Testimony before the House Public Education Committee on School Finance Reform:
Testimony before the Senate Finance Committee in support of SB 17.
Texas performs relatively well in measures of financial stability by ranking 16th nationwide in fiscal health and 2nd lowest in state debt per capita among the top 10 most populous states. These rankings along with historically high growth rates in economic output and population (see Chart 1) indicate that Texas has remained steadfast in having sound fiscal management.
However, a recent TPPF paper shows that there are increasingly troubling signs of fragility in the state’s fiscal position.
These signs of a rising burden of state liabilities (i.e., state debt and public pensions) could cost taxpayers billions of dollars without key reforms.
State debt outstanding, which is just the principal, amounted to $49.8 billion at the end of fiscal year (FY) 2016. While this amount is small compared with the $1.7 trillion economy, it has increased by 52.7 percent per capita since FY 2006 and is up to $1,790 owed per every man, woman, and child in Texas.
Debt outstanding tells only part of the story because the interest owed on this debt is also a taxpayer expense. Total debt service outstanding, which includes the principal and interest owed, is $80.8 billion, meaning every Texan owes roughly $3,000!
If these trends continue, they could jeopardize Texas’ AAA credit ratings by all three major credit rating agencies and raise the debt burden on taxpayers.
To reduce this concern, we recommend increasing debt transparency by requiring the following information on ballot propositions for voter approval of issuances of GO state debt: total debt service required to pay the proposed debt on time and in full and an estimate of the proposed debt’s influence on the average taxpayer’s taxes, as recommended for local debt.
Although state debt is a problem that must be addressed, the elephant in the room is state pensions.
Chart 2 shows the two largest state pension systems, Employees Retirement System (ERS) and Teachers Retirement System (TRS), with their estimated 8 percent annual return and the eight state debts with the highest computed compounded annual growth rates.
Volatile annual rates of return and fewer contributors paying for more beneficiaries are exhausting these defined-benefit (DB) plans. Assuming a less risky average 15-year Treasury rate of 2.3 percent compared with today’s 8 percent assumed return rate, Williams et al. estimate that unfunded liabilities for all of Texas’ state pensions of $360 billion ranks 3rd highest nationwide and of $13,120 per person ranks 14th lowest.
To alleviate this mounting state pension issue, we recommend changing these pension systems from DB plans to defined-contribution (DC) plans, whereby payments would be based on employee contributions and a defined government match with little to no transaction cost and the benefit of sustainability without higher taxes.
Finally, given the low computed compounded growth rates of state debt in Chart 2, we recommend that surpluses of state revenue be used to cut taxes before paying down state liabilities. This could be done by creating a budget-cutting tool called the Sales Tax Reduction (STaR) Fund or eliminating the state’s business margins tax. These tax cuts would help avoid leaving revenue unchanged for future spending.
Implementing ballot box transparency for state debt, converting public pensions to defined-contribution plans, and prioritizing state surpluses to cut taxes will help lower the burden of state liabilities on taxpayers.
Overview: Texas has a proven record of financial stability. Ranking 16th nationwide in fiscal health, 7th in lowest state debt per capita, and with historically high population growth rates accompanied by economic growth, these factors have kept Texas steadfast even during times of economic uncertainty. Relatively sound fiscal management has provided Texans a certain level of comfort, but increasingly evident signs of vulnerability are raising concerns about the state’s financial health.
The latest report from the Bureau of Economic Analysis (BEA) shows that many states’ economies improved in the third quarter of 2016. Real gross domestic product (GDP), a measure of inflation-adjusted economic output, increased in 48 states and the District of Columbia. This contributed to a faster U.S. annualized economic growth rate of 3.5 percent that quarter but then slowed to a 1.9 percent pace in the fourth quarter, which aligns with this national economic expansion’s growth rate that’s the slowest since WWII.
Faster GDP growth rates indicate increased economic activity that typically includes more job opportunities, higher pay, and other benefits. Although the U.S. reported unemployment rate averaged 4.9 percent in 2016, which some economists consider to be at or near full employment, the more accurate underutilization rate (U6) that includes the unemployed, underemployed, and discouraged workers of 9.6 percent suggests slack in the labor market.
The figure below shows that Texas’ real GDP increased by 4.3 percent in the third quarter, which ranks 12th highest nationally. This translates into an increase in economic output by $28 billion to $1.65 trillion, or 9 percent of the U.S. economy. Economic growth contributed to an average unemployment rate in 2016 of 4.5 percent with a U6 rate of 8.6 percent in the Lone Star State.
