A budget reform cheat sheet for legislators

Washington legislators are eyeing a constitutional amendment to deal with budget problems, but the real solution to the state's fiscal woes may lie in a different direction.

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Washington legislators are eyeing a constitutional amendment to deal with budget problems, but the real solution to the state's fiscal woes may lie in a different direction.

In the Washington legislature, lawmakers have introduced a constitutional amendment they say would remedy the state's ongoing problem with revenues that are out of sync with expenditures.

It’s understandable that they would like to avoid a repeat of the budget cutting trauma of the last three years — and that they might turn to the “balanced budget” approach, which appears to offer a convenient panacea to the always tough budgeting process.

But what is not explicable is that they have avoided looking carefully at other options to address continuing budget deficits. Deficits that have so far resulted in more than $10 billion in cuts to essential services, including higher education and the social safety net, and created a need for more than $1 billion in additional cuts in the current legislative session.

Not being considered are modifications to the state’s tax structure that would make it less susceptible to economic fluctuations and possibly solve other problems such as its appallingly high regressivity. Admittedly a tougher assignment, but doable.

The amendment under consideration would require general fund operating budgets to be balanced against revenues forecasted into the future by the Economic and Revenue Forecast Council (ERFC). Expenditures could not exceed forecasted revenues even if revenues increase. And if revenues decrease from the forecast, new revenues would not be permitted to make up for the shortfall.

The existing constitution gives both legislators and voters the authority to tax and spend. Though it doesn’t specify how the two must be balanced, state law does require the governor to submit a biennial budget to the legislature that is balanced in the two-year time frame.

Legislators already have both a legal and practical responsibility to enact balanced budgets. The constitution requires the legislature to provide annually “an accurate statement of the receipts and expenditures of public moneys.” And the quickest way to get unelected is to spend or tax unwisely.

Of course there are difficult trade-offs with every budget. This has been made abundantly clear by lawmakers’ inability to find the $1 billion needed to fund voter-passed initiatives mandating K-12 class size reductions and teacher cost-of living raises.

As initially drafted, the proposed constitutional amendment Senate Joint Resolution 8222, sponsored by Senator Jim Kastama (D-Puyallup) — would have required a six-year revenue projection. A floor amendment by Senator Joe Zarelli (R-Ridgefield) reduced the projected time to four years, and allowed budgets to be out of balance to the extent that they need to tap the Budget Stabilization Account, also known as the Rainy Day Fund.

Amending the state constitution is not, and should not be, a trivial matter. It requires a two-thirds vote in both houses and a simple majority of voters at a state general election. Getting to the two-thirds threshold requires bi-partisan support, and this usually starts with co-sponsors from both sides of the aisle.

SJR 8222 has eight co-sponsors, six Democrats and two Republicans. No one testified either for against when it passed out of the Senate Ways & Means Committee. It cleared the Senate February 13, with 13 Democrats joining all 23 Republicans in voting yea. Another 12 Democrats voted nay. There was only brief debate.

Its likelihood of passing in the House though, is low. The companion House bill (HJR 4225) sponsored by Rep. Shea (R-Spokane) has 31 co-sponsors — all Republicans. It has not had a hearing. It is unlikely that it will pass in the Democrat-controlled House.

The Dems' support of SJR 822 in the Senate probably reflects the body's narrow partisan and ideological split: often a few conservative "roadkill caucus" Democrats team up with Republicans to support or block legislation.

But surprises sometimes happen in the legislative give and take, so it's important to ask the question: How well would the four-year forward budget process work, and would it restrict budgeting flexibility?

Let's review Washington's budget situation just before and during the Great Recession of early 2008. The legislature had just adopted a biennial operating budget of $29.6 billion for 2007-09, passed on essentially a party line vote in May 2007.

The quarterly forecasts of ERFC in June and September 2007 were optimistic, increasing expected revenue by a total of $697 million.

At the time, there was some indication of a cooling national economy, but the projection for the state was upbeat: “The Washington economy has so far remained at least partially insulated from the national slowdown."

The next report was less so. In November 2007, the forecast indicated a $130 million revenue decrease. Still, it was not large enough to require a special session and a supplemental operating budget. That need only became clear when the February 2008 forecast showed a further revenue shortfall of $423 million.

Between the adoption of the 2007-09 budget in May 2007 and the adoption of the supplemental (adjusted) 2007-09 budget just eight months later in February 2008, the forecasted revenue spiked up by $697 million, before decreasing by $553 million.

This is an indication of the volatility of tax revenue and the difficulty of forecasting even a few months into the future. The recession was clearly an unprecedented period that challenged economic forecasters; a period perhaps never to be repeated, although given global economic uncertainties, who knows?

Still, the experience suggests that a four-year budgeting time frame would not provide much (if any) improvement over a two-year budget period. This doesn’t mean that budget writers should be oblivious to both real and possible future revenue fluctuations, or that they should they ignore changes in budget “drivers”, the variables that control entitlement and other operating expenditures.

An alternative approach to the need for a longer-term fiscal projection is to look to Gov. Chris Gregoire’s six-year 'outlook,' based on the latest revenue forecast and her proposed supplemental budget. The projection looks at both the revenue and expenditure sides of the ledger, and sends important signals to legislators and their constituents of impending revenue shortfalls.

Not only can the governor's 'outlook' be updated as new information becomes available — much more quickly than a formal ERFC forecasting process — it can incorporate assumptions concerning different spending and revenue patterns. Most importantly, unlike the proposed constitutional amendment, it retains legislators’ flexibility to deal with revenue shortfalls as they arise.

In the long term, the revenue volatility problem needs a fix. The state tax structure is heavily dependent on consumer spending. Almost half of state revenues are generated by the sales tax and the business and occupation tax. The latter, because it’s a tax on gross receipts, is dependent on consumer expenditure patterns.

Revenue volatility, and its inverse revenue stability, was last analyzed by the Washington State Tax Structure Study Committee in 2001-2002. 

The Committee, chaired by William H. Gates, Sr., was created by the legislature to examine the current tax system and develop tax alternatives that might better serve Washington state citizens, as well as encourage commerce and business creation. It examined key issues: elasticity, equity, and adequacy. And it looked at revenue stability which it addressed in conclusions contained in its final report.

Legislators who seek simple solutions to revenue volatility would do well to review the committee’s entire findings, although we'll provide one excerpt here:

“Stability requires that the amount of revenue collected by the tax system fluctuate no more than, and preferably less than, the level of state economic activity over the business cycle. This allows the state to maintain established services without resorting to large changes in tax rates or in other variables of the tax system.

The main finding is that Washington's mix of taxes, primarily its heavy dependence on the retail sales tax, causes revenues to increase on average more than personal income during good economic times and less than personal income in economic downturns. This causes revenue shortfalls in economic downturns, precipitating destabilizing fiscal crises, while in good economic times, excess revenues may result in permanent tax cuts or the adoption of new spending programs. These, in turn, exacerbate the problems in subsequent economic downturns.”

The Gates Committee did an excellent job in deconstructing the state’s tax system and identifying its problems. Legislators, before they enact problematic solutions, should review its findings. They might even want to commission a study that updates them in light of our recent Great Recession experiences.


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About the Authors & Contributors

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Dick Nelson

Dick Nelson is a former Washington State legislator. He currently contributes to the public debate on state and local fiscal issues through research and commentary. As when he was in the legislature, he prefers the Democratic Party.