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Out of Control Policy Blog Archives: 6.30.13–7.6.13

California Should Follow Connecticut's Lead on Film Tax Credits

After of wave of new and expanded state film tax credits in recent years, Connecticut has become one of the few to buck the film credit arms race and scale back its program. It is a moderate step, as the film credit was not permanently killed but rather merely suspended for two years, and TV productions will still be eligible for tax credits, but it is a start nonetheless. California and other states would be wise to follow—and improve upon—Connecticut's example.

According to a recent Wall Street Journal article, more than 80 movies have benefited to the tune of $137.4 million in tax credits since Connecticut's film and TV credit program was launched in 2006. In fiscal year 2012, the state provided $95.8 million in such tax credits, with $21.9 million going to films and the remaining $73.9 million going to television productions, which have comprised the bulk of the credits over the past few years. A $1.5 billion budget deficit prompted state legislators to reevaluate their priorities, however, and the film credit was one of the casualties.

California, like many other states, has gone in the other direction. Last year the state passed a 2-year, $200 million extension to its film tax credit, which was first implemented in 2009. In a study released earlier this year, I argued that the state's film credit, and a number of other state tax credits, unfairly tilt the playing field in favor of certain politically-connected businesses and industries. When the nationwide impact is considered, such state tax credits are, at best, a zero-sum game: resources are shifted from one state to another, but the credits themselves do not create any net economic growth. At the state level, tax credits can help to "steal" business away from other states, but there is also a corresponding opportunity cost. More capital and other resources are poured into the industries receiving favorable tax treatment, meaning that less resources are available to invest in all the other industries in the state. Moreover, this is, by definition, inefficient, since these resources would have been allocated differently in a truly free market without government intrusion.

It would be better to improve the overall business climate by treating all industries the same, reducing the overall corporate tax rate as much as possible, and letting the forces of supply and demand determine the winners and the losers. Not only would this allow for the greatest amount of prosperity, it would ensure that businesses had the greatest incentives to satisfy the needs of consumers, rather than the desires of politicians.

Using data from the California Franchise Tax Board and the Department of Finance, I estimated that the state could reduce its overall corporate tax rate by at least 20 percent by eliminating tax credits such as the Research and Development Credit, Accelerated Depreciation of Research and Experimental Costs, Double-Weighted Sales Factor (repealed by voters in November 2012), Film Credit, Low-Income Housing Credit, Hiring Credit, Percentage Depletion of Mineral and Other Natural Resources, and Expensing of Timber Growing Costs tax breaks—all without resulting in any net loss in revenue to the state. (Of course, reducing both state spending and taxes would be even better.)

Yet, the siren song of tax credits is tantalizing to politicians from both sides of the political spectrum who think they can "create jobs" (especially within their own districts) or want to reward certain industries for pragmatic or ideological reasons. As I wrote in the California tax credits study,

While targeted tax breaks might seem compelling as a means to attract and retain business in an increasingly competitive global economy, they clearly come with risks. Notwithstanding the fact that even fiscal conservatives may be seduced into supporting them—even based on legitimate desires for economic growth—they should be avoided because their distortionary effects on the state’s economy are harmful. Crony capitalism that benefits a few undermines the free-market capitalism that benefits the many.

Policymakers must be aware that when they implement policies that favor certain businesses or industries—through the tax code, state spending programs, or regulation—they are necessarily harming other industries. Moreover, in doing so, they diminish economic activity by redirecting capital away from the purposes taxpayers and investors prefer toward less efficient ends based on their own preferences. Besides, the “important” industries of today may not be the important industries of tomorrow.

Of course, special-interest politics tends to play a huge role in tax policy. Government is a poor venture capitalist precisely because the incentives and decision-making involved in spending someone else’s money are very different from those involved in spending one’s own money. Failures such as Solyndra are testament to this hubris.

To be clear: tax cuts are much needed in California’s high-tax, high-regulatory business climate and tax rates should be lowered as much as possible, but the rules should be applied evenly, rather than carving out special benefits for some.

