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By Nicole Gelinas

After The Fall: Saving Capitalism From Wall Street--and Washington

City Journal

Nicole Gelinas
Help Us, Governor Spitzer!
This crusading reformer has his work cut out for him.
Winter 2007

Many New Yorkers, dismayed at Albany’s sleaze, dysfunction, and stagnation, are cautiously optimistic about Eliot Spitzer as the Empire State’s new governor. After all, the former state attorney general ran on a platform of “wholesale reform, so that we can collectively get back to effectively dealing with the real problems of our state.” As Spitzer put it in one campaign speech, he’ll do to State Street what he did to Wall Street: open up a “system that is controlled by special interests . . . that is not efficient, is not open, and [is not] transparent.” Maybe he’ll put the fearless spirit with which he relentlessly attacked what he saw as private-sector corruption to work on the state level, too.

Trouble is, the new governor’s proposed reforms won’t come close to the heart of the problem, which runs very deep—deeper perhaps than Spitzer dares to let himself recognize.

There’s no question that New York’s already national notoriety for political corruption is worsening. Recently, and most spectacularly, Democratic comptroller Alan Hevesi, the state’s fiscal watchdog, resigned in a felony plea deal over his misappropriation of public resources for personal use. Republican state senate majority leader Joseph Bruno announced in December that the FBI is investigating his outside business practices, doubtless to see if he has exploited his legislative position for illegal gain. Right behind Hevesi and Bruno come Democratic state senator Efrain Gonzalez, Jr., indicted by the feds for misdirecting nearly $500,000 in pork-barrel legislative spending to his personal accounts, and Democratic assemblyman Brian McLaughlin, facing federal racketeering charges for stealing over $2 million through embezzlement and kickbacks, including $95,000 from Little League teams. It would be hard to go much lower.

As-yet-unprosecuted corruption is rife in major state programs. The New York Times reported last year that the state’s $45 billion Medicaid program loses up to $4 billion a year to fraudsters—such as the dentist who billed for 991 procedures supposedly done in a single day and ambulette companies charging for phantom rides. And Gonzalez’s indictment was only the beginning of federal investigations into the state legislature’s $170 million-per-year slush fund of “member items,” doled out by Bruno and Assembly Speaker Sheldon Silver to vote-rich community groups to protect incumbents’ seats, or to lawmakers and their districts, often to benefit those connected to the pol in question. (Silver himself gave more than $1 million last year to the Metropolitan Coordinating Council on Jewish Poverty, whose CEO is married to the speaker’s chief of staff.)

New York State has been unable or unwilling to clean up this mess. Though an Albany prosecutor indicted Hevesi, the feds—rather than state authorities—are working the cases against Bruno, Gonzalez, and McLaughlin, for example. Ironically, while Spitzer as attorney general claimed that he unleashed his prosecutorial hounds on Wall Street because federal agencies weren’t rooting out wrongdoing there, federal agencies have gone after New York public corruption in recent months because Spitzer never launched a systemic investigation in his own backyard.

That’s why a key job for Governor Spitzer—and one that it’s reasonable to expect him to take on, given his background—must be a major crackdown on public-sector fraud against New York taxpayers. Spitzer can rely on a tool befitting a star prosecutor: the Empire State’s century-old Moreland Act, which allows him to vest a team of investigators with subpoena powers to examine any aspect of state government. Over the decades, governors have used the act to scrutinize everything from nursing-home horrors to school-construction overruns. One 2006 Republican gubernatorial candidate, former Massachusetts governor Bill Weld, had pledged to launch a Moreland Commission on his first day in office to examine New York government, top to bottom.

In investigating state government corruption, Spitzer can draw on his own considerable prosecutorial experience. As attorney general, he excelled at using his subpoena power to dredge for documents at Wall Street firms and find evidence of illicit activity, while creating easy-to-follow PowerPoint presentations to make his intricate legal cases luminously clear to reporters—a skill that would come in handy in explaining to New Yorkers how, exactly, some state officials are abusing the public trust.

He’ll also benefit from his well-tended reputation for honesty. Since his election as governor in November, Spitzer has maintained that reputation by appointing professionals rather than political hacks to some key posts, such as Patrick Foye, a reportedly incorruptible corporate lawyer, to head the Empire State Development Corporation, a huge public authority that has long been a patronage-rich home for top fund-raisers and other political cronies.

