Trigger Term-Limits: Motivating Legislature Fiscal Accountability

Filed Under (Finance, U.S. Fiscal Policy) by Bob Gillespie on Jul 6, 2011

Balancing the budget is widely considered to be the foundation of state fiscal practices.” 

National Conference of State Legislatures Fiscal Brief: October 2010

By any measure the Illinois state legislature’s performance in managing the states fiscal affairs over the past years has be abysmal.  The state has run a budget deficit every year over the past ten years; it ranks 12th in debt per capita among the states; it has used state pension funding obligations and accounts payable to vendors as a “rainy day fund” to hide the deficits; and even after large tax increases in 2011 there is every likelihood the FY 2012 will have a deficit.  

Dissatisfaction with state legislatures is not a new phenomenon. Twenty years ago widespread dissatisfaction with the performance of legislators inspired the introduction of term-limits in many states in an effort to return to an earlier era of citizen legislators rather than career legislators.  This enthusiasm led to the adoption of term-limits by 21 states from 1990 to 2000.  Six states have subsequently abandoned term-limits either through the action of State Supreme Courts or state legislatures.

It has been over ten years since the last state adopted term-limits; obviously term-limits have not produced all the sought after benefits. Research attributes the disappointment with term-limits to: Loss of power of legislators to the information providers (agency staff, executive branch, lobbyist) and a decline in legislative experience among members of the legislature, which adversely affects the performance of the legislative bodies.

However, rather than abandon term-limits they should be used to reset legislator’s incentives from a focus on re-election to a focus on governing – why they were elected.  To accomplish this term-limits should be made contingent on the performance of the legislature in managing the state’s fiscal affairs.  A failure to meet the performance standard would trigger the imposition of term-limits.  The Trigger standard would be a function of the budget deficit. Deficit Trigger term-limit legislation would specify a maximum number of terms, lifetime or consecutive, and would be established by the legislature or referendum BUT the term-limits would be only triggered if the government budget deficit – averaged over the most recent four-year period – became negative.  Four years should include a full business cycle and give sufficient time to implement fiscal adjustments to cyclical shocks.  Term-limits would be held in abeyance so long as the average budget balance over the last four years was non-negative. 

For example, at the end of each fiscal year an independent government accounting agency would publish the average budget balance for the prior four years including the fiscal year just ended.  If this average were negative term-limits would immediately be triggered.  If the term-limit for an office had been set for four years, office holders would be barred from running for reelection if their service exceeded four years at the end of the current legislative term.   Once term-limits were triggered they would be rescinded only when the four-year average budget balance became non-negative.   But the trigger would then be reset.

Advantages of the Trigger Term-limits:

1)      The threat of trigger term-limits will motivate cooperation across party lines to correct a budget deficit.   If the trigger is tripped, no amount of media dollars or blame shifting rhetoric could save legislators of either party from the effects of term-limits — cooperation would be rewarded by longer tenure

2)      The annual announcement of the four-year average budget balance would focus media and public attention on legislative fiscal performance; a “Deficit Trigger” and its implications has dramatic appeal.

3)      The threat of term-limits should especially motivate legislative leaders to correct a deficit, as they are usually the most senior and consequently have careers most at risk from term-limits.

4)      Traditional term-limits eliminate groups of politicians at the end of their term limits whether their performance has been good and bad.  This is a waste of talent when the legislature has been performing in a professional manner.  Deficit Trigger Term-limits eliminate groups of politicians only when their performance has been unsatisfactory.  Group professionalism is rewarded.

5)      A Deficit Trigger threat is nonpartisan; it does not bias a solution to a budget deficit towards, either increasing taxes or decreasing government spending but it does preclude long-term borrowing as a budget deficit solution.

Design Details:

Since the Trigger Deficit measures the performance of the legislature an agency   independent of the legislature must be given the responsibility for measuring the deficit.   Measurement of the Trigger Deficit must be based on government accounting systems that meet modern profession standards such as those established by the Government Accounting Standards Board (GASB).  These standards would prohibit the use of bogus “rainy day funds”.  Shortfalls in public pension funding obligations or payments to vendors delayed over 90 days would count as part of the deficit.

