Ka-boom!

Went the Oregon general fund.  The Office of Economic Analysis blog has a nice picture that does a good job describing the torpedo they good ship Oregon took to her hull.

This is net receipts from February though April for the last 14 years.  Note how Oregon is $400,000 in the red in 2010, meaning we refunded $400,000 more than we took in during that period, and this is with 66 and 67.

What is going on?

...preliminary numbers show that the biggest culprit was capital gains. Following a 60 percent decline in capital gains income from the 2007 tax year to the 2008 tax year, we were expecting an additional 10 percent decline for the 2009 tax year. This was in line with what many other states were projecting (5 percent to -20 percent) based on an informal survey conducted early last winter. Unfortunately, preliminary estimates show that capital gains income likely dropped at least another 50 percent for the 2009 tax year. Going forward we believe that we will see an uptick in capital gains income, but carry forward losses and low levels of business transactions will limit growth.

Sigh.

Which brings me to another topic. Polictical football is being made of the decision not to call a special session and institute a 9% across-the-board cut. But, of course, as OPBs Chris Lehman reported lots of agencies only rely partly on general fund monies.  In fact K-12 education makes up more than 40% of general fund spending thanks to Measure 5.  Higher ed. another 10%. Mandated Medicaid about another 12%.  After that the only other significant portion is corrections and we see what a 9% cut will do there.   Given the dire state of K-12 in particular it seems difficult to understand why we wouldn't want to try and protect it.  But the reality of the numbers is stark: there just isn't a way to protect K-12 without totally gutting other state programs.  So while I like the idea of being more nuanced about cuts, there just aren't many degrees of freedom here.

Which of course brings me back to kicker reform and a rainy-day fund.  Yes, it does not fix long run trends that Tim Duy has very clearly explained, but a substantial rainy-day fund would allow us to avoid these types of draconian cuts to basic services in recessions.

No Support for a Rainy-Day Fund?

OPB is reporting on a poll they commissioned showing a decided lack of support for kicker reform leading to a permanent rainy-day fund. Frustratingly, they do not appear to be releasing the poll itself so one cannot know the exact wording of the questions. It is surprising as other recent polls mentioned by Peter Courtney and others have shown 58% support (which they say is still too low for it too succeed). Polls are extremely sensitive to the wording and order of the questions and it frustrates me that a news organization is not transparent about theirs (and any poll they report on).

So what gives? Why won't they release the poll?

This is a complicated issue and the academic in me thinks that all it takes is a little educatin' to get folks on board - but not if it is really at 38% support.

Fiscal Stability

My Op-Ed in The Oregonian today:

A rather depressing sense of complacency seems to have settled over the state Democratic leadership after the passage of Measures 66 and 67. But celebrating their passage as a major political victory -- and allowing their passage to become an excuse not to immediately address the fiscal instability that necessitated the new taxes -- is a serious mistake.

The taxes were not a victory to celebrate but a disheartening sign of the dysfunction of the state's fiscal system. The fact that we had to pass them should be seen as a defeat, not a victory, and as a condemnation of our stewardship of the state's finances. Letting these new taxes take our eyes off of real reform is to squander an opportunity to permanently fix what's wrong with the state's revenues.

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Read the rest at the Os web site.

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.

Economist's Notebook: Taxes and the Rainy-Day Fund

A rather depressing sense of self-satisfaction seems to have consumed the state democrats after the passage of Measures 66 & 67. But celebrating their passage as a major political victory, and allowing their passage to become an excuse not to immediately address the revenue instability that necessitated the new taxes, is a serious mistake. The taxes were not a victory to celebrate but a disheartening sign of the disfunction of the state's revenue system. The fact that we had to pass them should be seen as a defeat, not a victory, and as a condemnation of our stewardship of the state's finances. To allow these new taxes to take our eyes off of real reform is to squander an opportunity to permanently fix what's wrong with the states revenues. Everyone is (or should be) upset, and motivated to fix what is wrong.

One of the main reasons for this lack of urgency, I believe, is the sense that these new taxes were carefully targeted, so that there is little real effect on most Oregonians - that we get a free lunch. But this ignores one of the most basic lessons in economics: TAXES DON'T STAY WHERE YOU PUT THEM.

Even a tax on the wealthiest households don't stay there. Research has shown that employer's pay is based on real wages net of taxes - so businesses will end up compensating highly paid employees for the new taxes - which increases their cost of doing business, which will end up in higher prices and lower share performance, both of which affect everyone. [This is the reason, by the way, why income taxes do not turn out to be very effective in addressing income inequality] New taxes on businesses will have the same effect, eventually making their way into higher prices and lower quantities which means - yes - jobs. The point is all Oregonians end up paying these new taxes in some small way and so we should all be upset that we got to this point in the first place.

I supported the new taxes and still do: they were necessary in my opinion and the net effect should be minimal. But there will be effects, make no mistake. I would have preferred them to be entirely temporary because of this.

So it is time for the state legislature to stop wallowing in self-satisfied complacency and get a permanent rainy-day fund passed this year. I have been very critical of the Governor in the past, but he is spot on this time in trying to get this moving now. Because whether you voted for or against Measures 66 & 67 you shouldn't be happy - you should be motivated for real reform.

