What’s the next best thing to heaven?
Ask any Texan. Or better yet, try Tanya Tucker, born in Seminole, Texas in October 1958. She might just answer you by belting out the first stanza of her smash 1978 hit, “Texas When I Die,” in that gravelly voice of hers:
“When I die, I may not go to heaven
Lee Ainslie's Maverick Capital had a difficult third quarter, although many hedge funds did. The quarter ended with the S&P 500's worst month since the beginning of the COVID pandemic. Q3 2021 hedge fund letters, conferences and more Maverick fund returns Maverick USA was down 11.6% for the third quarter, bringing its year-to-date return to Read More
I don’t know if they let cowboys in
If they don’t just let me go to Texas
Texas is as close as I’ve been”
The point of the song is to glorify the Lone Star State as no other. And make no mistake, true Texans of all ages know and love the song. An out-of-state foreigner might venture that Texas has an ego. Yes, the state, replete with its own rallying cries. Remember “Remember the Alamo!”? Or if you prefer, the modern-day version, “Don’t Mess with Texas!” That last one may or may not have started out as an anti-littering campaign. But Texans cannot be one-upped in the adaptation department.
More recently, a crop of bumper stickers has blanketed the state’s highways and byways. Though state shapes are employed for illustration purposes on said stickers, you see the translation in the title: “Don’t CA my TX!” Ask any Texan about optionality if our taxes (let’s leave it there) even flirt with California’s. They’ll share with you the latest word bandied about: “Texit!”
Let’s use Forbes as the arbiter to explain the corporate and middle class mass departure out of California and into Texas in recent years. In 2016, Texas ranked fourth in Business Costs; California 43rd. Though there are a myriad of contributing factors to the relative unattractiveness of the Golden State, deeply underfunded pensions sit high on the list.
According to one CA resident and close friend, who also happens to be a crack economist, the back-of-the-envelope math works out as such: Stanford figures the state’s liabilities are in the neighborhood of $1 trillion, or $78,000 per household. Narrow it down to her county level, the local liability if you will, and there’s another $2 billion to consider, or $10,000 per household. Now here’s the rub. Double that $88,000 to account for the fact that various groups estimate upwards of half of CA residents don’t pay taxes. For the record, my friend is grappling with moving to a low-tax cold or low-tax warm state. Answer seems obvious but go figure.
The irony is recent headlines might cause her to steer clear of Texas given that the nation’s building pension tension first broke in Texas’ two biggest cities. Legislation is making its way through the Texas State Legislature to overhaul Houston’s firefighter and municipal employee pension. The zinger: the fix involves a cool $1 billion pension obligation bond that would require voter approval. Not to be outdone, subsequently, the Texas House voted unanimously to approve a rescue of Dallas’ Police and Fire Pension, which will also put taxpayers on the hook for a $1 billion, give or take. News that there’s been a run on a pension apparently has a stimulative effect on politicians.
The question is, will Texas begin to lose some of its appeal as the low-cost alternative to just about any other state in the nation? More to the point, are there other states out there that also appear to be dirt cheap but have pricey pension promises that will present themselves the next time markets swoon?
So much for judging low-tax-rate states by their covers. The good news is there’s a somewhat neutral intermediary to help conduct your analysis. You know, the rating agencies. Before you reach through your screen and try to land a knuckle sandwich, consider first that Moody’s and Standard & Poor’s have long been in the business of rating plain vanilla municipal bonds. We’re not talking about securities comprised of toxic mass that’s sliced and diced into credit sainthood. Plus, recent revisions to accounting rules require the agencies to visibly incorporate pension underfunding when scoring credits.
According to a recent Wells Fargo report penned by Wells Fargo Senior Analyst Natalie Cohen, over the last twelve months, this shift in accounting rules has triggered state-level downgrades of Alaska, Connecticut, Illinois, Kansas, Kentucky, New Jersey and West Virginia.
One caveat, especially at the local level, involves termination costs that can be triggered by a downgrade and accelerate payments. Detroit is a classic case in which ‘swap terminations’ tipped the city into bankruptcy. Moody’s, in particular, has devised a methodology to appraise stress using a uniform corporate bond rate; it’s called the “adjusted net pension liability (ANPL)” calculation. Included among those that lost their top credit rating because they had prohibitively high ANPLs are Evanston, IL, Minneapolis and Santa Fe along with a handful of highly-rated Ohio school districts.
It shouldn’t shock that many of the shakiest local credits reside within the weakest states. On a list Wells comprised using Merritt Research Services data, weak pensions contributed to 11 local government downgrades in Illinois, 10 in New Jersey and six in Connecticut. In what can only be described as fiscal hot potato, some states are also increasing the funds school districts are required to contribute to state retirement funds. One case in point: Local districts in Michigan previously contributed 16.5 percent of payrolls to the Michigan Public School Employee Retirement System; that has since been upped to 27 percent. Cohen calls it the ‘State-Local Trickle Down’ effect.