Deficit Trigger Term-limits will gradually eliminate chronic state government indebtedness. However, some forms of long-term government debt serves a very useful purpose.  When critical infrastructure is needed issuing long-term government bonds, debt, can most quickly finance it.   Since most infrastructures, e.g. bridges, roads, schools, etc., last for longer than one generation it is appropriate that the financing costs also be shared across generations.  Long-term government bonds accomplishes this.  Consequently, Trigger Deficit coverage should be confined to budget deficits in expenditures for currently consumed public services, e.g., salaries, transfer payments, non-capital expenditures, pension costs etc.  If in a given year the budget for these services is in deficit, short-term borrowing can be used to temporarily fund the deficit, but the borrowing cannot be long-term if term-limits are to be avoided.  Debt is a tool, not a magic wand.

The continuing state debt and fiscal disarray throws a long shadow of economic uncertainty over the state.  This uncertainty focuses on future tax rates, which affects business decisions on whether to invest or disinvest in Illinois and on taxpayers decisions to relocate.  Introducing Deficit Trigger Term-limits would send a signal that the state is serious about correcting this disarray.  Implementing them in Illinois by legislation or initiative will be challenging but just making the effort would be a message.

Social Security, Medicare, Medicaid: One of these things is not like the others

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on Feb 17, 2011

Interesting goings on in the world of government budgets these days.  I’ve written in the past about the problems of increasing health care costs in the U.S. and how this is a problem that, at this point, we just don’t know how to solve.  Social Security, on the other hand is another matter.  Despite the gloom and doom about the coming insolvency of the system, things aren’t really all that bad.  (Of course, that statement should be interpreted relative to health care entitlements, but still …)  I’m relatively uninformed on the subject, but it seems like, if we wanted to “fix” social security, we could (i) raise taxes, (ii) reduce benefits, (iii) increase the retirement age, or (iv) some combination of these.  None of these options is great, but any would work.

President Obama raised a similar point in his Tuesday press conference.  Asked about the “long-term crushing costs of Social Security, Medicare [and] Medicaid” which his budget proposal did not address, he responded:

Now, you talked about Social Security, Medicare and Medicaid.  The truth is Social Security is not the huge contributor to the deficit that the other two entitlements are.  …  Medicare and Medicaid are huge problems because health care costs are rising even as the population is getting older.

So, just how bad does the future look for Social Security?  Well, bad, but not that bad.  Take this excerpt from the Summary of the 2010 Annual Reports on the Status of the Social Security and Medicare Programs:

Social Security expenditures are expected to exceed tax receipts this year for the first time since 1983. The projected deficit of $41 billion this year (excluding interest income) is attributable to the recession and to an expected $25 billion downward adjustment to 2010 income that corrects for excess payroll tax revenue credited to the trust funds in earlier years. This deficit is expected to shrink substantially for 2011 and to return to small surpluses for years 2012-2014 due to the improving economy. After 2014 deficits are expected to grow rapidly as the baby boom generation’s retirement causes the number of beneficiaries to grow substantially more rapidly than the number of covered workers. The annual deficits will be made up by redeeming trust fund assets in amounts less than interest earnings through 2024, and then by redeeming trust fund assets until reserves are exhausted in 2037, at which point tax income would be sufficient to pay about 75 percent of scheduled benefits through 2084. The projected exhaustion date for the combined OASI and DI Trust Funds is unchanged from last year’s report.

So, even if NOTHING were done, Social Security would be able to pay at least 75 percent of scheduled benefits through 2084.  Like I said, that’s bad, but it could be worse.

What about health care?  For that, let’s turn to a new working paper by Kate Baicker and Jon Skinner entitled “Health Care Spending Growth and the Future of U.S. Tax Rates.”  Not exactly beach reading.  They note that health care spending currently accounts for 17.6 percent of GDP and health care expenditures currently grow, on average, about 2.5 percentage points faster per year than GDP.  If this trend continues, health care expenditures are expected to account for 26 percent of GDP by 2035.  Of course, escalating health care costs are expected to reduce GDP, so the future might actually be worse.  According to the CBO (reported by Newhouse here), if health care cost growth exceeds GDP growth by 1 percentage point (on average) until 2050, this will lead to a 3 – 16% decrease in GDP over what would have happened if there were no gap.  Things will be substantially worse if the 2 percentage point gap continues.

