Why Spending Restraint Matters

August 6, 2012

It’s time to roll back Oklahoma government spending to a more reasonable level, and to put in place safeguards against future explosions in state spending.

A Taxpayer Bill of Rights (TABOR) is designed to keep the growth in state government spending from exceeding the taxpayers’ ability to pay. Specifically, TABOR uses the growth formula of the inflation rate plus the rate of population growth to determine the spending limit. For instance, 3 percent inflation growth plus 1 percent population growth would yield a spending “speed limit” of 4 percent (3 percent plus 1 percent).

Chart 1 illustrates the growth in Oklahoma state government expenditures for fiscal years (FY) 1992 to 2010 (the latest year of data available from the U.S. Department of Commerce’s Census Bureau) historically and under a TABOR benchmark.1,2

The good news is that, between FY 1992 and FY 2000, state government expenditures were growing at the same pace as the TABOR benchmark.

However, between FY 2000 and FY 2002, state government expenditures jumped a whopping 51 percent—to $11.3 billion in FY 2002 from $7.5 billion in FY 2000. This dramatic growth pushed state government expenditure growth far above the TABOR limit. In fact, in FY 2002, the growth index value for state and local expenditures was 1.89 versus 1.31 for the TABOR limit.

As OCPA has repeatedly pointed out, Oklahoma government spending is at an all-time high. The most significant driver of state spending growth is federal funds, or what tax consumers often like to think of as “free” money. It is the federally induced welfare programs (such as Medicaid) which require ever-increasing state funding matches for the programs’ exploding costs that are driving such growth.

Examples of the growth in state spending include the irresponsible spending spree of FY 1996 to FY 2002 (wherein state appropriations increased more than $1.9 billion—or 49 percent) and the irresponsible spending spree of FY 2004 to FY 2010 (wherein state appropriations increased more than $2.1 billion—or 41 percent). Since that time, many lawmakers have continued the push to increase state spending by overwhelmingly passing the provider tax to “enhance” Medicaid reimbursement. According to Oklahoma House of Representatives fiscal documents, this new tax will generate approximately $152 million in state funds and an additional $268 million in federal funds.

More disturbing is that this jump in state government expenditures has also resulted in a permanent upward shift in the yearly rate of growth in expenditures. Prior to FY 2000, state government expenditures grew at an average rate of 2.9 percent. After FY 2000, state government expenditures grew at an average rate of 9.4 percent—or 324 percent higher! 3

As a result, the burden of state government spending has grown tremendously. In fact, if state spending after 2000 had continued to grow at the TABOR speed limit, then state spending would have been $6.8 billion lower in FY 2010—or $4,687 lower for every Oklahoma household.

However, the cost of over-spending is only the tip of the iceberg in terms of the total cost to Oklahoma’s economy. The larger cost is due to the “crowding out” effect that this state government spending has on the private sector.

Put simply, Oklahoma’s private sector, as a percent of personal income, is smaller than it should be.

Personal income is an important economic measure of a state’s well-being. Higher levels of personal income mean that a state’s residents are able to buy more goods and services, such as homes, cars, education, and health care. It is also a very useful way to gauge the ability of a state’s residents to pay taxes.

Fundamentally, personal income comes from two sources: the private sector and the public sector. The distinction between the two sectors is important because only the private sector creates new income. The public sector, in contrast, can only redistribute income through taxes and spending. More specifically, public-sector spending consists of personal current transfer receipts (Medicare, Medicaid, Social Security, etc.) and government employee compensation (federal, state, and local).

Oklahoma’s policymakers should be very concerned that, since 2000, state government spending has resulted in the “crowding out” of the private sector.4 In particular, much of this growth in state spending is being driven by SoonerCare (Oklahoma’s Medicaid program). In fact, according to data from the U.S. Census Bureau, between FY 1999 and FY 2009, “public welfare” (mostly Medicaid) grew by 195 percent—to $5.1 billion from $1.7 billion.

