The Reality of Renewables

by Rob Gordon

IN EXPLAINING WHY the United States has failed to tap its own energy resources, China’s People’s Daily explains: “The underlying reason is for environmental considerations.” According to the Chinese paper, “It would be a joke to say the US is short of oil.” The American public has figured out the joke’s been on them and is demanding that Washington do something. But the joke—or really, myth—of exhausted supplies is not the only bogus information in the public energy discussion. Another fallacy is that we can simply opt for a “sustainable” economy based on renewable energy.

As Ben Lieberman notes in his article starting on page 4, government efforts to pick winners and losers among energy alternatives has been a fool’s errand. Many in Washington, D.C., however, are bowing at the altar of renewable energy.

Calling some proponents of renewable energy fanatics isn’t itself a disparagement of renewable energy. Renewable sources have a part to play in meeting our energy needs. The fanaticism comes from those who seek to cut crucial energy sources that are somehow “bad” (fossil fuels, nuclear, and even hydropower) and peddle the myth that a renewable energy panacea where “good” energy like biomass, wind, and solar replace “bad” is just around the corner.

Energy, whether it’s the sort favored by renewables fanatics or not, is great stuff. It has created a world in which people have longer lives, the ultimate environmental metric. Physicists define energy as the capacity to do work. As such, it is the oxygen of economic growth. We could save a lot by doing less work—what economists call recession. But while a “sustainable”—read “smaller”—renewables-fueled economy might seem like nirvana to some, it’s not for most Americans. The reality is that if Washington follows the fanatics rather than a secure and affordable energy supply, our policies will generate a mirage that vanishes as we try to compete with a tighter, more expensive, and perhaps less reliable energy supply in an increasingly competitive global economy.

No energy source is good or bad. Each presents different considerations and has different attributes making it more or less efficient. What the much maligned fossil fuels—oil, natural gas, and coal—have that some of the touted renewable sources don’t is that they are energy-rich: Each drop of oil, chunk of coal, and wisp of gas is packed with energy. They are also portable. They can be taken where they are needed and used there. And they are reliable: We know coal will burn to make electricity, natural gas will ignite to heat our water, and gas will combust to drive our engine’s pistons. Those characteristics make these on-demand energy sources. But the future of our energy supply is increasingly in question.

Right now our energy supply is caught between the twin pincers of policies that stymie the most important and efficient energy sources and policies that push the substitution of the less efficient “good” renewables. Subsidies and mandates for “good” energy sources and restrictions on “bad” sources—drilling moratoriums, taxes or caps on CO2 emissions—are common Washington stock-in-trade. And a majority of states have already adopted policies pushing technologies like wind and solar. Despite this political meddling and the hype over renewables, some of the shine is starting to dull.

Ethanol’s political wheels have started to come off—if they haven’t already rolled across the median. Ethanol is kind of a “fossil fuel light.” Fossil fuels are the original biomass energy sources. Geologic processes—immense heat and pressure over time spans—converted biomass into rich energy sources. We are somewhat trying to emulate that process with renewable biomass, but doing so consumes quite a bit of energy itself. And while the fuel produced may be portable and reliable, there are a number of other problems such as the fact that the resources used to make ethanol have alternative uses. Instead of growing corn for ethanol, farmers could grow crops for food or fiber, or the land could be set aside for wildlife habitat. The loss of land for these uses is a real cost—one that consumers in particular have been feeling in the form of higher food prices.

Peaking under wind energy’s hood reveals some squeaks and rattles portending of stormy weather like the biomass squall. While wind-generated power has rocketed upward in absolute terms, its relative contribution was still less than 1 percent of the net electricity we generated in 2006. And that little bit isn’t cheap. Professors Bernard Weinstein and Terry Clover at the University of North Texas report that for every $100 million of investment, wind-power developers received over $74 million in federal tax credits and other benefits, not to mention additional corporate income tax breaks and local property tax abatements in Texas. Just how sustainable is that?

The answer is iffy—but relatively better than it would be for solar. Pointing out any of the freckles and warts of solar is taboo to renewables fanatics. But just like the myth of exhausted fossil fuels, the myth of an imminent solar panacea has got to go.

Sun worshipers point out that the Earth is bathed in sunlight. Perhaps one year’s worth is double the energy packed into all the Earth’s coal, oil, natural gas, and mined uranium. Such factoids are batted about while touting the potential for technologies like photovoltaic panels to capture solar energy. But we can’t blanket the Earth with the panels. Approximately 71 percent of the Earth is covered with water, and Antarctica and forests comprise about one-third of the rest. Do fanatics of renewables really want to replace our forests with solar panel farms? Other areas still are too far north or too far south to capture solar energy efficiently. But what really matters is all the sunshine that escapes the photovoltaic panel itself. After decades and millions of dollars, photovoltaic panels can’t efficiently collect much more than about 10 percent of the sunshine that hits them. This is not to say that there isn’t solar energy to be tapped, just that there’s even more hype.

There are sufficiently sunny places, but they’re not always where you need them. And as the three rules of real estate say, location matters. Solar energy isn’t really portable, and the greater the distance between where it’s collected and used, the more is needed. It’s just a law of physics. Energy is lost when it’s transferred over power lines—actually, a lot of it. So plunking solar panels in the Arizona desert to power New York City isn’t such a hot idea.

This reality is one of the reasons many solar advocates focus on distributed generation, i.e., putting things like photovoltaic panels close to where the captured energy will be used. Yet, according to Severin Borenstein, Director of the University of California Energy Institute at Berkeley, the cost of electricity generated from photovoltaic panels located near the point of consumption is too large for solar panels to be competitive. His analysis shows that even when plausible estimates of the value of reducing greenhouse gases are included, “it does not come close to making the net social return on installing [photovoltaic panels] today positive.”

Photovoltaic panels require a fair amount of space. Unlike relatively energy-rich fossil fuels, uranium, or even a flowing river, solar energy is diffuse. To meet U.S. electricity needs with solar panels we’d have to blanket thousands of square miles. That’s a huge footprint compared to the three square miles or so needed to tap the immense quantities of energy resources in the Arctic National Wildlife Refuge.

Then there’s the weather. Even in places where there’s lots of sunshine, solar isn’t 100 percent reliable. You can be sure, though, that the sun doesn’t shine at night, which means that solar power must be backed up by some other source.