Sectors of the Texas economy that contributed to the 4.3 percent growth rate were dominated by the wholesale trade (0.78 percentage points), finance and insurance (0.56 percentage points), and real estate and rental and leasing (0.46 percentage points). The only industry that was a drag on economic growth was the mining industry (-0.11 percentage points) from continued contraction in the oil and gas sector. However, that sector looks to get some reprieve as oil prices have increased since the third quarter.
Texas is the second largest state economy only behind California ($2.59 trillion), which expanded at a slower 3.3 percent rate in the third quarter. Regarding sectoral growth differences between these two states, Texas’ faster overall growth rate was driven primarily by sectoral positive growth differences in nondurable-goods manufacturing, wholesale trade, real estate and leasing, and agriculture.
On a larger scale, if Texas and California were separate economies, they would rank 11th and 6th, respectively, worldwide. By a private estimate of the cost of living, the Golden State has a 49 percent higher cost of living than Texas. This means greater purchasing power for many Texans compared with Californians.
Despite the declines in oil and gas-dominated areas statewide for the past two years, including the third quarter of 2016, Texas’ diverse economy and relatively limited government has supported economic expansion in most quarters during that period. While things look to improve with potentially higher oil prices and pro-growth federal policies, there’s much that the Texas Legislature can do to unleash economic growth by limiting spending and cutting taxes, especially eliminating the business margins tax.
This commentary originally appeared in The Gilmer Mirror on February 14, 2017.
Texas Governor Greg Abbott recently released his 2018-19 state budget proposal. He noted in that proposal, “Spending restraint must always be practiced, especially when the revenue projection is tight. While there are difficult choices to be made, the Governor’s budget funds the state’s priorities without issuing new debt, raising taxes, or utilizing the Economic Stabilization Fund.”
Some will claim that restraining or cutting government spending will slow economic growth. This point fails basic economics. Given that the state budget is funded by taxpayer dollars, fewer budgeted dollars means less takings from you, and more opportunities to prosper.
Of course, there are essential services provided by the government, but those limited, effective provisions are far fewer than we have today.
An indicator of this is the fact that the state’s current total budget—the footprint of government—is up 11.8 percent compared with compounded population growth plus inflation since 2004. This amounts to families of four paying roughly $1,600 more in taxes this year alone, thereby hampering your ability to satisfy desires and support economic activity.
The Governor gets it right that “spending restraint must always be made.” Like tightening your home budget when there’s less income and more essential expenses, so must state government. However, unlike your home budget, state government must collect tax dollars without generating income, so they must also consider how to leave more money in your pocket.
Fortunately, there are opportunities to achieve these goals of restraining spending through the Sales Tax Reduction (STaR) Fund and reducing tax burdens by eliminating the business franchise tax.
Texas House rules allow legislators to appropriate money cut from one program to another more preferred agency. This provides little opportunity for legislators to actually cut ineffective or excessive areas of the budget, leaving many legislators understandably frustrated with the budget process.
The STaR Fund, passed as ALEC model legislation in 2015, would be a budget-cutting mechanism to resolve this issue. It would operate by aggregating state surplus dollars from various sources (i.e., budget cuts, budget surpluses, and funds above the Economic Stabilization Fund cap) to temporarily reduce the state sales tax rate for a specified period. This would restrain the growth of government while keeping more money in your pocket.
As legislators consider which tax is the most costly for Texans, the reformed franchise tax, often called the margins tax, would top that list. It has been a failure since its reform in 2006 by restraining economic growth and job creation from the tax liability and cost of compliance. Since it is based on the gross revenue of a business with more than $1 million, businesses can have high revenues but be running net losses and be pushed further in the red by paying the margins tax.
Research shows that every year the margins tax is in place, Texans lose tens of billions of dollars in personal income and tens of thousands of new job opportunities. This leaves fewer opportunities for you to prosper. This must end.
By eliminating the margins tax, the Tax Foundation shows that the state’s business tax climate could increase from 14th highest nationally to third best. The combination of higher personal income, more job creation, and increased economic competitiveness makes abolishing this tax a no-brainer for legislators. While it may not be possible to entirely eliminate it this session, the largest cuts in the tax rates possible would be the best choice.
As the data make clear, Texas doesn’t have a revenue problem, it has a spending problem. By achieving the goals outlined by Governor Abbott to restrain spending, the 85th Legislature can take steps to create the STaR Fund and put the margins tax on a path to death as quickly as possible. These steps along with meeting the needs of Texas will hopefully allow for what could be a historic second consecutive conservative budget and better support the success of the Texas model.
