Monday, November 10, 2008

AFP: Did tax cuts cause the Napolitano Deficit?

Dear Arizona Taxpayer:

It’s recession time again in Arizona, and the state government is short of money, so the usual suspects are coming around, arguing for tax increases.

Some of the usual suspects are blaming the Napolitano Deficit on the income and property tax cuts passed in 2006. But the truth, as you can see in this graph, is that Arizona’s gigantic budget deficit was created by massive overspending during the last six years, pushed first and foremost by Gov. Janet Napolitano:

Even if the state government got its hands on all of the revenue it has given up since 2006, the state’s spending commitments in FY 2010 would still be $2 billion more than projected revenue.

To learn more about Arizona’s fiscal crisis, and how grassroots taxpayer action can help to balance our budgets and hold the line on taxes, be sure to attend our 2008 Defending the American Dream Summit on Saturday, December 6th. More information about the Summit is available here:

For Liberty, Tom


Re: Arizona needs a firm spending limit, not higher taxes.

(Submitted to the Arizona Republic, 7 November 2008)

It’s recession time again in Arizona, and the state government is short of money, so the usual suspects are coming around, arguing for tax increases.

Center-left ASU economist Dennis Hoffman (who also argued for tax increases during the last budget crisis) believes that tax cuts are to blame for Arizona’s current budget deficit (“ASU economist in high demand during fiscal crisis,” Monday, October 20, 2008).

Hoffman argues that before 1995, state general fund revenue averaged 4.5 percent of state GDP, while since 1995, after reductions in tax rates, it has averaged 3.5 percent. By simple logic, if you have the same amount of spending, with less revenue, you get deficits.

There are several problems with that analysis. First, taxes and spending are different sides of the same deficit coin. If spending increases remain modest, the government can balance its budgets, even with slower revenue growth.

But state spending increases, especially since Gov. Napolitano took office in 2003, have been anything but modest. >From FY 2004 to FY 2008, state spending increased by an average of over 12 percent annually, at a time when the state economy was growing at 7 percent (a figure inflated by the housing bubble). The result of rapid spending increases has been a significant increase in the size of government as a portion of the economy. According to the Governor’s own budget office, state government in 2007 spent more than 7 percent of state personal income—the highest level of spending since 1980.

Second, Hoffman’s 3.5 percent figure is an average. In years of robust economic growth, state taxes have higher-than-average yields. The state government then uses high tax revenues in boom years to ratchet up spending to unsustainably high levels. In 2006, for example, two out of every three dollars of the state’s projected budget surplus went to new spending, while one dollar went to income and property tax cuts.

By our projections (see chart), Arizona will enter FY 2010 with general fund spending commitments about $2.4 billion higher than available revenues. The higher revenues the state might have had without the 2006 income and property tax cuts would have covered less than one-fifth of the gap. And that assumes (unrealistically) that the extra revenue in FYs 2007 and 2008 would not have pushed spending even higher.

Third, although Arizona has indeed reduced its income tax rates since 1995, it has increased its sales tax rate. Although sales tax revenue should be relatively more stable, it has taken a beating in the recent economic downturn. But even with a more stable revenue source, the government will typically spend most of the new dollars it is given, and then leverage that revenue to spend more. The inevitable result when the economy turns south is a deficit.

Fourth, we need to look carefully when comparing budget deficits. Hoffman and other proponents of tax increases would likely credit the FY 1988 and 1989 tax increases for the apparently modest deficits during that period. But the mildness of those deficits is better explained by noting that spending coming out of the FY 1983 trough increased one-third as rapidly as it did coming out of the FY 2003 trough, with increases moderated to some extent by mid-year budget cuts in FYs 1986, 1987, and 1988.

(According to the Governor’s budget office, state spending as a portion of state personal income rose from 6.07 percent in FY 1983 to 6.94 percent in FY 1989—an average annual increase of 0.14 percentage points. State spending as a portion of state personal income rose from 5.38 percent in FY 2003 to 7.01 percent in FY 2007—an average annual increase of 0.41 percentage points.)

Compare the present crisis with the scenarios that would have occurred under two different spending limits (use the chart link below). If Arizona government had been subject to the Taxpayer Bill of Rights (TABOR) since 2003, with spending growth limited to the rate of growth of population plus inflation, there would be no budget deficit crisis. Under a more permissive limit, in which spending growth had been limited to the rate of growth of the Arizona economy, the FY 2010 deficit would be one quarter of its projected size.

Hoffman and other academic economists need to look up from their models for a few moments and observe how politicians actually behave. If Arizona government is to become fiscally responsible, it needs a firm spending limit, not higher taxes.

Tom Jenney

Arizona Director

Americans for Prosperity

PS: For those concerned about government’s possible role in alleviating poverty, please read Dr. Matthew Ladner’s Goldwater Institute study showing that Arizona’s poverty rate improved in the 1990s, at a time when Arizona government was shrinking as a portion of the state economy:

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