Thus, I offered some recommendations to help reduce the tax burden on California taxpayers and increase the fairness of the state's tax code:

  1. Eliminate special tax treatment wherever possible, particularly in cases where:

    a. The tax break’s purpose is not clearly defined;
    b. The tax break is not serving its intended purpose or has outlived its intended purpose;
    c. The tax break is narrowly tailored to benefit a specific industry or type of business; or
    d. The tax break is clearly an example of the government picking winners or losers for ideological or special-interest reasons.

  2. Wherever possible, lower broad tax rates down to tax break levels, rather than raise tax break levels up to broad tax rates.
  3. Require a clear statement of purpose and performance measures for each tax break—including existing tax breaks without a clear statement of purpose or relevant performance measures—in order to facilitate evaluations of the impact of tax breaks on taxpayers and the state budget.
  4. Establish a sunset commission to periodically evaluate tax breaks and other state regulations.
  5. Adopt a Base Realignment and Closure (BRAC)-style commission to evaluate existing tax breaks and regulations. Under this system, a commission would evaluate tax credits based on criteria like those in #1 above and recommend eliminating tax breaks that fail to meet those criteria. The recommendations would have to be considered as a whole and voted up or down by the legislature.

See the full California tax credit study here.

Related Research and Commentary:

» Tax Credits in California: Economic Growth Engine or Wasteful Corporate Welfare?

» "California Must Reform Tax Code to Spur Economic Growth" (with Jon Coupal) – Orange County Register

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Nation’s Road Conditions Show Slight Improvement; North Dakota, Kansas and Wyoming Have the Best, Most Cost-Effective Highway Systems

As Americans hit the road for the Fourth of July holiday, they’ll be driving on slightly smoother roads, crossing fewer deficient bridges and spending less time stuck in traffic jams according to Reason Foundation’s Annual Highway Report

Reason Foundation’s Annual Highway Report measures the condition and cost-effectiveness of state-owned roads in 11 categories, including pavement condition on urban and rural Interstates, urban traffic congestion, deficient bridges, unsafe narrow lanes, traffic fatalities, total spending per mile of state roads and administrative costs per mile. The study’s rankings are based on data that states reported to the federal government for 2009, the most recent year with full spending statistics available.

Nationwide there was small progress in every category except for pavement condition on rural arterial roads. These improvements were achieved at a time when per-mile expenditures dropped slightly. Despite receiving stimulus funding from the federal government in 2009, spending on state roads decreased slightly, by 0.6%, in 2009 compared to 2008.

“It’s hard to believe it when you hit a pothole or see a bridge in Washington collapse, but the nation’s roads have been getting better,” said David Hartgen, author of the study and emeritus transportation professor at the University of North Carolina at Charlotte. “There are still several states struggling and plenty of problem areas but progress continues to be made.”

Among the states plagued with problems are New Jersey and California. New Jersey spends $1.2 million per mile on its state-controlled roads. That’s nearly twice as much as the $679,000 per mile that the next biggest spending state—California—spends. North Carolina, home to the nation’s largest state highway system, spends $44,000 per mile on its roads. South Carolina spends just $31,000, the lowest per mile rate in the nation, according to a Reason Foundation study of all 50 state-controlled road systems.

Drivers in California and New Jersey may be wondering what they are getting in return for that money. More than 16 percent of urban Interstate pavement in each of those states is in poor condition. Only Hawaii ranks worse, with 27 percent of its urban Interstate pavement rated as poor.

Not only are California’s Interstates full of potholes, they are also jammed—80 percent of the state’s urban Interstates are congested. Minnesota has the next highest percentage of gridlocked Interstates, with 78 percent of urban Interstates deemed congested.

In terms of overall road conditions and cost-effectiveness, North Dakota has the country’s top ranked state-controlled road system, followed by Kansas (2nd), Wyoming (3rd), New Mexico (4th) and Montana (5th), according to Reason Foundation’s Annual Highway Report.