The bottom line is that these realities, not energy executives, are to blame for keeping the adoption of solar energy so limited. Solar power’s contribution to our net electricity generation in 2006 is measured not in tenths but hundredths of a percent—about one one-hundredth of 1 percent to be precise. And while wind now has far more potential than solar, it suffers from many similar problems.

It would be great if technological breakthroughs change these realities. And some entrepreneurs certainly are trying. According to Dow Jones Venture Source, investment by venture capitalists in U.S. companies was down about 12 percent in the second quarter compared to last year. Despite the down tick, renewable energy set a record with 26 deals pulling $650 million, and solar companies accounted for the top three second-quarter deals.

Kudos (and huge profits) to the entrepreneurs who develop the next big energy source. As soon as a renewable or another energy source becomes competitive, those who want to make a buck supplying it will do so. However, at best, policies that mandate renewables and stymie other energy sources complicate the task of figuring out just what energy sources and technologies would truly be the most efficient. At worst, built upon the idea that a renewable panacea is just around the corner, such policies will generate more problems than energy and seriously threaten a secure future for all Americans.


Mr. Gordon is Senior Advisor for Strategic Outreach at The Heritage Foundation.

The Allure of Public/Private Development

by Doug Kaplan

A FEW YEARS AGO, I ran into the administrator of the Santa Cruz County Redevelopment Agency. Our real estate development company had recently completed a small office building located on the periphery of the agency’s 3,760-acre redevelopment project area and the new tenant, Charles Schwab and Co., was ready to move in. After saying nice things about the building, the redevelopment administrator asked me: “How did it go?”

“Construction was uneventful,” I told him, “but getting permits was a nightmare.”

“You should have come to us,” he said. “We could have helped you.”

And he certainly could have helped us, since, as an executive director of a California redevelopment agency, he had at his disposal an arsenal of powerful weapons that he could deploy in aid of our project: He could exercise the power of eminent domain to seize our neighbor’s property, which he could use to augment our site; he could issue tax-free municipal bonds, which he could use to help finance our project; and perhaps most importantly, he had access to a priceless fast track through the tortuous regulatory and entitlement process.

We didn’t need more land. We didn’t need financing. As for his willingness to serve as our Virgil guiding us through the dark worlds of planning and building departments, that would have been tempting, but, as I said to the administrator, helping us navigate our way through his and his colleagues’ convoluted procedures was not the best use of his time.

“You’re the government,” I told him. “I don’t want you to do more for me; I just want you to do less to me.”

He didn’t understand. He just stared at me with the same perplexed expression that I’ve seen so many times on the faces of other redevelopment directors, economic development coordinators, members of committees with names like “Task Force for Economic Revitalization,” consultants hired to craft “Economic Development Strategic Plans,” and other well-meaning government officials who were dumbstruck by my response to their question, “How can we help?”

Our county’s economic development officer didn’t understand when I accepted her invitation to join her economic development task force, but on one condition: The task force would hold a single meeting during which we would agree to submit a one-page report to the county supervisors suggesting that the major obstacle to economic development was the supervisors themselves.

A local city manager and his economic development director didn’t understand my reaction to their invitation to form a “public/private partnership” to transform the blue-collar town’s former post office into a white-tablecloth restaurant. “If you really want to revitalize the downtown,” I told them, “then light the sidewalks, fix the roads, take care of the police, support the schools… .” The city manager interrupted: “Doug, people are shooting each other outside city hall. The council wants me to do something now!”

Today, in my home state of California, almost 400 cities and counties have gone into the development business by establishing captive government development agencies (typically, but misleadingly, called redevelopment agencies) that now control project areas covering more than 1.2 million acres, representing almost 15 percent of the assessed value of all real property in the state. These powerful agencies are sitting on war chests containing just under $10 billion in cash (as of June 30, 2006), which they are using to lavish subsidies and favors on large retailers, hotel operators, shopping center developers and other “public/private” partners. Meanwhile, business owners and developers like us, who choose to remain independent, are forced to run an ever-expanding gauntlet of government-imposed regulatory, administrative, and financial obstacles that make our work difficult and sometimes impossible. Today, a private developer faces a difficult choice: Go into business with the local development agency, or go it alone at great cost and peril.

Though this choice is rarely made explicit, sometimes it is. For instance, when San Jose shopping center owner Dennis Fong refused to cooperate with the local redevelopment agency, the agency responded by voting to seize Fong’s property through eminent domain and transfer it to the agency’s “public/private” partner in a competing project across the street. (The agency partially excused its action by claiming that it would be too “confusing to national retailers if two developers were recruiting tenants at generally the same time for the same market area.”)

More often the choice to join forces with the local government development agency is presented subtly, even innocently, such as the time the Santa Cruz County redevelopment administrator said to me: “You should have come to us. We could have helped you.” But however presented—whether as a threat or a friendly offer—the message to the development community from cities and counties across California and much of the nation is consistent: “We’re no longer just fee-collecting regulators; we’re now developers. We write the rules, we referee the game, and now we want to play. You’re welcome to walk onto the field alone, but do you really want to?”

A Development Odyssey

We walked onto the field alone when we began the Schwab project. Let me tell you what it was like.

Hello, Anybody Home? Before we could begin construction of the 2,700-square-foot Schwab building—about the size of a normal home—we needed a building permit, but before we could apply for a building permit we needed a “development permit,” which is best understood as a permit to apply for a permit. At the time, our county Planning Department would not accept walk-in applications for development permits, nor would it allow walk-in attempts to schedule an appointment—it would only accept telephone requests for an appointment. That presented a problem, however, since the employee responsible for scheduling appointments only accepted phone calls during a brief window of time once a day. We knew from previous experience that we would face tough competition from other applicants, all of whom would be trying to get through to the sole scheduler so, in anticipation of the problem, we ordered a service from the phone company called “repeat dialing,” figuring that this would help us snag an open line. Unfortunately, the County Planning Department was one step ahead of us: It had recently installed voicemail, so even though we could now get around the constant busy signal, we could only leave a message. We did get through—to voicemail—and we did leave our message, and then, like a nervous actor waiting for a callback after the big audition and afraid to wander more than 10 feet from the phone, we waited. Everybody in our office was told that if anyone from the Planning Department called: “Drop all other calls. Don’t put the department on hold. Don’t take a message. Make an appointment!”

