The Boston Phoenix November 30 - December 7, 2000

[Features]

Prosperity's thin veneer

Signs are mounting that the long economic expansion may be slowing -- or worse. That could spell trouble for local political leaders. Is the public ready for tough choices?

by Seth Gitell

As ugly as the post-election events in Florida have been, they only underscore the fact that the fat, easy days of the Clinton era have ended. The economic boom times are over -- yet politically, no one seems ready to deal with it. We're entering a new, more difficult fiscal climate, and the local big four -- Governor Paul Cellucci, House Speaker Thomas Finneran, Senate president Thomas Birmingham, and Boston mayor Thomas Menino -- are going to see their jobs get a lot harder.They've got, among many other new costs, a tax cut to fund, Big Dig overruns to cover, and a new ballpark to pay for. But in the coming years, returns from tax receipts will decline.

THE BIG FOUR: Celluci, Finneran (top), Menino, and Birmingham (bottom) will have to figure out how to pay for the new tax cut, Fenway Park infrastructure, Big Dig overruns, and rising health-care costs even as tax revenues fall.


What's happening now is a mirror image of what occurred as Massachusetts emerged from the last recession. Back then, most people -- shell-shocked by the recession of the late 1980s and early 1990s -- were locked into a recession mindset through the mid '90s, well after the slump had ended. Even though the economic recovery -- if not the economic boom from which we're now emerging -- was well under way, people still approached business dealings as if the economy had been in a slowdown.Nothing epitomized the disconnect between the national public mood and the economic turnaround more than the New York Times series "The Downsizing of America," which chronicled the thousands of layoffs that had taken place during the early part of the decade. Now it's just the opposite: recent consumer-confidence surveys -- such as the private index put together by the University of Michigan -- show that people still think times are good. But the evidence suggests otherwise.

Take the bursting of the Internet bubble. Reuters reports that a record 8789 jobs were cut from the Internet sector in November -- just six percent of the total 137,000 new American jobs reported by the Bureau
of Labor Statistics in October, but still significant. And the venture-capital-fueled Internet craze is what has sustained economic growth in Massachusetts for the past 24 months. Even if the epidemic of dot-com shut-downs fails to measure up to the demise of Digital, Wang, and other Route 128 companies a decade ago, the collective Internet-industry implosion will weaken the region. The stock of the once-vaunted Internet incubator CMGI of Andover is down 93 percent since January,and its much-heralded multimedia venture, iCast, will be shut down by the end of the year. Other dot-coms with a sizable local presence -- such as MotherNature.com and Furniture.com -- have met the same fate.

Optimists downplay these closures, saying the labor market is so tight that those displaced from failed dot-coms can quickly find employment elsewhere. But unemployment claims overall suggest that joblessness may be inching up. These claims rose to 7000 last week -- a new two-year high, and much higher than economists had anticipated. Sure, many of the laid-off HTML wizards will find new jobs; but they won't find ones offering the financial rewards they've come to expect. Many of the stock options, the carrot leading techies to put in all those long hours, are worthless. Union organizing has even taken place among Amazon's warehouse employees, who now complain about being underpaid -- although they didn't complain when the stock was on the sunny side of 100.

It's hard to measure the economic costs of diminished expectations -- but they're significant nonetheless. "If it affects spending, then it affects the economy," says Cynthia Latta, the principal US economist for Standard & Poor's DRI. "Just what that is going to do to spending, we don't know. People may scale down. If you were going to buy a Ferrari, maybe you'll buy a different kind of car -- or maybe you won't buy a car at all."

In the meantime, it's impossible to sugarcoat the exposure facing all the service companies that work with dot-coms. What are all those PR companies, law firms, and office-supply companies going to do? It's been less than a year since white-shoe law firms in Boston jacked up their pay scales to slow the bleeding of talent to tech companies. Testa, Hurwitz & Thibeault, for example, raised salaries for first-year associates 40 percent from $100,000 to $140,000. Hale & Dorr did likewise, offering its first-years $125,000. Now that those tech companies aren't so eager to recruit new talent -- or may even have gone out of business -- those law firms will have to make some decisions. Eventually they'll have to decide whether to scale back those pay raises or stop hiring so many new attorneys.

The spate of business closings also means that venture capitalists, previously so free with their dollars, are now taking a jaundiced view toward new investments. "The barriers on venture capital have definitely been raised," says Latta. "It's a lot harder to get venture capital now. A lot of the venture capital that went into Internet companies in the last several years was simply burnt up. That money is gone and there's nothing to show for it."

