Tuesday, October 30, 2007

Adam Pagnucco on the Budget: Part I

Adam Pagnucco of Crossing Georgia has been kind enough to share this detailed analysis of the budget. It's well worth reading to the end.


I produced this series in response to Senator Richard Madaleno’s budget briefing for a group of bloggers, including myself, on 10/29/07. While the mainstream media has churned out many articles on the drama of the state budget battle, speculating about Governor Martin O’Malley’s political fate and the relationship between the Senate President and the Speaker of the House, they have often overlooked more substantive issues. Senator Madaleno deserves high praise for his efforts to educate the blogosphere about the largest budget crisis to face the state in more than a decade.

Time now for a bit of disclosure. I have been a researcher in the labor movement for my entire adult career and write from that perspective. I am also a resident of Madaleno’s district and have contributed to his campaign fund in the past. That said, my conclusions are my own and do not reflect the views of Senator Madaleno, my union or the rest of the labor movement.

Part One of this series begins to outline the Governor’s proposal for eliminating the state’s budget deficit. Part Two finishes detailing the Governor’s proposal and examines its reliance on progressive and regressive measures. Part Three proposes an alternative for relieving some of the plan’s more regressive elements.

Part One: The Governor’s Plan to Eliminate Maryland’s Deficit

Upon taking office, Governor O’Malley inherited a structural state budget deficit. Simply put, the state was on track to spend $1.10 for every $1 in tax revenue for two principal reasons: a 10% income tax cut in 1997 and billions of additional spending on education (commonly called the Thornton Plan) started in 2002. The Governor balanced his fiscal year (FY) 2008 budget primarily by relying on reserves, but now faces a $1.7 billion general fund deficit in 2009. Unlike the free-spending federal government, the state is required to balance its budget.

Over the last couple months, the Governor proposed a budget reduction and revenue package totaling $1.679 billion to fix the deficit in FY 2009. He would also increase spending on education, transportation and health insurance by $328 million while drawing on left-over money from FY 2008 of $316 million. The Governor has now called a Special Session of the General Assembly to fix the deficit and his plan will be used as a starting point by the legislators.

Mainstream media coverage has reported on the items in the Governor’s proposal and the accompanying political tumult, but has largely omitted a very important question: is the proposal fair? For those of us on the left, fairness in tax policy is often defined in terms of whether taxes are “progressive” or “regressive.” Progressive taxes fall disproportionately on the wealthy. Examples include rising income tax rates at higher income brackets and taxes on capital gains, dividends and inheritances. Regressive taxes fall disproportionately on the poor. Examples include sales taxes and lotteries.

Progressivity is a paramount question for many people who voted for the Governor. Most left-wing activists worked very hard to elect him because they viewed him as caring much more about working-class economic interests than his predecessor. How does his deficit reduction package deliver for the Left’s priorities?

I investigate this question by examining each item in the Governor’s proposal and characterizing it as progressive, regressive or neutral. At the end, I add up the revenue in each of the three categories to determine their relative composition. Let’s look at what the Governor is proposing.

Sales Tax

The Governor proposes to raise Maryland’s sales tax from 5% to 6%. The new rate would equal that of Pennsylvania and West Virginia and exceed that of the District (5.75%) and Virginia (5%). The sales tax increase is by far the largest single element in the Governor’s plan, accounting for 43% of his package in FY 2009.

Sales taxes tend to be regressive since wealthier people generally devote less of their income to consumption than do poorer people. Maryland residents overwhelmingly disapprove of any increase – it drew only 29% support in a Washington Post poll released on 10/24/07. But the sales tax has three big virtues: it is simple to change, raises revenues immediately, and generates huge amounts of money. Those factors make the sales tax a budget component that may be impossible for legislators to resist.

Sales Tax: Regressive, 43% of Package

Budget Cuts

The Governor has proposed $437 million of budget reductions in FY 2009 but has supplied few details. The Washington Post reported on 9/28/07 that the Governor intended to realize $169 million in savings in FY 2009 by lowering increases in the state’s education spending formula. (He would still increase education spending by $119 million.) Because the education spending formula would provide for smaller increases, the state’s savings would grow larger each year. The remaining cuts, comprising $268 million, are unspecified.

Since poor people depend more heavily on public schools than the rich, reduced increases in education spending would be regressive. Without more detail, it is impossible to determine the impact of the remaining reductions. For now, I classify them as neutral.

Education: Regressive, 10% of Package

Remaining Cuts: Neutral, 16% of Package

Tobacco Taxes

The Governor would hike tobacco taxes by one dollar a pack, raising $170 million in FY 2009. At least part of the money would be dedicated to expanded health insurance. While there is ample justification for raising the tobacco tax – especially if the money is used for health care – it is a regressive tax. Interestingly, the additional revenues are projected to fall over time, leaving future revenue for health care an open question. Wide public approval (69% in the Post’s poll) guarantees passage.

Tobacco Tax: Regressive, 10% of Package

Income Tax

The Governor would add two higher-rate income brackets at $150,000 in income ($200,000 for couples) and $500,000 in income. At the same time, he would decrease the rates on the first $15,000 in income ($22,500 for couples), expand the earned income credit and increase the personal exemption for seniors. The net revenue increase would be $162 million in FY 2009.

A few Montgomery County politicians have questioned this restructuring, fearful that rich people would have an incentive to live in Virginia. But this measure is one of the most progressive features of the Governor’s plan and is favored by 62% of respondents to the Post’s poll.

Income Tax: Progressive, 10% of Package

In Part Two, I finish examining the Governor’s proposal and calculate its reliance on progressive and regressive measures.

Adam Pagnucco is the Assistant to the General President of the United Brotherhood of Carpenters and has been employed in the labor movement since 1994. The views in this column are his alone and do not represent official statements from the union.