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Reason's Len Gilroy Talks TVA Privatization, Annual Privatization Report on Heartland Institute Podcast

Posted on May 23, 2013, 3:54pm | Leonard Gilroy

Earlier this week, I had the pleasure of sitting down with the Heartland Institute's Steve Stanek for an episode of their Heartland Daily Podcast, where we discussed President Obama's recent budget proposal to study a potential privatization of the Tennessee Valley Authority (TVA). From Heartland's Somewhat Reasonable blog:

President Barack Obama has proposed studying the possibility of privatizing the Tennessee Valley Authority, the nation’s largest government-owned utility. Privatization expert Leonard Gilroy of The Reason Foundation tells Heartland's Steve Stanek why the president has a good idea, and why area politicians in both major political parties oppose it.

An iTunes link for this podcast is available here. Beyond the proposed TVA privatization, we also discussed several highlights from Reason Foundation's Annual Privatization Report 2013.

Speaking of the TVA, I was also quoted in a Budget and Tax News article last week on the privatization proposal. Here's an excerpt:

The Chattanooga Times Free Press newspaper declared in an editorial that opposing TVA privatization is a mistake and noted the disconnect between some Tennessee politicians who declare they favor free enterprise and limited government yet oppose privatization.

“The only real argument for keeping the TVA's assets in government hands are weak arguments like, ‘people like the TVA how it is’ and ‘that's how we've always done it.’ Sadly, that stale mindset has overtaken area Republican lawmakers who claim to oppose government control and socialist programs,” the newspaper’s editors wrote. [...]

Privatization expert Leonard Gilroy of Reason Foundation said he sees lots of institutional opposition to privatization.

"Despite being an utterly nonessential federal asset, there appears to be no political will in Congress whatsoever to authorize a TVA privatization," he said. "Senator Alexander, Senator [Bob] Corker (R) and other Tennessee congressmen of both political parties have already condemned the proposal to merely study privatization, which is all the President has proposed. This just goes to show how difficult it is in real life to shut down government agencies and enterprises once they spring to life and build constituencies."

Nonetheless, he said privatization ought to be studied.

"There's nothing inherently governmental about running a power business, so privatization could provide an opportunity to bring in a businesslike approach and more efficient operations and management compared to what's seen today as a government-owned enterprise," he said. "However, there would be some very thorny implementation issues to work out, not the least of which being how to handle the divestiture of the TVA land and power assets that were originally seized from private hands to begin with."

For a more detailed analysis of the merits and challenges associated with privatizing the TVA, check out this recent Reason Foundation article by Steve Esposito. 

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How to Avoid Closing Washington State Parks

Posted on May 17, 2013, 1:57pm | Leonard Gilroy

Many thanks to the Washington Policy Center for publishing my legislative memo today on how to avoid the closure of dozens of Washington State parks, as Gov. Inslee has proposed if his tax increase package fails to advance. Here's an excerpt:

The threat of closing five dozen state parks is yet another variation on the well-worn “Washington Monument Syndrome” tactic designed to threaten closure or disruption of popular amenities if tax increases are not approved.

Political tactics notwithstanding, Washington’s state parks system does indeed face significant funding challenges. General fund appropriations for parks have been on the decline for years, a predictable circumstance in a fiscal football game in which funding for major spending priorities like education, healthcare, public safety and public-sector retiree benefits increasingly crowds out funding for the “nice-to-have” amenities like state parks. The sooner that policymakers and citizens understand this basic trajectory is only going to intensify — and that new solutions are needed to sustain the “nice-to-have” items like state parks — the better.

Some in Washington have begun to realize this when it comes to parks. In recent years, the legislature pushed the Washington State Parks Commission to pursue financial self-sustainability, and to its credit, the agency has pursued a range of strategies that include staff reductions, an increasing reliance on user fees and non-recreational leases, and expanding revenue-generating assets within the parks themselves. While these actions have not solved the funding challenge, they have been useful steps to keep the parks system afloat.