But while illegal corruption wins headlines, it isn’t, by a long shot, New York’s most pressing problem. The larger issue is that much of the state government is today a legal racket. Many of the programs that the state funds or runs have become a kind of machine for shaking down taxpayers and funneling ever more of their money to special interests, who in turn shovel campaign contributions back to the legislators who do them these favors, working to keep them in perpetual power. It’s this legal racket—a conspiracy against the public—that Spitzer will have to dismantle if he really wants to turn New York around.

New York’s Medicaid program, nearly as large as next-largest California’s and Texas’s together, is the racket’s biggest component. It provides almost every imaginable service, including Viagra, fertility treatments, and lightly regulated services that seem designed to invite fraud, such as ambulette rides to and from doctors’ appointments. Medicaid’s spectacularly high reimbursement rates for inpatient services have long served as a life-support system for the state’s hospitals and nursing homes. And New York just covers more people: nearly one out of every five state residents participates in the program, including children of working parents, who could pay for insurance through their employers. The New York City health department notes that Medicaid paid for 52 percent of the babies born in the city last year.

Other states, such as Florida, have taken steps to reform Medicaid long before spending got as out of control as it has in New York. But Albany has never made a serious effort to reform the program. And overhauling it would be a hard slog, since the state’s entrenched and manifold Medicaid interests spend millions a year in political contributions and lobbying to keep things as they are. Just look at who heads the list of Albany’s leading political action committees and lobbying groups. According to the New York Public Interest Research Group, fully one-third of the $6 million spent by New York’s top 16 PACs in 2004 came from groups benefiting from Medicaid money, among them Dennis Rivera’s powerful Local 1199 of the Service Employees International Union (SEIU), which counts the state’s hospital workers among its members; the Empire Dental PAC; and the Pharmacy PAC.

The $3 million or so that this vast Medicaid industry spends annually on lobbying Albany clearly pays off. For instance, when then-governor George Pataki tried to pare a mere $4 million—not even a rounding error in the state budget—from the Medicaid program a couple of years ago by cutting funding for the private ambulette firms, senate chief Bruno swiftly restored the spending. Maybe he worried that elderly people wouldn’t be able to get to their doctors’ appointments. But, more likely, he blocked reform because a well-connected Albany lobbyist for the ambulette owners—so well connected, in fact, that he happened to be Bruno’s son Kenneth—entreated the legislature to resist the cuts, as the New York Post noted. (Bruno fils has stopped lobbying in order to start his own law firm, focused partly on personal-injury cases.)

Even the fact that Local 1199 didn’t protest last fall’s blue-ribbon state commission’s recommendations to close or reconfigure 58 state-subsidized hospitals isn’t a sign of the union’s weakness but of its Medicaid-bolstered strength. The recommendations were only a very modest start toward overhauling the state’s health-care system, and the closures won’t result in any net job losses. Had the commission tried to go further, its members doubtless realized, union opposition surely would have crushed it. For evidence, consider the tough warning that Local 1199’s Rivera and his ally, Greater New York Hospital Association head Kenneth Raske, issued with their tacit endorsement of the hospital downsizing: “There is simply no need for further cuts. Not only is there no need, there is an affirmative obligation to oppose them. Make no mistake: Medicaid budget cuts would doom the commission’s recommendations to failure.”

Right behind Medicaid spending are the huge sums that the state doles out for its 264,000 employees and its retirees. (The sheer size of the 1.3-million-strong state and local government workforce in New York State is staggering. As the Manhattan Institute’s E. J. McMahon notes, “One out of every eight New York workers is a unionized government employee; the ratio averages one out of 19 in the rest of the country.”) New York State has about 14 state government workers per 1,000 residents, compared with about two eighty years ago. And while these workers earn generous salaries relative to what they’d get in comparable private-sector jobs, especially upstate, it’s their guaranteed pension and health benefits that are really squeezing the state financially—nearly $5 billion annually (with municipalities shelling out even more).

State and local workers, including teachers, collectively bargain with their public-sector employers for their fat health-care benefits. But the governor and state legislature oversee their pensions, and unions learned long ago that they could get lavish benefits from Albany, despite the objections of the local and county governments that have to pick up the tab for their employees. In 2000, for instance, public-sector retirees won a permanent cost-of-living hike from the legislature and Pataki that costs New York City alone a whopping $1 billion annually. Pataki signed into law more than two dozen other sweeteners for Gotham workers during his tenure (and the legislature passed dozens more that he refused to sign).