Alaska’s state-controlled road system is the lowest quality and least cost-effective in the nation. Rhode Island (49th), Hawaii (48th), California (47th), New Jersey (46th) and New York (45th) also perform poorly.

Vermont’s roads showed the most improvement in the nation, improving from 42nd in the previous report to 28th in the new overall rankings. New Hampshire (27th) and Washington (24th) both improved nine spots in the rankings.

Minnesota system plummeted 17 spots in the rankings, from 25th to 42nd and Delaware dropped nine spots to 20th.

Massachusetts had the lowest traffic fatality rate, while Montana had the highest.

Reason Foundation’s Annual Highway Report
Overall Performance and Cost Effective Rankings

1. North Dakota
2. Kansas
3. Wyoming
4. New Mexico
5. Montana
6. Nebraska
7. South Carolina
8. Missouri
9. South Dakota
10. Mississippi
11. Texas
12. Georgia
13. Oregon
14. Kentucky
15. Virginia
16. Nevada
17. Idaho
18. New Hampshire
19. North Carolina
20. Delaware
21. Tennessee
22. Indiana
23. Arizona
24. Washington
25. Ohio
26. Utah
27. Alabama
28. Vermont
29. Maine
30. Michigan
31. Wisconsin
32. West Virginia
33. Iowa
34. Illinois
35. Louisiana
36. Arkansas
37. Florida
38. Oklahoma
39. Pennsylvania
40. Maryland
41. Colorado
42. Minnesota
43. Massachusetts
44. Connecticut
45. New York
46. New Jersey
47. California
48. Hawaii
49. Rhode Island
50. Alaska

Reason Foundation’s Annual Highway Report is online here and here (.pdf). For data from previous years, please see Reason’s report examining 20 years of U.S. highway data and trends.

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Los Angeles Faces Billions in Unfunded Pension Liabilities

With swearing in of former Los Angeles city councilman Eric Garcetti as mayor of Los Angeles on Sunday, the city has a new opportunity to steer itself in the right direction. Maybe.

The $7.7 billion city budget for fiscal year 2013-14, which began on Monday, purports to set the stage for a budget surplus by fiscal year 2017-18, though it forecasts budget deficits in excess of $95 million annually through 2017. The deficit reduction achieved for fiscal year 2013-14 involved one-time actions, including depleting the Los Angeles Budget Stabilization Fund of $53 million of $69 million, as well as one-time revenue increases. Garcetti will not be able to rely on such actions to close deficits.

Further, the 2013-14 budget does not include money to cover a scheduled 5.5% pay increase for city workers, which the city estimates would add $108 million to the 2014-15 budget.  

More challenging is Los Angeles’ unfunded liabilities in pension obligations and retiree health care. For years, Los Angeles has accumulated unsustainable pension obligations to city workers. Former mayor Antonio Villaraigosa and retired City Councilman Richard Alarcon, both having left office on Monday, are eligible for more than $100,000 per year in pensions for their public service, joining at least 841 retired city employees who collect over $100,000 in pensions annually. As of this writing, only Alarcon has applied for his estimated $115,000 pension. Meanwhile, exiting Councilwoman Jan Perry, who has worked in city government for nearly 22 years, recently withdrew her pension request of $84,098, deciding she was “not ready to retire,” thereby potentially increasing her pension earnings down the line.

It isn’t just public servants who are bestowed with such lavish retirement subsidies. According to a February 2012 Stanford Institute for Economic Policy Research (SIEPR) review of 24 public pension systems in California, Los Angeles employees receive pensions averaging $46,211, higher than any other system.  There are three pension funds in Los Angeles: the City of Los Angeles Fire and Police Pension System (LAFPPS), the Los Angeles City Employees’ Retirement System (LACERS), and the City of Los Angeles Water and Power Employees’ Retirement Plan (LAWPERP). Combined, these pension funds provide benefits to approximately 30,000 beneficiaries. According to the SIEPR study, the three funds were underfunded by a combined total of $27 billion. Due to the variability in discount rate estimates, Los Angeles city officials provide a lower, though still substantial estimate. LACERS estimates a $6 billion unfunded liability by fiscal year 2016-17, billions less than the $11 billion that SIEPR calculated. In January 2013, the moderate Pew calculated unfunded pension liabilities in Los Angeles at $4 billion. 