Short-term infusions of funding along the lines proposed by the governor are not a sustainable financial strategy if the goal is to keep parks open and thriving for the long term. Washington, like many other states, is due for a major rethinking of the structure and operation of the parks system itself. […]

Though it may be anathema to the preconceived visions held by some parks advocates, there is indeed a strong role for private-sector and non-profit operators in the state parks. For example, nonprofits played a major role in taking over operations of dozens of California state parks to help avoid closure amid 2012’s budget battles, and many municipal parks, zoos and aquariums, including New York City’s famed Central Park, have long been operated by nonprofit conservancies and “friends” groups.

Read the whole thing here or here for more on the role of the for-profit sector in operating Evergreen State parks.

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Louisiana Republicans Introduce Bills to Replicate Massachusetts's Pro-Union, Anti-Privatization “Pacheco Law”

Posted on May 9, 2013, 7:36pm | Leonard Gilroy

My latest column offers a critique of two bills introduced in the Louisiana legislature that are modeled after the Massachusetts "Pacheco Law," which is widely regarded as the most onerous and stringent anti-privatization law in the country. Here's a brief excerpt:

Two proposed bills introduced in the Louisiana legislature—and passed by a House committee earlier this week—raise serious barriers to fiscal responsibility, as the bills would effectively shut down the ability of the current and future governors to use the proven tool of competitive contracting to lower the costs of state government.

House Bill 240 (sponsored by Rep. Kenny Havard) and House Bill 519 (sponsored by Rep. Cameron Henry) are two alternative versions of a “Privatization Review Act” designed to place significant hurdles in front of routine, sensible privatization efforts used by governors of all political stripes across the country. Given the similarity to a 1993 law enacted in Massachusetts at the behest of government employee unions—and which has stymied privatization efforts in that state for two decades since—a more appropriate title for the proposed Louisiana bills would be the "Louisiana Government Employee Protection Act."

Specifically, HB 240 and HB 519 would prohibit agencies from entering into privatization contracts without prior legislative review and approval, and they would subject routine contracting decisions to onerous pre-procurement and contract review processes clearly designed to protect state employee jobs and elevate the interests of government employee unions over those of taxpayers at large.

The proposed bills are modeled nearly word-for-word after Massachusetts’ “Pacheco Law” (named for its legislative sponsor) that “has basically shut down all privatization efforts in state government,” according to an April 2013 Boston Globe editorial, which also noted that, “the purpose of state government isn’t to be a jobs program, particularly one that turns a blind eye to opportunities for savings.”

[...]

In January 2011, the Globe's editorial board wrote that the anti-privatization Pacheco Law “doesn’t just keep government agencies from saving money by hiring outside contractors to perform certain services. It also sends a broad message: In Massachusetts, the demands of special-interest groups — in this case, public-employee unions — can outweigh the obligation to run government efficiently."

Louisiana taxpayers would be right to question why some of their own state legislators are trying to replicate the law that has been so counterproductive in the Bay State for decades. Does Louisiana really want to become a profligate, big-spending state like Massachusetts and remove proven cost-cutting tools from the toolbox?

Read the full article here.

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Innovators in Action: Jacksonville, FL Commissioner of Public-Private Partnerships Renée Finley on Building the City's PPP Program to Drive Efficiency, Quality of Life

Posted on May 7, 2013, 3:36pm | Leonard Gilroy

Soon after taking office in July 2011, Jacksonville, Florida Mayor Alvin Brown established the city’s first Office of Public-Private Partnerships (PPPs) as a means to leverage greater returns from public resources by cultivating new funding sources for city initiatives, forging new partnerships with the private and nonprofit sectors, and optimizing the use of public assets and city-owned real estate.

Consistent with the office’s mission, Mayor Brown looked to the private sector for leadership of the new PPP office, ultimately appointing Renée Finley—an executive-on-loan from Florida Blue (formerly Blue Cross and Blue Shield of Florida)—in November 2011 to build the new office and set a course for PPPs in Jacksonville. In less than two years, the PPP office has already generated some significant results, including tapping approximately $7 million in direct private sector donations and grants, and approximately $2 million in identified cost savings opportunities through efficiency and competition initiatives.

In our latest interview in the Innovators in Action 2013 series, I interview Finley on the origins and accomplishments to date of Jacksonville’s PPP program, lessons learned along the way, and more. Here's a brief excerpt of the interview:

Leonard Gilroy, Reason Foundation: What drove Mayor Brown's decision to launch the Office of PPPs so early in his administration?

