Tax and spending limits: What other states are trying
by GARY E. SCHMITZ
While California's Proposition 13 has received the most conspicuous coverage in the nation's media, it was not the first nor even the most comprehensive measure undertaken by a state to control its spending and the spending of its local governments. Three states — Colorado, New Jersey and Tennessee — instituted spending limits of various kinds before the California measure was enacted; and voters in 11 other states, including Illinois, have since expressed their opinions on proposals to either put restraints on property taxes or to impose limitations on spending and other taxes (see box).
Property tax rollbacks of the Proposition 13 variety were passed last November in Idaho and Nevada, while voters rejected similar measures in Michigan and Oregon. In Arizona, Hawaii, Michigan and Texas, voters approved measures to impose limits on taxes and spending by keeping them in line with general economic growth in those states. Similar measures were rejected in Colorado, Nebraska and Oregon, but voters in Missouri gave their legislators the authority to reduce property taxes, and those in South Dakota voted to require a two-thirds majority in their legislature to enact any increase in taxes.
State and local taxes have been taking a larger percentage of people's income during the last 15 years. The increase from 1960 through 1975 for state and local taxes is 303 per cent. During the same period, U.S. personal income has grown 213 per cent, the federal budget by 204 per cent and the Gross National Product by 197 per cent.
Thompson Proposition strongly indicate that the people of Illinois want a limitation on the growth of state and local government, it is not clear what form those limitations should take. The measures developed by other states provide a context in which to examine the alternatives, however, and four basic types of spending limitation plans emerge: the Tennessee plan, the Arizona plan, the Colorado constitutional plan and the Colorado statutory plan. These represent four basic methods that other states have employed to limit state and
Spending limits, property tax limits in other states
ARIZONA State spending is limited to 7% of total state personal income by a constitutional amendment proposed by the legislature and approved by Arizona voters November 1978 (effective for the fiscal year 1980 budget). The limit may be exceeded by two-thirds vote of the legislature. There is no provision for surplus revenue.
COLORADO (constitutional) Annual increases in state and local expenditures would have been limited to the percent increase in the consumer price index by a constitutional amendment proposed by initiative but rejected by voters November 1978. The, limit could have been exceeded if approved by a majority of registered electors voting on the question in a special election. In an emergency, the limit could have been temporarily exceeded at the state level by the governor with consent of two-thirds of the legislature and at the local level by the executive officer with consent of two-thirds of the unit's legislative body. Any revenue surplus would have been placed in a surplus fund, and revenues in excess of 5% of the limit would have been used for tax reductions, credits or refunds.
COLORADO (statutory) State spending is limited to a 7% increase of the previous fiscal year by statute passed by the local spending. Since the limitation of state spending from state tax sources is the most common method of restraining govern-ment growth in other states, this analy-sis will focus on the implications of such measures for Illinois. It is not crucial to the analysis whether spending or taxes are limited, since the two are so closely related. From 1970 to 1977 Illinois tax revenue increased an average of 9 per-cent per year, while spending from state sources increased an average of 10 per-cent per year. legislature July I, 1977, effective immediately. Presumably the legislature may amend the limit since it is statutory. Revenue increases over 7% and up to 11 % go into a budget reserve fund; revenue increases over 11% must be returned to taxpayers as tax relief.
HAWAII State spending is limited to state economic growth by a constitutional measure drafted by the constitutional conven tion and approved by voters November 1978, effective for the fiscal 1980 budget. The limit may be exceeded by a two-thirds vote of the legislature. The legislature shall also provide for a tax refund or credit to taxpayers when-ever the state general fund balance at the close of two successive fiscal years exceeds 5% of the general fund for each of the two fiscal years.
IDAHO Property tax is limited to 1% of "actual market value as determined by assessors," by a statutory provision proposed. by initiative and approved by voters Novem-ber 1978. Indications are that it will be effective for the 1980 assessments. A two-thirds vote of the legislature is needed to change taxes (which is inconsistent with the state constitution which requires a simple majority on tax matters). Approval of two-thirds of the voters is needed to increase property taxes.
MICHIGAN (Headlee) State rev-enue growth is limited to the growth of state personal income, and growth of local lift revenue is limited to growth of the U.S. consumer price index, by a constitutional amendment proposed by initiative and approved by voters November 1978, effective in fiscal year 1980. Limits may not be changed without approval of the majority of qualified
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All the states that have adopted or considered limitations on the growth of government have exempted federal aid from the limitation. This raises a potential problem because federal aid for specific programs may be withdrawn in the future. If and when this occurs, the state must either appropriate money for the program — subject to the spending limit — or the program must be dropped. Since it is difficult to completely abolish a program after it is begun, this provision may result in the state funding programs that would not have been started in the absence of
federal aid.
The basis of the limit
The Tennessee plan allows state spending to increase at the same rate as the growth of the state's economy. In Tennessee and other states with this type of limit, personal income has been established as the measure of growth of the state's economy. Analysis of the average annual increase in Illinois personal income, tax revenue and electors, or in emergency situations, by request of the governor and two-thirds vote of the legislature. Revenue in excess of the limit shall be returned to taxpayers based on prorated income tax payment.
MICHIGAN (Tisch) Current property tax assessments would have been reduced from 50 to 25% of market value; annual assessment increases would have been limited to2.5%; the state income tax would have been allowed to increase from 4.6 to 5.6%; and a 1% local income tax would have been allowed. This was proposed by a constitutional amendment proposed by initiative which was defeated by voters November 1978. There were no provisions for excess revenue.
MISSOURI The legislature is authorized to roll back property taxes in the event of inflating assessments, by a constitutional amendment proposed by the legislature and approved by the voters November 1978, effective 60 days after approval.
NEBRASKA Increases in local government budgets would have been limited to 5% per year unless population increases exceeded 5%. This constitutional amendment proposed by initiative was rejected by voters November 1978. The limits could have been exceeded by a four-fifths vote of the legislature or a majority vote on the question in a local government district.
NEVADA Property tax is limited to 1% of full cash value based on appraised value tor the fiscal year beginning July 1,1975, by aconstitutional amendment proposed by initia-I live and approved by voters November 1978. It must again be approved by voters in 1980 to be effective for 1980 assessments for taxes payable in 1981. The amendment also pro-spending from tax sources during the period 1970-1976 shows that revenue and spending in Illinois are closely tied to the growth of personal income. Personal income of a state grows because of inflation and real economic growth (expansion in the level of goods and services). Illinois revenue is closely tied to personal income because the sales tax and the income tax, which combine to produce nearly two-thirds of the state's tax revenue, are both dependent on inflation and real growth in the vides that increases in assessed valuation are limited to 2%, and the limits may be overridden by a two-thirds vote of the legislature or two-thirds of the voters voting in a special election. Any tax increases or new taxes must be approved by a two-thirds vote of the legislature.
NEW JERSEY State spending in-creases are limited to growth in personal income, and county and municipal spending increases are limited to 5% per year, by statute drafted and approved by the legislature in 1976, effective for the state budget of fiscal 1978 and for local budgets for calendar year 1977. There are no provisions for overriding the state limit or for handling surplus state revenues. The local limit may be overridden by a simple majority vote in the next election of the local unit.
OREGON Property tax would have been limited to 1.5% of 1975 assessed valuation, and assessments would have been allowed to rise only 2%, by a constitutional amendment proposed by initiative but rejected by voters November 1978. Closely patterned after California's Proposition 13, the amendment provided that a two-thirds vote of the legislature was needed for new or increased state taxes, and a two-thirds vote of the voters was needed for special local taxes.
OREGON State spending would have been limited to 95% of the previous budget, after which state spending would have been tied to personal income, by a constitutional amendment proposed by the legislature but rejected by voters November 1978. The amendment would have limited local government spending to the increase in the consumer price index, adjusted for population change. It economy. Revenue from the sales tax increases as more goods are purchased (real economic growth) and as the price of the goods rises (inflation). Income tax revenue goes up as more people are employed (real economic growth) and as individual wages rise (inflation or productivity increases).
The figures in table 1 show that the adoption of a Tennessee-type spending limitation in Illinois would not have greatly affected the state's spending since 1970, primarily because Illinois adopted no new taxes during this period. After Illinois adopted the income tax, revenue and spending increased 48 per cent in one year, 1969 to 1970, while personal income increased 6 per cent. The adoption of the Tennessee-type limitation would prevent Illinois from levying any new taxes, or increasing the rates of existing taxes. But as long as the tax system is not altered in Illinois, state spending is already closely tied to personal income in the state.
This type of limitation plan causes some problems because personal in- also called for the state to finance a 50% reduction in residential personal property tax up to a limit of $1,500; relief was also provided for renters. To override the state spending limit, two-thirds vote of the legislature was required; to exceed the property tax limit, approval by voters was required. If the balance in revenues available for state government operating expenses was to exceed spending by 2% or more, the excess would have been distributed to those paying income tax.
SOUTH DAKOTA To increase any state or property taxes, a two-thirds vote of the legislature is required by a constitutional amendment proposed by the legislature and approved by voters November 1978, effective immediately.