Reforming pensions will be another Herculean task—and not just because New York State’s constitution protects benefits awarded for past service, so that any changes will have to be prospective. Public workers and retirees are committed voters and activists, forming a key component of local and state candidates’ get-out-the-vote drives, particularly effective in elections with low turnouts. The state’s public-employee unions also spend a lot on PACs and lobbying—about $4 million in 2004, excluding the teachers. Further, lots of nominally private-sector interests have a stake in seeing the state’s $145 billion pension fund grow even larger. Investment managers and lawyers reap millions in fees each year through managing New York’s money; plus, subsidized housing projects and other state-supported enterprises win when the state or city pension fund decides to “invest” taxpayer money in such projects. Perhaps because the interests are so powerful, Spitzer said nothing about pension reform in the agenda that he laid out in his State of the State address in January.

New York’s skyrocketing public education costs are another harmful product of the racket. New York spends the second-highest per-pupil amount in the nation on its public schools—nearly $14,000 a year—and it boasts the fifth-highest average public school teacher salary. Helping to secure and protect such generous spending is the teachers’ union, an Albany colossus that ponies up millions every year to state PACs and lobbyists and that provides get-out-the-vote troops in state elections. The teachers are pushing hard to establish universal pre-K, which would reinforce union ranks and cost taxpayers hundreds of millions more annually, and Spitzer has endorsed the idea in his State of the State address.

New York spends over 10 percent of its income-tax revenues—or $3.4 billion annually—on a ten-year-old program beloved by the teachers’ union called School-Tax Relief. STAR provides homeowners a partial exemption on the school-tax portion of their property taxes, seemingly insulating suburban homeowners, especially, from the full impact of those sky-high taxes. But in fact, all STAR does is shift some of the burden of school spending to the income tax, paid principally by affluent taxpayers throughout the state, who might now bear an even greater burden, because Spitzer has indicated that he intends to exclude wealthy families from the exemption. Because STAR imposes no cap on school spending, it has the perverse effect of encouraging local school districts to hike spending, since their own taxpayers don’t bear the full burden of those increases. That’s partly why, as the Manhattan Institute’s McMahon notes, local property taxes per student rose at twice the inflation rate during Governor Pataki’s final term. Nor does all the spending make New York kids smarter; they come in a mediocre 20th on the feds’ list of eighth-grade reading scores, ranked by state.

New York’s muscular teachers’ union also hurts innovation. Unionized teachers are behind the state legislature’s refusal to expand the number of privately run, often nonunion, charter schools in New York, even as parents desperate for a new approach flock to the existing 100 charters, necessitating lotteries to determine admission.

New York State’s special interests don’t just force up state taxes. They also drive up local government spending by getting legislators to impose or keep on the books onerous regulatory and legal mandates. Take the longstanding Wicks Law, which forces municipalities to award four separate contracts on building projects worth over $50,000, instead of hiring one general contractor, who could achieve efficiencies that would keep expenditures down. The result: costs as much as 40 percent higher on recent small-town building projects. Indefensible as Wicks is, construction unions, another Albany power, have persuaded Assembly Speaker Silver—whose influence in that body is virtually absolute—to derail all efforts to repeal the law.

Absurd personal-injury claims, including claims for pain and suffering, hammer New York municipalities, too. Gotham alone pays out over $500 million in awards and settlements each year, up nearly eightfold since the late seventies, after adjusting for inflation. Costs are so high, the city’s law department explains, in part because “even when a jury finds the city only slightly at fault,” state law requires Gotham to “foot the whole bill.” Abuses abound, including a case in which a driver, high on cocaine and heroin, swerved wildly around a New York City sanitation truck, injuring three pedestrians. A jury found Gotham 23 percent at fault—the truck driver might have made an illegal turn—but the city had to pay the full $18 million awarded.

To reduce such unjustifiable payouts, New York’s cities and towns have long petitioned Albany to set up a court of claims, modeled on the one that the state uses to adjudicate claims against it. Under such a system, appointed judges, not softhearted jurors, would hear claims and determine liability. But yet another Albany conspirator against the public—the trial lawyers’ lobby—has foiled sensible change, again by rallying the powerful Silver to its side.