Renée Finley, Commissioner of Public-Private Partnerships, City of Jacksonville, Florida: The concept started with the mayor and his vision to reform government. Coming into office, he was faced with a $53 million budget deficit, so he articulated a number of reform goals, one of which was to position the city government for the new economic reality that we were facing. And he had a second goal of improving the effectiveness and efficiency of government. Mayor Brown believes that we can attain more efficiency in the delivery of public services and achieve better results by leveraging the strengths of both the private and nonprofit sectors.

Gilroy: What goals did the mayor have in setting up the Office of PPPs? What were the areas of focus?

Finley: There were really four key areas of focus. The first was around optimizing assets and services, and the thought was, “how do we leverage the strengths and resources of the private and nonprofit sectors in the delivery of public services and public works?” And furthermore, he wanted to explore opportunities to leverage city assets—in particular, real estate assets—by getting them in the hands of the private sector so they can drive additional private investment for further economic development for the city.

The second area of focus was around the facilitation of private interest in economic and urban development. The third area of focus was to facilitate private support and nonprofit involvement in education and workforce development initiatives. And, the fourth area focuses on delivering partnerships that improve the quality of life for Jacksonville citizens.

Check out the full interview here for details on the results of Jacksonville's PPP initiatives thus far, which will hopefully inspire other cities to pursue similar endeavors.

Other articles featured in the Innovators in Action 2013 series are available here.

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New at Reason: Looking Back at the Last Year in Local Government Privatization

Posted on May 6, 2013, 4:25pm | Leonard Gilroy

The rollout of Reason Foundation's Annual Privatization Report 2013 continues today with the release of the Local Government Privatization section—authored by Reason's Harris Kenny, Adam Summers and Steven Titch—which provides an overview of the latest on privatization and public-private partnerships in local government. Articles include:

  • Mayor Emanuel Establishes Chicago Infrastructure Trust
  • Public-Private Partnerships for Parking Assets
  • Yonkers, New York Pursuing Innovative School Partnership Approach
  • City of Austin Releases Surprising Outsourcing Study
  • Georgia Contract Cities Continue to Evolve
  • Finding New Ways to Provide Parks and Recreation Amenities
  • Water and Wastewater Privatization Update
  • Solid Waste Collection Update
  • Non-Profit Partnerships for Animal Shelters Grow
  • ANALYSIS: Is Managed Competition Dead in San Diego?
  • ANALYSIS: San Diego, San Jose Lead the Way in Local Pension Reform
  • ANALYSIS: Despite Glossy Reports, Muni Broadband is Still a Net Money Loser
  • Local Government Privatization News and Notes

» Annual Privatization Report 2013: Local Government Privatization
» Complete Annual Privatization Report 2013

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New at Reason: Looking Back at the Last Year in State Government Privatization

Posted on April 22, 2013, 1:43pm | Leonard Gilroy

The rollout of Reason Foundation's Annual Privatization Report 2013 continues today with the release of the State Government Privatization section—authored by Reason's Leonard Gilroy and Lisa Snell—which offers an overview of the latest on privatization and public-private partnerships in state government. Topics include:

  • State Budget Update
  • Privatization of State Lottery Management
  • The Emergence of Social Impact Bonds: Paying for Success in Social Service Innovation
  • California Pioneers Public-Private Partnerships for Private Operation of State Parks
  • Higher Education Public-Private Partnerships Update
  • State Liquor Privatization Update
  • Social Infrastructure Public-Private Partnerships Update
  • Child Welfare Privatization Update
  • State Privatization News and Notes

» Annual Privatization Report 2013: State Government Privatization
» Complete Annual Privatization Report 2013

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New Jersey Announces Lottery Privatization Contract Award

Posted on April 12, 2013, 5:12pm | Leonard Gilroy

The New Jersey Department of the Treasury today announced its intention to award a 15-year contract for the private operation of the state's lottery that will bring a $120 million upfront payment to the state and an estimated $1.4 billion in additional net lottery revenue to the state over the life of the deal, relative to in-house operation. From the state's press release:

To ensure the future performance of the New Jersey Lottery exceeds its past record of providing essential support to State institutions and education programs, the Department of the Treasury’s Division of Purchase and Property has issued a Notice of Intent to award a 15-year contract to Northstar New Jersey Lottery Group to provide the Lottery with services to support its marketing and sales operations.

