Monday, January 26, 2009

Two Cheers for the Task Force on Revenue Restructuring

Editor's Note: Fred Thompson checks in again with a look at the recently released report from the Task Force on Comprehensive Revenue Restructuring (executive summary here, full draft report here).

Our state, Oregon, has a highly volatile revenue structure, both because of its composition and because of the jurisdiction’s size.

This causes all sorts of difficulties as it moves through the business cycle. State spending doesn’t fluctuate as much as revenue, but it fluctuates more than it should. The problem, however, is not revenue volatility per se but the nastiness that results from trying to adjust spending up and down to match current revenue flows and from trying to find the money needed to stabilize spending during downturns. During booms the state tends to grow spending at an unsustainable rate and then cuts spending way back during busts. As a consequence of these behaviors, the Pew Center on the States at Harvard’s Kennedy School of Government ranked Oregon’s money management practices 43rd out of 50 states.

Recognizing these issues, the legislature authorized the creation of a Task Force on Comprehensive Revenue Restructuring (OR House Bill 2530, June 30, 2007) to examine "Oregon’s tax structure from top to bottom." The task force was appointed by the Governor, Chaired by Lane Shetterly, and charged with assessing several options for change: replacing personal income and/or property taxes with a sales tax or a gross receipts tax and imposing a tax on business assets and/or a value-added tax in place of the corporate income tax. It very quickly became apparent to the task force members that, even if these options were politically feasible, they would not work to correct the problem, but would leave the state with a tax system that was less fair, less efficient, and less adequate than the existing tax structure and not significantly more stable. Moreover, it was obvious that Oregon’s long-term revenue trend was one of the highest in the nation and that its revenues would be sufficient to meet most future needs, if it could find a way to use savings and or borrowing to smooth out spending over time. What was initially hard for the task force to accept is that putting such a system into place requires only fairly modest institutional fixes. But, that is, indeed, the case.

Oregon’s constitution requires the legislature to enact a balanced budget in which planned spending is equal to or less than the revenue forecast. If the forecast is up, the state can plan to spend more; if the forecast is down, the state must scramble to cut the budget. Then, if actual revenue exceeds the forecast in the period in which the budget is executed, the state must return the difference to the taxpayers. If revenue falls short of the forecast, the state can make up the difference from savings or, if necessary, by borrowing. This is looser than the balanced budget requirement found in some jurisdictions, where, if actual revenue is less than forecasted, spending in the period of budget execution must be reduced to bring it into line with actual tax receipts (Hou & Smith 2006). Consequently, smoothing spending in Oregon requires only two changes to its budget process. The first would be to base the state revenue forecast on the state’s long-term rate of revenue growth rather than short-term revenue growth. The second would be to give savings or the retirement of general-obligation debt first priority for the use of revenues in excess of the forecast. And, that is essentially what the task force recommended: amend the method of estimating the end-of-session forecast of state revenue on which the budget is based and apply actual revenues in excess of the forecast to the state's general reserve fund (The Statesman-Journal, January 23: B-1).

However, a more satisfactory recommendation would have specified the method for estimating the end of session forecast. In my opinion, the state revenue forecast should reflect the state’s long-term, sustainable rate of expenditure growth. Otherwise, as one very insightful colleague observed: "If we believe that the problem is caused by the fact that many of our politicians have a distorted time preference … because they care mostly about the current generation and discount the future generation’s concerns too heavily, a debt‐financing regime is optimal. So we are back to square one – the original problem of inadequate reserves and too much spending." Unfortunately, the task force was unwilling to take this step, perhaps, because they weren’t fully persuaded that forecasting a sustainable rate of expenditure growth was workable, perhaps, because they persisted in viewing the problem as one of reduced tax receipts during economic downturns, or, perhaps a little of both.

What they have done is eminently sensible; what they have left undone is potentially very dangerous.

No comments: