Revenue: Growth or shrinkage?

Gov. James R. Thompson's proposed 1988 tax increase has followed his 1987 effort into oblivion. Those who argued that the state had enough money without new taxes held the field. Those who battled for higher taxes withdrew to reassemble for another battle.

Next year will bring another tax increase skirmish. The performance of the state's tax structure demands it. Increases in the state's general funds revenues trail both inflation and overall economic growth. Natural revenue growth is a myth. Natural revenue shrinkage is the reality.

Shrinking revenues did not mean a tax increase in either 1987 or 1988. In July of 1987 it meant budget cuts for most state agencies. In July of 1988, those cuts, and the fact that Illinois did not have to repeat $280 million in spending to correct past fiscal errors, allowed lawmakers to spend nearly $700 million more than they had the year before. Tax hike opponents urged the state to live within its means. And, for the year that will begin next July 1 — and the budget that lawmakers will fight over next spring — the state could easily hit $600 million in new spending without new taxes.

The growth in ability to spend belies an underlying revenue problem. A 1988 study by the Illinois Economic and Fiscal Commission, the General Assembly's revenue forecasters, concluded that between 1979 and 1987 general funds revenues grew 56.7 percent in nominal dollars but declined by 5.3 percent when those revenues were adjusted for inflation.

Richard Kolhauser, deputy director of Thompson's Bureau of the Budget, uses the metaphor of the fit between a shoe (revenues) and a foot (spending). Attention has been focused on the foot getting bigger, while in fact the shoe has also been getting smaller, he says.

Writing in the June issue of the University of Illinois' Illinois Business Review Kolhauser said, "The natural growth in revenues plays a vital role in public finance. It has been common to expect that the natural growth in state revenues will finance routine increases in the cost of state programs due to such causes as inflation and growth in service levels (caseloads)." A tax structure that produces natural revenue growth exceeding economic growth draws complaints from citizens and businesses, he said. A structure like Illinois' that produces natural revenue growth that lags behind economic growth, causes program cuts and tax rate increases, he added.

Kolhauser compared state general funds revenue growth with inflation as measured by the consumer price index and with the performance of the Illinois economy as measured by the state's personal income. He found that between fiscal years 1971 (the first full year of the income tax) and 1987 general funds revenues and lottery transfers (profits) grew at an average rate of 8.2 percent. That equalled the average annual growth in personal income and exceeded the growth in the consumer price index of 6.6 percent.

Then Kolhauser divided the period in two. He found that from 1971 to 1979 growth in tax revenues and lottery profits exceeded both inflation and the general growth in the economy. But from 1979 to

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1987 the revenue sources trailed both inflation and economic growth. His findings parallel those of the Economic and Fiscal Commission. Both found the individual income tax the strongest performer. Both identified legislative changes to the utility and sales taxes, together with the recent decline in lottery profits as sources of revenue loss.

Kolhauser estimates that general funds revenues have lagged $125 million a year behind growth in the state's economy. Gov. Thompson used a similar argument when he made his original budget proposal on February 25 and pointed to a decline in state tax revenues as a percentage of personal income. When he proposed a 40 percent increase in income tax rates on June 9, Thompson labeled as a myth the notion that natural revenue growth could cover the state's needs.

Those arguments will be used again, but they will not automatically succeed. House Speaker Michael J. Madigan (D-30, Chicago), the most vocal opponent of this year's 40 percent income tax rate hike, said that he could not justify Thompson's increase in a year that the state could increase spending $700 million without a tax hike. Next year, with modest economic growth, Illinois could easily have $600 million more to spend than it had this year. Then the question will become: Can a tax increase be justified in a year that the state has $600 million in new spending ability?

The money to avoid a tax increase could come, in part, because lawmakers used conservative revenue estimates in putting the current year's budget together. Revenues must come in strong, at or above the estimates of the Economic and Fiscal Commission. In mid-August the commission's estimates were $113 million higher than the Bureau of the Budget's. The legislative forecasting unit has pegged current year (fiscal year 1989) revenues at $12,076 billion. In mid-August the estimates from the governor's Bureau of the Budget stood at $11,963 billion. Lawmakers must also refrain from adding to spending that they have already approved (enacting supplemental spending requests). If those two things happen, lawmakers could be spared a vote on a tax increase next spring.

Look at the pattern in the state's general funds. For year one — fiscal year 1988, the year that ended June 30 — state lawmakers appropriated about $10.6 billion. But they had to spend $100 million (or $.1 billion) to repay the money borrowed the year before. That left $10.5 billion for program appropriations.

For year two — fiscal 1989, the year that began July 1 and that will end next June 30 — lawmakers set appropriations at $11.2 billion. That is $700 million ($.7 billion) ahead of the $10.5 billion in fiscal year 1988 (year one) appropriations. That's the new spending of which Speaker Madigan spoke. And they did that with relatively conservative revenue estimates. In 1987 Thompson criticized them for failing to raise taxes but spending as if they had. In 1988 the appropriations committees based their spending plan for fiscal 1989 on the more conservative revenue estimates of the governor's bureau. If the commission is right and if lawmakers determine there are no pressing needs that require new funding during the year, the state would end fiscal 1989 with $360 million in the bank, instead of the $246 million being projected by the Bureau of the Budget.

Turn now to year three — fiscal year 1990, the year that will begin July 1, 1989, and the budget that will be debated next spring. First, the state could begin year three as it ended year two, with $360 million in the bank. Next, a 4 percent growth in the commission's $12.08 billion 1989 (year two) revenue estimate would yield $484 million in new revenues for year three. If lawmakers decide to end the fiscal year 1990 (year three) with $246 million in the bank, they could spend $114 million of the $360 million they had in the bank. The $484 million in revenue increases plus the $114 million drawn from the reserves would provide $598 million — call it $600 million — more to spend than in fiscal year 1989 (year two). All told the state could appropriate about $11.8 billion in fiscal 1990 (year three). That much money could provide, without a tax increase, $200 million for elementary and secondary education, $100 million for higher education and $300 million for all other programs. Those increases are larger than any of those entities saw this year, but far below what schools and human service agencies have identified as their needs.

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Of the three things that must happen if the General Assembly is to have a chunk of money available for new spending next budget year, lawmakers can control only one. Barring a veto session tax increase that Thompson has ruled out, it is too late to do anything about the revenues except count them as they come in. The $115 million difference between the estimates of the legislative commission the executive bureau was just under 1 percent. The difference may reflect the greater caution on the part of the bureau, which must live with the consequences of revenues that fail to meet targets.

Another factor that no one can control is economic growth. These have been good economic times for the country. Ask George Bush. Even though Illinois has trailed the national growth, the state has benefitted. And the surge in exports that has fueled the second half of the national recovery could hold some benefits for Illinois' beleaguered manufacturers. One dark cloud that looms on the horizon is the national economy. Whoever is elected president will have to confront the twin trade and budget deficits early in his administration. Paul Vallas, executive director of the Economic and Fiscal Commission, puts it like this: "The question is not if there is going to be another recession, but when and why it will occur and how bad it will be."

What lawmakers can control is new spending. If revenues come in at the Economic and Fiscal Commission's levels, there will be pressure to increase spending. An increase of $100 million is less than 1 percent of total state general funds revenues, but it will draw a lot of attention from groups willing to spend the money, particularly in a year that lawmakers turned away numerous requests.

Given its natural revenue shrinkage, Illinois has balanced its budget with service cuts. Those who would constrain spending within available revenues have won victories in both years of the 85th General Assembly. Gov. Thompson applied the first set of constraints in July of 1987 when he slashed $363 million from the spending plan given him by lawmakers for fiscal year 1988. This spring lawmakers applied their own constraints when they fashioned a budget within Thompson's revenue estimates for fiscal year 1989. Both sets of restraints meant that those who receive state money got less than they asked for and that those who receive state services took cuts.

The outright cuts of fiscal 1988 and the hold-the-line restraint of 1989 changed the state budget picture. On June 30,1988, the state had $246 million in the bank. One year before it had $154 million. For only the third time in the last nine years the state ended a year with more in the bank than it started. The only other years that revenues exceeded spending were in the temporary income tax years of fiscal 1984 and 1985. When the bank balance grows or stays the same, the budget is considered balanced under the available balance concept.

And the state could finish this fiscal year on June 30 with a budget balanced under the budgetary balance concept. That would be almost historic. Under that concept the budget is balanced if the available balance — the money the state has in the bank on June 30 — covers spending charged to the previous fiscal year paid during the following July, August and September. In other words, no current year revenues are used to pay last year's bills. If the Economic and Fiscal Commission is right and if lawmakers don't spend the extra money, Illinois could have $360 million in the bank on June 30, 1989. In July, August and September of 1988 the state spent about $350 million to pay the previous fiscal year's bills. If it pays no more in 1989, the budget would be balanced under the budgetary balance concept. Since the state's first negative budgetary balance in 1976, only twice has the budget been balanced under this concept.

But the question is whether there will be a tax increase next year. Studies by Kolhauser and the Economic and Fiscal Commission can make a convincing case that Illinois has a revenue problem. The natural growth of revenues simply has not kept up with inflation. On the other hand, application of the Madigan standard that it is wrong to take money out of people's pockets when there is substantial new money to spend, dampens prospects fora tax hike.

There are a couple of things to watch for hints about what will happen. First revenues must come in at or above the commission's estimates, something that will not begin to become clear until after January. Second, if there is new money, lawmakers must resist the temptation to spend it this year and instead bank it for next. If the money comes in and lawmakers do not spend it, legislators may avoid putting their political lives on the line in a pitched battle over a tax increase.□

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