Tag Archives: budgets

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.

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.

Tax Holidays in the Dog Days of August

In what has become a common practice in about a dozen and a half states, August is the month for the sales tax holiday. Whether the goal is to encourage consumer spending or ostensibly offer tax relief to families, the three-day holiday waives sales tax on certain purchases – typically school supplies and clothing. Here’s a chart listing the states and the once-a-year exemptions they offer.

What exactly do sales tax holidays accomplish? Some claims:

  • They save consumers money.
  • They increase consumer spending on both tax-free and taxed items. On net, the result is more revenue in what the National Retail Federation calls a “win/win/win” for consumers, retailers and governments.
  • A weekend tax break keeps spending in the local economy. According to Bloomberg BNA Ohio and Michigan first experimented with a tax holiday on cars in 1980. New York picked up the weekend tax holiday in 1997 to entice borough residents to keep their clothes shopping dollars in NYC rather than cross the border to New Jersey’s malls.
  • It is a way for politicians to make good on tax relief without making permanent changes to the code.
The Tax Foundation claims that tax holidays only shift consumer spending and any savings in tax may be offset by higher retail prices. In addition, the “gimmick-y” exemption leads to arbitrary decisions (e.g. backpacks are exempt but briefcases are not – see Virginia). Basically, the one-time break is a way for politicians to crow about tax relief while avoiding more substantive reforms to the code such as broadening the base and lowering the rate of tax.
A 2009 econometric study, The Fiscal Impact of Sales Tax Holidays, by Adam Cole of the University of Michigan finds that sales tax holidays induce “timing behavior” in consumers. There is a reduction in sales and use tax collections by 4.18 percent in the month of the tax holiday. Half of this reduction is attributed to consumers timing their purchases to coincide with the tax-free weekend. Though there is no evidence that this leads to a large substitution of purchases during the rest of the calendar year.
Cole raises two interesting issues for researchers to consider. Do tax holidays produce cross-jurisidictional shopping effects? Secondly, because of their short duration, do tax holidays allow retailers to evade taxes by attributing earlier sales to the holiday weekend?

Marwell and McGranahan (2010) provide another set of questions to consider for those who over-sell the benefits of back-to-school bargains for family budgets. In their working paper, “The Effect of Sales Tax Holidays on Household Consumption Patterns“, the authors ask: Who’s shopping and what are they buying? Their preliminary findings suggest it is primarily upper income households and they are mainly purchasing clothes.

On a purely anecdotal note, I calculate that if our family went shopping during Virginia’s August 3-5 tax holiday we would have saved about $9.00 on backpacks and school shoes. To avoid the back-t0-school crowds we purchased those items at Tysons Corner the weekend before. If that’s the premium for efficient mall shopping, we paid it gladly.

 

The Ravitch Volker report: State Budget Crisis is Real

The recession of 2008 pulled the mask off of state budget pathologies that had been identified as institutional weaknesses in the decades leading to the crisis.

The “new normal” for state and local governments does not look like the booming 1980s and 1990s but in fact is riddled with many fiscal challenges.  Revenues aren’t what they were before 2008 though they are expected to reach pre-recession levels in FY 2013. The Medicaid and employee benefits bill is rising. The stimulus pushed forward budgetary reforms. These are some of the findings of the Ravitch-Volker Report, an effort of the State Budget Crisis Task Force which assembled in 2010-2012 to diagnose the major problems facing six states: California, Illinois, New Jersey, New York, Texas and Virginia.

Much of the analysis is non-controversial: Medicaid is eating up budgets, as are pensions costs and health care benefits.

Medicaid, currently at 24 percent of state spending, will continue to increase as enrollment, medical inflation and the increasing caseloads that come with higher unemployment increase costs. This is not a surprise. What is new is that the federal government is making it harder for cost-saving measure to be enacted, and “entrenched provider groups in each state resist reductions in Medicaid provider rates….”  I do not believe this is the intention of the authors of the report but the diagnosis of Medicaid’s future highlights the dysfunctional aspects of this federal-state pact which has led to the creation of special interests that benefit from inflating costs.