They say that the best laid plans cannot account for random molecules bumping around the universe. The rub is there’s nothing random about the rot spreading across the municipal landscape. The buck will eventually stop somewhere, even as states and municipalities endeavor to shift their growing burdens from here to there to anywhere. If you just squirmed in your seat, you know where this is going.
The theory is taxpayers will take the tax hikes of the future required to rescue pensions lying down, forcing the actuarial armies’ math to finally work out in practice, not fairyland theory. Let’s just say the jury isn’t even hung on such an outrageously optimistic outcome. Targeted residents are much more apt to follow in Cook County’s fleeing population’s footsteps, that is, pull up stakes and move to lower tax states.
Carry this inevitable, albeit eventual, process to its logical end-point and it’s easy enough to envision the United States having a periphery of its own consisting of shallow-tax-base, budgetary-basket-case, junky high-yielding municipal borrowers. Preening at the opposite end of the spectrum are states that have prudently managed their affairs and prevented unions from ruling the pension roost – pristine and pure investment grade municipals.
An aside if you’ve got the ‘G’ in PIIGS on the mind (remember the acronym for the European periphery?), don’t sap your synapses. There will be no Prexit. The Constitution doesn’t allow for it.
As for tax reform, that’s another story. John Mousseau, Cumberland Advisors’ in house municipal maven, recently published a one-pager titled, “Quick Take on Munis and the Trump Plan.” In the report, Mousseau calculates the math behind the lower tax rate that stems from the elimination of the ObamaCare tax on investment income for families making over $200,000 combined with the nixing of the alternative minimum tax. The first blush take is that taxable equivalent yields of 5.30 percent for the today’s 39.6-percent top federal bracket taxpayers will fall to 4.61 percent as the top bracket declines to 35 percent. That slippage, however, is offset by the closure of the loopholes and deductions proposed.
But what about rendering nondeductible state and local income taxes? Mousseau uses the high-income-tax state of California, where the top state tax rate is currently 13.3 percent on income over $1 million, to illustrate the impact of the proposed changes to the tax laws. Under existing tax law, that rate effectively declines to 7.5 percent. Eliminate both the federal deduction for state income taxes and the Obamacare tax and you land right back at 13.3 percent.
The result would be twofold: 1) demand rises for in-state tax-exempt bonds in high-tax states (prices up, yields down), and 2) major resistance on the parts of state and local governments against tax increases and a push to roll back tax rates as state taxes will abruptly and significantly rise from their current levels.
Mousseau’s bottom line:
“From today’s vantage point, we feel that muni bonds, particularly in the intermediate and longer maturities, should face little adjustment under the proposed plan and that the demand for municipal bonds in high-tax states should advance smartly.”
While a wash for municipal bond holders in general, the implication is that high tax states, especially those with deeply underfunded pensions, will find politicians struggling in their efforts to insure escape eludes essential taxpayers.
The next recession will only serve to expedite the exoduses. That will put the onus on DC politicians to ponder the profound, as in how does the country meet the aggregate challenge pensions present? At some point, clinical calculations will clash with the still-angry citizenry. Making matters worse, both pensioners and punished taxpayers are within their rights in feeling as if they’ve been wronged.
Who will represent taxpaying Californians who prefer to grow old enjoying their perfect vistas of the Pacific? For that matter, who will stand up for Texans who darkly joke that the real wall that will be eventually erected will rise up along the state’s northern border?
The closest thing to winners in this war of states are Texas real estate agents who have never had it so good. Loaded with sales proceeds courtesy of ostentatiously overpriced homes, California transplants tend to buy two homes instead of one, so flashily flush are they when they cross over the Red River. While that extra spacious back yard (of course they raze one of the two!) is all good and well for the eager emigrant jet set, the traffic is worse than ever.
So, is there a Texit in the cards? The late Supreme Court Justice Antonin Scalia assured us the answer is no: “If there was any constitutional issue resolved by the Civil War, it is that there is no right to secede.”
Try telling that to a tenacious Texan. As worthy residents of the state, who find themselves belting out Tucker’s gravelly-voice timeless hit racing down a dusty country road with the windows open will tell you, it’s not bond math that defines the allure of life in the Lone Star State. To the many, the proud, such a futile approach is akin to trying to put into words what the wind feels like to someone who has never felt a warm breeze against their face. Why bother? To borrow from another legendary bumper sticker: “I may not have been born in Texas. But I got here as fast as I could.”
Article by Danielle DiMartino Booth, author of Fed Up: An Insider’s Take on the Why the Federal Reserve is Bad for America