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Friday, March 17, 2017

A New Chapter for Wyoming - Updated Version

Upon reader request, here is an updated version of my vision for how to solve the fiscal and macroeconomic problems here in Wyoming.

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A New Chapter for Wyoming

Sven Larson, Ph.D., Economist




The solution to the Wyoming fiscal and economic crisis is centered around a structural redefinition of the role of government in our state’s economy. We have built a state and local government sector that is far bigger than what our economy can support, especially over the long term. Now that the tax base for government is returning to a more normal long-term level, it is necessary to do the same with the other side of the government budget: spending.

The right way forward for Wyoming is split into two types of reforms, short term and long term. The short-term reforms are of such a kind that they can be executed immediately and begin delivering results within approximately two fiscal years; these reforms will not have any lasting effects on the size of government, but they accomplish two important missions: they put an end to the “spending as usual” legislative practice that has brought us to the current fiscal crisis; and they create fiscal “breathing room”, allowing the legislature enough time to implement long-term reforms.





Short term reforms





Given the purpose of short-term reforms, the first order of business is to improve the efficiency of government operations. This is not about reforming spending programs per se, but reducing the operating cost of government. With a state government employing 15,000 people and total spending in excess of $7 billion, it is beyond question that there are efficiency gains to be found in the layers of the state government’s departments and agencies.


As an example of available efficiency gains, on February 25 the Wall Street Journal reported that several states have already begun the work to reform their Medicaid programs in the direction of cost containment:

Maine, for example, may limit most people on Medicaid to five years of benefits. Kentucky could require many recipients to work. Wisconsin exants to drug-test enrollees. ... Conservative legislators and governors in Arizona, Kentucky, Maine, Missouri, Ohio and Wisconsin are at the forefront of requesting ... waivers to the Medicaid program. ... Republicans say the new requirements would allow states to pursue innovative approaches to health-care provision that would lower costs. They add that requiring beneficiaries to have "skin in the game" makes them more involved in their care, leading to better patient outcomes

This type of reform is not going to contain the costs of Medicaid over the long term, simply because the entitlement itself remains structurally intact. However, this kind of reform can definitely help create the fiscal “breathing room” needed to give the legislature time to implement long-term reforms aimed at the structure of the Medicaid entitlement itself.

Another short-term reform is to change the relationship between Wyoming and the federal government regarding federally sponsored programs. Our state should therefore approach the White House and Congress and ask them to allow Wyoming to become an experimental state for reforms to federally sponsored programs. It would then be an open question what Wyoming would do with those programs, including Medicaid, K-12 education, transportation and welfare. Some of the reform space thus allowed could be used to initiate long-term structural reforms to some programs (see below) while other programs could do with less ambitious reforms (transportation).


A third, short-term reform is a workforce cost cap. Its purpose is to put an end to steadily increasing costs of the state workforce: according to Bureau of Economic Analysis data, in the period from July 2015 to June 2016 the state workforce remained unchanged in terms of number of employees, but the cost for the same workforce increased by $27 million. Disregarding the fiscal circumstances of the state budget, it is not at all strange that capable workers get a salary advance, but as a wise man once said, “ceteris is not always paribus” – you cannot always disregard the circumstances. When the state is projected to run deficits of hundreds of millions of dollars per year, the default solution should be to impose a cost cap on the entire state workforce.


More specifically, this cap would have the following properties.

  1. Cover every person working for government: full-time and part-time permanent employees as well as full-time and part-time temporary employees; but it would also have to cover employees funded by all forms of state funds: general, federal as well as other. Furthermore, it would have to extend to contractors of all kinds, as government otherwise would reduce its own staff and rely on staffing firms, consultants and other contractors. 
  2. Include all forms of employee compensation: wage, salary, benefits, paid-leave compensation and all sorts of fringe benefits; many forms of spending caps have proven to be ineffective because government agencies subjected to those caps have found ways around them - as have politicians opposed to them, whose job it is to pass appropriations for cash-limited government agencies.
  3. Once the "employee" and "compensation" variables are defined, a workforce cost cap would impose a total cash limit on how much government can spend on its employees. For the sake of argument, suppose that cap is $10,000, that government has 100 employees and that each of them is compensated by $100, of which $90 is salary and $10 is benefits. Let us say that government wants to hire more people. Since it can only spend $10,000, this means it has to reduce compensation accordingly: a salary cut of $10 per current employee opens up $1,000 for which government can now hire eleven new workers. Correspondingly, in order to give its employees a raise, government would have to fire some employees to free up cash.
  4. The cash limit is there to contain total costs, but it is perfectly reasonable to expect that those costs will change over time. Therefore, the workforce cost cap must include a mechanism to regulate cost increases. The only realistic option is to tie cost increases for the government workforce to increases in earnings in the private sector. For Wyoming, this would mean the cost increase in employee compensation in the private non-minerals sector of the Wyoming economy. (Both "employee compensation" and "private non-minerals sector" are easily defined by the classification systems used by the Bureau of Economic Analysis and the Bureau of Labor Statistics.) If the total employee compensation paid out to private, non-minerals workers increases by five percent in one year, then government can raise the cap on its workforce compensation by five percent. 

