University of Denver

July 12, 2005Are TABOR limits a match for Colorado's needs?

By Jon Zeschin

The Taxpayers’ Bill of Rights (TABOR) that was passed by Colorado voters in 1992 contains a complex series of limits on government’s ability to expand revenues and expenditures. One key feature of the growth limits is their peg to a combination of inflation (as measured by the Consumer Price Index “CPI”) and in the case of state government, the growth rate of the state’s population. For example, if inflation is 2% and the state’s population grows 1%, state revenue and expenditures may not grow more than 3% in the subsequent year. Another pre-existing legislative limit that was cemented in by TABOR limits state general fund growth to 6%, regardless of the actual sum of inflation and population growth.

When revenues decline year after year, as they did in 2002 and 2003, expenditures must fall to match. This resulting level of expenditures becomes the new “base” for setting the budget the subsequent year. When such a decline occurs, the TABOR inflation/population growth limits are then applied to that lower base. This so-called “ratchet effect” is addressed by the ballot measure that has been referred to voters in the November 2005 election.

The Colorado Economic Futures Panel has taken a neutral position on the ballot measure.

Our focus is on more fundamental, long-term questions. One question that begs to be asked is whether TABOR’s inflation + population growth formula is the right way to limit the growth of state government.

During the 1990s, with the state’s population growth averaging just less than 3% per year (a cumulative 31% growth over the decade) and inflation averaging just over 3% per year, the limit on state government revenues and expenses expanded by about a comfortable 6% per year. Bolstered by a booming economy, revenues grew even faster so that by the late 1990s, very large TABOR refunds were enjoyed by state residents. In that environment, the question of whether the TABOR limits were appropriate seldom came up as the state was able to fund its basic obligations.

Since the recession of 2001-02, the state has been faced with massive general fund budget and service cuts to make revenues and expenses match. Now that state revenues have begun to grow again, it seems like a good time to sit back and think about what we have learned about the TABOR limit process.

Intuitively, the inflation + population growth formula seems attractive. And, it may make sense for a few functions of state government. One example is a state function we are all familiar with — driver licenses. This is an area of government service that probably grows reasonably consistently with the rate of population growth — especially of those of a driving age. However, other major functions of state government are far more complex.

We’ll briefly examine four of the major functions of state government — K-12 education, Medicaid, higher education (state college system) and corrections. These functions accounted for almost 85% of state general fund expenditures in the most recent budget year. Let’s take a look to see whether the costs of each of these are fairly limited by inflation + population growth.

The single largest component of the costs of delivering K-12 education is personnel costs. While large increases in enrollment (population) will cause costs to rise, small increases in enrollment have very little effect on the largely fixed costs of running schools. And static or declining enrollment, as is the case for many school districts in Colorado, leave local school boards struggling to balance their budgets with increasing fixed costs for heating, school bus fuel and maintenance, and personnel salaries. Looking closer, teacher salaries can certainly be limited to inflation over the short run; however, this leaves no room for merit increases for those who are the best in this important career.

But a deeper look at just one factor in personnel costs makes the issue more complex. An important component of teacher compensation is health benefits. We all know that health care costs have risen at rates far higher than CPI increases. For example, a recent survey by the non-partisan Center for Studying Health System Change showed that health care costs rose over 8.2 % in both 2004 and 2003, down from a peak increase of 11.3% in 2001. These increases came at a time when CPI increases averaged just 2%!/p>

The costs of higher education — the state college system — track K-12 costs, so it is easy to see a similar mismatch there. Before you take off on the whole CU controversy though, it’s important to note that state funding for CU fell 40% per resident student between 2002 and 2005. With less than 10% of its total budget now coming from state funds, the legislature granted the University of Colorado “enterprise status,” effectively exempting itself from the TABOR limits.

The second biggest component of the state budget at about 22% is Medicaid and related health care programs. Medicaid is a “partnership” with the federal government under which the state is required to pay 50% of the costs of the program and must follow the eligibility and coverage set by the federal government.

Of course, the biggest component of Medicaid costs is the cost of health care payments to doctors, hospitals, nursing homes and other health care providers. We have just seen how far increases in the costs of health care have outstripped CPI increases. To make matters worse, the aging of our state population, combined with a growing uninsured population, are driving the number of Medicaid cases up significantly. Currently, Medicaid covers one in six children in Colorado, six out of 10 people in nursing homes and labor and delivery costs for 1 out of 3 births!

Finally, let’s take a quick look at the fourth largest component of the state budget — corrections. This seems like an area where cost increases should track the TABOR inflation + population growth limit, right? Wrong. Tougher law enforcement and sentencing laws drove the inmate population up 123% over the 1990s — a rate of increase nearly four times that of the population increase! There is little reason for this trend to change — typically, crime increases during more difficult economic times.

So where is the match for TABOR’s limits with Colorado’s needs? It seems pretty hard to find. Maybe while you’re waiting in line at the driver license office you can think of one! Better yet, with all that time on your hands, maybe you can think of a better measure than population + inflation to limit the growth of state government so that the limits match the real costs of the functions we require of state government. The Colorado Economic Futures Panel is very interested in your ideas.

Jon Zeschin is the president and founder of ESSENTIAL Advisers, Inc., a wealth management and investment advisory firm.