On the Frontier: Colorado’s Taxpayers Bill of Rights

Published February 1, 2004

Colorado is often cited as the state with the most stringent tax and expenditure limit (TEL) in the country. State elected officials nationwide can learn from how Colorado got its TEL and how it is attempting to cope with recent challenges.

Colorado’s Tax Revolt

One of the most important changes in Colorado tax policy was the adoption in 1987 of a flat income tax set at 5 percent, replacing the graduated income tax. The 5 percent flat rate was not revenue-neutral, capturing much of the windfall from the federal income tax reform of 1986. The income tax burden on Colorado citizens increased significantly, and the state became increasingly reliant on the income tax as a source of revenue.

This increased tax burden, and the rapid growth of government it paid for, set the stage for a tax revolt. A small group of tax fighters, led by Douglas Bruce, garnered the signatures needed to place the Taxpayer Bill of Rights (TABOR) initiative on the ballot. Initially, the measure lost to a coalition of powerful interest groups both public and private. But in 1992 the TABOR won the majority vote required for adoption as an amendment to the state constitution.

Colorado’s TABOR is currently the most stringent tax and spending limit in the country. Any increase in taxes, fees, or debt, at either the state or local level, must be approved by the voters. TABOR limits the amount of revenue growth the state can retain and spend to the sum of inflation and population growth. Revenue growth above that limit must be rebated to taxpayers. A similar limit is imposed on the growth of revenue and spending at the local level. The legislature can seek approval from taxpayers to spend surplus revenues.

In the 1990s Colorado experienced one of the most rapid rates of economic growth in the country. But state revenues increased even faster than the growth in personal income. Before TABOR kicked in, the state went on a spending spree, building highways, prisons, university buildings, and other projects at an unsustainable rate.

When TABOR was triggered that spending spree came to a halt. Over the three years from 1997 to 2000, TABOR limited spending growth to inflation and population increases, generating more than $3 billion in surplus revenue that was used for taxpayer refunds, rebates, and tax cuts.

Efforts to Circumvent

One should not underestimate the ability of legislators to circumvent even the most stringent tax and spending limit. TABOR provided that state legislators, through referendum, could request voter approval to spend surplus revenue. One of the first responses of the legislature was to request approval to spend about half the TABOR surplus. That referendum was soundly defeated by the voters.

A more effective ploy for the spenders was to shift more revenue and expenditures off-budget. TABOR also exempted from the limit a state enterprise that received less than 10 percent of its revenue from the state. A number of state enterprises achieved that status, and the University of Colorado was the first state university to apply for enterprise status.

TABOR also requires voter approval for any increase in public debt. Politicians have circumvented that provision by issuing Certificates of Participation (COPs) through a separate government entity created with the power to issue debt for the construction of a building that is then leased to the government. Theoretically the government is not obligated to repay the debt, although in reality the debt becomes a government obligation.

One of the most egregious actions of the legislature to circumvent the constraints of TABOR has been the deferral of taxpayer rebates by one year. Instead of refunding surplus revenue in the year it is generated, the surplus is placed in the general fund, financing current spending; required refunds are financed from revenue generated in the following year. That scheme worked fine in the 1990s when revenues were growing rapidly; it is a recipe for disaster when the economy enters recession and revenues fall.

Perhaps the most dangerous attack on TABOR was launched by the teacher union in 2000. Through the initiative process, this special interest group enacted Amendment 23 to exempt spending for K-12 government schools from the TABOR limit. Under Amendment 23 the state must maintain a constant rate of growth in spending for education K-12 each year. (This resembles action taken in 1988 by the California Teachers Association to corrupt the California TEL–the Gann Limit–through Proposition 98.)

Amendment 23 requires the state to earmark a share of state income tax revenue for an Education Trust Fund. State spending for K-12 education, now mandated by Amendment 23, has increased more than 12 percent above inflation and enrollment growth during the past four years, now comprising more than 41 percent of the general fund budget.

TABOR at Risk

In the current recession the Colorado economy has gone from one of the nation’s success stories to a relative basket case. Booms and busts have occurred throughout the state’s history. Today those booms and busts are tied not to natural resource industries, as in the past, but rather to industries of the new economy, such as telecommunications and high-technology industries, which have flourished in Colorado. This volatility in the state economy has wreaked havoc with state and local finance.

One explanation for Colorado government’s fiscal crisis is changes in tax policy. The progressivity built into the income tax, despite the adoption of a flat rate income tax, means income tax revenues fall more rapidly than the decline in personal income. The increased share of state revenues generated by the income tax has increased its volatility vis-á-vis state revenues. Recent tax cuts have reduced the income tax rate to 4.63 percent; further reductions in the rate, to between 4.00 and 4.25 percent, would be required to return that tax to complete revenue-neutrality.

Another explanation for Colorado’s fiscal crisis has been the overlay of the various constitutional provisions, in addition to TABOR, which control the fiscal outcome: property tax controls, Amendment 23’s school mandates, the statutory spending cap, etc. Also, the ratcheting down requirements of TABOR for both property taxes, during a time of falling assessed values, and of the state tax and spending limit, during a time of declining revenues, has exacerbated the recession effects on government resources. All of this has stirred some big-spending Coloradans to claim TABOR is to blame and to call for its complete repeal.

TABOR Reforms

To head off such a calamity, TEL experts and proponents have been debating various reforms and improvements of TABOR to prevent what are considered by some to be harsh–and inappropriate–outcomes. Among the suggested reforms:

  • Eliminate the “ratchet-back” effect. Under TABOR, when revenues decline, the spending limit falls in tandem so that the level of government spending starts anew from a lower base when the recession is over and economic recovery begins. Many tax limitation proponents prefer this approach and outcome. But it opens the TEL to unnecessary criticism and risk.

An alternative that would work for both state and local governments would be to maintain the spending limit at the previous year’s level throughout a recession, allowing it to increase only when revenues equal or exceed the spending limit. During this period, the decline in actual revenues would be offset by funds from the budget stabilization fund (see discussion below). This approach would prevent big spenders from calling for tax increases to fill in the “revenue gap.”

  • Establish a budget stabilization fund. In periods of rapid growth, when the state is generating surplus revenue above the revenue limit, a portion of the surplus revenue could be allocated to a budget stabilization fund, with the rest allocated to tax cuts and tax refunds. When the economy enters a recession, funds would be transferred automatically from the budget stabilization fund to the general fund to offset revenue shortfalls.
  • Establish a true emergency fund. In addition to the budget stabilization fund, and entirely separate from it, would be a fund to meet natural and other non-economic disasters when declared by the governor and agreed to by a supermajority of the legislature. Expenditures from the emergency fund would require an appropriation. Replenishment of the fund would be a top budget priority.

Next month: Lessons from 30 years of TEL experience

Lew Uhler, president of the National Tax Limitation Committee, chaired then-Governor Ronald Reagan’s Tax Reduction Task Force that developed Proposition 1. Uhler has remained active in the TEL movement nationally. Dr. Barry Poulson is a senior fellow in economic policy with the Independence Institute and professor of economics at the University of Colorado.