Tag Archives: Alaska

State tax refunds and limiting spending growth

This fall eligible Alaskans will be receiving a check of $1,100 from their state government. Although the amount of the check can vary, Alaskans receive one every fall – no strings attached. Other state residents are probably more familiar with IRS tax refunds that come every spring, but this “tax refund” that Alaskans receive is unique. It’s a feature that residents have benefited from for decades, even in times when the government has experienced fiscal stress. Considering the state’s unique and distressed budget situation that I’ve described in an earlier post, I think it warrants a discussion of the fiscal viability of their refunds.

A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that made closing Alaska’s budget gap this year very difficult. It even contributed to pulling down Alaska from 1st in our 2016 ranking of states by fiscal condition to 17th in our 2017 edition. Given this deterioration, it will be helpful to look into how and why Alaska residents receive dividend payments each year. There is no public finance rule that says giving refunds to residents is fiscally irresponsible, but there definitely are better ways to do it, and Alaska certainly hasn’t proven to display best practices.

Another state that we can look at for comparison is Colorado, which has a similar “tax refund” for residents but is structured very differently. Colorado’s Taxpayer Bill of Rights (TABOR) requires that higher than expected tax revenues each year be refunded to taxpayers and acts as a restraint on government spending growth. In contrast, Alaska’s check comes from the state’s Permanent Fund’s earnings that are generated from oil severance taxes each year, and acts more like a dividend from oil investment earnings.

Are distributing these refunds to taxpayers fiscally responsible? I am going to take a deeper look at these mechanisms to find out.

First, Alaska’s refund.

The figure below displays Alaska’s Permanent Fund checks since 2002 overlaid with the state’s revenue and expenditure trends, all adjusted for inflation. The highest check (in 2015 dollars) was $2,279 in 2008 and the lowest was $906 in 2012, with the average over this time period being about $1,497 per person. Although the check amounts do vary, Alaska has kept on top of delivering them, even in times of steep budget gaps like in 2002, 2009, and 2015. The Permanent Fund dividend formula is based on net income from the current plus the previous four fiscal years, so it makes sense that the check sizes are also cyclical in nature, albeit in a slightly delayed fashion behind oil revenue fluctuations.

Alaska’s dividend payments often end up on the chopping block during yearly budget debates, and there is growing pressure to at least have them reduced. Despite this, Alaska’s dividends are very popular with residents (who can blame them?) and probably won’t be going away for a long time; bringing a new meaning to the Permanent Fund’s name.

The Alaska Permanent Fund was established in 1976 by constitutional amendment and was seen as an investment in future generations, who might no longer have access to oil as a resource. Although this may have been decent forward-thinking, which is rare in state budgets, it does illustrate an interesting public finance story.

Alaska is a great example of a somewhat backwards situation. They generate high amounts of cash each year, but because of the way many of their funds are restricted they are forced to hoard much of it, and give the rest to citizens in the form of dividends. If a different state were to consider a similar dividend before dealing with serious structural budget flaws would be akin to putting the cart before the horse.

Luckily for Alaskan dividend recipients, there are many other areas that the state could reform first in order to improve their budget situation while avoiding cutting payments. As my colleague Adam Millsap has recommended, a fruitful area is tax reform. Alaska doesn’t have an income or sales tax; two of the most common sources of revenue for state governments. These are two potentially more stable sources of income than what the state currently has.

How does Colorado’s “tax refund” compare?

Colorado’s Taxpayer Bill of Rights (TABOR) has a feature that requires any tax revenue growth beyond inflation and population growth be refunded to taxpayers. It was adopted by Colorado voters in 1992 and it essentially restricts revenues by prohibiting any tax or spending increases without voter approval.

A recent example of this playing out was in 2014 when the state realized higher than expected tax revenues as a result of marijuana legalization. At the point of legalization, the plan was to direct tax revenues generated from the sale of marijuana towards schools or substance abuse program funding. But because of the higher than expected revenues, TABOR was triggered and it would require voter approval to decide if the excess revenues would be sent back to taxpayers or directed to other state programs.

In November of 2015, Colorado voters approved a statewide ballot measure that gave state lawmakers permission to spend $66.1 million in taxes collected from the sale of marijuana. The first $40 million was sent to school construction, the next $12 million to youth and substance abuse programs, and the remainder $14.2 billion to discretionary spending programs. A great example that although TABOR does generally restrain spending, citizens still have power to decline refunds in the name of program spending they are passionate about.

