Once More on the Kicker

Fred Thompson chimes in again on kicker reform:

Chuck Shekatoff of the Oregon Center for Public Policy reminds us of a very simple fact, one that probably ought to be obvious, but evidently isn’t: “revenue stability shouldn't be the goal...stability of the fiscal system should be the goal.” The things that government does for us, the services it provides have one fundamental attribute: they are all things we depend upon to get by – the legal system, incapacitating criminals and fire protection, education, a transportation network, a social safety net, clean water, etc. Moreover, deferring their delivery is prohibitively costly; these services must be provided in real time. That means their providers cannot be permitted to fail. If one were to formulate an objective function for most government programs it might look something like the following: maximize sustainability or reliability, subject to some minimum performance constraint. The essential requirement for meeting this service objective is stable funding.

The extreme measures taken by public officials to stabilize service delivery, together with persuasive evidence that spending volatility severely degrades service performance in government, attests to the critical importance of stable funding. For example, during New York’s fiscal crisis I observed that the City’s first response was to cut maintenance. From a purely financial perspective this make no sense. A properly maintained bridge wears out a rate of 1-2 percent a year; a bridge that isn’t maintained at all wears out at a rate of 15-20 percent a year. That’s a very costly source of cash. When one asked why, the answer usually went to the need to maintain services. Maintenance can be deferred, at a cost, operations can’t. Besides, what New York paid for cash by deferring maintenance is actually less than the price Oregon has often paid during past recessions, when the state borrowed from PERS at an implicit interest rate that exceeded twenty percent.

Instability can be attributed in part to the myopia of existing public-sector budget norms and rules, which tend to focus on balancing budgets one year at a time. Consequently, many students of budgeting want to put spending growth on a more stable path by basing it on long-term revenue growth rather than annual forecasts. Aaron Wildavsky, for example, proposed that the average rate of revenue growth should determine the permissible rate of expenditure growth. If cash outflows nevertheless continued to outstrip cash inflows, he further argued, a percentage or two ought be knocked off the planned (real) rate of expenditure growth until it looks like spending was back on a sustainable path.

The effectiveness of this general approach, both for controlling expenditure growth and for stabilizing programmatic support, is suggested by various case studies, most persuasively by the Chilean experience. The Chilean government has adopted a budget rule that allows a steady rate of spending growth adjusted for changes in its net worth. This system allowed Chile’s President, Michelle Bachelet, to resist intense pressure to boost spending earlier in her administration, when government revenues soared. Then, when the global recession came and revenue fell sharply, it allowed Chile to continue to grow spending at a sustainable rate, using assets that it had acquired during the boom. The upshot of this is that Bachelet is leaving office with the highest approval ratings of any President since the return of democracy to Chile.

It would be easy to make such a system work for Oregon. By basing our annual revenue forecast on the geometric mean of past revenue growth and balancing the budget against that forecast, we could put the state on a stable, sustainable spending path. Then, if revenues exceed the forecast by more than 2 percent, the excess would be placed in a rainy day fund and prudently invested by Oregon’s Treasurer. If revenues turned out to be less than the forecast by a similar amount, the Treasurer would go to the credit market to redress the cash shortfall. My own view is that kicker funds should never be returned to taxpayers except when the corpus of the rainy day fund exceeds the sum of the state’s general obligations debt plus a safety stock for emergencies – 30 percent of general fund outlays would be sufficient to cover shortfalls about seventy percent of the time assuming a three percent real growth rate in spending. Beyond that point, I have absolutely no reservations about returning any additional excess to taxpayers.

Under this proposal, the rainy day fund could only be depleted to make principal and interest payments on debt and those depletions would be automatic.