What about government revenues?  Here’s where it gets really scary.  Suppose that health care costs continue to grow at a rate 2.5 percentage points faster than GDP grows.  In 2007 (too lazy to look up this year’s number), spending on Medicare and Medicaid was about 4.5 percent of GDP.  If the 2.5 percentage point gap continues, CBO estimates that by 2050 spending on Medicare and Medicaid will account for approximately 20 percent of GDP.  If this increased expenditure were financed by increasing income taxes and rates for all income groups were increased proportionately, CBO says:

Before any economic feedbacks are taken into account, and again assuming that raising marginal tax rates was the only mechanism used to balance the budget, the tax rate in the lowest tax bracket would have to be increased from 10 percent to 26 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 66 percent; and the tax rate in the highest bracket would have to be raised from 35 percent to 92 percent. The top corporate income tax rate would also increase from 35 percent to 92 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. Revenues could fall significantly short of the amount needed to finance the growth of spending, and thus tax rates at this level may not be economically feasible.

Not that they need to, but in the longer term, things are even worse.  Chernew, Hirth and Cutler project the meaning of a 2 percentage point health expenditure-GDP gap until 2083 and find that, on average, 118 percent of all real income growth between now and 2083 will be devoted to health expenditures.  The Newhouse study illustrates this point with a graph showing that if a household has about $40,000 to spend on everything other than health care in 2008, under the current projections it will have about $30,000 to spend on everything else in 2084.

So, the comparison between Social Security and health care is pretty clear.  If nothing is done, Social Security will be able to pay at least 75% of benefits through 2084.  If nothing is done on the health care front, (according to the CBO report) “if health care costs per beneficiary grew an average of 2.5 percentage points faster than GDP per capita each year, as they have over the past four decades, and the spending was financed solely with a proportional increase in income tax rates, the economic costs would be significant and the circumstance probably impossible to sustain through 2050.”

Why are we doing this?

Filed Under (About this Blog, U.S. Fiscal Policy) by Don Fullerton on Sep 10, 2010

The primary purpose of this blog is to help citizens to read the newspaper and understand some public policy debate from more analytical perspectives.  Each of us truly believes that economic analysis has something to say about the world, and particularly about public policy.  So we give examples of what economics would say about one problem or another.

Often, when I explain some economic analysis, somebody says “well, that’s just good common sense!”.   Exactly.  Good economic analysis should be just good common sense.  Think about direct effects, and indirect effects, and then line up all the pros and cons.  The problem is that good common sense is just so rare these days.  Especially in politics.

I don’t mean to make political statements here, in this blog about how to analyze economic problems.  But let’s look critically at some statements by politicians AND economists, and use some good common sense.  Consider what you’ve heard: “I support a new research and development tax credit, because it will create jobs”.  Really?  Maybe.  But that can’t be the true primary purpose.  What does your common sense say?  If the true goal were to create jobs, then create jobs!  Government could hire people, or provide specific tax incentives targeted toward new hires.  The purpose of an R&D tax credit ought to be incentives to do R&D!  It should stand or fall on those merits.

There may be plenty of good reasons to enact an R&D credit, but let’s discuss THOSE reasons.  Let’s have an informed discussion.  Most importantly, let’s help newspaper readers decipher this kind of pandering, reject it, and insist upon hearing the true advantages and disadvantages of the policy.  Let’s have an informed debate and make the best decisions.

For another example, take the current debate about whether to extend the Bush-era tax cuts that are soon to expire.  Some say that this recession is the wrong time to raise taxes, while others point to huge budget deficits that would be made worse by cutting taxes. In particular, President Obama wants to make permanent the tax cuts on those earning less than $250,000 per year, and not extend the cuts on those earning more.  (Actually, of course, you have undoubtedly noticed the semantic problem, where Republicans say it would “raise taxes”, while Democrats say “not extend the Bush-era tax cuts”).