TENNESSEE State spending cannot increase faster than the state economy, according to a constitutional amendment drafted in August 1977 by the state constitutional convention and approved by voters March 7, 1978, and effective for fiscal year 1979 budget. Spending limits may be exceeded by a simple majority of the legislature. There is no provision for excess revenue.
TEXAS State spending increases are limited to the rate of economic growth, and property tax levies cannot be increased, according to a constitutional amendment drafted by a special session of the legislature and approved by voters November 1978. It is effective immediately, but legislators still must define economic growth. The state spending limit may be overridden by a majority vote of both legislative houses. To increase property tax levies, a local governing body must hold a public hearing. There is no provision for surplus funds.
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come must be estimated. In Tennessee, the state legislature voted to use the estimates of state personal income determined by the Tennessee Econometric Model developed at the University of Tennessee. In Arizona, the legislature established an Economic Estimates Commission which is required to publish final estimates of personal income in the state. The accuracy of these estimates is important since the level of state services is dependent on them.
The Arizona-type spending limitation plan requires that state spending may not exceed a fixed percentage of state personal income. Table 2 shows the relationship between Illinois personal income compared to spending from tax revenue. State appropriations from tax sources have been between 6 and 7 per cent of state personal income from 1970 to 1977, which emphasizes the stable relationship between Illinois personal income and spending.
The principle difference between the Arizona plan and the Tennessee plan is the flexibility of the former. The Tennessee plan assures that spending in the future must remain at the same percentage of state personal income as when the limitation is put into effect. The Arizona plan would allow for changes in this percentage. For example, if Illinois implemented an Arizona-type plan with spending limited to 6 per cent of personal income, state spending would have to be reduced until it reaches 6 per cent of personal income. This could occur through cuts in state spending, increases in personal income, or a combination of the two. State spending could increase in relation to personal income if an 8 per cent limit were adopted. After these adjustments were complete, state spendingcould again increase as personal income increases.
A Colorado constitutional amendment to limit spending was rejected by voters in November. It would have allowed spending to increase at the same rate as the rate of increase in the consumer price index. Table 2 shows the percentage increase in the consumer price index, compared to the percentage increase in state spending from 1970 to 1977 in Illinois. Table 2 shows that state spending from tax revenue in Illinois increased more than the increase in the consumer price index for every year since 1970. If implemented in Illinois, this Colorado constitutional proposal as opposed to Colorado statutory limit) would allow state spending to keep pace with inflation, but no new programs could be added without cutting some existing program.
As long as there is real growth (expansion in the level of goods and services) in a state's economy, this Colorado constitutional limit is more restrictive than the Tennessee plan. The Colorado plan does not allow state spending to grow in response to real economic growth. The Arizona plan may initially be more or less restrictive than the Colorado constitutional plan, depending on what percentage of personal income is established as the limit.
In implementing a Colorado constitutional type restriction there is a problem in obtaining estimates for the percentage change in the consumer price index. The Colorado constitutional plan provided that spending increases in a calendar year beginning in June were based on the percentage increase in the consumer price index in the previous full calendar year. The selection of this basis would have enabled the state to know six months in advance of the beginning of the next fiscal year what increase in expenditures would have been permitted.
The Colorado statutory plan limits appropriation increases to 7 per cent over the previous year. Since this Colorado statutory limit does not take into account economic conditions in the state, the choice of the constant percentage limitation becomes very important. If the increase is less than the average annual rate of inflation, about 7 percent in recent years, state spending will not keep up with increasing costs.
This type of plan has characteristics which make it particularly attractive as a method of limiting the growth of local government spending. Since spending is limited to a fixed percentage increase per year, there are no complications in estimating personal income or price changes in the area of local govern-ments. Although this plan is less flexible than the other three plans, local units government would know their future maximum levels of spending witl complete certainty. By allowing small increases in local government spending (3 to 5 per cent), large increases in the property tax may be avoided.
Excess revenue
Limitations on the growth of government activities are generally directed at restrictions on spending. Since the tax system is not changed, a growing economy may produce tax revenue in excess of the spending limit. Thisis particularly true if restrictive spending limits such as the Colorado statutory or Colorado constitutional plans are) adopted since economic growth is not considered in establishing the limit.
The Colorado statutory plan addresses this problem of excess revenue, Tax revenues in excess of the spending limit are deposited in a reserve fund to be used in case of emergencies, or to! finance state operations in case of a downturn in economic activity and a fall in tax revenue. To spend money front this fund, the approval of two-thirds both houses of the legislature and the consent of the governor are required Most plans specify a maximum dollar amount that can be maintained in the reserve fund, but the Colorado statutory plan provides that the fund cannot contain revenue in excess of 4 per cent the previous general fund budget.