Regardless of the ultimate unfunded pension liabilities, pensions have and will take up an increasing percentage of the city budget and thereby larger amounts of taxpayer money. From 2003 to 2012, unfunded pension liabilities have exploded from only $87 million to the current $4-27 billion range. As a percentage of the budget, in that same period, pension payments grew from 3% of the city budget to now over 15%.

Los Angeles did reform it’s LACERS system in 2012, raising the retirement age from 55 to 65, and reducing the maximum pension benefit from up to 100% of final salary to 75%. This plan only affects new hires beginning this month. Public safety and Department of Water and Power (DWP) workers are not affected.

Chief among Garcetti’s campaign promises was to take a look at the DWP.

While Los Angeles residents have seen rate hikes from the DWP, DWP workers have been living comfortably: the average salary for a DWP employee is over $100,000.  While the Los Angeles unemployment rate has stayed above 10% since 2008 until recently, DWP salaries have increased in that time period. Including, according to the Los Angeles Times, average pay for custodians, which grew from $56,060 to $69,995. For reference, the median household income in Los Angeles was $46,000 in 2011.

With Villaraigosa headed off to contemplate a gubernatorial candidacy, it remains to be seen how City Hall deals with this mess.

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San Francisco Transit Strike and the Union 1%

I appeared on FBN's Money with Melissa Francis today talking about the San Francisco Transit strike. Watch the segment here.   

The transit workers who earn on average over $70,000 in salary, and $50,000 in benefits per year (!) are demanding a 15% raise over 3 years. Meanwhile in the Bay Area unemployment remains around 6% and over 250,000 people are unemployed. And that does not count those who have given up looking or who had to take lower paying jobs.

And these are the people who the transit system union workers want to pay more so they can further inflate their already generous salaries. Wow.

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The Potential of Student-Based Budgeting for Florida

The school funding formula currently in place in Florida, called the Florida Education Finance Program, accomplishes student-based budgeting and uses the weighted student formula on the state-to-district level by allotting funds to schools based on enrollment and individual needs. In this way Florida demonstrates how funds at the state level can be distributed more equitably through a weighted student formula.  Florida's  greatest school-finance pitfall, however, is that it does not adhere to the same practices on the district level. Once state funds reach Florida's school districts, money is allotted to individual schools based on location, and oftentimes funds reach the schools in the form of staff positions rather than dollars. This design introduces a host of problems into the Florida school system that could be remedied if Florida adopted student-based budgeting in conjunction with the weighted student formula on the district level.

Since districts control how funds are allocated to individual schools in Florida, district officials rather than principals hold the vast majority of authority over budgeting, expenditures, curriculum, and hiring. If money were tied to individual students, however, principals would have a great deal more autonomy over the use of financial resources at their schools. When principals have this kind of control, money is allocated far more effectively because principals know firsthand exactly how funds should be distributed to best suit the needs of their unique student bodies. The increased autonomy of principals that accompanies student-based budgeting also alleviates inter-school inequities by allowing principals to tailor their hiring practices and other budgetary matters to their specific school, rather than adhering to the clunky one-size-fits-all models dictated by districts. For example, district regulations state that there shall be one allotted administrator per 300 students. In this case, a school with 300 students and a school with 599 students would both be allowed only one administrator, predisposing the former school to flourish and the latter to flounder. Such gross oversights could be entirely avoided by instituting a system in which funds are allotted on a per-pupil basis because principals would be able to make hiring designations based on their school's needs rather than district rules.