This Will Only Take a Moment. We were fortunate: Our building was tiny and our project unopposed, so our permits only took 20 months to process.

Just One More Department. We submitted 17 sets of plans that were routed to the 14 separate departments, agencies, and individuals who were charged with issuing the dozen separate approvals we needed to build our 2,700-square-foot building. By the time we were finished, we had passed an all-too-familiar milestone in our community: The number of government employees involved in the review and processing of our permits outnumbered the number of construction workers who would eventually build the building.

A Few Conditions. The planners assigned to our project loved to write reports. The environmental coordinator wrote a report for the project planner who produced a 45-page report for the zoning administrator who generated reports for the Planning Commission, which made recommendations to the Board of Supervisors. Everybody got reports. All these reports were finally distilled into a 12-page development permit, which contained more than 60 conditions, including a last-minute surprise that granted us permission to build an office building, provided that not more than half of the building was used for offices. Buried in a chart that was buried in the county’s zoning code, unnoticed by us and unnoticed by our project planner until late in the application process, was a requirement limiting the amount of office space within the “C1” commercial zone to no more than 50 percent of a building’s floor area. Our only remedy was to apply for rezoning—a half-year-long ordeal that would take us before the Planning Commission and Board of Supervisors.

Money, Money, Money. We paid about $40,000 in fees, which worked out to about $15 per square foot of building area. This does not include the cost of public improvements that we were required to build, nor does it include the cost of consultants and engineers that we hired to respond to the Planning Department’s endless requests for additional information. Altogether, we paid 27 separate fees, some more than once. One of these fees, the application fee, was charged “at cost,” which meant that the planner assigned to our project billed us $73 an hour for his time (which probably accounts for the 45-page reports).

Rules and Regulations. We had to comply with the Uniform Building Code and the Americans with Disabilities Act—that was a given—but we also had to comply with the jumble of rules and regulations buried in our county’s 1,184-page zoning code, the County General Plan, and County Design Review Ordinance. We had to comply with prevailing wage regulations since our water connection was deemed a “public project.” We also were caught in the clash of well-intentioned but often contradictory regulations issued by autonomous agencies like the fire district, water district, sanitation district, Redevelopment Agency, Federal Emergency Management Agency, and Regional Water Quality Control Board. (When the rules and regulations of autonomous bodies conflict, heaven help you, because nobody else can.)

A Matter of Taste. We hired a talented architect who designed a handsome building. Our project planner agreed; nevertheless, he regretfully informed us that we would have to redesign the building since it did not comply with a county design review regulation that dictated that all new development must be compatible with the surrounding neighborhood. Our building was not compatible, he said, and indeed it wasn’t. The immediate “neighborhood” consisted of an adjoining office building that we owned, a freeway that ran along the western boundary of the project, and a fast food restaurant and run-down gas station on opposite corners across the street.

We walked into the Planning Department in October 1996 seeking permission to build a tiny office building. We walked out in May 1998—nearly 20 months and over $40,000 later—shell-shocked but still standing, with permits in hand. As I later told the redevelopment administrator, the project from that point forward was uneventful and just six months later—one-third of the time it took to get permits—Charles Schwab & Co. moved into its new office.

A Story of Government Planning

Meanwhile, a different story was unfolding elsewhere in the county’s 3,760-acre redevelopment project area. Here are just the highlights, with a prologue that begins in the 1980s:

1980s. Orchard Supply Hardware, Nob Hill Foods, Home Depot, and other retailers consider building stores within the boundaries of the future project area. All abandon their plans after preliminary discussions with a demanding and often hostile county government. (Orchard Supply, for example, after completing preliminary studies, discovers that the county will demand nearly half a million dollars in impact fees and, like the others, walks away.)

1987. The county forms its own government development agency.

1990. The new government development agency seeks advice from the retail consulting firm of Keyser Marston Associates, which subsequently produces a report titled “County of Santa Cruz Retail Development Potential.” The $38,000 report does not mention the retailers who explored opening stores in the county but fled after learning what it would cost, but it does find that the county is underserved and concludes with six “key findings”:

  • Among the department stores, Macy’s, Ward’s, and Nordstrom are absent.
  • There are no fashion specialty stores in the county.
  • Among discount/department stores, Target, Whole Earth Access, and Wal-Mart are absent.
  • Among promotional tenants, about 35 Northern California tenants are not represented.
  • There are no warehouse retail operations in the county.
  • There are no catalog showrooms in the county.

(As an aside, some county residents wonder why the agency paid a consultant $38,000 to learn which stores are not in the county.)

1991. The County Board of Supervisors adopts the following economic development goals:

● “The Board will undertake appropriate economic development projects to increase local government revenues in order to provide expanded public services to the community.” (Translation: “We need money, so let’s develop something.”)

● “The Board will seek to coordinate and to act as a clearinghouse for economic development activities throughout the county.”

September 1994. The county’s in-house economic development coordinator submits to the Board of Supervisors an Economic Development Strategy Implementation Plan, which, among other recommendations, calls for the creation of a County Economic Development Strategic Action Team that will coordinate development of nine targeted industries, including “recycled manufacturing … high-tech recreation equipment design and manufacturing … Biotech … [and] marine sciences.”

November 1994. The administrator of the county’s redevelopment agency tells the supervisors that the agency is ready to enter into a public/private partnership to pursue an “exceptional project.” He writes that the “use of both eminent domain and financial assistance should only be used when there are overriding public benefits and where it can be demonstrated that such assistance is necessary for the project to proceed. While there are few projects which would meet such a test, there are some exceptional projects which will warrant such special consideration.”

1996. The agency and its public/private partner commence the “exceptional project”—a two-store retail center for Circuit City and Toys “R” Us.

Elsewhere in Santa Cruz County, city development agencies were doing the same thing. In the City of Watsonville, at the southern end of the county, the government development agency had demolished an entire city block, displacing 29 businesses, some of which had been operating in the same location for nearly 30 years—all to make way for a public/private development that never materialized. At the northern end of the county, in Santa Cruz—a city notorious for making life miserable for private developers— the government development agency ejected long-established, locally owned businesses to clear land for a public/private shopping center anchored by Cost Plus, OfficeMax, and PetSmart.

Today, in cities and counties throughout California, government development agencies are doing the same.