Furthermore, energy prices are skyrocketing. New England's major banks are seeing a deterioration in credit quality among the region's big retailers -- payments are coming in more slowly. Office-supply store Staples saw its third-quarter earnings drop by eight percent. Likewise, Gillette's earnings are below what experts expected of the South Boston company. The authoritative survey of the National Association of Purchasing Managers -- always on the frontline of economic fluctuation -- reports that more people think business is bad than good; this statistic usually leads the other indicators by three months. And the Boston Business Journal reported last week that both corporate-tax revenue and business excise-tax receipts in the state are down -- 2.8 percent and 5.6 percent respectively. No one is saying we're in a recession -- and we're not, it takes two consecutive quarters of negative gross national product for that. But things are getting worse. Message to Bay State pols? It's time to start worrying.

All this sounds alarmist, you say. Isn't the new luxury development Millennium Place almost sold out? Don't all outward appearances suggest the economy is continuing to hum along? Don't be so sure. Economists say one of the hallmarks of an incipient downturn is evidence that appears contradictory: one thing looks good, one thing looks bad. The consumer-confidence surveys say things are great; the purchasing-managers' survey says just the opposite.

Jill Thompson, a senior economist at FleetBoston Financial, says the positive economic climate of the past several years has been powered by consumer spending, not by high-tech industry. In fact, consumer spending -- financed largely by consumer and other kinds of debt -- has grown by five percent a year for the past four years. Ordinary consumers are spending more because they're buoyed by the stock profits of others -- a phenomenon she calls "vicarious spending." Mortgage and credit-card debt is up 40 percent, she points out. But given the dramatic increase in heating-oil prices for this winter, combined with the dip in the S&P 500 this year and the 32 percent drop in the NASDAQ since the beginning of the year, Thompson figures the economy is in for a bit of a shock. "Consumers who are already stretched by debt are going to find themselves tapped out," she says. And the longer it takes for this to happen, "the bigger the slowdown will be."

To date, these economic developments have been discussed in a vacuum -- as if the trends mattered only on CNBC's Squawk Box. But the new situation will directly affect leaders on both Beacon and Capitol Hills.

All politicians like to take credit for the budget surpluses at the state and national levels. But a major funding source for the government's coffers has been the taxes on people's profits from playing the stock market. The nonpartisan Massachusetts Taxpayers Foundation estimates that roughly 40 percent of the 10 percent increase in the state's revenue growth over the past several years can be attributed to capital gains -- and this may be a conservative estimate. Take away those profits and you take away the taxes on them. Because of losses in the second and third quarters this year, some investors may declare stock-market losses -- further reducing their tax payments.

As much as everyone has lauded the Clinton-era boom as a period of growth, some of its foundations may not be as sound as generally believed. A major New York economic expert echoes Thompson's assessment: "When the boom is built on leverage, the down cycle tends to be worse than people think." But here's where the problem for the Commonwealth is particularly severe. Not only is Massachusetts at the center of both the tech and money-management economies -- the State Street Corporation, for example, rebuilt North Quincy single-handedly on the back of the Wall Street boom -- but the state also did exactly the wrong thing at a precarious time: it reduced the revenue stream flowing into the treasury. The most optimistic view of the current slowdown is that the economy is experiencing what Federal Reserve chairman Alan Greenspan refers to as a "soft landing." But even a "soft landing" will wreak havoc on the state's lawmakers.

Only a few months ago, Governor Paul Cellucci campaigned successfully for the Question 4 income-tax cut. If the boom vanishes, much of the substantive argument for the tax cut vanishes with it. The passage of a new tax benefit for charitable giving will further reduce the state's share of the wealth. And with a slower economy, that means a smaller reservoir of funds available for state taxation. "All these initiatives for either decreased taxes or increased spending are coming at exactly the wrong time," says Thompson. "You're going to look at sharply lower revenue growth in the next year. It may take them a year or two to figure that out at the government level."

Two people who had better figure out the new environment quickly are Governor Cellucci and Mayor Menino. For Cellucci, a declining economy will put him up there with Michael Dukakis, who presided over the last major recession. Cellucci's pro-tax-cut rhetoric will be exposed as dishonest in the face of a budgetary shortfall.

