Tag Archives: budget

Governors’ Priorities in 2013: Medicaid Funding, Pension Reform

As the month of March draws to a close, most governors have, by this point, taken to the podiums of their respective states and outlined their priorities for the next legislative year in their State of the State addresses. Mike Maciag at Governing magazine painstakingly reviewed the transcripts of all 49 State of the State addresses delivered so far (Louisiana, for some reason, takes a leisurely approach to this tradition) and tallied the most popular initiatives in a helpful summary. While there were some small state trends in addressing hot-button social issues like climate change (7 governors), gay rights (7 governors), and marijuana decriminalization (2 states), the biggest areas of overlap from state governors concerned Medicaid spending and state pension obligations.

Medicaid Spending

Judging from their addresses, the most common concern facing governors this year is the expansion of state Medicaid financing prompted by the Supreme Court’s ruling on the Affordable Care Act last year. While the ACA originally required states to raise their eligibility standards to cover everyone below 138 percent of the federal poverty level, the Supreme Court overturned this requirement and left up to the states whether or not they wanted to participate in the expansion in exchange for federal funding or politely decline to partake.  The governors of a whopping 30 states referenced the Medicaid issue at least once during their speech. Some of the governors, like Gov. Phil Bryant of Mississippi, brought up the issue to explain why they made the decision to become one of the 14 states that decided not to participate in the expansion. Others took to defending their decision to participate in the expansion, like Gov. John Kasich of Ohio, who outlined how his state’s participation would benefit fellow Buckeyes suffering from mental illness and addiction.

Neither the considerable amount of concern nor the markedly divergent positions of the governors are especially shocking. A recent Mercatus Research paper conducted by senior fellow Charles Blahous addresses the nebulous options facing state governments in their decision on whether to participate in the expansion. This decision is not one to make lightly: in 2011, state Medicaid spending accounted for almost 24 percent of all state budget expenditures and these costs are expected to rise by upwards of 150 percent in the next decade. The answer to whether a given state should opt in or opt out of the expansion is not a straightforward one and depends on the unique financial situations of each state. Participating in the Medicaid expansion may indeed make sense for Ohioans while at the same time being a terrible deal for Mississippi. However, what is optimal for an individual state may not be good for the country as a whole. Ohio’s decision to participate in the expansion may end up hurting residents of Mississippi and other states who forgo participating in the expansion because of the unintended effects of cost shifting among the federal and state governments. It is very difficult to project exactly who will be the winners or losers in the Medicaid expansion at this point in time, but is very likely that states will fall into one of either category.

Pensions

Another pressing concern for state governors is the health (or lack thereof) of their state pension systems. The governors of 20 states, including the man who brought us “Squeezy the Pension Python” himself, Illinois Gov. Pat Quinn, tackled the issue during their State of the State addresses. Among these states are a few to which Eileen has given testimony on this very issue within the past year.

In Montana, for instance, Gov. Steve Bullock promised a “detailed plan that will shore up [his state’s] retirement systems and do so without raising taxes.” While I was unable to find this plan on the governor’s website, two dueling reform proposals–one to amend the current defined benefit system, another to replace it with a defined contribution system–are currently duking it out in the Montana state legislature. While it is unclear which of the two proposals will make it onto the law books, let’s hope that the Montana Joint Select Committee on Pensions heeds Eileen’s suggestions from her testimony to them last month, and only makes changes to their pension system that are “based on an accurate accounting of the value of the benefits due to employees.”

Civil Disobedience and Detroit’s financial manager

Michigan’s Governor Rick Synder may be greeted by protestors when he arrives for a meeting today on Detroit’s financial condition. His recent appointment of Kevyn Orr as the city’s emergency financial manager has angered many of Detroit’s residents who are afraid he has powers that are far too sweeping and is thereby destroying local control. The purpose of the financial manager law is to help the city stave off bankruptcy and allows the emergency manager the ability to renegotiate labor contracts and potentially sell city assets. The last recession has worsened the already-struggling city’s financial outlook. Detroit has a $327 million budget deficit and $14 billion in long-term debt and has shown very little willingness to make the kind of structural changes it needs in order to stay solvent.

Detroit’s problems are acute. The city’s population has fallen from 1.8 million to 700,000, giving the city, “a look and feel that rivals post World War II Europe.” But as Public Sector Inc’s Steve Eide writes, the real problem is that local leaders have proven unable to deal with fiscal realities for far too long. His chart shows the consequences. The gap between estimated revenues and expenditures over time is striking. In sum, Detroit overestimates its revenues and underestimates its spending, by a lot, when it plans for the budget. That is a governance and administration crisis and one that the state has decided needs outside intervention to set straight.