Obviously, the last point also means that if the private non-minerals sector cuts its employee compensation, then the government workforce cost cap must be reduced by the same percentage.

Why use the non-minerals sector? There are two reasons for this. First, the minerals industry pays its employees disproportionately well (as they should); if government workforce compensation was even partly tied to their earnings, its costs would run amok in good times for the volatile minerals industry - and plunge unpredictably in bad economic times. Neither violent upswings nor rapid downswings are good for the long-term stability of government (regardless of its size). 


Secondly, for far too long our state government has been too focused on minerals as the bread and butter of our private sector. Yet most Wyomingites do not work in the minerals industry. Furthermore, if our state's economy had been blessed with a couple of strong secondary industries, the downturn in minerals would not have hit our state as badly as it did. 


One reason why our state is still relatively dependent on minerals is that our lawmakers have had no incentives to care about anything outside the severance-tax paying minerals industry. Therefore, by tying government workforce compensation to the non-minerals sector we might get policy reforms that make lives much better for small, non-minerals businesses.



In summary, short term reforms are:

  • Efficiency study – improve the operation of government and eke out cost advantages that give the state legislature some fiscal breathing room while addressing long-term reforms;
  • Federal funds freedom – apply to allow Wyoming to operate federally sponsored programs without the regulatory ties that are currently attached to the money;
  • Workforce cost cap – tie the increase of total state government workforce compensation to the increase in workforce compensation in the non-minerals private sector.



Long term reforms





In its last leg of the 2017 session the state legislature passed the school-funding omnibus bill, which created a commission to study school funding. It is fairly easy to see that this will lead to proposals for higher taxes. As an alternative, the legislature should appoint a commission for the advancement of economic freedom. This commission would concentrate on:

  1. structural, permanent, reductions to government spending; identifying fiscally and economically relevant reforms, outline a time table for them and specify the legislative steps needed to execute them;
  2. regulatory overhaul: map, identify and eliminate regulations on private business activity; identify regulatory "hot spots" that impose particularly high costs and are especially stifling on business establishment, operations and expansion; and
  3. develop a proposal for turning Wyoming into an economic freedom zone.

This last point is not to be mistaken for the irresponsible "prosperity zones" that Compact for America has proposed; unlike the "prosperity zone" the focus of which is to benefit predatory capitalism, an economic freedom zone is focused on strengthening, preserving and developing a free-market based economy. In order to implement an EFZ in Wyoming, we would need to coordinate the deregulation of the private sector with structural, permanent reforms to government spending.

In terms of reforms to specific programs, there are two that stand out as particularly beneficial from both a fiscal and a macroeconomic viewpoint: Medicaid and K-12 education.





Program specifics: Medicaid





Medicaid reform depends in part on what is going to happen at the federal level, but the general direction in which President Trump and the Congressional Republicans are moving, suggests that there will be growing opportunities for states to innovate with Medicaid reforms. Wyoming should capitalize on this new, emerging climate for state fiscal sovereignty. While the federal government must approve state Medicaid overhaul, sound economic arguments would likely convince President-elect Trump to allow Wyoming the needed reform room.


The purpose for bringing Medicaid home is threefold:

  • the program works more in tandem with the rest of the health insurance market here in Wyoming (which can be substantially beneficial if Congress passes the “right” kind of Obamacare reform);
  • the costs go down without harming those who have been lured into depending on government for their health care; and
  • we can, eventually, make Medicaid redundant.

The first point is the most important one. Medicaid "in tandem with" private health insurance simply means that people on Medicaid would become health insurance shoppers like the rest of us. The key instrument here is a voucher for health insurance, which is then used to buy private insurance plans. Under the current ACA, such a voucher would not carry much weight on the insurance market here in Wyoming, but if we open the state's Medicaid system to a national market, it will be a lot easier for Medicaid enrollees to find a plan that suits their needs, at a reasonable cost. 