The Tax Equity Alliance for Massachusetts opposed Question 4 for, among other reasons, the possibility that the tax cut would make it harder to fund many of the programs the group views as vital to a healthy state -- education, health care, housing. In the context of an economic downturn, TEAM's arguments carry more weight. "A phenomenal economic growth spurt can mask a variety of fiscal sins," says TEAM's executive director, Jim St. George. "On the downside, I don't care how good a fiscal manager you are. How do you write a budget that has long-term stability in it when there's so much less money available?"

Although the impact of Question 4 will be muted to a degree because it is being phased in over three years, its arrival in conjunction with a possible downturn may still cause pain. This is especially true given some of the financial commitments the Commonwealth must honor in the coming years. Cellucci, for example, must continue to fund the Big Dig, including potential cost overruns that have not yet come to light. The state has pledged $114 million to fund services for mentally retarded adults, and faces potential legal exposure for keeping mentally ill adults in psychiatric hospitals because there aren't enough outpatient services. An even bigger budget buster is health care. Right now, health care makes up 25 percent of the state budget. With health-care costs -- most in the form of Medicaid reimbursements to hospitals -- well outpacing inflation, even maintaining current benefit levels will become more difficult for the state. As costs increase, less money will be available for other needs, such as roads and bridges or education. The one-two punch of Question 4 and the probable slowdown will make it harder to fund the state's new pharmacy program for seniors, which cost $100 million this year. In a slightly chillier economic climate, the Commonwealth may not be able to bear the cost of another Harvard Pilgrim-style meltdown.

"In the end, nobody can divine the future. It's not out of the question that several things can go wrong at once," says Michael Widmer, the president of the Massachusetts Taxpayers Foundation.

Warren Tolman, a former Democratic state senator and a 2002 gubernatorial aspirant, says that "in a number of areas, we've had an opportunity to act and we've squandered it." Tolman cites health-care insurance, early-childhood education, and the state's infrastructure as areas leaders could have targeted, but didn't.

Another Democratic gubernatorial hopeful, Steve Grossman, puts the blame more directly on Cellucci: "Paul Cellucci painted a very rosy picture indeed about this year's tax picture. If it turns out he was overly optimistic, that might not be that much different from his prediction that the Big Dig would be on time and on budget during the 1998 election campaign."

Nor is Menino immune from trouble. The mayor had a tough time raising the $3 million -- cut by the governor -- that he needed for his summer-job program this year. With less money available, providing the city services that have become the mayor's bread and butter will become more difficult. In a worst-case scenario, Menino could become vulnerable when he's up for re-election next fall.

The political disputes of recent times have been the debates of plenty. The good times have allowed politicians in these parts to coast. The most serious challenges have involved diversionary trifles, such as the effort to build a new stadium for the Boston Red Sox. What will happen when these guys are actually tested, which a slower economy will do? Of the big four, Finneran and Birmingham are both better suited to weather the storm. Finneran, whose fiscal prudence has earned him criticism over the years, could benefit because he'll argue that that's what his tough-minded philosophy was for. And Birmingham could profit because FDR-style positioning always seems to hold appeal in tough times. Expect him to wrap himself in the flag of serving the poor should the economy worsen. But if the next budget process resembles the interminable 1999 budget negotiations, both will pay the price.

For his part, Birmingham has his eye on the possibility of an economic downturn. "Whether or not our economy slows has a significant effect on determining the impact of the more than $1 billion tax cut," Birmingham said in a statement provided to the Phoenix. "The combination of reduced revenues and an economic downturn would provide an unwelcome challenge." He pointed out that a potential slowdown could hinder the state's effort to provide $17 million in fuel assistance to state residents. "With the Cellucci-Swift tax cut being implemented we are less able to provide this type of warranted assistance," Birmingham said. "If the economy slows, then the revenue decline will be felt, and should oil prices continue to rise, it is clear that the state's ability to help ordinary residents cope is diminished."

Much as the Florida fracas has riveted the country's attention on national politics, a significant economic downturn could direct the Commonwealth's focus back to its political leaders. The human pain caused by any serious dip in the economy -- or even a recession -- is a high price to pay for political involvement. Some of that pain could probably be averted if the current political gang paid attention to problems now afoot, rather than sweeping them under the rug as Dukakis did during his presidential run in 1988.

Are our leaders up to the challenge?

Seth Gitell can be reached at sgitell@phx.com.


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