Standard & Poors likes the appointment and has upgraded Detroit’s credit rating outlook to “stable.”

The battle of the taxes

In my last post, I discussed several exciting tax reforms that are gaining support in a handful of states. In an effort to improve the competitiveness and economic growth of these states, the plans would lower or eliminate individual and corporate income taxes and replace these revenues with funds raised by streamlined sales taxes. Since I covered this topic, legislators in two more states, Missouri and New Mexico, have demonstrated interest in adopting this type of overhaul of their state tax systems.

At the same time, policymakers in other states across the country are likewise taking advantage of their majority status by pushing their preferred tax plans through state legislatures and state referendums. These plans provide a sharp contrast with those proposed by those states that I discussed in my last post; rather than prioritizing lowering income tax burdens, leaders in these states hope to improve their fiscal outlooks by increasing income taxes.

Here’s what some of these states have in the works:

  • Massachusetts: Gov. Deval L. Patrick surprised his constituents last month during his State of the State address by calling for a 1 percentage point increase in state income tax rates while simultaneously slashing state sales taxes from 6.25% to 4.5%. Patrick defended these tax changes on the grounds of increasing investments in transportation, infrastructure, and education while improving state competitiveness. Additionally, the governor called for a doubling of personal exemptions to soften the blow of the income tax increases on low-income residents.
  • Minnesota: Gov. Mark Dayton presented a grab bag of tax reform proposals when he revealed his two-year budget plan for the state of Minnesota two weeks ago. In an effort to move his state away from a reliance on property taxes to generate revenue, Dayton has proposed to raise income taxes on the top 2% of earners within the state. At the same time, he hopes to reduce property tax burdens, lower the state sales tax from 6.875% to 5.5%, and cut the corporate tax rate by 14%.
  • Maryland: Last May, Maryland Gov. Martin O’Malley called a special legislative session to balance their state budget to avoid scheduled cuts of $500 million in state spending on education and state personnel. Rather than accepting a “cuts-only” approach to balancing state finances, O’Malley strongly pushed for income tax hikes on Marylanders that earned more than $100,000 a year and created a new top rate of 5.75% on income over $250,000 a year. These tax hikes were signed into law after the session convened last year and took effect that June.
  • California: At the urging of Gov. Jerry Brown, California voters decided to raise income taxes on their wealthiest residents and increase their state sales tax from 7.25% to 7.5% by voting in favor of Proposition 30 last November. In a bid to put an end to years of deficit spending and finally balance the state budget, Brown went to bat for the creation of four new income tax brackets for high-income earners in California. There is some doubt that these measures will actually generate the revenues that the governor is anticipating due to an exodus of taxpayers fleeing the new 13.3% income tax and uncertain prospects for economic growth within the state. 

It is interesting that these governors have defended their proposals using some of the same rhetoric that governors and legislators in other states used to defend their plans to lower income tax rates. All of these policymakers believe that their proposals will increase competitiveness, improve economic growth, and create jobs for their states. Can both sides be right at the same time?

Economic intuition suggests that policymakers should create a tax system that imposes the lowest burdens on the engines of economic growth. It makes sense, then, for states to avoid taxing individual and corporate income so that these groups have more money to save and invest. Additionally  increasing marginal tax rates on income and investments limits the returns to these activities and causes people to work and invest less. Saving and investment, not consumption, are the drivers of economic growth. Empirical studies have demonstrated that raising marginal income tax rates have damaging effects on economic growth. Policymakers in Massachusetts, Minnesota, Maryland, and California may have erred in their decisions to shift taxation towards income and away from consumption. The economies of these states may see lower rates of growth as a result.

In my last post, I mused that the successes of states that have lowered or eliminated their state income taxes may prompt other states to adopt similar reforms. If the states that have taken the opposite approach by raising income taxes see slowed economic growth as a result, they will hopefully serve as a cautionary tale to other states that might be considering these proposals.

Distinguishing between Medicaid Expenditures and Health Outcomes

As the LA Times reports, the Obama administration has vowed not to approve any cuts to Medicaid during budget negotiations:

Preserving Medicaid funding became even more crucial to the Obama administration after the Supreme Court ruled last summer that states were not required to expand their Medicaid coverage. Administration officials are working hard to convince states to expand and do not want any federal funding cuts that could discourage governors from implementing the law.

“There is a big irony,” said Ron Pollack, executive director of Washington-based Families USA, a leading Medicaid advocate. “The fact that the Supreme Court undermined the Medicaid expansion is now resulting in greater support and a deeper commitment to making sure the program is not cut back.”