As an example of what a Medicaid enrollee could purchase, consider the following experiment. as of FY 2015, Wyoming spent a total of $566.4 million on Medicaid. If we took over Medicaid from the federal government, this would be the total bill we as Wyoming taxpayers would have to foot. 


Of this total Medicaid cost, $276 million goes toward long-term care and Medicare reimbursements. The rest is mostly acute-care costs, with minor amounts going toward managed care and hospitals with disproportionately high share of Medicaid enrollees among patients. Let us assume that the 55,000 Medicaid enrollees who are younger than 65 share an equal proportion of the remaining $290.4 million. This comes out to $5,536 per person, per year. 


Suppose, now, that we have a family of four who is enrolled in Wyoming Medicaid. Their health care costs the state $21,127 per year. Suppose, now, that we give them a voucher for that amount and send them out on a national health insurance market to buy a plan of their choice. 


Plans in Wyoming tend to be expensive. A representative plan - where there are no tax subsidies - costs this family $19,908 per year. Add to that a $1,500 group deductible and the total annual cost is $21,408. 


To provide coverage under Medicaid we have to assume that the voucher pays the deductible on top of the premium. As a result, the total cost of this representative Wyoming plan exceeds the cap of the voucher. Our Medicaid-enrolled family will have to look elsewhere. 

Consider a plan in Maryland, which has a total cost of $16,508 per year. If the family chooses this plan, the Wyoming Medicaid system can save $4,699 per year. Applied to all 55,000 Medicaid enrollees younger than 65, Wyoming taxpayers would save $64.6 million per year. 


These numbers are all obtained under the assumption that the Affordable Care Act remains in place. If a repeal-and-replace reform takes us back to a health insurance market comparable to where it was before the ACA went into effect, there is a very good chance that a nationally applicable Medicaid voucher could cut the cost of the non-65 portion of Medicaid by up to 40 percent, or something in the vicinity of $116 million. 


If we apportion the federal funds for Medicaid, this amount is relatively close to the federal funding share. Under static conditions, it would not allow Wyoming to operate Medicaid completely on its current in-state funding. However, assuming market-oriented reforms to Obamacare, the case for a thrifty Medicaid system improves dramatically. If we can reform our health care industry here in Wyoming so that health care costs in general drop by 15 percent, then the cost of health insurance will - over time - adjust itself to that lower figure. That could push the cost of Medicaid in our state down to something equal to what the state is paying.


Even better: once private insurance becomes cheaper, we can encourage private employers to provide health insurance for their employees. (The Affordable Care Act has made it unaffordable for many small businesses to do just that.) Once more employers cover their employees, fewer will need Medicaid and costs will begin to tumble simply by virtue of reforms that give the private sector back control over something that government should never have been involved in the first place.  


Again, the main problem with any reform to our health care and health insurance industries is that Congress has decided to get so deeply involved in both, that states have much less room for its own reforms. It takes much more at the state level to get any reforms done, especially to obtain substantial cost savings, than it did before the ACA.  


That said, there are still things we can do on our own. One of them is to start the process to give Wyoming full jurisdiction over its own Medicaid system, and then move the system as close as possible to a free-market program. 





Program specifics: school choice





The debate over school choice often focuses on principled arguments, such as individual and parental freedom, religious rights, etc. These are important arguments and they should be considered first and foremost in the school-choice debate. However, that does not mean that the economic issues are to be ignored - on the contrary. Given the economic crisis here in Wyoming, we must take into account the economic aspects of any kind of government-spending reforms. If we can combine principled arguments for school choice with good fiscal and macroeconomic arguments, then obviously we have a winning recipe.


The fact of the matter is that school choice could be an economic boom for Wyoming.


It could be a $450-million industry creating thousands of new private-sector jobs. 


There are two steps to the economic benefits of educational freedom: the macroeconomic effects of new businesses - for-profit or not-for-profit - opening up around the state; and the positive, long-term benefits on youth entrepreneurship that is associated with school choice.

The last point is almost never brought up in the context of school choice, yet there is convincing research that shows that kids who have had the freedom of school choice are 25 percent more likely to start businesses and choose an entrepreneurial career, than kids in non-choice school systems.[1] This means, plain and simple, that if we had a school-choice system in Wyoming, we would not only see more businesses emerge and grow in our state, but we would also retain a larger share of every class that graduates high school. Governor Mead has expressed an interest in seeing both things happen; he now has yet another reason to come out in favor of school choice.