Not that it had to work too hard. Silver’s support for the litigious status quo is even more self-interested than it appears. Consider one huge trial-lawyer payout during the nineties. As Albany reporting vet Jay Gallagher describes the case in his book The Politics of Decline, two adult brothers, Virgil and John Brown, climbed over a railing at Coney Island and jumped off a pier into shallow water, breaking their necks. The brothers made headlines when they won a $104 million judgment against city taxpayers (later cut by two-thirds by an appeals court). Who represented the Brown brothers, taking home an estimated $8–12 million fee for his trouble? Attorney Harvey Weitz, a former associate of Silver’s at a prominent tort-law firm.

Off the books, the New York racket has one more way of transferring money from the public to special interests: the state’s gigantic system of 640 or more unaccountable public authorities, laden with over $40 billion of state-backed debt. The authorities run everything from trains, bridges, tunnels, and roads (the Metropolitan Transportation Authority and the Thruway Authority) to vaguely defined “economic development” schemes (the Empire State Development Corporation).

The economic-development authorities are particularly dubious. They’re legacies of the sixties, when then-governor Nelson Rockefeller thought that state-run economic development would help insulate citizens from disruptions in the private-sector economy, including the loss of upstate manufacturing jobs to the south and overseas. The authorities help favored companies and developers obtain tax and zoning exemptions as well as invest state money directly in favored businesses, giving them a leg up over the competition.

But such central planning, even when run by disinterested professionals, can’t replace the wisdom of the market. When the ESDC makes the right decision about supporting a business or industry, it simply displaces private-sector development. When it makes the wrong one, it has no bottom-line discipline—a financial loss or shareholders who question results—to force it to change course, as private-sector firms do. The result is wasteful government spending on commercially unsound projects and on unproductive government jobs, supported by higher taxes—not a healthier private-sector economy.

A recently approved ESDC-backed project, the Atlantic Yards basketball and housing project in Brooklyn, sponsored by politically connected development firm Forest City Ratner, is a perfect example of this wasteful superfluity. To build its stadium and 6,000 or so apartments in central Brooklyn, FC Ratner needs about $500 million in state and local subsidies, and it depends, too, on the state’s eminent-domain power to condemn properties in the project’s footprint. But much of the state’s involvement here is unnecessary. The central Brooklyn area where FC Ratner plans to build was an up-and-coming neighborhood, winning new private residential and commercial investment, long before the state-supported development firm announced its plans three years ago.

Spitzer deserves kudos for appointing an upright fellow to run the ESDC. The real goal, though, should be to shut it—and other authorities—down. But that’s one more tall order. Brooklyn state senator Seymour Lachman, author of an Albany exposé, Three Men in a Room, helps explain why: “It would be difficult to imagine the struggling upstate economy being able to survive on its own if it were weaned from the public trough. This may be the state bureaucracy’s biggest virtue, as an important hedge against the vicissitudes of the market economy for tens of thousands of New Yorkers, their families, and their towns.” In many parts of New York, of course, the state’s spending and the high taxes that accompany it have pushed private investment away, producing the economic blight for which the pols think more state spending is a remedy—though it is hardly a sustainable one. The nominally private-sector construction firms and vendors that profit from authority contracts all over New York like things the way they are, too. All that taxpayer-supported debt is also a gold mine for the nominally private-sector lawyers and bankers who arrange the debt and sell it to investors.

Top state pols have close personal and political ties with the authorities, making these largely unaccountable entities even less assailable. Recent governors have long used their privilege of appointing executives to the authorities as a patronage tool, while other top state pols have relied on them as a source of state- supported pork. (It’s worth noting in this light the recent news that Bruno arranged a $500,000-plus grant through the ESDC’s venture-capital fund for a company, Evident Technologies, whose politically connected major investor, Jared Abbruzzese, is a close friend of the senator and had provided him with plane rides.)

The public authorities are a little like Frankenstein’s monster: once created, they’re hard to destroy. While a governor could use his veto power on an obscure state commission, the Public Authorities Control Board, to impose a moratorium on state-supported debt for new public-authority projects, New York would have to find a way to pay back the authorities’ existing debt before even thinking about persuading them to close up shop.

Medicaid, education spending, public pensions, onerous regulations and legal mandates, public authorities—they’re all part of the public-sector racket that has replaced the old Madisonian ideal, in which special interests like farmers would battle other special interests like industrialists, creating a rough approximation of the public good. Spitzer’s proposed fixes, while sometimes meritorious, don’t address the racket’s real source: New York’s vast expansion of government over the last century. That gigantic state has made it lucrative for special interests to align themselves not against one another but against the taxpayers, who haven’t succeeded in forming an effective faction to fight back. Instead, they vote with their feet and leave the state.