Additionally, attributing funds to schools on a per-pupil basis would ensure better overall school quality and promote transparency. Financially decentralizing Florida's schools districts by adopting per-pupil funding would allow parents to send their children to any school within a district, meaning that schools would have to compete to garner students and their accompanying funds. This element of competition makes certain that the quality of Florida's schools would universally rise in an attempt to attract students armed with expanded autonomy over where they choose to seek their educations. Finally, student based budgeting is a clear, simple, straightforward method of distributing funds, which promotes transparency and consequently stymies corruption and financial mismanagement. Under SBB, stakeholders can easily discern why each school receives the amount of resources it does, and they can track whether or not the funds are being properly applied based on the characteristics of the student body and their corresponding weighted monetary values.

Student-based budgeting and the weighted student formula would help to make Florida's public schools more efficient, transparent, and equitable.

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Governor Brown’s New School Funding Program Shows Promise, but Lacks Mechanisms to Ensure Transparency and Equity

Governor Brown's proposed 8-year initiative to increase educational funding in California for individual students recently passed, marking the advent of a total overhaul of the California public education system. The formula includes three key elements: base level funding for California's 6.2 million k-12 students, a supplement for every child classified as high needs (English-learner, low income, foster child), and bonus funds separate from the supplement for districts with the highest concentrations of high-needs students.

Additionally, a compromise to amend the plan includes an extra $3 billion in base level funding to ensure that almost every district (particularly those lacking in significant numbers of disadvantaged students) will receive state funds to compensate for budget cuts in the 2007-2008 budget crisis. For the 40 districts that otherwise would not have gotten their cut funds restored under the new program, an "economic recovery payment" will be issued to them to ensure that they do not lose funds under the new program. In order to increase funds in these areas, supplemental funding for high-needs children will be reduced. In districts with large percentages of high-needs students, however, supplemental funding will increase.

While this plan offers promising steps towards improving the quality of education for individual students, legislators have no plans to implement a tracking system for how much money students generate for each school and how much money each school receives from its respective district.

Without a mechanism in place to ensure transparency, there is no way to know if the increased funds will actually serve their intended purposes. As Lisa Snell writes, "While Governor Brown's plan distributes money to school districts with larger numbers of disadvantaged students, it does not do enough to ensure that the money gets to these students' schools or to the students themselves-aside from threatening audits or sanctions if disadvantaged students fail to meet performance targets." Because only district and not school-level reporting is mandatory, individual schools can't be held accountable for the way they spend the increased funds.

If mandatory school-level reporting is not instituted, the status quo within the California public system will be sustained, with the increased funds being used to fortify already over-funded programs and demographics. For example, as the Editorial Board of the Sacramento Bee states, "Upper-middle-class parents will demand resources and get them. Teachers, in the collective bargaining process, will put pressure on for higher salaries and hiring of more teachers."

In order to prevent the maintenance of these inequities, school-level reporting must be instituted. Senator Alex Padilla, D-Los Angeles, is one of the chief proponents of instituting mandatory school-level reporting.

If school level reporting were made mandatory, individual rather than average teacher salaries would be reported, exposing inequities among schools, and schools would be held accountable for the way they spend their money due to the increased financial transparency facilitated by school-level reporting.

However, to ensure the utmost success of Brown's program, legislators should look beyond just school-level reporting. They should institute a system of student-based budgeting in which funds follow the students to their individual schools and are weighted based on the unique needs of each student. This system ensures the increased funds will be spent as they are intended to be because individual principals control the way funds are allotted and can therefore adjust the use of funds to best suit the needs of each individual student. Also, student-based budgeting ensures total financial transparency because students are assigned specific financial allotments based on their individual needs that follow them to their schools of choice within their districts, so the amount of money and its intended uses are readily apparent based on student demographics at each school.

Brown's measures are a step in the right direction, but without school-level reporting and student-based budgeting, their successful implementation remains questionable.

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LAUSD to Use Construction Funds for $500 Million to Distribute iPads to All Students

LAUSD recently approved a contract with Apple to buy iPads for 30,000 students, for a total cost of $30 million. They will also be hiring about 15 "facilitators" and providing training and support for the first 47 schools to adopt the program. This purchase is just the first step in a plan to purchase iPads for all 650,000 LAUSD students, with a price tag of about half a billion dollars.