 

The second figure here displays TABOR refunds compared with state revenues and expenditures over time. Adjusted for inflation, checks have varied from $18 in 2005 to $351 in 1999, much smaller than the Alaska dividend checks. TABOR checks have only tended to be distributed when revenues have exceeded expenses. The main reason why checks weren’t distributed between 2006 and 2009, despite a revenue surplus, was because of Referendum C which removed TABOR’s revenue limit for five years, allowing the state to keep collections exceeding the rule. The revenue limit has since been reinstated, but some question the effectiveness of TABOR given an earlier amendment in 2000 which exempts much of education spending from TABOR restrictions.

The main distinguishing factor between Colorado’s refund and Alaska’s Permanent Fund dividend is that the former also acts as a constraint on spending growth. By requiring the legislature to get voter approval before any tax increase or spending of new money, it implements automatic checks on these activities. Many states attempt to do this through what are called “Tax and Expenditure Limits” or TELs.

The worry is that left unchecked, state spending can grow to unsustainable levels.

Tax and Expenditure Limits

A review of the literature up to 2012 found that although the earliest studies were largely skeptical of the effectiveness of TELs, as time has passed more research points to the contrary. TELs can restrain spending, but only in certain circumstances.

My colleague Matt Mitchell found in 2010 that TELs are more effective when they (1) bind spending rather than revenue, (2) require a super-majority rather than a simple majority vote to be overridden, (3) immediately refund revenue collected in excess of the limit, and (4) prohibit unfunded mandates on local government.

Applying these criteria to Colorado’s TABOR we see that it does well in some areas and could improve in others. TABOR’s biggest strength is that it immediately refunds revenue collected in excess of the limit in its formula, pending voter approval to do otherwise. Automatically refunding surpluses makes it difficult for governments to use excess funds irresponsibly and also gives taxpayers an incentive to support TABOR.

Colorado’s TABOR does well to limit revenue growth according to a formula, rather than to a fixed number or no limitation at all. The formula partially meets Mitchell’s standards. It stands up well with the most stringent TELs by limiting government growth that exceeds inflation and population growth, but could actually be improved if it limited actual spending growth rather than focusing on tax revenue. When a TEL or similar law limits revenues, policymakers can respond by resorting to implementing more fees or borrowing. There’s some evidence of this occurring in Colorado, with fees becoming more popular as a way to raise revenue since TABOR’s passing. A spending-based TEL is more difficult to evade.

Despite its faults, Colorado’s TABOR structure appears to be doing better than attempts to constrain spending growth in other states. The National Conference of State Legislatures still considers it one of the strictest TELs in the nation. Other states, like Arkansas, could learn a lot from Colorado. A recent Mercatus study analyzes Arkansas’ Revenue Stabilization Law and suggests that it is missing a component similar to Colorado’s TABOR formula to refund excess revenues.

How much a state spends is ultimately up to its residents and legislature. Some states may have a preference for more spending than others, but given the tendency for government spending to grow towards an unsustainable direction, having a conversation about how to slow this is key. Implementing TEL-like checks allows for spending to be monitored and that tax dollars be spent more strategically.

Alaska’s Permanent Fund dividend is not structured as well as Colorado’s, but perhaps the state’s saving grace is that it has a relatively well structured TEL. Similarly to Colorado’s TABOR, Alaska’s TEL limits budget growth to the sum of inflation and population growth and is codified in the constitution. Alaska’s TEL doesn’t immediately refund revenue that is collected in excess of the limit to taxpayers as Colorado’s TABOR does, but it does target spending rather than revenues.

Colorado’s and Alaska’s TELs can compete when it comes to restraining spending, but Colorado’s is certainly more strict. Colorado’s expenditures have grown by about 55 percent over the last decade, while Alaska’s has grown approximately 120 percent.

The Lesson

Comparing Colorado and Alaska’s situations reveals two different ways of giving tax refunds to residents. Doing so doesn’t necessarily have to be fiscally irresponsible. Colorado has provided refunds to residents when state revenues have exceeded expenses and as a result this has acted as a restraint on over-spending higher than expected revenues. Although Colorado’s TABOR has been amended over time, its general structure illustrates the effectiveness of institutional restrains on spending. The unintended effects of TABOR, such as the increase in fees, could be well addressed by specifically targeting spending rather revenue, like in the case of Alaska’s TEL. Alaska may have had their future residents’ best intent in mind when they designed their Permanent Fund Dividend, but perhaps this goal of passing forward oil investment earnings should have been paired with preparing for the potential of cyclical budget woes.