Planning Means Control

Does it really matter that local governments have become one of the driving forces behind commercial development in California and elsewhere in the country? It does.

First of all, government development agencies undermine the laws and traditions that curb the ability of our elected officials to impose their individual tastes on the rest of us. When an Oakland city council member said, “In a very progressive city like Oakland, Wal-Mart is not a favorite store. Target might be,” the audience could dismiss the comment as the personal taste of a young professional attorney. But the moment she and her colleagues adjourn their council meeting and immediately reconvene as the city’s development agency—poof!—like Clark Kent stepping out of the phone booth as Superman, she is instantly transformed into a public official with the means, money, and power to impose her tastes on every shopper in the community.

But it is more than just a matter of taste. Government development agencies give public officials extraordinary power to protect individual self-interest. In the mid-1990s, shortly after the popular owner of the City of Santa Cruz’s largest bookstore completed his term as mayor and a director of the city’s development agency, the agency inserted unusual conditions in its development agreements for two public/private projects near the former director’s bookstore. One agreement, which was for a large downtown retail/office complex, included this condition: “… no part of the Site shall at any time be used as a bookstore operated by a national retailer of books.” The second agreement, which was for a major public/private shopping center project, prohibited bookstores altogether.

Government development agencies are also guilty of driving up the cost of doing business, particularly when it comes to land values. In the early 1990s the San Jose Business Journal reported: “The San Jose Redevelopment Agency paid $2 million, or $182 a square foot, for the 11,000-square-foot San Jose Metropolitan Chamber of Commerce building in downtown San Jose in March. Almost every other building sold in 1992 went for less than $100 a square foot, and many went for less than $50 a square foot.” More often than not, local governments don’t catalyze private development; they drive it away by making it too expensive. A variation of the same theme came up during my conversation with the city manager and economic development director who wanted to give us money to turn their town’s old post office into a white-tablecloth restaurant. “You won’t attract developers, you’ll drive them away,” I told them. “If I was the next developer to come along and I wanted to put a nice restaurant in the Lettunich Building (which was located one block away), I wouldn’t because I could never compete with your subsidized restaurant. You can’t be just a little pregnant,” I said. “It’s all or none. If you subsidize one business, you have to subsidize them all.”

Government development agencies also contribute to the homogenization of America’s cities and towns. Swing by the Las Vegas Convention Center in the middle of May and you’ll see why. Every spring, at the annual meeting of the International Council of Shopping Centers, you’ll find government officials from villages, towns, and cities across the country who have come to Las Vegas to woo the nation’s largest retailers and developers. They offer lavish subsidies to land big deals, which is just one more reason that “small is beautiful” is morphing into “bigger is better,” and “national chain” is trumping “locally grown” in communities nationwide.

Finally, and most importantly, government development agencies undermine communities. Jane Jacobs, in The Death and Life of Great American Cities, alluded to this when she wrote: “Successful city districts are never dotted with junkyards, but that is not why these districts are successful. It is the other way around. They lack junkyards because they are successful.” In other words, “A city area … is not a failure because of being all old. It is the other way around. The area is all old because it is a failure.” She understood what government development advocates have difficulty comprehending: Public development is something done for a community, not by a community, and therefore is more likely to harm than help.

Government development officials use words like “building” and “plan” as nouns. Their agencies produce a plan; they deliver a building or project. But in vibrant communities, words like “plan” or “building” are primarily verbs: a talented chef planning his own restaurant; a co-op owner remodeling her flat; an immigrant couple juggling multiple jobs, saving so they can start a business; even a grumpy developer on the prowl for tired buildings to restore—people, all day, every day, planning and building a better life for themselves and their families, friends, congregants, customers, and community. When government development officials step in, take over, and do for people what people want to and should do themselves, these officials are substituting their plans and structures for the life, spirit, and activity that is a vibrant community.

The next time a government development official determines that something “cannot be accomplished by private industry acting alone,” he or she should ask: “Why not?” If the answer is too much government interference, then the solution is less interference, not more. Or think of it this way: If cutting taxes, reducing fees, and streamlining regulations benefits government’s public/private partners, then think what miracles could occur if government did the same for everyone. Do less to us and watch us have fun taking care of the rest.


Mr. Kaplan is co-founder of the Lomak Property Group, Inc. This article is excerpted from his longer article “Simplify, Don’t Subsidize: The Right Way to Support Private Development,” published by the Institute for Justice, June 2008.

Who Will Tell the People? Medicaid Has Ruined Arizona’s Finances and It’s a Prelude for the Rest of the States

by Michael S. Greve and Philip Wallach

This year and for many years to come, the state of Arizona—where Goldwater conservatism was born—will face significant budget deficits. The culprit, say Michael Greve and Philip Wallach, is the skewed incentives that the federal Medicaid program gives to the states. Moreover, they say, the problem will overtake almost all the states soon unless something is done to fix it. Medicaid is an uncapped federal matching grant program, which means states that expand Medicaid eligibility and coverage are rewarded with additional federal dollars. Expanding the program is cheap, but cutting it is expensive. A state that decides to save a buck on Medicaid loses federal dollars in the bargain. Such matching-grant programs, say Greve and Wallach, “ratchet up spending and taxes and tend to exacerbate the states’ boom-and-bust budget cycles.” But the problem goes far beyond this simple imbalance of incentives. By and large, public officials understand how Medicaid undermines state government finances, but none are talking about it. Arizona lawmakers, whose hands are tied by constitutional limits on their budgetary discretion, have resorted to raising revenue by increasing fines on motorists and allowing more debt. As for the other states, the state governors all want more federal dollars coming their way. As Greve and Wallach note, since the locus of the problem is the incentives of a federal matching-grant program, federal lawmakers will have to take the lead in finding a solution. Especially worrisome, therefore, is the fact that many federal lawmakers see Medicaid not as a problem at all; rather, they see Medicaid expansion as a preliminary act for their mother of all solutions: nationalizing health care. Those who want to preserve and expand private health insurance have their work cut out. —Editor

 

ALL IS NOT WELL in Senator John McCain’s home state. Confronted with a general fund budget shortfall of more than $1.3 billion, the Arizona legislature in June enacted modest cuts (primarily in community college and prison budgets), a stepped-up traffic enforcement system to produce some $90 million in speeding tickets, and $2 billion in new debt—half of it to close the hole in the $10.9 billion budget. (The other half will fund university construction.) The budget is a stopgap measure that bodes ill both for next year’s budget and for the state’s fiscal future, and no Arizona politician pretends otherwise.