The Conservative Texas Budget Coalition, which includes the Texas Public Policy Foundation and 13 other member organizations, recently presented our agenda for the 2017 Texas Legislature. You can view the press conference here and the press release with statements from most members.
Here is my statement: “The Conservative Texas Budget limits increases in the budget to no more than $147.5 billion in state funds and $218.5 billion in all funds,” said Vance Ginn, Ph.D., economist in the Center for Fiscal Policy at TPPF. “These limits are based on a 4.5 percent increase in population growth plus inflation during the previous two fiscal years. By limiting government spending to just meeting the needs of Texans, legislators can do more to increase the entrepreneurial spirit and job creation in Texas.”
The Coalition welcomes the newest member of the Coalition, Citizens Against Government Waste. Here’s the updated one-pager with all 14 member organizations and our agenda items.
Regarding the CTB agenda items, the Foundation has recently released the following publications:
Through these efforts, we hope to reduce the size and scope of government in Texas so Texans have the best opportunity to flourish.
Watch video here: http://tlcsenate.granicus.com/MediaPlayer.php?view_id=42&clip_id=11666
Texas House rules allow legislators to appropriate money cut from one program to another more preferred agency. This provides little opportunity for legislators to actually cut ineffective or excessive areas of the budget, leaving many legislators understandably frustrated with the budget process. For example, if legislators cut $1 million from the Arts Commission’s budget, it would be available to appropriate to any other agency.
Fortunately, there’s a budget-cutting mechanism called the Sales Tax Reduction (STaR) fund that would keep the $1 million in taxpayers’ pocket by lowering the state’s sales tax rate. The STaR fund, which was passed as ALEC model legislation in 2015, would operate by aggregating state surplus dollars from various sources (i.e., budget cuts, budget surpluses, and funds above the economic stabilization fund cap) to temporarily reduce the state sales tax rate for a specified period.
A first step in determining budget cuts is for the Legislature to switch from the current opaque strategic-based budgeting approach to the more transparent program-based budget format. This would allow legislators to more effectively conduct zero-based budgeting. This process would start each agency’s budget at zero dollars and ask agencies to explain why every program is necessary and effective while verifying with outcome-based measures. This oversight holds agencies accountable for their expenditures and allows opportunities to find excessive budget areas to cut.
After determining these budget cuts, legislators could appropriate those funds to the STaR fund instead of on another potentially ineffective program. Other ways to allocate money to the fund would be budget surpluses and severance taxes from oil and gas production that exceed the economic stabilization fund’s (ESF ) cap.
The STaR fund would continue to accumulate money from these sources until the end of the fiscal period when the Comptroller would use the fund’s amount to estimate how much to cut the state sales tax rate of 6.25 percent and for how long.
It makes economic and fiscal sense to cut the sales tax rate because it has the broadest base, is highly visible, and easy to change the way it’s levied. Another tax reduction item could be the business franchise tax, but this onerous tax should be eliminated as quickly as possible instead of just chipping away at it for a temporary period.
Texas taxpayers, businesses and individuals alike, will be able to enjoy less taxation and have more money to satisfy their needs if legislators employ zero-based budgeting to adequately allocate money to the STaR fund every session. While the STaR fund wouldn’t be available in the 2017 Legislative Session, as it would need to be put in place first, it would setup a terrific opportunity for needed budget reforms in the 2019 Legislative Session.
Overall, the STaR fund provides one of the simplest and most visible means for the government to prioritize expenditures and cut the budget to assure that the Texas model continues to support prosperity for all.
A Conservative Texas Budget (CTB) is one where biennial appropriations (General Appropriations Act and supplemental appropriations, when available) of state funds (excludes federal funds) and all funds—the footprint of government—increase by no more than population growth plus inflation. The 2018-19 CTB limits are $147.5 billion in state funds and $218.5 billion in all funds.
These CTB growth rate limit is based on a 4.5 percent increase in population growth plus inflation during fiscal years 2015 and 2016. The CTB limit amounts are a 4.5 percent increase above the 2016-17 initial appropriations. We include in a recent one-pager information on the starting points in the House and Senate versions of the 2018-19 proposed appropriations.
The table below shows agencies and programs of state government that increase in initial all funds appropriations by more than the CTB growth rate limit of 4.5 percent, except for General Academic Institutions and the Railroad Commission in the Senate version. Although these increases may be appropriate, these are some of the budget items that should be scrutinized during the legislative process so that the final budget will meet the CTB criteria.
Ph.D. Economist at the Texas Public Policy Foundation. Blog posts are publications by the author.