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The first tax and expenditure limitation (TEL) was proposed by California Gov. Ronald Reagan in 1972. In the years since then, numerous states have adopted TELs. By studying these laws, we have discovered principles and design concepts for effective tax limitation.
In spring 1978, under the leadership of State Rep. David Copeland, the people of Tennessee adopted the first constitutional tax limitation measure in the nation, the work product of a state constitutional convention.
Then came Proposition 13 in California in June 1978. While not itself a TEL (it was primarily a limitation on the growth of property taxes), Prop. 13 was the catalyst that ignited a national tax revolt. Things began to happen quickly across the country:
- Arizona, under the leadership of then-Senate Majority Leader Sandra Day O’Connor, adopted a TEL referendum in 1978.
- In November 1978, Michigan adopted the Headlee Amendment, which restricted state spending as a share of personal income.
- In 1979, California adopted a Prop. 1-type TEL (the Gann Limit) that for the first time limited the growth of state spending by measuring it against inflation and population or per-capita personal income growth, instead of a percentage of state personal income growth, which really tightened the year-over-year control over taxes and government spending.
- Also in 1979, Washington State adopted a TEL (Initiative 62).
- In 1980, Missouri adopted the Hancock Amendment, again using a percentage of state personal income growth as the measure.
- In 1980, Massachusetts’s Prop. 2 ½ drew heavily on the language of California’s Prop. 1 in order to control the growth of local governments.
Many other states have since adopted constitutional or statutory controls. But many were not tough enough or sufficiently well enforced or honored to be effective. Circumvention began in earnest in Missouri as the legislature and courts played games with the revenue base and school financing. In California in 1989, wily Assembly Speaker Willie Brown corrupted the Gann Limit formula in a statewide initiative devoted to improving California’s roads and highways.
It is clear that constitutional (not statutory) TELs initiated by the people (in those states that permit referenda and initiatives) are the strongest and most resistant to circumvention. Furthermore, limiting year-over-year growth in spending to population and inflation changes, as well as imposing limits on both state and local governments, provides the greatest safeguards for the taxpayers.
From these lessons the TEL design was improved, culminating in the best models in Colorado (1992) and Washington State (1993). While the Washington initiative has been circumvented by subsequent action of the state legislature (Washington law permits only statutory initiatives, which remain immune from legislative changes for only two years), Colorado’s “Taxpayers Bill of Rights” (TABOR) has been very successful. Colorado’s economy has boomed while tax cuts and surplus rebates have become the order of the day.
Principles and Design Concepts
Summarizing 30 years of tax limitation experience isn’t easy, but we offer the following principles and design concepts:
- While laws control men, only constitutions control governments. Fiscal discipline imposed not bythose we elect, but upon them, is the only safe route. A TEL is an important element of people power: It reinforces the basic notion that all power derives from the people, the consent of the governed. A TEL, to be truly effective, must be embodied in a state’s constitution. Those states with the initiative/referendum process have the best chance for a good TEL.
- Voting rules make a difference. Super-majority votes of the legislature for tax increases and emergency appropriations are key disciplines. Votes by the people to increase taxes, fees, and debt, and to allow the government to spend more than the limit would otherwise allow, are essential to the integrity of a TEL. Efforts to circumvent established votes of the people for general obligation bonds or other debt instruments must be prevented.
- The definitions of the TEL limits are crucial. Linking the TEL limit to personal income growth, or even a portion of that growth, is too generous. A TEL limit based on the growth of population plus inflation is a more stringent constraint on the growth of revenue and expenditures. The TEL must apply to local as well as state governments. Otherwise, constraint at the state level can be circumvented by shifting functions to local governments. No government function, such as education, should be permitted to remain outside the TEL, and there should be no earmarking of a specific revenue source for a designated government function.
- Tax reductions should occur as quickly as possible. To the extent possible, taxes should be cut in advance of the generation of a surplus to reduce extraction costs and leave productive resources in the hands of those who produced them. Actual surplus revenues above the TEL limit should be rebated as quickly as possible so they do not tempt legislators to creatively circumvent the limit and spend the surplus.
- Allow limits to be suspended in bad economic times. The revenue/spending limit should be suspended during bad economic times when tax revenues actually decline year-over-year. In that event, the prior year’s revenue/spending limit remains “frozen” into the future until, once again, revenues increase beyond the revenue/spending limit.
- Create multiple funds for surplus revenues. There should not be a single reserve or rainy-day fund. Multiple funds for different purposes with different operational rules should be established. A portion of the surplus revenue above the TEL limit should be allocated to a budget stabilization fund (BSF). The share of surplus revenue allocated to the BSF and that allocated to tax rebates should be defined, and a cap placed on the BSF. All surplus revenue above that cap should be offset by tax cuts or tax rebates.
The BSF should be used during economic downturns when revenues actually decline year-over-year (except when such decline is the result of an explicit tax elimination or rate reduction). The transfer of funds from the BSF to the general fund should occur automatically on a quarterly basis and in a specified amount when the director of the state department of finance (or similarly situated officer) determines that revenues in a particular quarter have declined from the revenue level of the same quarter in the preceding year. Neither the legislature nor the governor should have any role in this determination of transfers.
- Create an emergency fund. An emergency fund (EF) should be established representing approximately 3 percent of general fund revenues, preferably funded out of revenues within the limit in preceding years. Appropriations may be made from this fund for natural or other non-economic disasters upon declaration of an emergency by the governor and a super-majority vote of the legislature. The EF should be refunded in the year following such appropriations.
- Adopt a rule on which taxes to cut. When tax cuts are made to reduce future surpluses, the cuts should be made in taxes in reasonable proportion to their contribution to that surplus. Cuts that reduce or eliminate tax system progressivity are to be given preference as they will preclude excessive future surpluses.
Tax and expenditure limits now have a rich history. If we fail to heed the lessons of history, we are doomed to repeat them. As we move forward to restore existing limits and to pass new ones, we must heed those lessons.
Lew Uhler is president of the National Tax Limitation Committee and Dr. Barry Poulson is a senior fellow with the Independence Institute and professor of economics at the University of Colorado.