Measured as a percentage of the state’s fiscal year 2008 general fund, Arizona’s projected FY 2009 deficit was the most serious shortfall of any state, exceeding even California’s. Cyclical factors contributed: Arizona is heavily exposed to the meltdown in the subprime mortgage market and its attendant economic and fiscal consequences. But then again, Arizonans have long enjoyed a relatively modest, broad-based tax burden imposed on an economy that has for four decades been among the fastest-growing in the nation. How did the state get into such a pickle?

In an April 2008 Wall Street Journal op-ed of uncommon chutzpah, Arizona governor Janet Napolitano attributes her state’s travails to Washington’s alleged failure to “pay its bills.” Characterizing supposed cuts in federal transfer programs—including contemplated and rejected cuts—as federal “debts” to the states, she maintains that “Arizona would not be in deficit this year” if Washington paid up on only a few of its obligations. The governor could not be more wrong. Arizona’s fiscal crisis is due chiefly to the state’s expansion of its Medicaid programs. That decision, in turn, is largely attributable to the perverse incentives created by Medicaid’s inordinately generous transfers to the states. To oversimplify slightly, states get into fiscal trouble not because the feds shirk their obligations, but because they have made promises to pay in the first place. While Arizona’s problems are exacerbated by a dysfunctional political system, the state’s predicament illustrates a pervasive structural crisis.

Arizona’s fiscal crisis is due chiefly to the state’s expansion of its Medicaid programs. That decision, in turn, is largely attributable to the perverse incentives created by Medicaid’s inordinately generous transfers to the states. To oversimplify slightly, states get into fiscal trouble not because the feds shirk their obligations, but because they have made promises to pay in the first place.

Taxes, Spending and Federal Transfers

Despite a relatively conservative political climate, Arizona used to be a high-tax state. Over the decades, however, Arizona’s tax burden has remained roughly constant, while that of many other states has risen. As a result, Arizona has improved its position relative to other states. By the most widely used measure (the Tax Foundation’s index of state tax burdens), Arizona is now near the median in terms of combined state and local tax burden on citizens.

Over the past decade, however, restraint on the tax front has been accompanied by a lack of spending discipline. Between 1997 and 2006, inflation-adjusted per-capita state spending increased from a previously stable level of roughly $3,300 to over $4,200.

Two factors explain the situation. First, Arizona has outperformed the U.S. economy for four consecutive decades. The 1990s were especially kind to Arizona, as the real size of its economy nearly doubled between 1990 and 2000. Sustained economic growth covered budgetary decisions that might otherwise have proven unsustainable.

Second, generous federal transfer payments have helped Arizona expand the size of government without commensurate tax increases. Federal spending in the state rose from $6,823 per capita in 2000 to $8,039 in 2005 (in 2007 dollars). In FY 2009, federal transfer payments to the state are expected to amount to $8.31 billion, or 28.6 percent of the state’s expenditures.

In Arizona, as elsewhere, federal funding principally sustains the service sector rather than the physical infrastructure. Three functions—health, welfare, and education—account for over 90 percent of federal transfers. The agency receiving the most funds is the hilariously misnamed Arizona Health Care Cost Containment System (AHCCCS), which administers the state’s Medicaid program. AHCCCS has for several years accounted for well over half of all federal funds received.

Like many smaller states (especially in the Southwest and Mountain West), Arizona has been a net beneficiary of a “cooperative federalism” that shuffles tax dollars through Washington, D.C., and returns them to the states. The state’s balance of payments has been consistently positive, meaning that federal transfers have exceeded Arizona taxpayers’ federal tax payments.

However, the fiscal effects of federal-to-state transfers are not unambiguously positive, even for net recipient states like Arizona. While federal grant programs may have some fiscal substitution effect, on balance they increase state and local taxation and spending. By making program expansions look cheap and making cuts look outrageously expensive, federal matching grants ratchet up spending and taxes and tend to exacerbate the states’ boom-and- bust budget cycles. All else equal, those effects increase in proportion to the matching program’s size and generosity.

Far and away the biggest federal transfer program, accounting for $190.6 billion—43 percent of all federal transfer payments to states and localities in FY 2007—is Medicaid. The program features a very high federal funding ratio coupled with highly decentralized spending authority and a lack of effective federal fiscal or program control. Arizona’s experience illustrates the malign effects of that form of fiscal decentralization.

Medicaid: The Arizona Experience

Under Medicaid, the federal government reimburses between 50 percent and 77 percent of a state’s qualifying expenditures, depending on the state’s wealth. Put differently, a state can purchase a dollar’s worth of Medicaid health services at a cost of less than 50 cents to itself. Less happily, it cannot cut a dollar from its domestic budget without “losing” federal transfers. Table 1 shows Arizona’s basic fiscal calculus with respect to Medicaid and the related, even more generous federal State Children’s Health Insurance Program (SCHIP).

Table 1: Perverse Incentives 
Arizona’s Incentive to Increase Spending Arizona’s Incentive Not to Reduce a Matched Program
With a Medicaid matching rate of 66.2 percent, for each dollar Arizona spends on Medicaid, the federal government sends the state $1.96. To reduce state Medicaid spending by $1, Arizona would have to reduce total Medicaid spending by $2.96
With an SCHIP matching rate of 76.34 percent, for every dollar Arizona spends on SCHIP, the federal governments sends the state $3.23. To reduce state SCHIP spending by $1, Arizona would have to reduce total SCHIP spending by $4.23.

Medicaid is an uncapped entitlement program, meaning that total as well as federal costs are unconstrained by any federal fiscal limit. Federal programmatic controls are likewise weak. While Medicaid mandates the coverage of certain services and populations, the lion’s share of expenses is incurred for “optional” services for beneficiaries (especially the elderly), which the states may, but need not, provide as a condition of federal funding. Throughout the Bill Clinton and George W. Bush administrations, the federal government has readily granted the states waivers from Medicaid mandates and limitations. Some states now cover families with incomes of up to 275 percent of the poverty level. Almost all provide long-term care for the poor and low- income elderly. In a few states, one-third of the population is now on Medicaid. In Arizona, about one-fifth of the population receives health care coverage through AHCCCS.