Paying for Medicaid remains a major challenge for states. The program has been jointly funded by states and the federal government since it was created. And many states, including California, Illinois and New York, have had to make painful cutbacks in recent years to balance their budgets by reducing physician fees and paring benefits, such as dental care.

However, protecting Medicaid spending — without changing incentives for the healthcare industry or patients — does not necessarily mean improved health outcomes for beneficiaries. As of 2011, nearly one-third of doctors said that they would not accept new Medicaid patients because they are losing money on those who they do see, indicating not only a lower quality of care for Medicaid patients compared to those on private insurance, but reduced access to care. Under the current Medicaid structure, states are incentivized to spend more to receive larger federal matching funds grants, but at the same time federal requirements limit opportunities to improve quality of care through innovation.

The State Health Flexibility Act proposed by Representative Todd Rokita (R-IN) proposes a way to change these incentives. Under the State Health Flexibility Act, state funding for Medicaid and the Children’s Health Insurance Program would be capped at current spending levels. At the same time, states would be released from many federal Medicaid mandates and instead would have the flexibility to determine eligibility and benefits at the state level. Rokita proposed this bill last year, and parts of the bill made it into the House budget.

While this bill seems unlikely to make any progress under the current administration, it mirrors reforms proposed by at least one democratic state governor. Oregon’s Governor John Kitzhaber, a former emergency room doctor, received a Medicaid waiver in 2011 to receive a one-time $1.9 billion payment from the federal government to close the state’s Medicaid funding gap. In exchange, he promised to repay this money if the state failed to keep Medicaid costs growth at a rate two-percent below the rest of the country. Kitzhaber sought to achieve this by allowing local knowledge to guide cost savings. The Washington Post reports:

Oregon divided the state into 15 region and gave each one a set amount to care for each patient. These regions can divvy their dollars however they please, so long as patients hit certain quality metrics, like ensuring that adolescents get well-care visits and that steps are taken to control high blood pressure.

The hope is that each of the 15 regions, known as coordinated care organizations, will invest only in the most cost-effective health care. A behavioral health worker who can prevent emergency admissions becomes a lot more valuable, the thinking goes, when Medicaid funding is limited.

While the Oregon plan is not a block grant — the federal government has not capped the amount that it will provide to the state — it does share some similarities with the State Health Flexibility Act. The state and its designated regions have a strong incentive to provide their Medicaid recipients better health outcomes at lower costs because if they fail the state will have to repay $1.9 billion to the federal government. Additionally, the state and the regions have the freedom to find cost savings at the level of patients and hospitals, which isn’t possible under federal requirements.

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.

Eileen Norcross on News Channel 8 Capital Insider discussing Virginia and the fiscal cliff

Last week I appeared on NewsChannel 8’s Capital Insider to discuss how the fiscal cliff affects Virginia. There are several potential effects depending on what the final package looks like. Let’s assume the deductions for the Child Care Tax Credit, EITC, and capital depreciation go away. This means, according to The Pew Center, where the state’s tax code is linked to the federal (like Virginia) tax revenues will increase. That’s because removing income tax deductions increases Adjusted Gross Income (AGI) on the individual’s income tax filing (or on the corporation’s filing) thus the income on which the government may levy tax increases. According to fellow Mercatus scholar, Jason Fichtner, that could amount to millions of dollars for a state.

On the federal budget side of the equation,the $109 billion in potential reductions is now equally shared between defense and non-defense spending. Of concern is the extent to which the region’s economy is dependent on this for employment. Nearly 20 percent of the region’s economy is linked to federal spending. Two points: The cuts are reductions in the rate of growth in spending. For defense spending, they are relatively small cuts representing a return to 2007 spending levels as Veronique points out. So, these reductions not likely to bring about the major shakeup in the regional economy that some fear. Secondly, the fact that these cuts are causing worry is well-taken. It highlights the importance of diversification in an economy.

Where revenues, or GDP, or employment in a region is too closely tied to one industry, a very large and sudden change in that industry can spell trouble. An analogy: New Jersey’s and New York’s dependence on financial industry revenues via their income tax structure led to a revenue shock when the market crashed in 2008, as the New York Fed notes.

On transportation spending there are some good proposals on the table in the legislature and the executive. Some involve raising the gas tax (which hasn’t been increased since 1986), and others involve tolls. The best way to raise transportation revenues is via taxes or fees that are linked to those using the roads. Now is no time to start punching more holes in the tax code to give breaks to favored industries (even if they are making Academy-award quality films) or to encourage particular activities.

