According to
Gov. Arnold Schwarzaenegger, California’s new $146
billion state budget will have no operating deficit. But there are serious
questions about the reliability of the numbers because California, unlike other
states, does not require dynamic revenue analysis, contrary to the wishes of
many state Democrats.
Dynamic
revenue analysis, as opposed to static analysis used in California, looks at
the effects of taxes on people’s incentives and the long-term fiscal impact.
For example, a static analysis always concludes that a 10 percent cut in the
tax rate will decrease state tax revenues by 10 percent. It assumes, despite
the rate reduction, that the level of economic activity will remain unchanged.
Dynamic
analysis, in contrast, recognizes that the lower tax rate will spur economic
growth through more capital investment, entrepreneurship, and productivity. So,
long term, a lower tax rate might actually increase tax revenue. Dynamic
analysis presents a truer picture of the effects of government policy,
something the state once required.
In 1994, the
legislature passed, and Gov. Pete Wilson signed, a bill requiring the
Department of Finance and the Legislative Analyst’s Office to analyze the
dynamic effects of major tax bills and budget proposals. U.C. Berkeley
economists created a dynamic model that the state used until 2000, when the
mandate was allowed to lapse.
In 2003 and
2005, State Senator Mark Ridley-Thomas, a Los Angeles Democrat, authored bills
that would have reinstated dynamic analysis, which then State Treasurer Phil Angelides supported. Although approved by the legislature,
Gov. Schwarzenegger vetoed both bills. That is unfortunate because dynamic
analysis would improve California’s poor budgeting process.
For example,
in recent months, state tax revenues were $800 million less than projected by
state officials. The LAO’s revenue projections from fiscal year 2004 through
2006 were off by more than $5 billion each year. More precise estimates would
enable state lawmakers to plan and budget more effectively and would inform the
public of the full economic impact of proposed tax and spending legislation.
Many current state officers see the value in dynamic analysis.
A dynamic
analysis was recently performed by Ernst & Young on a tax-rate reduction
bill authored by San Francisco Democratic Assemblywoman Fiona Ma.
In contrast
to the static analysis performed by the Franchise Tax Board, the dynamic analysis
concluded the bill would produce 56,800 new California jobs, a $3.7-billion
increase in personal income, a $5.5-billion increase in gross state product,
and $1.1 billion in new business investment through 2016.
Using an
updated version of the state’s old model, the California Environmental
Protection Agency voluntarily performs dynamic analysis on proposed regulations
intended to reduce greenhouse gas emissions. Other state governments use
dynamic analysis too.
A 2003 survey
found that 10 states performed dynamic analysis and most used models produced
by private companies. Using its own model, the federal government routinely
conducts dynamic analyses of budget, tax, and spending proposals to inform
legislators, regulators, and the public about the macroeconomic effects of
policy.
Though not
perfect, dynamic analysis provides a truer picture of the long-term
consequences of government policies. And with competition and fine-tuning, the
accuracy of dynamic analysis will improve over time. In November, CalEPA took the right approach when it held a conference to
assess four different dynamic models. The State of California need not be in
the business of creating its own dynamic model when competition among private
companies that already produce these models will result in better models and
improved forecasts over time.
Gov.
Schwarzenegger should work to reinstate mandatory dynamic analysis that was
first implemented by fellow Republican Pete Wilson. And the California
legislature should learn from Democratic Assemblywoman Ma’s experience and pass
legislation requiring dynamic analysis using privately produced models.
California’s
taxpayers deserve a modern budgeting process that works.
Lawrence J. McQuillan, Ph.D., is Director of Business and Economic
Studies at the Pacific Research Institute in San Francisco, where Matthew C.
Piccolo is a summer policy analyst. They can be contacted at
LMcQuillan@pacificresearch.org.