States Aim to Eliminate Corporate and Individual Income Taxes

Although the prospects of fundamental tax reform on the federal level continue to look bleak, the sprigs of beneficial tax proposals in states across the US are beginning to grow and gain political support. Perhaps motivated by the twin problems of tough budgeting options and mounting liability obligations that states face in this stubborn economy, the governors of several states have recommended a variety of tax reform proposals, many of which aim to lower or completely eliminate corporate and individual income taxes, which would increase state economic growth and hopefully improve the revenues that flow into state coffers along the way.

Here is a sampling of the proposals:

  • Nebraska: During his State of the State address last week, Gov. Dave Heineman outlined his vision of a reformed tax system that would be “modernized and transformed” to reflect the realities of his state’s current economic environment. His bold plan would completely eliminate the income tax and corporate income tax in Nebraska and shift to a sales tax as the state’s main revenue source. To do this, the governor proposes to eliminate approximately $2.8 billion dollars in sales tax exemptions for purchases as diverse as school lunches and visits to the laundromat. If the entire plan proves to be politically unpalatable, Heineman is prepared to settle for at least reducing these rates as a way to improve his state’s competitiveness.
  • North Carolina: Legislative leaders in the Tar Heel State have likewise been eying their individual and corporate income taxes as cumbersome impediments to economic growth and competitiveness that they’d like to jettison. State Senate leader Phil Berger made waves last week by announcing his coalition’s intentions to ax these taxes. In their place would be a higher sales tax, up from 6.75% to 8%, which would be free from the myriad exemptions that have clogged the revenue-generating abilities of the sales tax over the years.
  • Louisiana: In a similar vein, Gov. Bobby Jindal of Louisiana has called for the elimination of the individual and corporate income taxes in his state. In a prepared statement given to the Times-Picayune, Jindal emphasized the need to simplify Louisiana’s currently complex tax system in order to “foster an environment where businesses want to invest and create good-paying jobs.” To ensure that the proposal is revenue neutral, Jindal proposes to raise sale taxes while keeping those rates as “low and flat” as possible.
  • Kansas: Emboldened by the previous legislative year’s successful income tax rate reduction and an overwhelmingly supportive legislature, Kansas Gov. Sam Brownback laid out his plans to further lower the top Kansas state income tax rate from the current 4.9% to 3.5%. Eventually, Brownback dreams of completely abolishing the income tax. “Look out Texas,” he chided during last week’s State of the State address, “here comes Kansas!” Like the other states that are aiming to lower or remove state income taxes, Kansas would make up for the loss in revenue through an increased sales tax. Bonus points for Kansas: Brownback is also eying the Kansas mortgage interest tax deduction as the next to go, the benefits of which I discussed in my last post.

These plans for reform are as bold as they are novel; no state has legislatively eliminated state income taxes since resource-rich Alaska did so in 1980. It is interesting that the aforementioned reform leaders all referenced the uncertainty and complexity of their current state tax systems as the primary motivator for eliminating state income taxes. Seth Giertz and Jacob Feldman tackled this issue in their Mercatus Research paper, “The Economic Costs of Tax Policy Uncertainty,” last fall. The authors argued that complex tax systems that are laden with targeted deductions tend to concentrate benefits towards the politically-connected and therefore result in an inefficient tax system to the detriment of everyone within that system.

Additionally, moving to a sales tax model of revenue-generation may provide state governments with a more stable revenue source when compared to the previous regime based on personal and corporate income taxes. As Matt argued before, the progressive taxation of personal and corporate income is a particularly volatile source of revenue and tends to suddenly dry up in times of economic hardship. What’s more, a state’s reliance on corporate and personal income taxes as a primary source of revenue is associated with large state budget gaps, a constant concern for squeezed state finances.

If these governors are successful and they are able to move their states to a straightforward tax system based on a sales tax, they will likely see the economic growth and increased investment that they seek.

Keep an eye on these states in the following year: depending on the success of their reforms and tax policies, more states could be soon to follow.

The New York Times Database on Government Granted Privilege

Louise Story of the New York Times has earned her salary many times over this week. She and her colleagues have created a searchable database of targeted incentives (read: privileges) that states offer particular firms. To my knowledge, it is the most comprehensive database on the subject to date, containing information on over 150,000 awards.