On the pension front the Ravitch-Volker report points to the the role discount rates have played in the pension funding problems facing the state and local governments, in particular in New Jersey. And they also note the reliance on budgetary gimmicks that may even result in a kind of budgetary “cynicism.” A point I have made in the past.

But the report also makes a few assumptions about the interplay of federal, state and local spending that I think could benefit from an expanded debate. The authors warn that cuts in federal discretionary spending will doom subsidiary governments. On the surface, that’s true. Cuts in aid mean less money in state coffers for education, transportation and other areas. But the larger question is what are the fiscal effects of grants-in-aid between governments? There is the public choice literature to consider on the role of fiscal illusion in finances. And further, does the current model of delivering these services actually work as intended?

Their recommendations are largely sound. Many of them have been made before: more transparent accounting, a tightening of rainy day fund rules (see our recent paper on Illinois), broad-based tax systems should replace narrow ones, the re-establishment of the Advisory Commission on Intergovernmental Relations (ACIR). Abolished in 1995 ACIR was concerned with evaluating the fiscal impact of federal policies in the states. Further the commission recommends the federal government work with the states to help control Medicaid costs, and the re-evaluation by states of their own local needs including municipal finances and infrastructure spending.

The report is timely, contains good information and brings many challenges to the fore. But this discussion can also benefit from a larger debate over the current federal-state-local spending model which dates largely to the middle of last century. This debate is not merely about how books are balanced but how citizens are governed in our federalist system. The Ravitch-Volker report is sober but cautious in this regard. The report sketches out the fiscal picture of the U.S. in broad strokes and offers general principles for states to follow and it is sure to create discussion among policymakers in the coming months.

 

 

 

 

 

Detroit’s Financial Future

This post originally appeared at Market Urbanism.

After flirting with Chapter 9 bankruptcy or a state takeover of its finances, Detroit has reached a deal with the state of Michigan that will allow it to remain independently managed with a requirement for state oversight. The Detroit Free Press reports:

The city has seven days to create the positions of chief financial officer and program management director and 30 days after that to make a hire from a list of three candidates from the mayor and state treasurer. Lewis said the city is compiling a list of candidates.

“We’ve got a lot of requirements that are in the agreement,” Lewis said. “We’ve got a lot of work to do (with the agreement) and then getting to the work of fixing the city. Our focus is on executing the plan and getting the resources here to execute the plan.”

Snyder reiterated that the city “shouldn’t expect” a cash bailout, adding that Detroit is one of many troubled communities in the state. But he said the state would use its resources in a variety of ways to help the city.

Snyder said the agreement assures the things that need to be done will get done, describing it as a “progressive series of steps” that first allow the mayor and the council to make the decisions, and then empowers the project manager to do so if they don’t. “This is a legal document designed to deal with situations when they don’t go right,” he said.

While bankruptcy protection offers the advantage to cities of achieving a more manageable debt load, it doesn’t come without a cost. Bankruptcy would add an additional stigma to Detroit, already known for municipal financial distress, encouraging business disinvestment.

Vallejo, CA filed for bankruptcy in 2008, and as the New York Times explains, the city is still in a difficult financial position. After bankruptcy cities have less room in their budgets to provide public services such as infrastructure, parks, and schools while their tax rates don’t fall accordingly. This contributes to further erosion of the tax base as businesses and residents leave the city.

Municipal bankruptcy is always a two-sided issue involving both revenue and debt. At The Atlantic Cities, Emily Badger covers the equation from the revenue side. While cities often both subsidize and enforce sprawl through road-building, parking requirements, and minimum lot sizes, these policies are detrimental to their property tax equations. She cites the positive example of Asheville, NC as a city that has taken advantage of denser downtown redevelopment to improve its ratio of property taxes to infrastructure costs:

Asheville has a Super Walmart about two-and-a-half miles east of downtown. Its tax value is a whopping $20 million. But it sits on 34 acres of land. This means that the Super Walmart yields about $6,500 an acre in property taxes, while that remodeled JCPenney downtown is worth $634,000 in tax revenue per acre. (Add sales tax revenue, and the downtown property is still worth more than six times as much as the Walmart per acre.)

