Fiscal Fissure

Governor Jane Hull is closing her eyes to what could be the only answer to a state budget crisis -- raising taxes.
Todd H. Lillard

State lawmakers are completely ignoring a powerful tool that can be used to deal with a massive $675 million state budget shortfall in fiscal 2002 and a projected $850 million deficit in fiscal 2003.

Tax increases.

Raising revenue to help cover the shortfall in the state's budget is an option that no political leader has been willing to broach. It will take powerful political leadership to achieve, because any tax increase requires a supermajority (two-thirds) vote of the Legislature.

Such leadership is not on the horizon.

Instead, the governor and the Legislature are intent on slashing more than $1 billion in spending from the state budget over the next two years.

But raising taxes and increasing government spending is precisely what lawmakers must do if Arizona intends to be anything more than an embarrassingly backward member of the union, says Arizona State University economist Tom Rex.

"If you want to compete in the modern world with other states in economic development, government plays a role," he says. "Unless you want to relegate Arizona to the distant past and leave it in the dust of the rest of the country, you are going to have to spend more money."

Rex's dire warning is lost on lawmakers who continue to repeat the budget mantra championed by former governor J. Fife Symington III: Cut taxes, restrain spending and let the private sector carry the day. A New Times analysis of the numbers ("Breach of Contract," December 28, 1995) during Symington's tenure showed the policy would cause a fiscal train wreck should the country sink into another recession, which is exactly what is happening now.

Symington-era tax cuts helped slash $812 million that would have been collected this year into state coffers. If that money had been collected, there would be no budget deficit.

"Is raising taxes an option?" Governor Jane Hull said in her speech to the Legislature to open the special session that began two weeks ago. "Absolutely not. We cannot tax our way out of this downturn. In fact, a tax increase would actually hurt our citizens and result in more lost jobs."

Asked if the Legislature would ignore Hull's position and raise taxes to help close the deficit, Senate President Randall Gnant said, "When you see bovines aeronautically inclined."

While such a strident posture against expanding the role of state government has worked well at the ballot box for the last decade, the policy is condemning Arizona to a future that is more closely aligned with Sonora, Mexico, than, say, California, or, for that matter, just about any other state in the union, says Rex.

Rex has been sifting through state economic data since the 1980s. He works at Arizona State University's Bank One Economic Outlook Center and considers himself to be fiscally conservative. Throughout the years, his economic projections and analysis have been accurate and free from political influence.

The evolution of the New Economy based on information, the Internet and services will require Arizona to spend far more on education, transportation, the environment and basic services that improve life if Arizona expects to attract elite companies offering high-paying jobs, Rex says.

But his prognosis for Arizona's economic future is becoming increasingly bleak.

Rex says the Legislature's anti-tax, anti-spending philosophy "is dooming the state to continue as a poor state forever."

Rex offers a few key economic indicators to support his thesis:

• Arizona government spending on current operations -- exempting highway and school construction -- ranks last in the United States on a per capita basis and is 25 percent below the national average.

Including highway and school construction outlays in Arizona -- which are above the national average because of the state's rapid growth -- slightly improves Arizona's overall per capita spending to 19 percent below the national average. Only Arkansas and Oklahoma were lower.

• Low expenditures coincide with very low tax and user fee collections. Total Arizona governmental revenue per capita in 1998-99 was 19 percent below the national average, ranking 49th.

• Personal income in Arizona ranks 43rd in the nation, and 12 percent below the national average.

• The average wage last year in Arizona was 7 percent below the national average -- lower than any year prior to 1989.

Arizona's low national rankings are a sharp departure from 20 years ago, Rex says. During the early to mid-1980s, Arizona "ranked in the middle of the states on per capita government revenues and expenditures."

But with the election of Evan Mecham in 1986, followed by Symington in 1991, Arizona fell further behind.

Between 1986 and 1999, Rex says Arizona ranked 48th in the nation for increases in government revenue and spending. Only Alaska and Wyoming -- both highly dependent on the slumping energy industry for government revenue -- had lesser increases.  

The statistics translate into a fast-growing economy that is creating large numbers of low-paying, entry-level jobs filled primarily by workers immigrating from Mexico.

"We had a huge increase in the Hispanic population in the 1990s," Rex says. "Most, with low education and low wages. They were just coming in response to the fact that the Arizona economy was creating those jobs."

Arizona's political leadership, Rex says, is locking the state into an outmoded economy based on a lean tax structure that will tend to attract more marginally profitable companies.