Due to its structure, Medicaid has been the primary cause of a huge increase in federal grants to the states. For example, the real per-capita size of Medicaid grants has grown almost exponentially (see figure 1).

Unsurprisingly, Medicaid expenditures constitute an ever-growing share of state expenditures. In 1987, that share amounted to slightly more than 10 percent. In 1992, the number was 17.8 percent; in 2006, 22.2 percent.

In Arizona, the crowding-out has been far more severe and rapid. The state’s involvement with Medicaid did not begin until 1982, with the creation of AHCCCS. Previously, Arizona had been the only state to reject federal Medicaid funds. (Individual counties provided a piecemeal system of health care for the state’s indigent.) AHCCCS was the first statewide Medicaid program to use managed care, offering recipients a variety of private and public health plans that channeled them into private physicians’ offices. As recently as 2002, AHCCCS was cited as a model Medicaid program.

But AHCCCS has since caused much fiscal and budgetary trouble. These difficulties can be traced to the enactment of Proposition 204 in 2000, which substantially expanded Medicaid-eligible populations and services. Proposition 204 significantly loosened eligibility requirements for several AHCCCS programs. (For example, it allowed persons with incomes above the poverty line to spend down their income on medical bills to qualify for coverage.) The background and origins of that fateful voter referendum merit a brief discussion.

In 1998, state attorneys general and the country’s major tobacco companies signed the so-called Master Settlement Agreement (MSA), which established a nationwide regulatory regime for the sale and marketing of tobacco products and, moreover, entitled the states to a stream of payments, originally estimated at $206 billion over the first 25 years of the MSA. (Arizona’s share of those proceeds is 1.5 percent.) Nominally, the payments were supposed to make the states whole for past tobacco-related health care expenditures under Medicaid. On that interpretation and under then-extant law, the greater portion of the recovery should have reverted to the federal government, which had incurred those expenses in the first instance. The states, however, persuaded Congress to amend federal law so as to allow them to keep the entire recovery.

In a fine illustration of Medicaid’s incentive effects, many states decided to leverage the “recovery” of expenditures they had not incurred into a second payment stream of federal dollars by devoting the tobacco payments to Medicaid programs. That, in substance, was the intent behind Arizona’s Proposition 204. Each MSA windfall dollar spent on Medicaid, the calculus went, would bring in another $1.96 from the federal government.

In one sense, Proposition 204 paid off: after a prolonged downward drift, federal funds as a proportion of Arizona’s total spending rose as Proposition 204 kicked in. The collateral effects, however, have been harrowing. Medicaid spending in Arizona was slightly over 10 percent of total spending in 1987. It hovered around 15 percent in the years prior to Proposition 204 and then rose sharply. One could argue that Proposition 204 simply brought Arizona—to that point a Medicaid “laggard”—up to the standard of other states. As figure 2 shows, however, Medicaid spending in Arizona now exceeds the average spending level.

Contrary to the pro-204 campaign rhetoric at the time, it soon became clear that the MSA funds (and the federal dollars that they leverage) would not remotely cover Proposition 204’s expansion of the Medicaid population and services. As a result, general fund spending on Medicaid has also risen very sharply. Medicaid spending has increased from a relatively stable pre-204 level of roughly 8 percent of general fund spending to a projected 14.4 percent in FY 2009. The raw numbers are more bracing. In 2000, Arizona general fund spending on Medicaid was just $463 million. That figure is projected to grow to $1.5 billion in FY 2009, representing a threefold increase in less than a decade.

The extent to which one attributes Arizona’s budget travails to Proposition 204 depends on the baseline. Had the state shifted a chunk of preexisting general fund Medicaid obligations to an MSA payment fund (as opposed to trying to leverage those funds into additional federal payments), it would have confronted no fiscal crisis at all. Had it held Medicaid general fund spending constant at 8 percent (that is, in line with other expenditures), the FY 2009 shortfall would still have been less than half the $1.3 billion-plus amount—still not a pretty picture, but far more manageable. Slice the numbers as you will, though: Medicaid and Proposition 204 are the principal culprits. No other factor or set of factors comes close.

Among the more demoralizing aspects of the Arizona legislature’s budget debate is the fact that Medicaid and Proposition 204 have gone virtually unmentioned. While the legislature’s research staff has consistently supplied sophisticated analyses of the basic facts and trends, no politician wants to tell the voters the truth. Putting aside the awkwardness of attacking a popular referendum, the political absurdity of proposing a three-dollar cut in services for a mere dollar in domestic savings has stopped even Goldwaterite legislators in their tracks. Those forces in Arizona politics resisted Medicaid participation until 1982—when the program was a shadow of its present self—because they knew that to play the game was to concede it. And so it has come to pass.

Is Arizona Special?

Medicaid and Proposition 204 have only just begun to wreak their havoc in Arizona. MSA tobacco payments have fallen well below predicted levels and will continue to fall, due mainly to declining smoking rates. Revenues from the aforementioned tobacco tax fund are affected by the same trend, which is further exacerbated by the fact that Arizona law forbids smoking in just about any public place except in Indian casinos. In short, Medicaid expenses will increasingly be paid out of the general fund.

The Arizona legislature is arguably the nation’s most constrained legislature. It can do little to avert a fiscal train wreck, thanks largely to the conjunction of Proposition 204 with two other referendums. Proposition 108, adopted in 1992, requires a two-thirds majority in both houses to make a net increase in the state’s revenue collection, thus effectively taking tax increases off the table. More fatefully, the 1998 Arizona Voter Protection Act requires a three- fourths majority of legislators to alter spending on programs created by referendum. Proposition 204-required spending is locked in unless three-fourths of both houses of the legislature vote to overrule.

The option of finding offsets for increased Medicaid spending elsewhere in the budget is illusory. Only the general fund and “other appropriated funds”—less than half of all state expenditures combined—are actually subject to the legislature’s appropriation authority. “Other” appropriated funds are earmarked, and even within the general fund, about 60 percent of spending is essentially nondiscretionary, as it is automatically set to increase or decrease each year. Thus, short of closing down community colleges and state prisons (or, perhaps, launching an aggressive pro-smoking campaign to raise short-term revenues and long-term mortality rates among Medicaid consumers), the Arizona legislature can do only what it has, in fact, done: enact phony cuts, use traffic enforcement as a revenue device (not a tax and therefore not subject to the Proposition 108 two-thirds requirement), and issue a pile of new debt.