Virginia’s in a good starting position to handle what may be in store for the US over the coming years. Virginia has a relatively flat tax structure with low rates. It has a good regulatory environment. This is one reason why people and businesses have located here.

Keep the tax and regulatory rules fair and non-discriminatory and let the entrepreneurs discover the opportunities. Don’t develop an appetite for debt financing. A tax system  is meant to collect revenues and not engineer individual or corporate behavior. Today, Virginia beats all of its neighbors in terms of economic freedom by a long shot. The goal for Virginia policymakers: keep it this way.

Here’s the clip

The most egregious budget gimmicks of 2012: pension underfunding

Bob Williams at State Budget Solutions has a nice chart that shows by how much states are underfunding their pensions. Budgets are always about tradeoffs. But not funding the pension is similar to skipping credit card payments without cutting into your daily expenses at all (or figuring out how to boost your income).

Here’s the link.

In addition, the article notes all the other ways states  have of papering over deficits – floating bonds, revenue estimates, shifting dates around. This isn’t confined to the usual suspects (Illinois, New Jersey, California). There are plenty of examples to share from across the country.

 

 

New Research on Streamlining Commissions

Tomorrow I’ll be at the Association for Public Policy Analysis and Management Fall Research Conference to present research on streamlining commissions with Carmine Scavo. Carmine and I have written one paper developing a methodology for studying these commissions, and we’re now working on case studies of commissions in nine states.

Well over half of states have appointed one or more streamlining commissions in efforts to find budget savings or to improve state programs. We’re studying streamlining efforts in California, New Mexico, Louisiana, Alabama, Colorado, New York, Maine and Virginia. We hope to get an idea of how effectively these commissions have reduced the size of state government and found efficiencies in existing programs. We also hope to identify the characteristics that make commissions most likely to meet their goals.

In our first paper, we hypothesized that commission success would depend on the following characteristics:

1) clearly defined objectives regarding their final product;

2) a clear timeline for this deliverable with an opportunity to publish interim advice. Preliminary findings indicate that the commission should have at least one year to work;

3) adequate funds to hire an independent staff to study some issues in depth;

4) a majority of the commission members from outside the government. The commission chair certainly should be from outside the government in order to help to get around the challenges that inherently restrict the ability to find streamlining opportunities while working in government. Preliminary findings indicate that representatives from the state legislature and administration should be involved as a minority of the membership to ensure that the commission’s recommendations have buy-in from policymakers.

So far, our research indicates that funding for commissions may not be as important as we’d though. Some commissions have achieved successes with essentially no budgets while others that were well-funded developed recommendations that didn’t go anywhere.

Tomorrow we will be presenting our preliminary findings on the California Commission on the 21st Century Economy, the Colorado Pits and Peeves Roundtable Initiative, and the Virginia Commission on Government Reform and Restructuring. Once we finish this research I will write up our findings in more depth here. If any of you will be attending the APPAM conference, I hope to see you there.

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.

SEPTA and interest rate swaps

Interest rate swaps became a relatively popular means for municipal governments to save some money during the 1990s and into the 2000s. The basic idea is that an issuer (the government) enters into a contract with a bank to exchange interest rate payments on a cash flow. These can be structured to exchange a fixed payment for a variable payment in return, or vice versa.

These interest payments are calculated based on an underlying asset or instrument, such as a bond. That makes interest rate swaps a derivative, as their value is derived from an underlying financial instrument.

The issuer’s goal is to hedge against fluctuating interest rates and impart some stability to their budget.The bank’s incentive is to make a fee. It works for the issuer when they guess correctly and – by way of example -the issuer agrees to a payment based on a fixed rate of interest that is low relative to the adjustable rate of interest the bank pays to the municipality in return.

But that’s not what happened as rates began to fall after 2008. Many municipal issuers found themselves paying banks a fixed rate that was high relative to the variable rate the bank was paying in return. Jefferson County, Alabama is the most notorious example, as my recent article in US News explains. At work in this larger story is the role the LIBOR interest rate rigging scandal played in suppressing the variable rate leading some governments to sue banks for damages.

Pennsylvania governments were particularly keen on interest rates swaps, with 626 swaps having been entered into across the Commonwealth. Depending on how they were structured, some entities have come out ahead. The majority have lost on the contracts. That includes SEPTA, as Pennsylvania Watchdog explains.

Is the problem with the interest rate swap concept? I’d argue that the answer lies in how they are used. What might be a good hedging instrument for the financial sector exposes the public sector to a set of risks that aren’t fully appreciated. The risks -including the real hazard that the municipality incorrectly guessed the direction interest rates would travel- are passed on to taxpayers or service users.