The more immediate macroeconomic benefits of school choice are associated with the establishment of new businesses around the state. It does not really matter what form of association the new schools choose: if they are not-for-profit organizations, foundations, LLCs or incorporated, does not make a difference at the macroeconomic level. What matters is instead the potential for new jobs and better education at lower cost. 

A realistic estimate of the economic benefits from school choice suggests that if Wyoming families were allowed the same school-choice opportunities as they have in Wisconsin, we could soon have 11,000 jobs in private schools all over our state. Add to that the emergence of businesses in support of private schools as well as the return of tax money to the private sector (when the cost of K-12 education goes down) and we have the potential give our state economy a major boost. 


The Wisconsin school-choice model is interesting as an object of comparison for primarily two reasons: it started in Milwaukee in 1990, being very much tried and true by now; and has since expanded to a point where it enrolls 34 percent of all eligible K-12 students in the state. 


Annually, private schools produce educational services for almost $2.9 billion in Wisconsin. It is important to keep in mind that this number includes all kinds of private-instruction institutions, not limited to K-12 education. However, if we make the reasonable assumption that the K-12 schools are overwhelmingly dominant in this category - a fair assumption - we can use it as part of a hypothetical scenario explaining the benefits that school choice would have for Wyoming.


In 2014 private schools in Wisconsin employed 70,566 people. Their average employee compensation was $35,754 which does not sound like much; in fact, it implies that teachers in private schools make much less money than in public schools. That, however, would be a rush to conclusion. We cannot distinguish teachers from other employee categories in available data; it is reasonable to assume, though, that private schools have more part-time workers and fewer well-paid administrators than public schools. Especially the last point pulls down the average compensation figure.  


The employee and compensation figures are important as we proceed. Before we put them to work, though, let us take a quick look at some facts about the Wisconsin school-choice system. There are four different programs, three based on vouchers and one based on a tax credit (all numbers are from 2015):

  • The Milwaukee Parental Choice program has 26,686 participating students, which amounts to 57 percent of all students eligible for the program; average voucher funding is $7,366; students go to 113 different schools;
  • The Statewide Parental Choice program has 1,011 participating students, which amounts to 26 percent of all eligible students; average voucher funding is $7,388; students go to 31 different schools;
  • The Racine Private School Choice program - local to the city of Racine, 30 miles south of Milwaukee - has 1,733 participating students, which amounts to 25 percent of all eligible students; average voucher funding is $7,324; students go to 15 different schools;
  • The Individual K-12 Private School Tax Credit program - which started in 2014 - has an estimated 38,500 participating students, which amounts to 27 percent of all eligible students; average tax credit is $4,696.

In total, almost 68,000 students benefit from school choice in Wisconsin, which is one third of all the 200,000 eligible students. By comparison, there are approximately 867,000 students in Wisconsin K-12 schools, which means that, so far, the choice programs have only reached a portion of all students. 

Let us assume that we in Wyoming created a school-choice program that offered both vouchers and tax credits. Let us also assume that we made all 94,000 K-12 students in our state eligible for the program; that the vouchers and tax credits provided the same average funding as in Wisconsin; and that we, like them, could reach a 34-percent participation rate among eligible students. 


Here is the estimated outcome: 
  1. We would have almost 32,000 students in private schools of their parents' choice;
  2. Vouchers would pay almost $235 million to those schools;
  3. Assuming additional private funding - tuitions paid directly by parents, donations to non-profits, contributions from churches to confessional schools, etc - private schools could produce a total economic value of $447 million per year;
  4. Assuming the same school employee to student ratio as in the Wisconsin private-school system, private schools in Wyoming would employ more than 11,000 people;
  5. With an average employee compensation on par with Wisconsin, private-school employees would earn a total of more than $401 million per year.

To put the 11,000-job figure in perspective, oil and gas extraction employs less than 10,000 people in our state. 

With a total economic value of $447 million per year, private schools would be as important to our economy as private hospitals, nursing homes and residential-care facilities.


Add to this the fact that a student in this hypothetical school-choice program costs $9,000 less per year than a student in public schools. We can now reduce the state's budget deficit by $287 million - and that is before we consider the positive multiplier and accelerator effects from the school-choice program.