[. . .]

All of this is also just looking at the revenue side of the ledger. Low-density development isn’t just a poor way to make property-tax revenue. It’s extremely expensive to maintain. In fact, it’s only feasible if we’re expanding development at the periphery into eternity, forever bringing in revenue from new construction that can help pay for the existing subdivisions we’ve already built.

[. . .]

“The thing is it all works fine when you have all this new growth and the new gap is met by all these new permit fees – that’s like free money,” Joe Minicozzi [of Public Interest Projects] says.

Cities should not be in the business of requiring the sort of development that is most expensive for them to support. However, this analysis ignores the debt side of Chapter 9, one that may be even more difficult to tackle politically. Despite the harm that poor financial management causes, local elected officials simply do not have the proper incentives to avoid it.

Politicians operate on election cycles, and during their time in office they generally seek to provide their constituents with the best possible services at the lowest tax rate. This leads them to put off payment on long term debt and liabilities using accounting gimmicks and fiscal evasion techniques to spend more on goods that residents will see in the near term.

A combination of debt and declining revenue has put Detroit in the position it’s in today. Its urban development strategy must be a part of the property tax revenue solution. Perhaps the new officials that the city hires will help with debt management, but this additional oversight is unlikely to overcome the incentives of election cycles.

Virginia and New Jersey wrangle over taxes, spending and pensions

In the past week Virginia and New Jersey have put together their proposed budgets. One thing they have in common: how much to set aside for pension benefits, and how to pay for it? Governor McDonnell of Virginia proposes less spending on education than is sought by the House and Senate. The Governor wants to fund spending with increased fees. The Senate prefers an increase in the gas tax.

Virginia operates with a biennial budget and McDonnell’s two-year $85 billion spending proposal is the largest spending plan in the state’s history. Of the $438 million proposed for education, $342 million is earmarked for teacher’s pensions. Governor McDonnell will make the annual payment (more or less) as calculated by state actuaries and proposes increasing the employee contribution to 6 percent. The Senate rejects increased employee contributions. The House, by contrast, thinks the Governor should go further with structural pension reforms.

In New Jersey Governor Christie will make 2/7ths of the full contribution to New Jersey’s pension system. It’s too little, too late and the needed contribution is already terribly underestimated. In addition Christie’s $32.1 billion budget represents a spending increase of 8.2 percent over last year. There are proposed spending increases for K-12 education and universities, but also cuts to municipal aid for distressed cities, including Camden which has been almost entirely dependent on state aid for decades. It appears optimistic revenue projections figure into the proposal. The Governor proposes a 10 percent cut in income taxes across the board and a restoration of the Earned Income Tax Credit (EITC).

The structural problems in New Jersey’s fiscal landscape remain. And these structural problems are apparent in many other states. It is not a problem easily solved. The means of financing schools – bound up with income taxes, state aid and their effect on property taxes and spending, instituted in 1976, remains in place. Factor in the resistance of governments to confront the real costs associated with employee pensions – a problem shared by all states and  many municipalities. The present problem is that recovering revenues may lead states to feel comfortable again. But that would be misplaced. Instead, lawmakers would do well to view their state’s long-term fiscal trends without the aid of rose-colored glasses.

 

New Medicaid Case Study Highlights the Role of Politics in Policy

Last week, Scott Beaulier and Brandon Pizzola released new research on Medicaid, conducting case studies of five states that have implemented reform measures designed to control program costs. They find that the political climate is essential to the success of reforms.

