Tag Archives: TELs

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.

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.

TEL Event and TEL Podcast

If you couldn’t make it to GMU last week for the Tax and Expenditure panel, you are in luck: the tech team at Mercatus was good enough to capture it for posterity:

I thank our two guests: Assemblyman Micah Kellner of the NY-65th district and Nick Kasprak of the Tax Foundation.

Nick has created a very handy on-line tool. It does what my paper on state spending restraint did: it traces out what states would (theoreticall) have spent had they adopted TELs in certain time periods. Unlike my paper, however, Nick’s tool is interactive, it examines all states, and it allows users to see the different impact of different types of TELs. Check it out.

I learned a number of things from Assemblyman Kellner. Perhaps the most-interesting thing I learned: if you live in the 65th district of NY and if your family earns $250k or more, the state considers you poor enough to qualify for affordable housing rent control but rich enough to pay the “millionaire’s” tax. The assemblyman notes that in pricey NYC, a lot of people who live modest lifestyles actually fall into this category.

I presented the results of my  paper on tax and expenditure limits.

Also this week, the Tax Foundation’s Richard Morrison interviewed me about TELs in their weekly podcast.

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.

CAP Act: Baby Steps Towards Fiscal Responsibility – Tentative and Toothless

This afternoon Senators Bob Corker (R-Tenn.) and Claire McCaskill (D-Mo) will introduce legislation to “force Congress to dramatically cut spending over 10 years”. From the Senator’s website:

At a time when many families have been forced to tighten their pocketbooks, Congress must also learn to do the same. This bill isn’t just about cutting back this year or next year; it’s about instilling permanent discipline to keep spending at a responsible level,” McCaskill said.

The Commitment to American Prosperity Act, the “CAP Act,” would:

(1) Put in place a 10-year glide path to cap all spending – discretionary and mandatory – to a declining percentage of the country’s gross domestic product, eventually bringing spending down from the current level, 24.7 percent of GDP, to the 40-year historical level of 20.6 percent, and

(2) If Congress fails to meet the annual cap, authorize the Office of Management and Budget to make evenly distributed, simultaneous cuts throughout the federal budget to bring spending down to the pre-determined level. Only a two-thirds vote in both houses of Congress could override the binding cap …

I’m very pessimistic about this, for many reasons. Procedurally, the Act only institutes a new budgetary point of order, which can be overridden with super-majority votes in both houses. That is, the Act doesn’t compel anyone to act fiscally responsibly unless they’re inclined to do so. If we had such restrained legislators, a cap wouldn’t be necessary to begin with. Currently the House can override budgetary points of order with a simple majority vote, so this is an improvement, but not one I expect to have serious results.

The technical aspects of the Cap Act are similarly merit-less. First, the baselines are all skewed; why should we accept 20.6% of GDP spending as the new ‘normal’? Historically, Federal receipts average right around 18% of GDP, so locking in 20% would still put us on a trajectory towards systemic deficits. Given that we’re starting from a baseline where Federal debt rapidly approaches 100% of GDP, this isn’t a responsible plan to reign in spending. Similarly, the “lookback GDP” guidelines will count 2009, 2010, and 2011 spending, which has already exploded far beyond what is fiscally sustainable, or historically precedented. The “glide path” isn’t a serious measure of fiscal sustainability; it places us, in just five years, at the same debt-to-gdp ratio that trigged an economic meltdown in Greece last year. So the bill doesn’t set reasonable baselines, it doesn’t do anything to address the deficit, and if Matt’s work with similar TELs in the states holds, high-income economies like ours tend to use spending caps as excuses to grow spending beyond the levels they otherwise would.

There are some technical merits, but they’re merely cosmetic. Bringing Social Security back ‘on-budget’ is a good start, but this bill still leaves massive loopholes for ’emergency spending’, which the New York Times called a new way of political life six years ago. That trend hasn’t changed one iota since; if anything it’s gotten worse. A unified Democratic Congress couldn’t pass any budget last year. It’s one of the few constitutional powers actually entrusted to the Congress, and they failed. Which leads to my separation-of-powers concerns with this legislation. It’s unclear from a first reading, but where is the authority for Congress to entrust sequestration power with OMB, an executive branch agency?

Finally, there are massive political concerns with the legislation. It seems poised as a cover for fiscally irresponsible co-sponsors like McCaskill and John McCain (who both supported TARP and the GM Bailout; McCaskill also voted for Obamacare while McCain has his own big government medical plan to push) to claim the mantle of fiscal responsibility. We’ve already seen that movie, and it was terrible the first time.

In sum, I don’t see any reason the bill would restrain spending to a responsible or sustainable level. The bill has some good ideas, but they’re wandering in a wilderness of bad ones. The impulse is good, the execution is terrible.

Note: Sorry a rough draft went up on the RSS feed earlier, WordPress is a cruel mistress sometimes.

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.

Shooting the Rocky Mountain Cocker Spaniel

cosprIn November, voters in Colorado Springs voted against a measure that would triple the city’s property taxes, and as a result, local government has begun to issue many painful cuts in services. The city was the birthplace of the nation’s most restrictive Tax and Expenditure Limit, so it is no surprise that residents were not in favor of the steep increase.

Colorado’s Tax Payer’s Bill of Rights (TABOR) prevents the state and municipalities from raising taxes without voter consent. The issue of whether state-level TELs should limit home rule by constraining local spending is controversial, but as the law stands it undeniably gives voters control of budgeting.

The official reaction to this vote has been ugly. Budget officials seem to be punishing their constituents for their fiscal preferences by shooting the cocker spaniel, as their Boston counterparts threatened.  The expression refers to politicians who generally threaten to take away valued services, but in this case they are following through. Colorado Springs politicians are choosing to make the necessary budget cuts by turning off street lights, cutting park budgets, and even removing city trash cans, in what seems to be an effort to anger residents rather than make the most efficient cuts possible.

Marketplace’s Kai Ryssdal interviews a resident on the issue:

“They’re going for the things that are easy to cut rather than the things that are hard to cut. And the things that are hard to cut deal with human beings and personnel.”

Fowler says the city needs to look much harder at pay-cuts and lay-offs. But city officials have decided that its employees shouldn’t take pay cuts just because residents want to keep taxes low. So instead, Parks and Recreation took a big hit. That department’s budget was recently slashed by 75 percent.

Perhaps these extreme, if inefficient, measures in Colorado Springs will lead voters to pass a tax increase in the next election. Or these budget-cutting tactics could end the careers of incumbent politicians.