No doubt, the constraints on the Arizona legislature’s budgetary authority have reached troublesome dimensions. And, no doubt, the unintended consequences of a profusion of referendums—enacted one at a time, without any serious consideration of their aggregate effects on institutional practices—ought to give pause to conservatives who believe that populism and government restraint usually go together. But while those features of Arizona politics have exacerbated the crisis in that state, the root cause is Medicaid’s incentive structure. As the “all states” curve in our graph suggests, no state has been able to resist the lure of providing “free” services for pennies on the dollar. Every state has to wrestle with the attendant fiscal displacement effects. Arizona is special (if at all) only in that most other state legislatures can resort more easily to tax increases. Arizona instead resorted to aping the Bush administration’s major domestic policy innovation: the tax-free, debt-only finance of a major public health program.

No state can avoid the choice between more debt or rip-roaring tax hikes, combined in some way. The only plausible solutions to the states’ Medicaid-induced fiscal troubles are to be found in Washington. Those solutions, however, have foundered and will continue to founder—paradoxically, due to the opposition of the states.

No Way Out

It is tempting but wrong to view Medicaid’s stupendous, irresistible growth trends and its effects on state budgets as accidents. Medicaid is designed to be fiscally unsustainable—but politically self-sustaining.

Health insurance and health care are the subjects of an intense debate between proponents of government-provided health care and advocates of more consumer choice and competition. In that fight over inches of political territory, Medicaid hands a decisive advantage to the government health care camp. First, the program expands inexorably when Congress does what it does best, which is nothing. Second, Medicaid effectively enlists the intergovernmental lobby—the National Governors Association, the National Conference of State Legislatures, and their sister organizations—in a campaign for government- provided health care. In principle, everyone knows how to make Medicaid fiscally sustainable, both for the federal government and the states: cap the program at some level and perhaps recategorize the populations and services that qualify under the program. All states, however, regardless of party and fiscal condition, unanimously denounce even rhetorical gestures in that direction. Opposition to the state lobby’s “give us more money” demands—the very root of the states’ financial troubles—looks like an ideological crusade rather than a rational policy response to a real problem. Hence, it fails.

Medicaid has created a political wonderland: To a man and woman, public officials who know the program to be ruinous to their states nonetheless clamor for more of the same. There is no will or incentive in Washington for a call to reality—not among Democrats, who rightly view Medicaid (and SCHIP) as HillaryCare on a bicycle, and not among Republicans, who are receptive to the intergovernmental lobby’s call for “states’ rights” and its clamor against “unfunded mandates” (and never mind that Medicaid is neither). Eventually, Medicaid will fall victim to the late Herbert Stein’s law: Something that cannot go on will eventually stop. No one knows on what terms it will stop. We do know this, though: Before it stops, there will be a lot more Arizonas.


Dr. Greve is the John G. Searle Scholar at the American Enterprise Institute. Mr. Wallach is a graduate student in political science at Princeton University. This article is adapted from their paper “As Arizona Goes, So Goes the Nation: How Medicaid Ruins the States’ Fiscal Health” published by the American Enterprise Institute, July 2008, available at www.aei.org/publications/pubID.28340/pub_detail.asp.

Celebrate the Constitution with the Bill of Rights Institute

by Victoria Hughes

SEPTEMBER 17 IS CONSTITUTION DAY. For every citizen who honors and upholds that document’s principles, this is a great day to celebrate and a great opportunity to educate our fellow citizens about what it means to be an American.

A last-minute provision to the “Consolidated Appropriations Act of 2005” transformed Constitution Day from a rarely recognized date into a major opportunity to educate Americans about individual liberty, limited government, and the responsibilities of citizenship. This federal law requires schools—from kindergarten through university—that receive any federal funding to teach students about the United States Constitution on September 17. This requirement creates a demand for information that is easily accessible, accurate, and engaging to students as well as a general audience.

Most people believe knowledge of the Constitution is a key component of national identity, according to a recently released poll by the Bradley Project on National Identity. Eighty-six percent of respondents believe that there is a unique American identity based on freedom and opportunity secured by the Constitution including freedom of speech, religious liberty, and private property. Respondents younger than 35 years old were more likely to hold that there is no unique American identity.

In response to the opportunity offered by Constitution Day and the importance of increasing knowledge about the Constitution, especially among young Americans, the Bill of Rights Institute has developed a wide range of Web-based activities and education programs that focus on the Constitution, the Founders, and what it means to be an American. Web-based activities include an interactive Constitution Day Quiz, Constitution Jeopardy, and a Constitution Crossword Puzzle to test knowledge of our Founding document. A flash animated game, “Madison’s Notes are Missing,” transports players back in time to interview 12 Constitutional Convention delegates, including George Mason and Alexander Hamilton, about key issues discussed at the Convention in Philadelphia.

In addition to the constitutional principles, the Bill of Rights Institute spotlights the character and lives of the Founders with Founders Online. This Web feature offers opportunities to meet the Founders with downloadable portraits, short audio biographies, and thought-provoking quotations from the great Americans who shaped our Constitution including well-known figures such as James Madison (the Father the Constitution), and lesser-known figures such as South Carolina’s Charles Pinckney (Constitution Charlie).

The Bill of Rights Institute invites citizens to download and print the 12-page Celebrate the Constitution booklet. With topics ranging from First Amendment freedoms to American heroes, the booklet offers educational ideas to engage Americans of all ages. All of these Web-based resources can be found at www.BillofRightsInstitute.org/ConstitutionDay.

Since its founding in 1999, the Bill of Rights Institute has focused on increasing young Americans’ knowledge of the Constitution, the Founders, and the rights and responsibilities of citizenship. Working with a network of constitutional scholars and outstanding classroom teachers, the Bill of Rights Institute is reaching one-third of high school and middle school classes in American history, civics, and American government. More than 35,000 teachers from all 50 states have registered to receive our printed instructional material and electronic eLessons. In addition, over 14,000 teachers have attended our Constitutional Seminars conducted in 45 states and the District of Columbia to increase their own background knowledge of America’s founding principles.