Tax revenue in excess of 4 per cent of the Colorado general fund budget must be returned to the taxpayers in the form of tax relief. During 1978 Colorado taxpayers received $65 million in income tax relief and $35 million in property tax relief. The steeply graduated income tax in Colorado combinel with the restrictive 7 per cent limit of spending increases per year produced this tax revenue surplus in Colorado, Since Illinois' flat rate income tax would not cause tax revenue to increase as fas as Colorado's graduated income tax, Illinois taxpayers should not expect similar tax relief from surplus revenues
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This would especially hold if Illinois did not adopt a restrictive plan like Colorado's present statutory plan.
Exceeding the limit
All the spending limitation plans contain an "escape clause" which allows the limit to be exceeded in case of emergency. The Tennessee plan provides for the most flexible escape clause: the limitation may be set aside for one year at a time by a simple majority vote of the two houses of the state legislature. The Arizona plan requires the affirmative vote of two-thirds of both houses of the legislature to exceed the limit. The Colorado constitutional plan provides that the limitation on expenditures for local government units could be exceeded by approval of a majority of electors voting at a special election, or by the declaration of an emergency by two-thirds of the governing body of a local unit and its chief executive officer. An emergency could be declared at the state level with the agreement of the governor and two-thirds of the members of both chambers of the Colorado legislature.
Intergovernmental relations
Although all spending limitation plans exclude federal funds from the limitation, federally mandated programs could cause problems. If a federal mandate requires state or local governments to undertake a specific program and provides the financing of the program, this spending would not be charged against the limitation. But if the federal government does not fully fund the mandated program, the state or local funds used would be subject to the spending limitation.
The Tennessee spending limitation, which applies only to the state level, could be a problem as the state approaches its spending limit. If new programs are being demanded at the same time, the state may require they be funded by local governments. This would put severe pressure on the chief source of local revenue — the property tax. In response to this problem, the Tennessee constitutional limit requires the state to "share" in the costs of new programs it imposes on local govern-ments. In adopting a limitation applied only to state spending, it may be useful to require full funding by the state of programs required by local governments. This would avoid increasing the pressure on local property taxes and would more effectively limit state and local spending.
The proposed constitutional limit in Colorado applied to the spending of both the state and local government. The plan also included a unique provision that could cause problems relating to state mandated programs. The plan would require the state to fully fund any new state mandated costs, and the mandated monies would be subject to the state spending limit. Although any state mandate would be entirely funded by state government, such monies would also affect the local governmental unit's spending limitation. The effect of this provision is that spending for state mandated programs is included under both the state and local limit. This double counting under the Colorado constitutional plan also would result in local governments being faced with the dilemma of reducing other services in order to implement state mandated programs, unless a change in spending were approved at a special election.
Nebraska voters turned down a proposal to limit local spending increases to 5 per cent per year. An effective local limit of this type is an attempt to reduce the large increases in property taxes, which were partially responsible for the sucess of Proposition 13 and the beginning of the national "tax revolt." Proposals that limit local spending but ignore state spending may not result in a reduction in total state and local spending, but may shift future increases to the state level, thereby increasing the centralization of government.
Debt limits
It is difficult to predict the long-run consequences of taxing and spending limitations because the oldest state limitations have been in effect for less than two years. However, an examination of the history of Illinois'experience with debt limitations may point out some unexpected results of constitutional restrictions. Under the 1870 Illinois Constitution, state debt could not exceed $250,000 (except to defend the state from invasion or war). This limitation was not effective; by 1970 Illinois had incurred $ 1.3 billion in debt, of which more than $1 billion was in revenue bonds used to evade the constitutional restriction. These revenue bonds were not backed by the full borrowing power of the state, and their interest rate was !4 to x/i per cent higher than on general obligation bonds. The final result of the constitutional restriction on state debt was an increase in the cost of debt service for the State of Illinois.
To be sure, the four types of spending limits discussed in this article are more flexible than the former, flat $250,000 state debt limit, but there could be similar long-run changes in spending patterns to evade the spending limits. State services which are presently funded by state tax money could be funded by user charges. Effective spending limitations on state and local governments may cause new programs to be undertaken at the federal level, speeding up the centralization of government, and causing federal spending and taxes to increase. An effective limit on federal, state and local spending could mean that in the long run services such as education and transportation may no longer be affordable to government and may instead be provided by private companies operating for profit. Spending limitations will not cause the demand for new services to disappear, but may result in these services being provided by different organizations in the future.
One's view of tax and spending limitations depends on his view of the proper role of scope of government. Economist Milton Friedman believes government is the cause of most of the problems in society, and he "is in favor of tax cuts under any circumstances." On the other hand, economist Walter Heller believes that tax limits cannot deal with issues of fairness and equity in taxation and efficiency of government.
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