"Over the last decade, we made really large changes in the public sector spending, and those changes are in essence opposite to the way the New Economy is going," Rex says. "We simply are not going to be able to compete on these kinds of issues."

Indeed, while Governor Hull recognizes the importance of education in the economy, her rhetoric is focused on simply maintaining the current level of spending -- which is the lowest in the United States on a per-student basis.

"I will oppose cuts to K-12 funding," she told the Legislature. "Education is the engine that drives our economy. It is the heart and soul of our future."

The Legislature's mishandling of the state economy is rooted in a widespread, and wrong, belief that state tax reductions in the 1990s would spur economic growth, Rex says.

Rex says the state tax cuts actually did little to spur the economy -- the state economy simply grew along with the rest of a nation that experienced the longest economic upswing since World War II.

Many legislators, Rex says, have bastardized a concept developed in the 1980s during the Reagan administration known as "supply side economics" by claiming that any tax reduction will result in an automatic increase in economic output.

Overlooked in their zeal to slash taxes, Rex says, is a fundamental premise that supply side economics will only work in a situation where the tax rate is above the optimal level. In Arizona, state revenue collections are below the national average.

"They have generalized in this state that any and all tax cuts spark economic growth," Rex says. "That's completely crazy."

Supply side economics might work in a state with very high tax rates, high unemployment and underutilized industrial capacity. In that case, a reduction in taxes could spur businesses to increase production and hire more workers.

But Arizona's relatively cheap tax structure, combined with low unemployment and high utilization of industry, is not responsive to further tax cuts.

"How in the world can that create some sort of economic boost?" Rex asks.

Tax cuts do attract more businesses to Arizona. But these businesses tend to be low-paying industries that breed a host of social problems that government must then address, such as soaring high school dropout rates that currently lead the nation.

Arizona "just keeps going on this wild notion of cutting taxes and spending and believing that is not going to harm you, but it is going to benefit you," Rex says. "There is no basis for that."

Despite Rex's warnings, it is clear that the state Legislature and Governor Hull intend to balance the budgets primarily by imposing across-the-board spending cuts on state agencies.

The brunt of the budget slashing will be felt by the state's largest agencies: the Board of Regents, which operates the three state universities; the Department of Education; the School Facilities Board that funds new school construction; Arizona Health Care Cost Containment System; Department of Health Services; and the Department of Economic Security.

Lawmakers are considering cuts over the next two years of about $255 million from the state universities, $155 million from the school facilities board, $149 million from AHCCCS, which provides health care services to the poor, $147 million from the Department of Education that directs K-12 programs, $100 million from the Department of Health Services, with the bulk of the cuts coming from spending on the mentally ill, and $44.3 million from the Department of Economic Security.

House Appropriations Chairman Laura Knaperek, a Republican, along with Senate Appropriations Chairman Democrat Ruth Solomon, have been reviewing the state budget and have crafted a plan that so far calls for the permanent elimination of about $250 million in state programs.

Knaperek says her goal is to find another $200 million in permanent reductions in spending and then tap the state's budget stabilization fund, also known as the rainy day fund, for another $200 million or so to cover most of the budget deficit of $675 million for next year.  

Knaperek says the reductions can be made without reducing promised pay raises to state employees, who are slated to receive a 10 percent increase spread over fiscal 2002 and 2003.

While state employees may be spared by the budget cutters, at least for a while, there is no doubt that lower spending levels will have a profound impact on state services for lower-income families already struggling to cover basic bills.

The state's tight rein on spending and taxes has done little to change the poverty rate. Census data show the poverty rate in Arizona for children under 18 increased slightly over the last decade, rising to 22 percent from 21.7 percent in 1990. Arizona is eighth-highest in the nation for the percentage of residents living in poverty.

"Legislators need to understand the precarious position of Arizona's families," says Carol Kamin, executive director of the Children's Action Alliance. "Hard choices must be made, but they don't need to be made at the expense of those who can least afford them."

The hardest choice for the Legislature would be to raise taxes to cover the anticipated increase in spending for social services that always accompanies an economic slowdown. The Legislature did that the last time the state faced a recession in the late 1980s. The tax hikes were rolled back when the economy rebounded a few years later.

"The precedent is there. It's been done before," Rex says.

"If you are not going to do that, then you are faced with nothing but spending cuts. But you are talking about a state that already is ranked 50th in funding current operations and burying us even deeper."

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