OK, it’s getting hard to format what is now a back-and-forth between Pacific Research Institute Economist Dr. Benjamin Zycher and Mike Genest, the California Director of Finance. In a nutshell, they are going back and forth over the language of the potential spending cap that is in the Big-5 Big-Tax deal. So, below you have in RED summaries of Zycher’s observations as penned by Genest (you can see all of Zycher’s original observations here). Then in GREEN are Genest’s responses. Now, in BLUE are Zycher’s responses to Genest.
I HAVE FAITH IN ENTERPRISE LEGISLATIVE STAFF MEMBERS TO MAKE SURE THIS IMPORTANT EXCHANGE GETS TO THEIR BOSSES DOWN IN CAUCUS… :-)
Oh yes – this is a great opportunity to make a further editorial comment about how this process is being rushed way too quickly. Heck, we can’t even get policy experts to agree on what should be very objective issues. Isn’t it time give this a few more days and let all of these questions be answered in a less harried environment? What a STUPID way to run state government.
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Zycher observed: The degree to which the estimated revenue projection trend and the Budget Stabilization Fund would operate actually to limit general-fund spending is not clear.
Genest Response: Incorrect. The governor could not simply suspend the transfer of revenues into the new rainy-day fund. While Article XVI Section 20 (e) of the state constitution currently allows governors to suspend the transfers, the budget reform before the Legislature today specifically amends that section.
The amendments rule out transfers beginning in state fiscal year 2010-11, except under two conditions: (1) when the rainy-day fund is full (i.e., it has a balance equal to 12. 5 percent of the state’s General Fund), or (2) in years in which there is a need to withdraw money from the rainy-day fund. And in that case, a withdrawal can only happen to bring revenues up to a "current services level budget" — the previous year’s spending level increased only for inflation and population growth.
Zycher: It may be the case that Messrs. David and Genest have a different version of the language than I, but my version reads "The transfer of moneys from the General Fund to the Budget Stabilization Fund may be suspended or reduced for a fiscal year as specified by an executive order issued by the Governor…" Given that a suspension or reduction of funds to the BSF are "rule[d] out" except under two conditions means explicitly that they are not ruled out. The constraint (2) noted above by Mr. Genest is likely to prove far looser than he imagines, in that "a need to withdraw money…" is a conclusion that can be reached under a wide variety of criteria, and indeed is one that will be by governors with differing goals, subjected to differing pressures, and confronted with different political incentives. Moreover, the "inflation and population growth" constraint is likely to prove far more elastic than Mr. Genest imagines, because the data needed for that calculation are unlikely to be available a few months after the end of the previous fiscal year; and a fortiori during the previous fiscal year when planning for the next fiscal year proceeds. This means that the current services constraint will be subject to some manipulation, an outcome hardly unknown in Sacramento. Which inflation index? Which population projection? Will either or both be adjusted for purported errors in the underlying methodologies, whether real or imagined? Etc. Small "adjustments" easily can result in substantial changes in allowable spending; Mr. Genest’s faith in the importance of this constraint on transfers is far stronger than is warranted.
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Zycher observed: The methodology for projecting revenues is highly problematic.
Genest Response: A simple ten-year trend is the best and fairest approach. Using this kind of trend would dramatically reduce the variability compared to what we’ve actually experienced.
In the long term, the trend method is self-correcting; meaning, if an anomalous year of very high revenue or very low revenue affects the trend projection disproportionately one year, it will be offset by more normal years in the future.
In fact, if you take the past ten years, the two largest spikes in state revenue growth were 23 percent and 15 percent, while there were two years of 15 percent drops. Under the formula used to stabilize revenues in the budget reform proposal, the high growth years would have been just 10 and 15 percent increases and there would only have been one year in which revenues would have dropped, and then by only 4 percent. Obviously, the formula does a great job of bringing stability to state revenues.