Let’s look critically.  This debate raises THREE separate issues, where many commentators have deliberately confused the issue by talking about one when they really mean something else.  The three issues are (1) details of good tax policy, (2) the recession, and (3) how much to tax the rich compared to the poor or middle class.

First, policymakers could raise some taxes and lower others.  The analysis of good tax policy involves many such choices about each credit or deduction, which requires details and debate on each such feature of the tax code.  Raising or lowering the rate of tax is not the only option; policymakers COULD provide targeted credits (i.e. for jobs or for R&D), or they could simply enforce existing laws and collect from those who currently cheat!

Second, both sides of the debate point to the recession, as a reason to cut taxes on the middle class, or as a reason to cut taxes on the rich.  Both of those arguments are beside the point.  Politicians like to appeal to the fears of voters by invoking the recession and jobs.  But it can’t possibly make much difference to the recession whether we cut taxes on the rich, or cut taxes on the poor or middle class – for the same overall tax revenue.  

Third, the key to this debate is not whether to raise or lower overall taxes.  It’s about the balance of taxes on the rich vs. poor.  On THAT debate, economics has no special role!  It’s a matter of personal preference, ethics, or social justice.  Society must decide how much to take from the rich in order to help the poor through tax cuts or social safety net.  Both sides of the debate are being disingenuous by appealing to other arguments, that a tax cut will hurt the deficit or help the economy.  We are not debating any major tax cut or stimulus here; the debate is all about how much to tax the rich vs. how much to tax the poor or middle class, those under $250,000 per year.

Economistmom.com has an excellent insight into this debate over the actual utility of the tax cuts and what their designed goal is versus their stated goal.  I encourage you to check out her post from 9/13, “Those ‘Best for Nothing’ Bush/Obama Tax Cuts”.  In it she makes the case that “for whatever economic goal you can think of, whether short-term or longer-term, there’s some fiscal policy even better suited for that goal.  So the Bush/Obama tax cuts aren’t ‘good for nothing.’  They’re just ‘best for nothing’.”

The Great Recession and State Budget Deficits

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Oct 23, 2009

We write this blog for the University of Illinois “Center for Business and Public Policy” (CBPP), which is NOT the same as the Center on Budget and Policy Priorities.  That other center provides some useful information, however, such as the new report on state budgets.  It says “48 states have addressed or still face shortfalls in their budgets for fiscal year 2010, totaling $178 billion or 26 percent of state budgets.”

The most famous example of a state fiscal disaster is California, which accumulated a total gap during FY 2009 of $37 billion (equal to 36.7 percent of the states general fund).  The state later issued IOUs instead of actually paying for some services.

While the long-run fiscal problems of the Federal government are severe and well documented, the short-run budgetary problems in Washington, DC are simple compared to those at state capitals across the country for two reasons.

First, almost all states have balanced-budget statues.  (In fact, only Vermont allows deficit spending.)  The inability to run budget deficits during a recession limits the options of governors and state legislatures when dealing with shortfalls.  Indeed, standard doctrine suggests that governments should run deficits during recessions to stimulate economic activity.  Without the deficit spending option, states must cut expenditures or raise taxes, exactly the opposite of what they should be doing to counteract the downturn.

Second, this particular recession has put a great strain on state revenues due to the collapse in housing prices and the steep decline in consumer spending.  Unfortunately, most states rely on property taxes and sales taxes for revenue, instead of income taxes.  Yet housing prices are unlikely to rebound soon, as a glut of foreclosures remains in many states.  Also, it appears that consumers have  shifted to a higher savings rate, which lowers sales tax revenue.  Potentially, tax rates could be increased to cover the budget gaps, but that option is politically difficult during recession.

In response to these two problems, the Federal government has increased transfers to the states as part of the American Investment and Recovery Act.  Since the Federal government CAN run a deficit, these transfers help get around the balanced-budget statutes and allow for less draconian state expenditure cuts.  However, the lag in revenue recovery at the state level still means years of tight budgets ahead.