Monday, May 10, 2010

If I Ran the Zoo

Growing up, Dr. Seuss’s If I Ran the Zoo was one of my favorite books. The book told the tale of how a zoo would be different if a child ran it. I am no longer a child but the Minnesota budget mess prompts me to imagine what I would do to address the state’s short term and long term budgetary mess.

Describing the Budget Problem
First, what is the mess? Prior to the Supreme Court’s unallotment decision last week the state had about a $1 billion dollar deficit. As a result of the decision it is effectively $2.7 billion more. Some cuts have been made already so the estimate is that the current biennial deficit is at least $3 billion. The short term problem then is how to close this $3 billion hole.

Long term there is a structural deficit in Minnesota. For the biennial beginning in July, 2011, the estimate already is that the deficit is at least $5-6 billion. Put into perspective, the current biennial budget is about $30 billion. Assuming the same for the next biennial, a $5-6 B deficit approaches 20% of the budget. Because of these problems, a couple of months ago one of the major bond raters threatened to downgrade Minnesota’s bond rating. The story received little notice but it is a sign that our economic house is not in order. Overall, we face major financial challenges.

How did we Get Here?
There are lots of competing theories about the causes of the budget problem. DFLers will argue that Governor Pawlenty’s refusal to raise taxes is the cause, although they too went along with many of his budget priorities. Additionally, Governor Ventura proposed lots of tax cuts that both parties supported. Additionally, in 2002 when Ventura was still governor and the economy and budget were tanking back then he proposed both budget cuts and tax increases that both the DFL and GOP rejected. In fact, gubernatorial candidates Roger Moe and Tim Pawlenty teamed up to reject the Ventura solution and also pushed through a law declaring that inflation would be counted by the state in revenue forecasts but not for obligations. This stupid trick has distorted the budget ever since, providing a prime reason for the structural deficit.

There are others who argue that Pawlenty’s ill-fated and illegal use of unallotment is the reason for the short term problems, whereas others could argue that had the DFL not been politically outmaneuvered last year we would not be where we are. There is a ton of finger pointing but simply put, blame can be placed on all parties for the state’s fiscal and budget woes. The task now is to ascertain the best route towards fiscal health.

A New Starting Point: Five Economic Truths
If I ran the zoo (the state) I would start by accepting five facts.

1. The state faces a serious budget problem that cannot be ignored. We cannot grow our way out of the economic state we are in and instead we need to be honest about what needs to be done. Reason and facts need to replace ideology and political ambition. A governor running for president, a Speaker running for governor, and most everyone else in the legislature running for re-election have little incentive to be honest and tackle the tough issues this year.
2. The budget cannot be balanced by cutting waste. There is a persistent myth out there that the state is still full of waste and fraud and if we simply cut it we can balance the budget. I saw some comments in the readers’ section of the on-line Star Tribune making this assertion. Believing this is true is like believing in the 1990s that welfare (AFDC) was busting the budget. The reality back then was that AFDC was less than one-half of one percent of the federal budget.

After all the budget cuts in the last few years there is no real fat or waste that amounts to much of anything that can be cut or eliminated to balance the budget. This is just a myth.

Now if by waste or fraud someone means government should not be performing some function that is a matter of political philosophy. Debating the role of government in society is reasonable and honest so if someone wants to say government should do less, say so and then describe what it is the government should not do. Don’t just droll out the phrase waste and fraud.

Presently, about 40% of the state budget is K-12, about 10% higher ed, and about 25-30% health and human services. This is 75%-80% of the budget. Given these numbers, what one needs to ask what and where one can cut.

3. Budget gimmicks do not work. Not counting inflation for obligations is one of the gimmicks that has caused problems. So is the trick that we can save money by pushing obligations into the next budget years. One version of this is to delay school payments. The delay in payments is similar to an individual paying off one credit card balance by charging it to another. It solves nothing. Additionally, by delaying payments to schools, schools will have to do short term borrowing, resulting in overall more costs to taxpayers.

4. Tax cuts. Lots of people will bemoan the mantra that taxes on businesses are bad; discouraging investment and encouraging relocation. The best economic research on this questions the real impact of taxes on businesses, finding that they are a relatively minor factor for businesses in making investment and location decisions. The research does not say they are not a factor, only that they are a minor factor.

5. Cuts in state spending hurt the state economy and real people. Paul Krugman correctly describes state balanced-budget requirements as damaging to economic stimulation during recessions. The federal stimulus bill was offset by state cuts. If the state cuts spending that overall hurts the state. If it lays off people that adds to unemployment. If it cuts money to keep granny in a nursing home it hurts granny. If it cuts money to a special diet program or to health care someone is hurt. We need to consider and remember the human faces associated with budget cuts.

What to do?
Given these five facts, what would I do if I ran the zoo?

In the short term (for the current biennium) here are my ideas.

1. Rescind the 2000 Ventura tax cuts that decreased the state income tax rates and shifted property taxes from businesses to residential properties.

2. Extend sales taxes to services, coupled with a higher exemption for the poor. A sales tax on services will turn a regressive tax into a progressive one and reflect the reality of a new economy that is more service orientated. This new tax would also have a lower rate although that might not be possible in the short term.

3. Mark Dayton has proposed raising taxes on millionaires. The idea needs more detail but the suggestion should be to income taxes on those making more than $250,000 per year. This is the top 5% income bracket in the USA, and close to the top 10% in Minnesota.

4. Repeal all corporate tax incentives and corporate welfare. Last year Representative Ann Lenczewski proposed this. This is a good idea especially given how little they really help.

5. Repeal or cap the Minnesota mortgage interest deduction. This deduction is simply a subsidy for the housing industry and it mostly benefits those who buy McMansions that are environmentally wasteful. If one does not want to eliminate all of the deduction then cap it to the amount that can be claimed.

These are a few ideas for the short term. Yes they involve tax increases but there are also eliminations of corporate and middle class welfare that are not necessary. I would make these changes before proposing any other cuts to state spending.

Now for the long term what do we need to do? Here are other ideas.

1. Truth in budgeting. Eliminate the inflation discrepancy and count it for both revenue and obligations.

2. Eliminate all constitutionally mandated and dedicated budget funds. I am specifically referring to the gas tax and the new amendment for the arts and the environment. I am not saying eliminate the taxes just the constitutional dedication of the funds. Such a dedication constrains the state regarding how to spend and shift money during emergencies and it also serves as an effect limit on how much money is really spent on these programs. Plus such dedication of funds is what in part got California in trouble.

3. Eliminate the state’s requirement for a balanced budget. Paul Krugman is correct. The state should be allowed to do some very short term borrowing and deficit spending in economic emergencies, subject to constraints. As much as anything else this balanced budget requirement is the cause of our current mess. In a MinnPost piece over a year ago I said this and stick by this.

4. Consider eliminating the state corporate income tax and replace with a higher individual tax. There is some evidence that corporate income taxes pass on to lower income individuals. If true then eliminate the tax. For those of you who worry about business taxes, you should like this.

Overall, these are just some ideas to restore budget sense to the state. I assume here that my goal is not to hurt the poor and disadvantaged and balance the budget on their backs. I accept the idea that we are a collective society with an obligation to help one another. Moreover, my ideas have not addressed the other ought of how the state can invest to help the economy. That is a discussion for another day.

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