Will any of Spitzer’s proposals address these grave problems and bring about the reform that New York State needs? Will they beat back the Empire State racket by cutting spending and reforming Medicaid, school funding, and the state’s future pension benefits? Will they repeal the Wicks Law and spearhead tort reform?

The new governor says that he wants to overhaul New York’s political process, including establishing a system of nonpartisan legislative redistricting, so that challengers have at least an outside chance of overcoming the privileges of incumbency—such as districts gerrymandered to return one party forever. (Good-government groups on the left and the right often cite New York as the least democratic state in the union; only one incumbent has lost a reelection bid in recent years.) Spitzer also proposes to reform New York’s campaign-finance system by closing loopholes that allow individuals and corporations to contribute unlimited amounts of money, forbidding companies that do business with the state to give to candidates (and so ending “pay to play”), and setting up a system of public matching funds for some private contributions.

Certainly, nonpartisan redistricting would be a step forward for small-d democracy, though it will doubtless take New York years, if not decades, to see real results (arriving, perhaps, via a revitalized, principled Republican Party). But some of Spitzer’s other fixes falter. Stricter campaign-finance laws, including Spitzer’s ultimate aim of having campaigns entirely financed by public money, aside from violating the First Amendment and shoveling yet more taxpayer funds to the political class, just don’t work. If there’s anything that national efforts at campaign-finance reform over the past decade have proved, it’s that money always finds a way to power. In Albany, moreover, public matching funds are likely to prove a recipe for further taxpayer abuse. New York pols have happily rewarded family members and friends with plum political positions or contracts. These same family members could just as easily work on taxpayer-financed political campaigns.

Spitzer’s post-election proposals that specifically address elements of the racket are not confidence-inspiring. His main reform proposal for Medicaid, for instance, is to add half a million eligible kids and 900,000 uninsured adults to the program, though many uncovered adults work in the private sector, where they might obtain coverage through employers if Spitzer took steps to help lower the cost of private coverage in the state. Instead, by expanding Medicaid to cover more working adults, Spitzer is bringing a form of universal health coverage to New York. On the tax front Spitzer wants to expand STAR, not substantially reform it.

But if he does try to hold the line on spending, he will have a handy tool: New York’s constitution gives the governor strong powers to write an executive annual budget and protect it from some legislative excesses. While the legislature can add spending to individual lines in the governor’s budget and can override the governor’s vetoes of such new spending if it has the votes, it cannot use the budget to set policy (the state court of appeals affirmed the governor’s constitutional power in this area in 2004). What’s more, many Albany watchers believe that the legislature wouldn’t dare override a popular first-term governor’s budget vetoes.

Because New York’s budget is already so big, Spitzer could achieve significant results simply by holding annual spending to inflation. Over Pataki’s final term, state-funded spending increased 17 percent in real terms. If Spitzer follows the same pattern, total state-funded spending won’t be the equivalent of today’s $77 billion by 2011; it will be more than $90 billion in today’s dollars. If Spitzer and the legislature instead keep growth in the budget to inflation, they’ll “save” that $13 billion difference for taxpayers. If revenue continues to outpace inflation, as it generally has—personal income, driven largely by the success of downstate’s financial industry, has grown nearly 2 percentage points faster per year than inflation since 1977—Spitzer could use the savings for large and sustainable tax cuts.

But spending restraint won’t help New Yorkers in the long run unless real reforms of the public sector accompany it. As Governor Arnold Schwarzenegger’s efforts to curtail special interests in California proved two years ago, and Governor Jon Corzine’s struggle to cut property taxes in New Jersey proved last December, such fundamental reforms would ignite massive public-sector demonstrations, garnering sympathetic press coverage galore. Spitzer will no doubt be ever mindful of those 1.3 million New York voters who belong to public-sector unions. The task would also require the ambitious Spitzer to take on the very special interests whose support he needs to attain national office. After all, teachers, unions, and trial lawyers collectively dominate the national Democratic Party.

But if Spitzer does choose to take on this fight and begin the work of saving New York by shrinking its government, he’ll truly be a hero. And he’ll have proved in this decade, as Mayor Giuliani did in the last, that the best (and perhaps the only) cure for a dysfunctional government is a real leader, with vision and will.

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