Among her findings: Alaska, West Virginia, and Nebraska give up more per resident than any other state and Oklahoma and West Virginia “give up amounts equal to about one-third of their budgets, and Maine allocates nearly a fifth.”

Here is the database.

Also check out her articles, “How Taxpayers Bankroll Businesses,” “Winners and Losers in Texas,” and “When Hollywood Comes to Town.”

Readers of this blog know where to go for more information on the economic and social costs of government-granted privilege.

States Look to Rainy Day Funds to Avoid Future Crises

For the past nine quarters, state revenue collections have been increasing and are now approaching 2008 levels after adjusting for inflation. Many state policymakers are no longer facing the near-ubiquitous budget gaps of fiscal year 2012, but at the moment those memories seem to remain fresh in their minds.

Many states are looking to rainy day funds as a tool to avoid the revenue shortfalls they have experienced since the recession. In Wisconsin, for example, Governor Walker recently made headlines by building up the states’ fund to $125.4 million. In Texas, the state’s significant Rainy Day Fund has reached over $8 billion, behind only Alaska’s fund that holds over $18 billion.

A June report from the Tax Foundation shows Texas and Alaska are the only states with funds that are significant enough to protect states from budget stress in future business cycle downturns. As the Tax Foundation analysis explains, state rainy day funds can be a useful to smooth spending over the business cycle. Research that Matt Mitchell and Nick Tuszynski cite demonstrates that rainy day funds governed by strict rules about when they may be tapped do achieve modest success in smoothing revenue volatility. Because most states have balanced budget requirements, when tax revenues fall during business cycle downturns, states must respond by raising taxes or cutting spending, both pro-cyclical options. If states are required to contribute to rainy day funds when they have revenue surpluses and then are able to draw on these savings during downturns in order to avoid tax increases or spending cuts, this pro-cyclical trend can be avoided.

The Texas Public Policy Foundation points out some of the benefits of large rainy day funds:

Maintaining large “rainy day” funds  benefits Texas and Alaska in three ways:

1) These states do not rely  on large pots of one-time funding to pay for ongoing expenses, but rather balance their books by bringing spending in line with revenues;

2) These states  have reserves on hand to deal with emergencies; and

3) Having a large “rainy day” fund improves the states’ bond rating which means lower interest rates for borrowing.

However, even as more states begin making significant contributions to their rainy day funds, they have not fulfilled their pension obligations. According to states’ own estimates of their pension liabilities, states’ unfunded pension liabilities total about $1 billion. However using private sector accounting methods, states are actually on the hook for over $3 trillion in unfunded pension liabilities. Because states do not use the risk-free discount rate to value these liabilities, the surpluses they think they have to contribute to rainy day funds are illusions.

Even if states were already contributing appropriately to their pension funds and systematically contributed to rainy day funds during revenue upswings, it’s not clear that rainy day funds are a path toward fiscal discipline.  Because of the perpetual tendency for government to grow, it’s unlikely that state policymakers will take any steps to reduce the growth of government during times of economic growth. If states successfully save tax revenues in rainy day funds to avoid having to make spending cuts during recessions, states will not have to decrease spending at any point during the business cycle. States’ balanced budget requirements can provide a mechanism that helps states cut spending in some areas when revenues drop off, but rainy day funds obviate this requirement. Successful use of rainy day funds could contribute to the trend of states’ spending growing fast than GDP.

Supporters of substantial rainy day funds should acknowledge that these cushions — which on the one hand may provide significant benefits to taxpayers — come at the expense of cyclical opportunities to cut the size of state governments to bring them in line with tax revenues. Without the necessity of cutting spending at some point, state budgets might grow more rapidly that they already are, hindering economic growth in the long run. Whether or not rainy day funds increase the growth rate is an empirical question that advocates should research before recommending this strategy, and this possible drawback should be weighed against their potential to reduce revenue volatility.

State Revenue Uncertainty

Yesterday the National Conference of State Legislatures released its State Budget Update for 2012, projecting that states’ revenues are approaching levels not seen since before the recession. This means that the budget deficits that have been common in most states over the past few years will hopefully be rare this fiscal year. As Reuters reports:

The situation is now turning around. Only California and the state of Washington currently are projecting deficits for fiscal 2012, according to NCSL. At the same time, resource-rich states like Alaska, Wyoming and North Dakota expect big balances for fiscal 2012, which ended on June 30 for most states.

