The Texas economy has performed relatively well during much of the pastfifteen years regarding economic output and job creation under a fiscally responsible system of low taxes and smart regulation. However, this Texas model can be strengthened to support greater prosperity by reforming the state’s weak constitutional spending limit.
The current limit caps the growth of non-constitutionally dedicated general revenue—about 45 percent of the state’s total budget—to an estimated growth rate in the state’s economy. Statutorily, the state’s economy is measured by a 33-month projection of personal income, which is “the sum of net earnings by place of residence, property income, and personal current transfer receipts.”
Meanwhile, Table 1 provides budget information from the Foundation’s The Real Texas Budget report that shows growth in the state budget has increased 68.5 percent since the 2004-2005 biennium under this limit. After adjusting the budget for the key metric of population growth plus inflation, it’s up 11.8 percent. This translates into Texans paying $22 billion more in taxes during the current 2016-17 budget cycle than if the Legislature had increased the budget each period by this key metric.
Clearly, budget growth must be brought under control so that the rising burden of taxation doesn’t continue to keep Texans from reaching their full potential. To accomplish this, the Foundation advocates for the Legislature to adopt a conservative spending limit that makes three key reforms.
First, the Legislature should apply the spending limit to the entire budget. The current limit leaves more than half of government spending uncapped. This provides legislators with incentive to constitutionally dedicate funds to move them outside of the cap so they can spend more under the cap thereby growing the entire budget. Limiting the entire budget would end this practice while increasing the limit’s effectiveness and improving budget transparency.
Second, the cap should be based on the lowest growth rate among state population growth plus inflation, total state personal income, and total gross state product instead of the current limit of just personal income.
Third, the budget cap should be calculated using the growth rate from the two fiscal years immediately preceding a regular legislative session instead of making arbitrary predictions about future economic growth. This would reduce budget volatility and help absorb unexpected economic events that could influence the budget like the steep drop in oil prices since 2014.
Historically, population growth plus inflation is usually the lowest metric and relatively more stable over time than the other metrics. However, we are mindful of the Great Inflation during the 1970s and don’t think it’s appropriate to grow government spending at double-digit rates of inflation, which is why we suggest the lowest of the three metrics. Research finds that simply moving the spending limit to population growth plus inflation will lead to tax relief and accelerated economic growth.
Figure 1 shows that the adopted growth rate in personal income is typically higher than our lowest metric each period.
To summarize our reform proposal of a conservative spending limit more succinctly:
Figure 2 shows that if the Foundation’s conservative spending limit had been in place since FY 2004, the average Texas family could have saved roughly $2,000 in taxes per year. This doesn’t mean that we are calling for $28 billion in spending cuts, but rather making the case that government spending could have increased at a much slower pace and met the needs of Texans since the 2004-05 budget.
Critics claim that a spending limit based on population growth plus inflation is inflexible and sclerotic. At a recent Texas Senate Finance Committee hearing on reforming the spending limit, the argument was made that the current measure of personal income is simply a version of the equation: population growth plus inflation plus productivity. If this equation is correct, a limit based on population growth plus inflation fails to account for the importance of productivity.
Regardless, an increase in private sector productivity doesn’t necessarily require a corresponding increase in government spending. Moreover, a more productive private sector signals that the marginal return per dollar would be greater in the private sector, meaning that more dollars should stay there instead of being taxed to pay for higher government spending. If government productivity is what’s considered in this calculation, it would be practically impossible to measure and would likely be zero over time.
Therefore, if this personal income equation is appropriate, productivity would either make the spending limit growth rate less than or equal to population growth plus inflation, which is what the Foundation calls for in the Conservative Texas Budget. If legislators deem that spending should grow by more than this, they have the flexibility to argue their case to voters and vote to bust the cap.
The current spending limit has contributed to excessive spending. Texas needs to adopt a conservative spending limit to better control the budget and remain a model for other states to follow.
Ph.D. Economist at the Texas Public Policy Foundation. Blog posts are publications by the author.