Recently, the Bill of Rights Institute launched a variety of student programs to engage young people directly with these important ideas. The Institute’s student programs include a Web site, www.DoYouHavetheRight.org, that features changing monthly themes, and an online study guide to the Constitution for students to explore. Constitutional Academies conducted in Washington, D.C., for high school students who want to deepen their understanding of America’s Founding principles, are offered for college credit. For students who enjoy the challenge of competition, the Bill of Rights Institute organizes a Constitution Bee patterned after the National Spelling Bee.

The Institute’s largest student program, the “Being an American” essay contest, challenges high school students to reflect on the civic values that most define our American character. In the past two years, over 17,000 students from 19 states and the District of Columbia responded by writing essays citing documents such as the Declaration of Independence, the Constitution, and the Bill of Rights; referencing great Americans including George Washington, Thomas Edison, and William Lloyd Garrison; and focusing on responsibility, respect, courage, perseverance, and love of liberty. The contest will be available to students in all 50 states beginning in September and can be found at www.BeingAnAmerican.org.

This school year, 90 prizes will be awarded to “Being an American” essay contest winners and their teachers totaling nearly $200,000. Also, the top 27 essayists and their teachers will be brought to Washington, D.C., where they will participate in an awards gala and an educational program on America’s Founding principles from March 29 to 31, 2009.


Ms. Hughes is President of the Bill of Rights Institute. She can be reached at vhughes@BillofRightsInstitute.org.

Why Conservatives Need Good Documentaries

by Jay W. Richards

THOSE OF US IN THE CONSERVATIVE AND FREE MARKET MOVEMENT are fond of quoting the title of Richard Weaver’s famous book, Ideas Have Consequences. Weaver is surely right. Even a superficial study of history shows that certain ideas, usually beginning in academia, do have consequences. If we didn’t believe that, most of us would probably be doing something else.

Still, ideas all by themselves don’t do anything. To be consequential, ideas have to be spread and eventually implemented. But how do ideas developed by a few academics end up shaping the views of millions of ordinary people? In a 1949 paper, “The Intellectual and Socialism,” Friedrich Hayek argued that public intellectuals played a crucial role in translating academic ideas, like socialism, for the wider population.

In the decades since Hayek wrote his essay, the conservative movement has expanded profoundly. Following Hayek’s analysis, there are now scores of think tanks incubating ideas that, if implemented, would change our culture for the better. And we don’t hide our ideas under a bushel. The movement also has many public intellectuals in almost every form of media, from talk radio and television commentary to blogs and bestselling trade press books.

But there’s still a gap in what I call the “aesthetic media,” as distinct from the news media, which includes everything from art and music to dramatic films and documentaries. In this area, we are behind the curve. Aesthetic media is both a form of communication and an art form. And whether we like it or not, aesthetic media, and especially visual media, influences almost everyone. Recent studies suggest that the average American derives more information from visual media than from any other source. In less than two years, video content has flooded the Internet, and there’s no sign of it slowing down. That’s a problem, because while we’ve been developing and publishing clear and cogent ideas, and expanding the visibility of our public intellectuals, the Left has mastered these forms of communication that now shape what most people believe.

With few exceptions, we aren’t really competitive with, say, Michael Moore and Al Gore. Moore has no economic expertise, but his ideas on the economy probably influence more people than the world’s most prominent economist. And Al Gore is no climate scientist, but can anyone deny his worldwide influence in the debate over global warming? Both of these men are perceived as experts because they translate (often inaccurately) the ideas of intellectuals using one form of visual media—the documentary. In this way, the views of left-wing public intellectuals have become more amplified than even Hayek could have imagined.

Of course, much visual media is persuasive primarily by being pervasive. Most advertising falls into this category. But a few forms, like documentaries, can be powerful tools of communication, because they allow one to combine message and metaphor in a way that can be entertaining, educational, and persuasive. Few other genres allow expert testimony and arguments (message) alongside narrative, visual effects, symbolic imagery, and score (metaphor). Five seconds of partisan sermonizing can ruin an otherwise good action movie. Not so with the documentary. With documentaries, you can make an argument. For that reason, if we really want our ideas to have consequences, we need to enhance our ability to create good documentaries.

Of course, lots of people try to produce documentaries. Some succeed. But most fail. For conservative think tanks and policy groups, the difficulty can be even more acute, since our commitment to facts and arguments doesn’t often mix well with the aesthetic disposition needed to make good visual media.

To succeed, I think we need to balance two competing but also complementary tendencies. The tendency of “idea and movement” people is to see visual and other media as a means to an end. Our primary interest in a documentary is bound to be its message. This is as it should be. We’re in the idea business after all. In making films, however, this commitment to our message might lead us merely to transliterate our arguments into video, rather than to translate them into an entirely different medium of communication. A white paper isn’t a trade press book. And a trade press book isn’t a video documentary. A white paper turned into a documentary is easy to recognize because, well, it’s really bad.

In contrast, most filmmakers tend to see a film in aesthetic terms, and as an end in itself. Most filmmakers prefer metaphor to explicit message. They squirm when they see evidence and premises pushed to a clear conclusion. This is a valuable tendency, since, like it or not, most people’s beliefs are shaped by much more than argument. But it is also dangerous. A filmmaker’s commitment to the artistic merits of a film can sometimes override his commitment to the truth or the clarity of its message.

At the extreme is Ron Mann, director of Go Further and Comic Book Confidential, who said: “All documentaries are propaganda … . There is no such thing as objective truth, only point of view.” Unfortunately, this is a common conviction among those on the far Left: You tell your lies; I tell mine. May the better propagandist win. This is not a conviction we should ever entertain. We should tell the truth, insofar as we are able.

But that doesn’t mean we can’t try to persuade and entertain. It doesn’t mean we can’t appeal to sentiments and emotion. It doesn’t mean we have to avoid symbolism and high aesthetic standards. It means that we must do all these things while preserving good arguments and evidence, and without trying to manipulate the emotions of viewers.

That’s an extremely tall order. Still, what we seek to create are products with high artistic merit that also make our points persuasively. I think the best productions—and the most persuasive ones—will be those that best balance and integrate these competing tendencies, that best combine metaphor and message. We already have the right ideas. Now let’s do the hard work of learning to disseminate them effectively in a world increasingly dominated by visual media.


Dr. Richards is a research fellow at the Acton Institute and the director of Acton Media. He is the executive producer of The Call of the Entrepreneur (2007) and The Birth of Freedom (2008).

 
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