 

Macroeconomic Benefits





The long-term reforms discussed here are only two examples. They are, however, the two that have the biggest fiscal and macroeconomic impact over time; they are also labor intensive enough in terms of legislative effort that it would be unrealistic to expect the legislature to be able to focus on other reforms simultaneously with Medicaid and K-12 education.


Assuming that these would be the only two long-term reforms, there are nevertheless some notable macroeconomic benefits from them.


The total expectable tax cuts under these reforms amount to $393 million. Assuming that these cuts are designed squarely to benefit Wyoming families, they would, on average, put $2,678 back in the pockets of a family with two parents and two children. Given the average propensity to consume for the Wyoming economy, we can expect them to spend, on average, $2,080 more per year. Overall, we would be looking at a 1.3-percent increase in private consumption, but more importantly, applying a standard Keynesian consumption multiplier points to a GDP growth effect of $1.4 billion.


This represents a 3.8-percent growth in current-price GDP, or approximately two percent adjusted for inflation.


The current-price GDP growth is important for estimates of tax-revenue effects from the initial tax cut. Inflation-adjusted GDP growth tells us how much more economic value is actually being produced in Wyoming, a number that helps us assess the overall level and direction of prosperity in our state. If prosperity is growing, then our legislature is on its right track when it comes to fiscal policy; if prosperity is stagnant or declining, they better change their policies fast.


Against the positive effects of tax cuts, there are the negative effects of a reduction in government spending. Standard Keynesian multipliers assume that government spending has the same multiplicative effects on macroeconomic activity as private-sector spending. This is incorrect for two reasons. First, there are efficiency losses in government due to its monopolized position within its industries, K-12 education being one of them. This reduces the multiplier effect of a dollar spent through government compared to the same spending through the private sector. Secondly, when a cut in government spending is countered, dollar for dollar, by tax cuts, the negative multiplier effects from spending cuts are more than neutralized by the positive multiplier effects from tax cuts. Added to this is the net creation of an estimated $202 million worth of private-sector activity from the K-12 education reforms alone. If we make the reasonable assumption that this amount equals the negative multiplier effects from reductions in government spending, the aforementioned two-percent GDP growth gain is established as a net benefit to the Wyoming economy.


In terms of new jobs, the extra growth is equivalent to the employee compensation of 38,500 non-minerals private-sector workers. That does not mean that a $1.4-billion addition to current-price GDP will create that many new jobs, but it does mean that there is great potential for jobs creation in the wake of the structural spending reforms. A realistic assumption is 20,000 new jobs at the end of the multiplier cycle.


There are several variables that have not been included in this analysis, simply because of their high degree of uncertainty. Three important ones are:

  1. The jobs creation from Medicaid reform. When patients can buy health insurance under a voucher-based Medicaid system, they will probably increase their demand for health care. It is, however, not possible to estimate by how much until we have more details about the Obamacare reforms that Congress and President Trump will agree to. The exact nature of the reforms will eventually decide how much more health care patients will be able to demand under a Medicaid voucher.
  2. Private schools will require investments, primarily but not solely in school facilities. This will add substantial albeit temporary spending to the growth effect of the reform. It is not realistic to estimate this growth effect until a more detailed study has been conducted of where, geographically, the greatest need may come in the form of new school facilities. Such a study is not realistic until there is more information about the exact effects of a voucher system on the choice of homeschooling vs. schooling in facilities. At that point, demand for new school facilities can be compared to the supply of real estate in the local markets, and thus an estimate be made of the need for new investments. As a general point, the greater demand for private schools, the bigger the potential demand for real estate investment.
  3. Even though efficiency improvements in government are generally not beneficial over the long term, there can be exceptions that will make a notable, permanent difference to what remains of the state government after long-term spending reforms. Available literature does not give much guideline as to the possible long-term effects of efficiency improvements, other than to suggest that the effects are either insignificant or entirely transitory. More research is needed here to establish whether or not there are any long-term gains to be expected outside of Medicaid and K-12 education. Until such effects can be expected, the logical default assumption is that they do not exist. This, however, does not mean that a program to improve efficiency does not have short-term effects – on the contrary, it is over the short term that efficiency improvements can be expected to actually make a difference for the better in government budgets.

 Future studies can address these uncertainties as more information, and more analysis becomes available. For now, we will have to settle with the expectable, positive effects from the suggested reforms. Which, frankly, are far better than any comparable outlook.



[1] Sobel, R and King, K: Does school choice increase the rate of youth entrepreneurship? Economics of Education Review, Volume 27, Issue 4, August 2008; 429-438.

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