 3% a year or even better, 2% a year, it would still allow government spending to grow. But compared to sort of a trend line of 5% spending growth, 2% to 3% spending growth would force the politicians and the state legislature and the governor's mansion, it would force them to make trade-offs and to set priorities. And the interest groups would have to sort of fight against each other and make the case. Oh no, we want more money for roads. No, we want more money for education. No, we want more money for whatever it is that people want spending out in Hawaii, maybe for the education system, for the universities. I have no idea. But the key thing is just like a business has to sort of set priorities, just like a household has to make decisions of how to allocate income. The great thing about a spending cap is it forces the politicians to actually sit down, squabble with each other, fight amongst themselves, but eventually hammer out a deal within the confines of something that actually promotes responsible long-run fiscal policy. And by the way, I should say, it's not just that Colorado is a good example, both Switzerland and Hong Kong have constitutional spending caps. And those are two of the most successful jurisdictions anywhere in the world. In terms of fiscal policy, Hong Kong, of course, has separate problems with whether or not Beijing is going to crack down, but in terms of fiscal policy, a low rate flat tax, a rapidly growing economy, and a fiscal system that is so strong that there's zero government debt. As a matter of fact, they have almost two years of revenue in the bank. So they could actually collect no revenue for two years and still finance their budget. And Switzerland's economy and their budget is so strong that investors are actually paying money to Switzerland for the privilege of owning Swiss government bonds, which to me is crazy. I mean, you're really going to give Switzerland $100 so that one year from now you get back $99, but that's how strong their fiscal situation is because they have this spending cap that is basically limited the budget, so it only grows 2% a year. Well, Dan, I should have told you at the outset that some politicians watching are probably going to say, but we do have a spending cap in Hawaii, and that is true, but the reality is two thirds of the vote by the state legislature can override it and it has happened virtually every year. Recently, the governor gave his state of the state address in which he announced his budget supplement, and lo and behold, it violates the spending cap. So how do you structure a spending cap so that it doesn't actually get overridden by the legislature? That's a great question because we've had spending caps since 2011 on part of the budget in Washington, the so-called discretionary part of the budget, not the entitlements, and that worked great. We had a sequester back in early 2013, and the deficit was coming down, government spending was under control, but then what happened? Three separate times, or maybe now it's four separate times, politicians in the House and the Senate, in conjunction with the White House, have agreed to bust the spending caps. So you're right, if you have a spending cap in Hawaii, but the politicians can routinely violate it with a two thirds vote, then frankly, do you really have a spending cap? We still technically have the spending caps on discretionary outlays in Washington, but everyone knows now they don't mean anything because every year or two years, they're gonna come to some agreement, the Republicans and the Democrats, the two big spending parties, as I sometimes joke, they're gonna come to an agreement to spend more money. That's why whatever it is they did in Colorado, well, actually I know what they did in Colorado, in Colorado in order to increase revenue, which is what you need to do to get around this indirect spending cap, you have to have a vote of the people. You have to go to the voters and say, can we basically spend more money? They did that actually last year. They tried to basically gut Tabor, so they didn't have to refund the extra revenue to tax pay. And in a state like Colorado, which is really trended to the left, they still understand that Tabor has been a very responsible, good policy, and by a vote of 55 to 45, they voted to preserve Tabor because they know it's a good deal. Now, I'm giving you what's the right design. Of course, the fundamental challenge that you're probably about to ask me is, well, how can we get the state legislature and the governor to support something that will handcuff them? It's like the prisoners are in charge of the prison. Do they want to make it tough to escape? Of course they don't. They want to make it easy to escape. But the people of Hawaii ultimately, if they want to preserve, you have a wonderful state, great place to live and stuff like that, but there are some much needed reforms to make sure that the economy can be strong in the future. About balancing the budget. But what is the fundamental difference between balancing the budget and having spending caps? And why should spending caps be the first place we go? Remember at the start of our discussion in the segment, I talked about this ratchet effect when there's a recession, revenues fall, but then when the economy's growing strong, revenues might increase six, seven, eight, nine, 10% a year. Well, that creates this boom bus cycle when you have a balanced budget requirement. And specifically, there's two problems. When the revenues are coming in strong, politicians can spend a lot of money. That's no good. But when there's a recession, which of course is exactly the time politicians like to spend money to show that they're compassionate, a balanced budget requirement tells them they have to cut spending, which of course is why they usually say, no, no, we'll raise taxes instead, which of course undermines the competitiveness of a state and a job creation and the private sector. You don't want to do that either. The good thing about a spending cap, but let's say that you have a two or 3% spending cap. If there's a recession and your revenues are dropping 5% a year, well, politicians in the state capital can still increase spending by two or 3% a year. But here's the key thing. When the economy is strong and revenues are growing 6%, 7%, 8%, 9% a year, they can still only increase spending 3%, or whatever the spending cap is, I'm using 2%, 3%, you get the point. The key thing is there's a very stable system where revenues, where spending can grow during a recession, but it can't grow rapidly when there's an economic boom. And what's really fascinating about this issue, I come from a free market background. I've been working for free market think tanks. So some people listening to this program, watching this program might be thinking, oh, he's just giving some, you know, hardcore free market message that isn't practical for the state of Hawaii. Here's the amazing thing. The International Monetary Fund, which is definitely not a free market institution. The Organization for Economic Cooperation and Development, which if anything is a less leaning institution, they have both, they're professional economists who work for those international organizations. They have looked at different fiscal rules around the world, and they have both concluded that having a spending cap is the only effective long-run fiscal rule. Now, here's what it boils down to. I think a spending cap unquestionably is the best policy. Now, one of my left-wing friends might say, okay, Dan, I agree with you, but I want that spending cap to allow spending to grow 4% a year. And I'll say, no, no, it would be better than the long-run spending growth 2% a year. That's a decision for the political system. But if we harken back to what we were talking about earlier, the key thing is just to make sure that that spending cap somehow has spending no higher than the long-run projected rate of growth of the state's private economy, which is of course the state's tax base. So I think it should be a low spending cap. Some other people might think it should be a little bit higher of a spending cap, but the key thing, so long as it's not higher than the projected rate of growth of the private economy, you're gonna make progress on it. I think you'll make better progress with a stricter spending cap, but even if the spending cap is higher, as long as it's enforceable, so long as the politicians can't wiggle their way out of it, I think you can make real progress. Yeah, and I just got a quick question in closing. About 23% of our budget in the state of Hawaii is special funds and revolving funds. Is that rather high compared to other states? And should we have concerns about it? I confess I've never seen data on how different states measure things like that. There's lots of data about how much of a state's budget is their own revenue and how much is transfers from water to ocean to that. But I've never seen data on revolving funds and different special vehicles like that. I know that in Colorado, since we talked about their spending caps, give you a quick warning that even with a very good spending cap like that, the politicians are ways to recharacterize taxes as fees so that they can escape some of the responsibility that the table are sending cap and poses on them. So any policy you have, politicians are gonna try to get around it, which just underscores why it's important to have a very well-designed. Very good. Well, Dan, I wanna thank you for your time for being with us today here at the Grassroot Institute on Think Tech, Hawaii and wish you the very best in your continued work there in Washington, DC. Thanks for being with us, Dan. Okay, yeah, thank you for having me on the program. My guest today has been Dan Mitchell, an economist at the Center for Freedom and Prosperity in Washington, DC. I think that he's said some things that are very fascinating and insightful for us as we manage our budget here in the state of Hawaii. I'm Kili Akina with the Grassroot Institute. Until next time, aloha.