As a consequence, Oklahoma’s taxpayers will pay a steep price—not only with higher tax bills, but also lower incomes. Chart 2 shows the clear relationship between the size of the state’s private sector and per-household income. In 2010, Oklahoma had one of the smallest private sectors in the country (62.8 percent, 41st) and one of the lowest per-household incomes ($91,116, 35th).

However, had Oklahoma’s state government spending continued post-2000 at the TABOR benchmark, then the state’s private sector would have been $6.8 billion larger. Chart 2 shows that Oklahoma’s private sector would have been 68 percent (ranked 24th) of personal income instead of the actual 62.8 percent (ranked 41st). As a result, household income would have been up to $13,176 higher thanks to the work of a larger private sector—$104,292 versus $91,116.

In conclusion, overspending by Oklahoma’s state government, relative to the TABOR benchmark, is costing taxpayers dearly. First, overspending is costing taxpayers up to $4,867 in higher taxes (though much of this is paid for by Uncle Sam). Second, this overspending is resulting in the crowding out of Oklahoma’s private sector—which now costs up to $13,176 per household in lost personal income.

While it is impossible to undo history, Oklahoma’s policymakers should heed the lessons of history. Policymakers should begin the work of unwinding the massive growth in state government spending that began in 2000.

A good first step is to take a serious look at state programs operated with federal funds. In particular, as OCPA fiscal policy director Jonathan Small has pointed out, “oversight of state agencies’ application for federal funds, and operation of programs using federal funds, must begin immediately. The current budget review process is inadequate. There are simply too many programs being operated by state agencies, and too much money being spent. Just as lawmakers have established committees specifically for certain policy issues needing intense review (e.g., DHS), it is time to form an oversight committee designed specifically to review and make recommendations for all state programs utilizing federal funds.”

Once spending has returned to a more reasonable level, policymakers should put into place a Taxpayer Bill of Rights to protect against future explosions in state spending. Then the private sector could get back to work increasing incomes and creating new jobs.

Economists J. Scott Moody (M.A., George Mason University) and Wendy P. Warcholik (Ph.D., George Mason University) are OCPA research fellows.

Endnotes

1 Expenditure data are net of intergovernmental transfers.

2 The comparative growth indices shown in Chart 1 were created by setting the base year (1992) equal to one and then multiplying each successive year by the growth rate. This makes it easier to visualize the relative growth differentials without worrying about the differences in starting values.

3 Even if we look only at state appropriations (rather than total expenditures), the TABOR limit is still being exceeded, according to OCPA fiscal policy director Jonathan Small. For example, a number of lawmakers advocated for such a limit in FY 2005. If state appropriations were subject to a TABOR limit, using FY 2005 as a baseline, Small says state appropriations for FY 2013 would have been limited to $6,743,170,959.25. Yet actual state appropriations were $6,828,529,375, thus exceeding a TABOR limit by more than $85 million. Further, if a TABOR limit were applied using FY 2012 as a baseline, state appropriations for FY 2013 would have been limited to $6,760,190,009.02. Yet actual state appropriations were $6,828,529,375, thus exceeding a TABOR limit by more than $68 million.

4 The economic loss estimates in this study are derived from the significant positive correlation between per-household personal income with the private-sector share of personal income for 2010 as shown in Chart 2. Put simply, the bigger the private sector, the greater is per-household personal income. States with larger private sectors will grow faster over time than states with smaller private sectors. For example, let’s compare two states that are virtually identical in every way except for the size of the private sector—New Hampshire and Maine. In 2010, New Hampshire had the largest private sector (75.4 percent) and the 12th highest per household personal income ($110,877), whereas Maine had only the 39th largest private sector (64.2 percent) and the 41st highest per household personal income ($87,575). As such, New Hampshire’s per household personal income is 27 percent higher, or $23,302, thanks to a more vigorous private sector. The personal income data are from the Bureau of Economic Analysis, which is adjusted into “per household” using data from the Census Bureau.