Four reasons why tax cuts have nothing to do with causing Arizona's current budget deficit.
It's recession time again in Arizona, and the state government is short of money, so the usual suspects are coming around, arguing for tax increases.
Center-left ASU economists Dennis Hoffman and Tom Rex (who also argued for tax increases during the last budget crisis) believe that tax cuts are to blame for Arizona's current budget deficit.
Hoffman and Rex argue that before 1995, state general fund revenue averaged 4.5 percent of state GDP, while since 1995, after reductions in tax rates, it has averaged 3.5 percent. By simple logic, if you have the same amount of spending, with less revenue, you get deficits.
There are several problems with that analysis. First, taxes and spending are different sides of the same deficit coin. If spending increases remain modest, the government can balance its budgets, even with slower revenue growth.
But state spending increases, especially since Gov. Napolitano took office in 2003, have been anything but modest. From FY 2004 to FY 2008, state spending increased by 59 percent, at a time when the state economy grew only 42 percent (a figure inflated by the housing bubble). The result of rapid spending increases has been a significant increase in the size of government as a portion of the economy. According to the Governor's own budget office, state government in 2007 spent more than 7 percent of state personal income-the highest level of spending since 1980.
Second, the 3.5 percent figure is an average. In years of robust economic growth, state taxes have higher-than-average yields. The state government then uses high tax revenues in boom years to ratchet up spending to unsustainably high levels. In 2006, for example, two out of every three dollars of the state's projected budget surplus went to new spending, while one dollar went to income and property tax cuts.
By our projections (see chart), Arizona will enter FY 2010 with general fund spending commitments about $2.4 billion higher than available revenues. The higher revenues the state might have had without the 2006 income and property tax cuts would have covered less than one-fifth of the gap. And that assumes (unrealistically) that the extra revenue in FYs 2007 and 2008 would not have pushed spending even higher.
Third, although Arizona has indeed reduced its income tax rates since 1995, it has increased its sales tax rate. Although sales tax revenue should be relatively more stable, it has taken a beating in the recent economic downturn. But even with a more stable revenue source, the government will typically spend most of the new dollars it is given, and then leverage that revenue to spend more. The inevitable result when the economy turns south is a deficit.
Fourth, we need to look carefully when comparing budget deficits. Hoffman, Rex, and other proponents of tax increases would likely credit the FY 1988 and 1989 tax increases for the apparently modest deficits during that period. But the mildness of those deficits is better explained by noting that spending coming out of the FY 1983 trough increased one-third as rapidly as it did coming out of the FY 2003 trough,* with increases moderated to some extent by mid-year budget cuts in FYs 1986, 1987, and 1988.
Compare the present crisis with the scenarios that would have occurred under two different spending limits (see chart). If Arizona government had been subject to the Taxpayer Bill of Rights (TABOR) since 2003, with spending growth limited to the rate of growth of population plus inflation, there would be no budget deficit crisis. Under a more permissive limit, in which spending growth had been limited to the rate of growth of the Arizona economy, the FY 2010 deficit would be one quarter of its projected size.
Hoffman, Rex, and other academic economists need to look up from their models for a few moments and observe how politicians actually behave. If Arizona government is to become fiscally responsible, it needs a firm spending limit, not higher taxes.
(*According to the Governor's budget office, state spending as a portion of state personal income rose from 6.07 percent in FY 1983 to 6.94 percent in FY 1989-an average annual increase of 0.14 percentage points. State spending as a portion of state personal income rose from 5.38 percent in FY 2003 to 7.01 percent in FY 2007-an average annual increase of 0.41 percentage points.)
"In years of robust economic growth, state taxes have higher-than-average yields. The state government then uses high tax revenues in boom years to ratchet up spending to unsustainably high levels."
This is what got California into trouble. When revenues came rolling in during '90s boom years, Democrats under Gov. Gray Davis passed new spending on programs that required continuous funding thereafter rather than those that required only a one-time expenditure. Then came the bust, and Davis paid the price.
"…academic economists need to look up from their models for a few moments and observe how politicians actually behave."
Here again we can look at California as a recent example. When the federal government offered the state $2B to help it out of its debt, CA's politicians resurrected $2B new spending on programs shelved because of the crisis. Since government always spends more than it takes in, needless to say, the amount ultimately spent probably would have ended up being more than $2B after all was said and done.
The Roman Circus lives. Government sells their votes to the group offering either the largest number of votes or the most money. We are moving toward the need for a new American Revolution to reinstate the original principles of the constitution and take government out of everyday lives.
Arizona's issues are a microcosm of the national woes and can only be solved by smaller government performing only its constitutionally determined duties.
Maybe the revolution could start with law suits against every government law that circumvents federal or state constitutions. That would bring most federal laws into litigation.