By Jeremy Horpedahl, ACRE Director and UCA Associate Professor of Economics
Every session the Arkansas legislature considers many major and minor changes to both tax and budget policy. But it’s much rarer to see proposals to dramatically reform the entire fiscal process in Arkansas. As state legislators have begun to debate potential constitutional amendments to refer to the voters, one potential amendment would make fundamental changes to the way Arkansas tax and spending policy works in the future. The legislature can refer three constitutional amendments to the people each year, and 33 amendments have been proposed so far this session, though they will be narrowing down this list to just three amendments this week.
The proposed HJR1005 would establish for the first time in Arkansas a “tax and expenditure limit” (TEL), which the author of the proposed amendment (Rep. Wayne Long) refer to as the “Arkansas Taxpayer Bill of Rights.” While the title of the amendment is a reference to Colorado’s similar Taxpayer Bill of Rights, Colorado is not the only state with such a rule. About half of U.S. states have a rule that limits how much state tax revenue or spending can grow in a given year, usually based on a formula that takes into account some economic factors (such as growth in state income, or population and inflation). Arkansas has no such rule.
In this post I will briefly explain how a tax and expenditure limit works, what the research says about TELs, and highlight the primary features of the proposed amendment. Even if this amendment is not chosen as one of the three referred by the legislature this year, it gives Arkansans an opportunity to start thinking about the possibility of a policy such as this in the future.
ACRE has long suggested that a TEL of some sort would be beneficial for Arkansas’s state budgeting process. In a 2017 paper on state spending that I co-authored with Jacob Bundrick, we suggested a TEL as a possible reform to address increasing state spending, as well as putting the state’s balanced budget rule into the state constitution. ACRE Policy Analyst Joseph Johns has discussed the potential benefits of a TEL for Arkansas’s budget in the context of large budget surpluses last year. Enacting a TEL was also one of ACRE’s top 10 priorities for the current legislative session. Joseph Johns has also written a short background paper (available upon request) explaining the history of Arkansas’s fiscal institutions, as well as showing some examples of how different TEL rules would have affected state spending levels over the past few decades.
What is a Tax and Expenditure Limit?
A tax and expenditure limit is a fiscal rule that states adopt, either through their constitution or by statute, to limit the growth of state tax revenue or state spending based on a set of rules. They remove some of the discretion that legislators have over tax rates and spending levels, ensuring that taxpayers have some certainty about the growth of government.
About half of U.S. states have a fiscal rule that can be classified as a TEL, but the rules vary widely across states. Some are in state constitutions, some are instituted by statute. Some limit spending, while others limit revenue collection. Some TELs can be overridden with legislative supermajorities or public votes. A few require immediate refunds of any surplus over the TEL rule.
The TEL rules also vary across states. Some use population growth plus the rate of inflation. Some use either the growth in state income, or limit government spending to a specific share of state income. Some use specific, simple numerical limits on government growth, others have complex formulas that take into consideration many factors. They can be found in both liberal and conservative states, higher and lower income states, and more urban as well as more rural states. But they all have a common goal, which is providing taxpayers with some assurance that government growth won’t exceed a certain limit by a simple majority vote of the legislature.
What does the Academic Research on TELs Teach Us?
While early research into TELs suggested they may not be effective at limiting state spending growth, subsequent research has looked more into the details of which sorts of TELs work and which do not. A 1992 paper by Harold Elder found that specific kinds of TEL rules can be effective. Research by Michael New suggests that TELs are more likely to be effective when they use an “inflation plus population growth” rule, and when they immediately refund surpluses to taxpayers. Knowing which TELs have been effective can help Arkansas craft a TEL rule that fits our own needs, and will work as intended, while avoiding the pitfalls of curtailing revenue growth or state spending mandated within the Arkansas constitution.
Some recent research, such as a 2008 paper by Thad Kousser and co-authors, once again finds that TELs do not necessarily constrain state spending, but likely because “state officials can circumvent them by raising money through fees.” Again, this is a case where Arkansas can learn from fiscal rules that have been implemented in other states to strengthen the laws that we pass and avoid oversights made by others. As an example, in Colorado the legislature established “enterprise funds” which are private businesses delivering state services, partially funded by fees, which avoid the cap of Colorado’s TEL.
In a 2010 Mercatus Center paper, Matthew Mitchell attempted to summarize the research and provide additional analysis of TEL rules based on the various strands of research already in the literature. He found the following key results from his survey of when TELs are effective:
- Constitutional (instead of statutory)
- Limit spending (rather than revenue)
- Automatically refund surpluses
- Requirement of supermajority or public vote to override
Furthermore, Mitchell found that TELs are more likely to work in states with lower-income levels (this is primarily driven by states using income growth as the TEL limit, since low-income states have tended to grow slower in recent decades).
What Would the Proposed “Arkansas Taxpayer Bill of Rights” Do?
HJR1005 makes the following changes to Arkansas’s budget process:
- Requires a state balanced budget
- Requires approval by three-fourths of each chamber (or a vote of the public) to increase any tax rate or establish a new tax
- Limits the annual increase in state general revenue to 3 percent per year
- Places excess revenue in the Catastrophic Reserve Fund and Budget Stabilization Trust Fund, until both reach 20 percent of previous fiscal year’s expenditures
- Refund any excess revenue to taxpayers by temporarily reducing income or sales tax rates
Arkansas does have several balanced budget requirements, including Amendment 20 to the constitution which requires popular approval for issuing state debt. But most of the other requirements are in statute, such as a requirement that the Governor propose a balanced budget and that the Department of Finance and Administration avoid deficits. Putting this requirement into the constitution will solidify the practice of passing balanced budgets in Arkansas, and strengthening the state’s Revenue Stabilization Act.
Amendment 19 to the Arkansas constitution required that any increase in existing tax rates at the time of the amendment (1934) be approved by voters or three-fourths of both chambers of the legislature. But it did not place any limits on new taxes. Thus, when Arkansas enacted its general sales tax a few years later (1937), it was not bound by Amendment 19, and has been continuously increased in recent decades (sometimes by voters, though often by the legislature). The proposed amendment this year would extend Amendment 19 to cover all current and future taxes.
Placing a hard limit of 3 percent growth in state spending will have a clear impact on state spending growth over time. In the past three decades, year-over-year state general revenue spending has grown by more than 3 percent in about half of the fiscal years (see the background paper by Joseph Johns for the data and calculations under other TEL rules). This cap is different from most state TELs, which typically use a limit based on some economic measure, such as income growth or inflation, but it is not completely unique. Ohio uses a limit of 3.5 percent per year (unless inflation plus population growth is greater). Before the adoption of the current TEL in Colorado, they used a 7 percent annual growth limit.
The final provisions of the proposed amendment which first ensure that the reserve funds are well funded, but then returns the excess to taxpayers, are some of the most important protections for taxpayers in the amendment. States as widely varied as California, Michigan, Missouri, and Oregon have provisions in their TELs that taxpayers will immediately be refunded the excess revenue if certain conditions are met. As Arkansas taxpayers saw record state surpluses of over $1 billion in the past two fiscal years, no doubt they would have preferred that some of that surplus be refunded to them. This amendment would make those refunds a reality in future Arkansas budgets.