Wednesday, February 8, 2017

Budget Analysis 2: Spending Cuts

This the second budget-analysis article is focused on long-term, permanent spending cuts. Of which there are none in the governor's budget.

But first, and on a related note, some good news:
A growing faction of GOP lawmakers who say voters will not accept tax increases triumphed late Friday as the House voted against raising the sales tax to solve Wyoming’s education funding crisis. The House rejected first a two-cent increase and then a half-cent increase in sales taxes. Taking the state sales tax from four to six cents on each dollar of sales would have generated an estimated $300 million a year, according to Rep. David Northrup (R, HD-50, Powell), chairman of the House Education Committee.
Based on what calculations? Friends of higher taxes often forget to take into account the small problem that consumers have a penchant for adjusting their spending, both regular and irregular, to tax hikes. Regular spending declines as people buy the same products but cheaper brands to keep their family budgets intact; with more frugal consumer spending, sales-tax revenue do not measure up to the statist estimate.

Irregular spending is affected when Wyomingites buy their cars in Montana, which has no sales tax, or Colorado, where you can escape a hefty upfront sales-tax bill on your car. Instead, you roll the tax into your vehicle financing.

Either way, the state of Wyoming would be left with zero sales-tax dollars - and the tax hikers wold have come back and raised another tax. 

The vote in the House on Friday may not have stopped the tax hikers' campaign, but it has at least shown them that there is real, solid resistance to bad ideas. Kudos to everyone who voted against the sales-tax increases!

Hopefully, as a follow-up on this vote our state legislators will concentrate on the spending side of the budget. When they do, they need to bring our state in the direction of permanent solutions to our over-spending problem. This is a different track of spending cuts than what Governor Mead proposed in his budget.

As the budget stands today, not counting the 28 amendments on file so far, its proposed spending cuts look as follows:

Total General Fund Federal Funds Other Funds
Before cuts  7,680,366,395  2,858,478,357  1,380,602,574  3,441,285,464
After cuts  7,496,853,395  2,610,259,428  1,362,660,019  3,523,933,948
Difference in dollars -183,513,000 -248,218,929 -17,942,555  82,648,484
Difference, percent-2.4%-8.7%-1.3%2.4%

As mentioned yesterday, only four of the 46 sections in the budget (counting all judicial districts as one aggregated section) get increased total funding. Looking at the General Fund only, the increases are even fewer and farther in between: only the Office of the Public Defender gets a boost of GF money. The other three with increased total appropriations get it through either Federal or Other Funds. 

Spending cuts are applied across the board, with most sections seeing a reduction in total funding by 4-10 percent. For the total budget, though, the spending reduction is 2.4 percent. As the table above explains, increases in Federal and Other appropriations dampen the effects of the General Fund cuts.

When spending is cut across the board, it is for the most part an unproductive strategy over the longer term. All government spending programs have "cost drivers" built into them, variables that automatically, or habitually, lead to rising costs over time. Normally, I recommend elected officials to stay away from across-the-board cuts for precisely this reason: they require a fair amount of legislative and political effort and only provide temporary budget relief. 

In the circumstances we are in today, though, it is actually a good idea to use across-the-board cuts, but only as the beginning of a process leading to long-term, permanent reductions that change the trajectory of government spending.  

Here is how it works. Government spending programs are primarily driven by the entitlements that the legislature has promised to people. Those entitlements have a certain value, determined by: 1) how many people are entitled; 2) the quality of the product they are entitled to (such as health care through Medicaid); and 3) the quantity of the product (such as how many times per year a Medicaid enrollee can go see a doctor for a specific condition). 

In general, these three cost drivers cause government spending to increase steadily over time. The more entitlements government promises people, the more steeply the spending curve will rise.

To pay for the entitlements, government imposes taxes on us. The revenue that comes out of those taxes is determined by: a) the tax rate; and b) the size and growth of the economic activity that the tax applies to. 

It is easy to see where the problem lies here: tax revenue is determined by completely different variables than those that determine government spending. To make matters worse, the more government grows, the bigger the gap will be between the trajectories of tax revenue and government spending. Since tax revenue is dependent on the so-called Laffer curve, the gap between spending and revenue accelerates as government grows bigger and requires higher taxes. 

The figure below schematically illustrates this basic, common-sense principle:

Figure 1

This is, again, the basic mechanic structure behind government finances, when spending is driven primarily by entitlements. Let us now add an across-the-board spending cut and see what difference it makes:

Figure 2

We can push the spending trajectory down a little bit, thereby increasing the room for budget balancing. However, the long-term trajectory of government spending is still divergent from the long-term trajectory of tax revenue. 

Herein lies the problem: we need reforms that fundamentally change the trajectory of government spending. The spending cuts in Governor Mead's budget give us some breathing room - it expands the "green zone" as in Figure 2 - but if we do not use it to roll out structural spending reforms, then the across-the-board cuts will do us very little good. 

Tomorrow's article will add structural spending reforms to Governor Mead's budget. The ideas for spending reforms will be based on proposals that I have already published, primarily focused on education and Medicaid. There will also be an efficiency-enhancing element added to the reforms.

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