State Budget Problems Lead to Renewed Interest in TELs

Published January 1, 2004

Thoughtful leaders in many states are fed up with the fiscal roller coaster they have experienced during the past decade and want to smooth out the ride. The result in many states is new interest in constitutional tax and expenditure limitations (TELs) and efforts to improve limits where they currently exist.

Roller Coaster Ride

States are paying a heavy price for allowing rapid tax revenue growth during the 1990s to fuel an unsustainable expansion in spending. Between fiscal years 1990 and 2001, state tax revenue grew 86 percent. Inflation and population growth grew at a combined rate of 55 percent during that same period.

If states had limited spending growth to the rate of increase in inflation and population, according to analysts from the Cato Institute, state budgets would have been $93 billion smaller by FY01 than they actually were. The savings are roughly twice the size of today’s state budget gaps.

If revenue growth higher than the benchmark had been given back to taxpayers in permanent tax cuts and annual rebates, the rebates could have been temporarily suspended during FY02 and FY03 to provide a cushion with which to balance state budgets.

Origins in California

In 1972, Governor Ronald Reagan decided California government was too big, and its swings between feast and famine were too wild and unpredictable. He wanted to reduce the size of state and local governments, putting them on a diet that would control government growth and stabilize their fiscal practices.

The backdrop to Reagan’s fiscal initiative was a decade of explosive growth in state government. During the decade of the ’60s, when population and inflation increased just over 60 percent, total state spending increased 160 percent, also dwarfing personal income growth of 115 percent. In other words, California government was consuming an ever-larger share of the state economy, threatening the private sector’s ability to prosper.

Reagan established the Governor’s Tax Reduction Task Force to analyze the problem and come up with some original, surefire answers. The task force presented its work to Reagan in December 1972, having concluded that a constitutional amendment, limiting the growth of taxes and spending year over year, was the answer.

Since this TEL was a case of first impression, the drafters interviewed nearly every financial bureaucrat and fiscal expert in the state to get it right. There were 44 drafts before the proposed amendment was submitted to the legislature and ultimately placed on the state ballot as an initiative at a special election called by the governor in November 1973. The “Revenue Control and Tax Reduction Initiative” was designated Proposition 1.

Key Features of TELs

The key elements of Prop. 1 have become the cornerstones of effective TELs–then and now. They are:

  • Limit on government growth. Prop. 1 limited state expenditures to the then-percent of state personal income (about 8.5 percent) and required that percentage to be reduced by .1 percent per year until it reached 7 percent, at which time the legislature (by a two-thirds vote) could halt the annual reduction.

Other states followed the personal income percentage formula without the annual reductions, which has been found to be entirely too generous. It is now clear that annual increases in expenditures should be limited to the growth in inflation and population, as in the Colorado TABOR model. That approach avoids another element of the original California design, i.e., the establishment of an economic estimates commission to determine the spending limit for the year based on estimates of personal income growth. By using specifically identified population and inflation indicators, government officials cannot “play” with the formula.

  • Defining the tax and spending base. The California limit exempted a variety of spending and revenues, i.e., bond payments, federal funds, gifts to the state, etc. It has been determined since that broadening the base of included expenditure and revenue sources is the best answer.
  • Super-majority vote on taxes. Prop. 1 required a two-thirds vote to increase the rate or base of any existing tax or to add a new tax.
  • Tax surplus fund. Tax revenues in excess of allowable expenditures were to be transferred to the tax surplus fund and refunded to the people. The measure explicitly required the legislature to minimize surpluses by making periodic refunds and reducing tax rates.

A lot has been learned over the years about the games played with such revenues. It is essential to capture these excess funds and rebate them as soon as possible.

  • Emergency fund. A fund equal to .2 percent of state personal income (about 3 percent of the state budget) was set aside for emergencies, which could be determined by the governor alone.

Over the years this provision has morphed to include a declaration by the governor, super-majority vote by the legislature, and explicit limitation on the types of emergencies, i.e., natural disasters, not economic crises, for which the funds may be used. For economic recessions, a Budget Stabilization Fund is now the recommended approach.

  • Exceeding the limit. Prop. 1 contained an explicit provision for exceeding the limit based on a vote of the people following a two-thirds vote of the legislature for that purpose. Current models recognize that at any time the people can vote to increase spending/taxes in a measure providing for same and that an existing limit would be adjusted by that amount.
  • State mandates. The state was required to reimburse local governments for newly mandated programs or increases in the costs of existing mandated programs. This provision is essential to prevent an expenditure-limited state government from shifting costs to locals to escape the real impact of the state limit.

Experience has demonstrated that state governments are very creative in the ways they circumvent this discipline. It is essential that a state watchdog committee or organization, including taxpayer representatives and members of local government, monitor and enforce this provision.

  • Local government tax/expenditure limit. Prop. 1 recognized that state and local governments are part of a total fiscal system. It would not benefit taxpayers to control state expenditures only to have local governments fill in the gap. Prop. 1 set limits on local property tax rates, which could be changed only by a vote of the people. It allowed emergency expenditures over the limit only upon a four-fifths vote of the local governing board. The legislature could adjust property tax levels to meet special circumstances.
  • Shifts in program responsibilities. The limits at the state and local levels could be automatically adjusted for shifts of program responsibilities between the state and local units of government and the federal government. This provision has found its way into most current TELs to allow changes in responsibility for welfare, health, and other programs as between various governmental units.

A TEL is not a substitute for, but an addition to, every other fiscal restraint device extant in any state: gubernatorial line-item veto, impoundment or rescission authority, sunset laws, performance-based budgeting, etc. It will work with a part- or full-time legislature, a biennial or single-year budget, any type of state balanced budget requirement, etc. It will work with any type of tax structure, whether progressive or regressive.

Simply stated, a TEL automatically (constitutionally) says to the governor and legislators, “here’s the total amount you may spend this year; you decide how to allocate it and how to raise it.” That is the essence of a TEL.

Next month: Colorado’s Taxpayers Bill of Rights

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.