Kicker Reform and Rainy Day Funds

On my way to Corvallis this morning I listened to a podcast of OPBs Think Out Loud show on kicker reform. It was an especially good show, largely because guests Tom Potiowsky and Lane Shetterly did a very good job explaining how the kicker works and how the Task Force on Comprehensive Revenue Restructuring's proposed reform would work. I recommend the show very highly for those wanting to familiarize themselves with the issues.

Two things that were said stuck out to me however:

1. Tom Potiowsky made the claim, when asked about why our revenue volatility is so high, that not having a sales tax is partly to blame. But there is a very large body of evidence that sales taxes are not significantly more stable than income taxes - especially in the short-run. [Just look at the current revenue situation in Washington state] So I was astonished to hear him say this.

That said, the focus was on the fact that we have revenue instability and what to do with it and the solution of a rainy-day fund was emphasized. But I think it is important that people understand that a sales tax is not a solution to revenue instability.

2. Steve Buckstein, of the Cascade Police Institute, made another astonishing claim in saying that kicker reform as proposed would decrease state volatility at the cost of increasing individual volatility. Say what? State revenues that come in in excess of a forecast do so mainly because individual incomes were higher than expected. To not return a kicker to households would actually decrease volatility to both parties. On what basis he made this claim is simply beyond me.

Also, his preferred solution, cutting state spending so money can be diverted into a rainy-day fund without touching the kicker is a pretty weak solution for a state that has, for example, one of the worst systems of public education in the nation.

Chile's Rainy-Day Fund

Reader Jacob Grier sent along this article from the Wall Street Journal which describes Chile's rainy-day fund and how useful it is at the moment. Here is an excerpt:

By MATT MOFFETT
SANTIAGO, Chile -- During the emerging economies' commodities boom a few years back, Chilean Finance Minister Andrés Velasco was a wet blanket at the fiesta. Chile, the world's largest copper producer, was reaping a bonanza from the quadrupling in the metal's price. Mr. Velasco insisted on squirreling away a large chunk in a rainy-day fund.

As the savings swelled above $20 billion -- more than 15% of Chile's economic output -- Mr. Velasco faced growing pressure to break open the piggy bank. In September, protesters barged into a presentation by Mr. Velasco, carrying an effigy of him and shouting, "The copper money is for the poor people."

The 48-year-old Mr. Velasco, wary that a flood of copper income could generate lending and consumption bubbles, stood his ground, even as the popularity of the center-left government withered. Latin American history, he cautioned, was full of "booms that had been mismanaged and ended badly."

Finance Minister Andrés Velasco built Chile's rainy-day fund. Today Mr. Velasco looks like a prophet. Since the onset of the global economic crisis, copper prices have fallen by 50%, in line with the sharp decline in other commodities. Emerging economies that got too giddy in the good years are now coping with nasty hangovers. Soybean-dependent Argentina is facing a possible debt default while oil-rich Russia has been stuck bailing out banks and companies that got in over their heads in debt.

Thanks to Mr. Velasco's caution, Chile is now in a position to try to bootstrap its own recovery from the global recession. Mr. Velasco's preemptive moves have kept Chile's government from having to spend a single peso on bank bailouts. Having paid down foreign debt during the fat years, Chile is now a net creditor nation, with a debt rating that was upgraded by Moody's Investors Service in March.

And now Chile is pouring some of its copper savings into a massive stimulus plan, consisting of job-creating public-works projects, tax breaks for business, investments to keep mines operating and other goodies. Chile's plan is one of the largest stimulus packages in the world relative to the size of its economy. The Chilean program is the equivalent of 2.8% of gross domestic product, versus 2% in the U.S.

As a result, economists expect the nation's annual economic output to decline a very slight 0.5% this year, compared with much steeper declines elsewhere.

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The moral of this story is, of course, you should always defer to the economists! (Velasco has a PhD in economics from Columbia). Such a fund would be pretty nice to have in Oregon right now, huh?

A Permanent Rainy-Day Fund?

The Oregonian is reporting on a plan coming out of the state legislature to put in front of voters a plan to create a permanent rainy day fund. Friend of the blog Fred Thompson and co-authors have looked at this problem in the midst of the last round of budget woes (only a few years ago) and their analysis is interesting and raises some questions:

• Why not also relax fiscal rules and allow borrowing during economic downturns?
• Is $1.5 billion enough? Thompson, et. al., suggest it is in the right ballpark, but given the current revenue gap which might easily eclipse $4 billion over the next two and a half years, it might need to be bigger.
• Why build something on top of this ridiculous rule that depends on an economic forecast (as Paul Krugman says economic forecasting is slightly less respectable than witchcraft)? We are fortunate to have a talented and professional state economist in Tom Potiowsky, but I am sure even Tom would tell you that forecasting is simply very educated guesswork. Why not come up with something new and better?

Still, I am very, very supportive of this initiative, it is the right idea and needs to happen. I think that this puts the emphasis in the right place: spending stability rather than revenue stability (which is unachievable).