Zycher: The past ten years are not prologue. The simple reality is that a ten-year projection based upon regression methodology will be driven by the earliest and latest observations; that is incontrovertible. Moreover, Mr. Genest focuses on "variability," but that is not the issue. The issue is the effect of outliers on the trend projection; that projection can be seriously biased with little effect at all on "variability," by which I assume that Mr. Genest means the variance around the trend line. Moreover, "stability [in] state revenues" is not the issue; that is a function of the tax system and the elasticity of revenues with respect to changes in economic growth. The trend line does not "stabilize" anything; it offers a revenue projection only, and it is likely to be biased. Two issues are raised by the proposed regression methodology: Is it likely to be sensitive to outliers, particularly early and late—the answer is yes—and does it provide incentives for policymakers to avoid actions that harm the state economy. The answer to the latter question is: Not really.
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Zycher observed: The language allows future tax increases not to affect the projected revenue trend, but does allow the assumed revenues from a tax increase to be included in revenues for the then-current fiscal year.
Genest Response: The budget reform proposal focuses on actual revenues coming into the state, rather than an estimation or other artificial formula. That is the soundest way of actually stabilizing the revenue stream. If what Dr. Zycher is taking issue with is that the budget reform proposal does not prevent any future tax increases, he’s correct, it does nothing to alter the already-high bar that exists to preclude any tax increases in California: the two-thirds vote requirement of the Legislature that protects against frivolous or unnecessary tax increases.
Zycher: Given that the revenue projection methodology is driven not by "actual revenues" but instead by a (simplistic) regression model, the basis for Mr. Genest’s initial claim in the paragraph immediately above is unclear. And Mr. Genest seems to be confusing a stabilization of the actual revenue stream—which can be accomplished only by reforming the California tax system—with a stabilization of the projected revenue stream, which is a purely bureaucratic objective far less important substantively, and which the proposed regression methodology is unlikely to do in any event (see above). In any event, my original point is that the proposed "reform" allows the adverse future economic and revenue effects of tax increases to be ignored, while allowing the revenue gains from a tax increase to be included in the given future budget then under consideration. Mr. Genest seems to believe that the issue is whether taxes will be easier to increase; no, that is not the issue. The issue is the effect of tax increases on current and future revenue projections; the methodology assumes away the adverse effects of tax increases but recognizes the additional revenues. That will yield a serious political bias regardless of the two-thirds requirement, and a bias in the revenue projections as well.
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Zycher observed: In particular, the proposed ten-year projection as a fiscal constraint will make future tax reduction very difficult.
Genest Response: Future tax cuts would be very possible – the ideological make-up of the Legislature permitting, and any cuts would result in an automatic reduction in the trend line used to set spending limits.
Zycher: No, Mr. Genest is quite incorrect. The proposed methodology will ignore the favorable future economic and revenue effects of tax reduction, while showing a reduction in revenue for the given future budget then under consideration. That translates to a bias precisely the opposite of that discussed above: The revenue projection methodology will be used to hinder proposals for tax reduction.
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Zycher observed: Fiscal institutions should be designed to focus official attention on economic growth directly.
Genest Response: The wild swings in state revenues that have led to our chronic and recurring budget crises were set in motion by swings in the economy! What California’s state budget system needs is exactly the opposite: to be less reliant on economic conditions and tied to something more stable.
Zycher: Mr. Genest is missing the point; perhaps my writing skills are poor. Again, Mr. Genest confuses reform of the revenue system—the actual tax instruments used by the state—with the implementation of a spending constraint that does not increase political incentives to tax and regulate more. The issue here is the implicit spending constraint discussed above: Revenues above the projected trend must go into the BSF (unless the governor decides that there is a "need to withdraw money"). Does that spending constraint yield incentives to raise taxes and to substitute regulation in place of general fund taxation and outlays? Yes, it does. Is there another approach that would force policymakers to focus directly on the economic effects of their proposals? Yes, there is: A spending limit defined in terms of the economy and its growth would do that. The proposed system does the opposite: It rewards higher taxes, the spending constraint is weakened by its own terms, and it provides no disincentives to regulate.