This version of 'Kick the Can' will cost us all dearly.

Dr. Paul Rahe is a professor of History at Hillsdale College (to some this is a dubious distinction). But today, he has posted a column on BigGovernment.com that speaks about economics. He takes great pains to describe in very simple language two types of recessions. First, he describes the economic downturn we've all experienced, a business cycle recession:

Downturns occasioned by the business cycle are caused by overproduction. When businesses have more stock than they can sell, they stop producing and lay off workers. The workers laid off and no longer getting paychecks cut back on their consumption, and this in turn reduces the demand for goods and services and causes other businesses, which find their products and services no longer as much in demand, to curtail their efforts and lay off another set of workers. And so the recession grows, building on itself, until some businesses find that they have underproduced or underprovided for the services in demand. Then, the same process takes place in reverse with stepped-up production and a stepped-up provision of services requiring stepped-up employment, which occasions more consumption requiring another round of stepped-up production and provision of services and a further increase in employment and so forth – until production and provision once more overshoot demand. In the absence of perfect knowledge, human beings living in commercial societies are fated to suffer from an oscillation of this sort – between boom and bust.

The second type of recession is a fiscal recession, again from Dr. Rahe:

The last one we experienced in the United States began in 1929, and it was a doozy. Fiscal recessions are a function of the level of indebtedness. The one in 1929 was preceded by an extended period in which the Federal Reserve Board, supported by the Secretary of the Treasury, followed an easy-money policy. Interest was low; money was lent to all and sundry on easy terms; home-buyers and consumers took out loans they could not manage; and investors with borrowed money took great risks in attempts to make a quick buck. Bubbles appeared; and when the stock market finally crashed and the unemployment rate went up, the number of bankruptcies was legion. Those able to manage their debts concentrated on paying them down; and, for a good long time thereafter, Americans were very, very reluctant to take on debt.

Dr. Rahe argues that we are in a fiscal recession. I believe he is correct.

Here is a chart posted on Mish's Global Economic Trend Analysis:

Today we are seeing a correction to this fiscal recession as consumers reduce their debt. And just like in the period after the Great Depression, many families are adapting to a new way of household finance. They are no longer using revolving credit to make purchases. Here is a bit of evidence reported in the New York Times yesterday,

The lowest percentage of shoppers in the 27-year-history of a national survey said they used credit cards over the Thanksgiving weekend, while the use of general credit cards like Visa and MasterCard fell 11 percent in the third quarter from a year earlier, according to the credit bureau TransUnion.

According to Dr. Rahe, "Something like 2.1 million houses are in foreclosure," and "the real estate market has not cleared."

Most local governments receive the bulk of their revenue from two sources: sales taxes and property taxes.

A decline in consumer credit will necessarily mean lower consumer spending, especially on the kinds of goods that local governments typically assess a sales tax (e.g. not food, and not pharmacy). In fact, in Rowlett, TX, sales tax collections from October 2010 are down almost 20% compared to October 2009 (Source: Texas Comptroller of Public Accounts). Property appraisal values are down, and therefore, property tax collections will be down as well.

Add to this mixture, a burgeoning expense to fund the pension system for city employees, and you have the same recipe for disaster that other cities and states are facing. Other governments are addressing their budget problems in diverse ways:

• In San Diego, Mayor Jerry Sanders (the city's former police chief) is pushing to eliminate pension plans for new city employees, offering 401(k)-like savings accounts instead.
• In Wisconsin, Governor-elect Scott Walker raised the possibility of essentially abolishing state employee unions on Tuesday as one option to control rising employee benefits costs and eliminate the state's budget deficit.
• In Houston, Mayor Annise Parker said Wednesday that mandatory furloughs for civilian city employees likely will be used to help close the city's remaining $30 million budget gap.

Add to these maneuvers, a few options specific to pensions such as:

• prohibiting the practice of allowing retiring employees to work hundreds of hours of overtime in their final year, and then counting that pay in determining the pension payment.
• treating new employees differently and by stopping existing employees from accumulating new benefits. (This would require a change in Texas state law)
• requiring employees accept lower benefits. (For Rowlett this might include a reduced match by the city or reducing or eliminating funding for COLA adjustments)
• RAISING PROPERTY TAXES

Like many governments, those responsible for such decisions are more likely to kick this can down the road then to deal with it now. For places like San Diego, Houston, Wisconsin Illinois, and California, the can has hit a wall. My sources tell me that Rowlett's City Council may choose to kick the can just a little bit further.

In this game of Kick the Can, the problem doesn't go away, it only gets worse.