Medicaid is a cost driver in state budgets for several reasons, but an important factor is that most states have designed the program so that a formula determines the amount of federal money they receive based on state-level Medicaid spending. Reforms which move to essentially a block grant program, as implemented in Rhode Island and Washington, have so far successfully reduced Medicaid spending by eliminating this incentive. These two states have moved to a system where the federal government pledges a fixed yearly amount toward their Medicaid spending. If the full amount is not spent, the remainder can be transferred to the general fund. This reverses the incentive from spending as much as possible to searching for cost savings. Both states have also introduced measures of individual patient responsibility, requiring, for example, that Medicaid recipients do not rely on emergency rooms for routine care. While it is too soon to tell if Rhode Island and Washington will manage to control costs in the long run, both states appear to have achieved improved incentive structures for doing so.

These states passed reform bills not by making a gradual transition to new policies, but by moving decisively. In contrast, Florida lawmakers attempted to test reforms in two counties before expanding them to apply to the rest of the state. This time lag served as an opportunity for interest groups to block further changes. Rhode Island and Washington developed support from these interest groups by framing the issue as the state against the federal government rather than one of winners and losers within the state. In Tennessee reform has not been successful because key interest groups like the Tennessee Medical Association did not get behind proposed reforms, making them unworkable in practice.

Despite the apparent successes in Rhode Island and Washington, the federalism research that Ben and Eileen explored last week reveals that block grants are not a panacea. Block grants, like all intergovernmental spending, carry with them fiscal illusion. This obfuscates program costs to taxpayers by spreading the funding across multiple layers of government. While moving from a matching funds formula to a block grant is an improvement in transparency, total spending is still obscured. Furthermore, while neither state has failed to keep spending within the the budgeted block grant so far, it’s hardly inconceivable that program costs will outpace grants at some point, leading states to seek bailouts after implementing reforms.

The demonstrated reasons to be pessimistic about the viability of programs whose costs are shared across state and federal governments leave reason to question whether or not block grants are successful tools for curbing costs in the long run. However, Rhode Island and Washington have chosen a path that is at least more sustainable than other states, which face incentives to increase Medicaid spending with no limit in sight.

What Makes for a Good Balanced Budget Amendment?

Today, the U.S. House will begin debating a balanced budget amendment. This morning, the editorial board of the Wall Street Journal chastised Speaker Boehner for offering a “vanilla amendment that merely calls for a balanced budget, with no spending limitations or supermajority tax requirements.” Their worry is that, “Under Mr. Boehner’s amendment, spending could rise to 25% or 30% or more of GDP, so long as the budget is balanced.”

This is a misplaced worry. Right now, Congress is able to vote benefits for current voters while putting about 45 percent of the tab on non-voters (our posterity). It doesn’t take a complicated economic model to see that this arrangement systematically biases spending upward. And any amendment that requires current voters to pay for current spending will diminish that bias. As I told the House Judiciary Committee last month, in states where balanced budget requirements are stricter, spending is lower.

Moreover, the editors’ preferred amendment—one that includes some sort of spending limitation—is actually unlikely to achieve its goal. Last year, I examined the operation of various spending limits, using data from 49 states covering 30 years (I wrote about my research in an OpEd in the Journal). I found that those tax and expenditure limits “that limit budgets to some share of income had no statistically significant impact on either state-only spending or on combined state and local spending.” It may be that when states bind themselves with such limits, they make sure that the limit is set so high that it fails to actually constrain.

As far as supermajority requirements for tax increases are concerned, research does suggest that these can limit spending. I guess it is a political call as to whether such a requirement should be tied to a balanced budget amendment. In my view, a balanced budget amendment requires strong bipartisan support for it to be effective. But I don’t do politics.

I do agree with the editors in one regard. There is no need to settle for a “vanilla amendment.” There are many different varieties of balanced budget amendments and some of these have much stronger features than others. In my view, the most-effective amendments are those that:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

There are amendments that have these characteristics. For example, H.J. Res. 81 (which now has 54 cosponsors), has all three.

In other news, the amazing Cord Blomquist has managed to get my testimony on the YouTubes: