Tag Archives: TEL

Come learn about whether tax and expenditure limits work

A few years ago I did a study on state Tax and Expenditure Limits (TELs). These are state rules—written into statutes or constitutions—which are designed to arrest the growth of state spending. New Jersey was the first state to adopt a TEL in 1976, and now about 30 states have some variety of TEL.

As I explained in a Wall Street Journal OpEd at the time, though fiscal conservatives have spent decades championing TELs, “these laws may actually be doing more harm than good.” The problem is that the most common variety of TEL—one that limits spending to some share of residents’ income—actually leads to more spending in high-income states. Not all TELs have this feature and my research suggests that the details matter. I found that TELs that limit spending growth to the sum of inflation and population growth, for example, seem to arrest spending in both high and low income states.

Now, Bemjamin Zycher of the American Enterprise Institute has revisited the question with an interesting and provocative new paper that reaches an even more pessimistic conclusion that I did.

Come to AEI tomorrow at noon where I and others will be discussing Zycher’s paper. Other discussants include Nicholas Johnson of the Center on Budget and Policy Priorities and Michael New of the University of Michigan-Dearborn. The event will be moderated by Mark Perry of AEI and the University of Michigan-Flint.

It promises to be a fun and lively discussion. Details here.

Illinois’ Fiscal Breaking Points

In a forthcoming paper with Eileen Norcross,“Illinois’ Fiscal Breaking Points,” we un-pack the current crisis in Illinois.

Our review of Illinois’ fiscal and economic indicators shows in addition to a $7.7 billion deficit in the state’s General Fund, Illinois faces $173 billion in unfunded pension liabilities as well as $70 billion in outstanding bonded debt.

To make matters worse the policies currently in place to keep state spending in check are loophole-ridden.  For example, the state has a balanced budget requirement but Section 25 of the State Finance Act allows the legislature to defer Medicaid claims and other payments into the next fiscal year in order to balance the budget.  This budgetary loophole has resulted in over $20 billion in deferred payments since FY 2000. The loophole is slowly being phased out as a budget balancing maneuver.

The recently enacted spending cap limits government spending to 2 percent of year-to-year growth in General Expenditures through FY 2017 and thus for the first time in Illinois’ history places limits on state spending.  However, as research by Mitchell (2010) shows, a TEL that limits budget growth to the sum of inflation plus population growth would be a much better option for the state.

Ultimately, Illinoisans have recognized that their state’s fiscal irresponsibility has resulted in a poor institutional environment and they are voting with their feet by leaving the state. Illinois lost a net of 1,227,347 residents from 1991 to 2009, the city of Chicago has fewer residents than it did in 1920, and the state consistently remains below average in its number of entrepreneurs.

In our paper Eileen and I argue that if the state of Illinois wishes to reverse this resident and business out-migration then the legislature and the Governor must stop focusing on revenue enhancements through increased taxation and borrowing and instead make serious institutional spending reforms.

Strengthen the state’s spending limit and balanced budget requirement, moving the state’s pension system to a defined contribution plan while also removing the constitutional protections to the current plan, and getting rid of tax incentive programs that target individual industries and/or activities.

Illinois is by no means a failed state. If the state continues to promote its growth enhancing policies, such as its flat rate income tax, while also taking the necessary steps towards institutional reform then Illinois’ future may not be as bleak as it currently seems.

Tax and Expenditure Limits: A Panel Discussion

More than half of all states operate under some sort of state tax and expenditure limit (or TEL). And with nearly every state facing the most-serious fiscal crisis of a generation, these sorts of limits are increasingly talked about as a solution. But do they work? Are there nuances? What do states need to know before implementing one? How would a TEL affect your state? 

Join us in two weeks for a panel discussion here at the Mercatus Center. We hope to address these issues and others. New York State Assemblymember Micah Kellner (D-65th) and Tax Foundation programmer and analyst, Nick Kasprak, will be speaking, as will I.

Mr. Kasprak and his colleagues have developed a really neat online tool to see the theoretical impact of TELs in each state. Check it out. 

Assemblyman Kellner will talk about the fiscal troubles in New York and the potential impact of a TEL there.

I’ll be discussing recent research on the effectiveness of TELs, including my own recent paper.

If you can’t make it to Arlington in person, the event will be livestreamed on the event page.

How Can States Limit Spending?

What can states do to arrest the rapid growth in state spending? What tools do state legislators have to limit the growth of their budgets?

One popular tool is a “tax and expenditure limitation” (TEL). This is a formal rule—written into a state’s statutes or its constitution—that limits the growth of its budget via a fixed formula. Twenty seven states currently operate under TELs, but their design varies considerably from state to state. In my latest working paper, I examine the various ways TELs might be structured to see which varieties work best and under what circumstances.

I examined data from 49 states over 30 years (sorry Alaska, most researchers ignore your budget data since it is so strange). The analysis also included a standard set of control variables to account for the impact that other factors might have on state budgets.

Perhaps the most-surprising thing I found was that TELs have a different impact in high and low-income states (others have found this too). As the Figure below shows, in low-income states, TELs seem to reduce spending as a share of total personal income by about 4/10 of one percentage point (or about 3 percent relative to the average state spending share). But in high-income states, TELs increase spending as a share of total person income by about 2/10 of one percentage point.

What accounts for this? It appears that the driving factor is the fact that TELs often include income in their formula (by limiting budget growth to some multiple of personal income growth or by limiting budget size to some share of total personal income). So in high-income states, these types of formulas fail to restrain and may actually act as an excuse for the state to spend up to the limit.  

Not all TELs have this strange characteristic. As indicated by the figure below, TELs that limit budget growth to the sum of inflation and population growth seem to limit spending as a share of total personal income in both high and low-income states.

What other characteristics make for more-effective TELs? I found that four others seem to stand out:

  • The TEL should automatically and immediately refunds revenue in excess of the limit to taxpayers. This means policy makers won’t have a chance to spend the surplus and it means that taxpayers will come to appreciate the merit of the limit first-hand.
  • The TEL should target spending rather than revenue. This makes it harder to get around the limit through borrowing.
  • The TEL should be codified in the state constitution rather than in statute. This makes it more-binding.
  • The TEL should require a supermajority or a public vote to be overridden. All TELs can be overridden in case of emergencies. But to have any teeth at all, the TEL should require a supermajority vote to do this. Without, it is more like a suggested limit on spending, rather than an actual limit.

There are a lot more details in the paper, which can be found here.