By Barry W. Poulson, PhD, MPI Senior Fellow, and John Merrifield, PhD
MPI Policy Note: Budgeting For Results – A Fiscal Roadmap For Montana
Based on an MPI Study by Barry Poulson, Ph. D. and John Merrifield, Ph.D.
BOTTOM LINE UP FRONT:
Montana has experienced unconstrained state government spending growth, resulting in a structural deficit in which future revenues will not match future spending obligations. Making matters worse is a flawed budgeting process where spending increases are “baselined” into each biennial budget regardless of affordability or necessity. When you combine the “baseline” budgeting approach to the structural deficit, recent surpluses simply are not big enough to keep Montana in the black long term. If Montana is to keep its fiscal house in order for our generation and those to come, lawmakers must look closely at these challenges in the 2013 Legislature. MPI proposes that Montana convert to a priority-based budgeting system that will empower legislators with much greater spending oversight and accountability to taxpayers.
There is a structural deficit in the state budget.
- A state is said to have a structural deficit if under current law state revenues are projected to fall below state expenditures in the long run. Structural deficits, unlike current account deficits, are not linked to the business cycle but rather to the fiscal rules that determine expenditure growth in the long run. These rules often encourage deferring difficult choices to future lawmakers.
- Short term surpluses, like the one forecasted for the upcoming 2015 Biennium, tend to mask the significance of long term structural deficits because lawmakers and the public perceive that the state’s fiscal outlook is rosy. Although Montana is sitting on one of the largest surpluses in the last decade, it is a drop in the bucket compared to revenues needed for future spending obligations.
- Medicaid, unfunded liabilities in public employee and teacher pension programs, annualization of one-time federal money, and off-budget expenditures represent the bulk of Montana’s structural deficit.
- Temporary federal injections have allowed state Medicaid spending to grow at a reasonable rate or even decline. However, Medicaid spending could increase $70 million by the end of the decade depending how the Affordable Care Act is implemented in Montana.
- Unfunded or underfunded pension liabilities for state workers are over $3 billion and very likely worse given unrealistically high assumptions for returns on pension fund investment portfolios.
- Various off-budget expenditures account for nearly a quarter of the state’s overall spending but are not prioritized with other state budgetary goals and obligations. This “earmarked” spending is automatic and generally immune from the rigors of the normal budgeting process.
- The structural deficit is unsustainable and requires a change in the fiscal rules of the game and no windfall of surplus revenue will rectify the long term balance sheet.
Montana’s budget process is seriously flawed, resulting in a bias towards spending growth.
- Montana’s “present law” system begins with existing agency budgets, adjusts them for inflation and other factors, and uses the outcome as a baseline for future budgets. Spending increases are automatically carried into future years regardless of revenues and priorities. The only way Montana has been able to keep up with present obligations is with minor cuts and the “luck” of unanticipated surpluses.
- The system implicitly assumes that all current spending is both efficient and effective, and that the justifications behind all existing state programs and expenditures remain valid. Actual performance and need are not systematically measured.
- The result is a baseline budget that will almost always be larger than its predecessor. Any reduction to this budget is treated as a cut, even though it may still increase spending levels from previous years.
- The burden is on our citizen legislators to find, propose, and defend cuts to the proposed budget, something they are ill-equipped to do during a biennial 90-day session as special interests and government officials lobby for their programs. Moreover, there is an automatic political liability for any lawmaker that tries to restrain spending.
MPI recommends the state convert to a priority-based budget system.
- Priority-based budgeting has been implemented successfully in a number of states. It is not experimental and the benefits are real and measurable.
- The process begins by asking four basic questions: 1) What are the essential services the state must perform? 2) How can the state deliver essential services efficiently and effectively? 3) How should the state budget be allocated for the delivery of essential services? 4) How can the state assure that essential services are delivered efficiently and effectively in the long run?
- Programs, rather than agencies, are evaluated based on their effectiveness and efficiency in addressing these four questions. Since each program is evaluated against objective criteria and against other programs with similar goals, results will be measurable and redundancy will be minimized.
- This process forces lawmakers to acknowledge the fact that resources are limited, and then prioritize spending to achieve the greatest impact for the least amount of spending during each budget cycle. It also requires lawmakers to be accountable to those paying the bill – i.e. taxpayers – and not special interest groups and agency bureaucrats.
Other reforms are also necessary to resolve Montana’s structural deficit.
- Off-budget or statutory spending makes up nearly 25 percent of state expenditures. This spending is automatic and outside the purview of normal budget processes. These “earmarks,” which stood at about $2.2 billion for the 2013 Biennium, should be forced to compete with other programs for taxpayer dollars.
- Unfunded federal health care mandates greatly increase Montana’s Medicaid and pension liabilities. Federal subsidies will end at about the time costs will begin to significantly increase, resulting in unsustainable state obligations. Implementation of the Affordable Care Act could increase the cost of the program by nearly $100 million by the end of the decade.
- Underfunded state pension programs will increasingly draw on budget resources and siphon funding from essential programs. Montana’s defined benefit system should be stabilized and then converted to a defined contribution system for new hires.
Dynamic tax scoring demonstrates that Montana can change its tax policy to boost growth.
- This study uses dynamic scoring to analyze the impact of new fiscal rules and fiscal policies on budget stabilization and economic growth in Montana, which include tax and expenditure limits, a budget stabilization fund, an emergency fund, and capital investment fund.
- The tax and expenditure limit caps the growth in general fund spending at the rate of population growth plus inflation. Surplus revenue above that cap is allocated to the budget stabilization fund, emergency fund, and capital investment fund. When the cap is reached on those funds additional surplus revenue is offset by tax cuts or tax rebates.
- The study then simulates the impact of the new fiscal rules and fiscal policies on economic growth. The simulation revises personal income and future tax revenues when dollars shift between the public and private sectors, or when tax rates drop, and when idle fund balances accrue interest payments.
- In the baseline simulation, the new fiscal rules allow for a 3.5 percentage point reduction in personal income tax rates. That reduction in personal income tax rates significantly increases the rate of economic growth. Higher growth in personal income generates additional tax revenue, offsetting some of the static revenue effects of the rate cuts.
- Lastly, the study simulates a revenue neutral replacement of the income tax with a sales tax. This revenue neutral sales tax rate for Montana is estimated at 5.3 percent, close to the national average. This tax reform boosts economic growth even more than the income tax rate cuts simulated in this study.
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