District officials claim that the introduction of iPads into the classroom marks an important educational advance for LAUSD. Frequently cited benefits of the program include the iPad's integral role in the new Common Core curriculum, to be instituted beginning in the 2014-15 school year, in which children will be required to take tests electronically, and the device's ability to serve as an equalizer for students who otherwise would not have access to computers outside the classroom.

Proponents of the program also argue that iPads will increase technological literacy for students, a vital skill for entering the workplace.

While these are not illegitimate educational benefits, the financial burden of the program far outweighs anything less than dramatic, revolutionary changes to the quality of LAUSD education-something this program surely will not, and does not even purport to, achieve.

The devices will be paid for with voter-approved 30-year construction bonds. This seems irresponsible in a school district which the Los Angeles Times' Steve Lopez reported as having "billions of dollars in deferred maintenance, with no fewer than 35,000 unresolved calls for basic repairs and service, with broken air conditioners, leaky roofs and crumbling bleachers, among other problems."

Additionally, the district will be paying off the debts incurred by the program until 2043, long after the devices have faded into obsolescence. This continues an unfortunate trend of using long-term debt to pay for instructional expenses that should be managed out of general revenue rather than construction bonds.

The students will even be permitted to take the devices home, raising concerns of damage and theft that will impose even greater expenses on the school district.

While iPads may marginally aid in education, such a gargantuan purchase seems more frivolous than forward thinking.

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Sasha Volokh on Privatized Regulation and Antitrust

Sasha Volokh has a new article on Reason.org discussing the implications of a recent Fourth Circuit Court ruling related to privatized regulation and antitrust issues. Here's the intro:

Federal antitrust law enshrines a public-private dichotomy: unlike the private sector, state governments are completely immune from antitrust suits under the doctrine of Parker v. Brown (1943). Thus, a state legislature could restrict entry into an industry and fix product prices at monopoly levels with impunity; for the sake of federalism, courts would defer to its choice, at least for purposes of federal antitrust law. Municipalities, on the other hand—unlike states themselves—aren’t sovereign. They aren’t immune from antitrust law unless they can show that they’re following the state’s clearly articulated policy (see this previous post for a discussion of the clear articulation requirement). Private parties, understandably enough, get even less deference: they need to additionally show that they’re actively supervised by the state. If a municipality can’t show a clearly articulated state policy, or if a private party can’t show that plus active state supervision, it can be sued for antitrust violations and held liable for triple damages.

Even though municipalities can be thought of as an unusual type of state agency, the Supreme Court has never authoritatively decided how to treat state agencies generally under antitrust law. Are they more public, like municipalities, or more like private bodies? At first glance, it seems obvious that they should be considered governmental and thus more like municipalities, but in reality there’s a large gray area, depending on how the state agencies are constituted. A previous post has discussed the fuzziness of the public-private distinction—how private contractors can come to be treated like government agencies for some purposes, or how apparently public bodies can be treated like private corporations.

A recent Federal Trade Commission (FTC) ruling shows how that fuzziness plays out in the antitrust context. A state board of dental examiners, charged with regulating the practice of dentistry in North Carolina, was labeled as public under state law, but it was composed predominantly of practicing dentists, elected by no one but other practicing dentists. The FTC held that such a board, while nominally governmental, was in fact substantially private, making its oversight of the dentistry business an exercise in privatized regulation; and thus the board was fully subject to federal antitrust law unless it could show active state supervision. On May 31, the Fourth Circuit upheld the FTC’s ruling, in North Carolina State Board of Dental Examiners v. FTC. This case could potentially have interesting implications for the legality of privatized regulation in other areas, though it turns out that the result may be different in different federal circuits.

The full article is available here, and all of Volokh's recent legal analyses written for Reason Foundation on an array of privatization-related topics are archived here.

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