For fiscal 2013, none of the states are projecting deficits, with 10 states and Washington, D.C., eyeing balances equal to 10 percent or more of general fund spending, the NCSL reported. However, year-end balances of just 0.1 percent to 4.9 percent are projected in nearly a quarter of the states.

Not everyone is as optimistic about state budgets in the coming year. This new report contrasts sharply with a study from the Center on Budget and Policy Priorities, which earlier this summer found that 31 states faced budget gaps in 2012, and that states face a combined $55 billion shortfall for 2013. However, if the NCSL findings are correct, this is very good news for states that have had to resort to midyear cuts and tax increases to balance budgets in the post-recession years.

If states can more easily meet their constitutionally required balanced budgets this year, policymakers should take this opportunity to look at their long-run debt challenges. As I wrote in a USA Today op ed last week, state debt levels are headed to levels that will threaten economic growth. Mounting interest costs will also mean that tax dollars increasingly go to pay for past services, rather than current services.

Whether or not states are in a better position for avoiding deficits in the current year, they need to address their debt levels for long run economic growth. Outspending current revenues is a constant temptation for elected officials who want to stay in office through public support of state programs. However, voters should demand responsible fiscal policy to address debt problems now, before this becomes even more difficult to do down the road.

Rating State Business Tax Climates

Today the Tax Foundation released its annual State Business Tax Climate Index.

Good tax policy is not just about low rates. The Index’s author, Kail Padgitt, writes:

State lawmakers are always mindful of their states’ business tax climates but they are often tempted to lure business with lucrative tax incentives and subsidies instead of broad-based tax reform. This can be a dangerous proposition.

The public choice pressures that Dr. Padgitt is talking about encourage state policy makers to cut special tax deals for politically-important businesses and to keep rates high for those who are aren’t so well-connected. The Business Tax Climate report is a nice antidote to such thinking:

The goal of the index is to focus lawmakers’ attention on the importance of good tax fundamentals: enacting low tax rates and granting as few deductions, exemptions and credits as possible. This “broad base, low rate” approach is the antithesis of most efforts by state economic development departments who specialize in designing “packages” of short-term tax abatements, exemptions, and other give-aways for prospective employers who have announced that they would consider relocating. Those packages routinely include such large state and local exemptions that resident businesses must pay higher taxes to make up for the lost revenue.

The best climates: South Dakota, Alaska, Wyoming, Nevada, Florida, Montana, New Hampshire, Delaware, Utah and Indiana.

And the worst: New York, California, New Jersey, Connecticut, Ohio, Iowa, Maryland, Minnesota, Rhode Island and North Carolina.

Can Government Put Idle Resources to Good Use?

“Big chunk of economic stimulus yet to be spent by state, local governments”

This is according to the Washington Post. They write:

The $862 billion package was divided roughly in thirds among tax cuts, aid to states and the unemployed, and investments in infrastructure, health care and other areas. The first two have delivered most of their boost, but much of the investment spending is moving far more slowly. At the end of July, nearly 18 months after the stimulus passed, more than half of the $275 billion in investments had yet to be spent.

Meanwhile, from up in Alaska, I read that that state is slated to receive a piece of the new state aid passed last week, despite the fact that it doesn’t seem to need it:

Alaska is eligible to receive $23.5 million dollars of the $10 billion total, according to the U.S. Department of Education. Alaska’s allocation comes despite a healthy revenue surplus this year that has allowed the state to actually increase school funding.

So money is not being spent that should be spent; meanwhile, other money is being spent that shouldn’t be. Stimulus defenders will say that any time a big organization spends a lot of money, mistakes are bound to be made. And they are right. But I would argue that these sorts of mistakes are far more likely when the organization in question is the government.

Remember the Keynesian story: remove idle resources from the private sector, put them to work, and the economy will grow (provided government borrowing doesn’t crowd-out valuable private investments and provided consumers don’t hold back in anticipation of future tax increases). But the whole Keynesian idea rests on the notion that governments can effectively put resources to higher-valued use than the private sector. This requires government to know what is and is not valuable; to know when and where to spend the money; and to know that – had it been borrowed by someone else in the private sector – the money wouldn’t have been put to better use. Moreover, government has to do all of this without the benefit of the signals that help the private sector allocate resources: no profits, no losses, (almost) no price mechanism.