As part of the contract terms which guarantee the State a minimum amount of income, Northstar NJ will provide an accelerated payment of $120 million to the State upon the final award and execution of the contract. It has also committed to generating at least $1.42 billion of total additional net income for the State from Lottery operations over the life of the contract with a potential actual increase in net income of $6.88 billion. The $1.42 billion mark is above and beyond what the State could expect to see if Lottery operations remain unchanged.

Northstar NJ is a joint venture consisting of GTECH Corporation of Providence, Rhode Island, Scientific Games International of Alpharetta, Georgia, and OSI LTT NJ Holdings, a unit of the Ontario Municipal Employees Retirement System (OMERS). GTECH and Scientific Games are two of the world’s leading companies in lottery management and OMERS is one of the largest pension funds in Canada.

“For more than 40 years, the Lottery has provided critical financial support to New Jersey’s institutions and educational programs. The contract we plan to enter into with Northstar New Jersey protects that legacy commitment to New Jerseyans by positioning the Lottery for sustained growth and continued success in the face of an increasingly complex and competitive marketplace,” said State Treasurer Andrew Sidamon-Eristoff.

Carole Hedinger, executive director of the Lottery, said the contract will immediately strengthen its operations. “GTECH and Scientific Games have outstanding records of success in helping public lotteries grow their revenues and improve their operations. Their business plan for the Lottery is solid, well-researched and builds upon our existing strengths.”

New Jersey now becomes the fourth state—after Illinois, Indiana and Pennsylvania—to move forward with a private management agreement for lottery operations in recent years. The shift to private management has already occurred in Illinois and Indiana, while officials in Pennsylvania continue to renegotiate their contract after the state's Attorney General raised several legal concerns in February, which has slowed the process in the Commonwealth.

Check back to reason.org in the coming weeks for my state lottery privatization roundup as part of our Annual Privatization Report 2013.

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Innovators in Action: Swampscott, MA Selectman Barry Greenfield on Breaking the State’s Control of Municipal Pensions in Massachusetts

Posted on April 8, 2013, 8:45am | Leonard Gilroy

In Massachusetts, the state mandates the types of retirement benefits that municipal governments provide to employees, effectively precluding local governments from having full control of their fiscal destiny. As unfunded pension and retiree healthcare obligations continue to mount in local governments in Massachusetts—as across the country—at least one town is trying to end the state's grip on local governments and give them the ability to pursue their own tailored, financially sustainable retiree benefit reforms.

The push for local control is being driven by Barry Greenfield, a selectman in Swampscott, Massachusetts and the founder and publisher of EfficientGov.com, a publication aimed at spreading public policy innovations. Greenfield has led the push to build a coalition of Massachusetts cities and towns—all of which have unfunded retiree benefit obligations—to build support for legislation that would give local governments the power to determine retirement benefits, rather than having the state mandate what municipalities provide.

Swampscott offers an illustrative example of the challenge local governments face. The town of 13,700 people has an unfunded liability of approximately $38 million dollars, and current pension costs account for close to 10% of the town’s budget. Worse, the town faces an $80 million unfunded liability in retiree healthcare. Together, retiree pension and healthcare benefits are currently consuming almost 20 percent of the town’s annual budget.

In our latest interview in the Innovators in Action 2013 series, I interview Greenfield on his efforts to give local governments the power to determine public employment retirement benefits in Massachusetts, getting the state out of a key aspect of municipal decisionmaking. Here's a brief excerpt of the interview:

Leonard Gilroy, Reason Foundation: Can you describe what prompted you to launch your current pension reform initiative?

Barry Greenfield, Town of Swampscott, MA Selectman: My town, Swampscott, is involved in a state-run public employee pension plan—a mandated retirement system that we pay the cost for, but which is overseen by the state. This plan covers public employees and teachers as well. It’s a defined-benefit plan where the retirement benefits for your pension are based on years of service, a multiplier that’s based on what type of employee you are, and what age you retire, in addition to employee contributions and investment return. The town contributes to those retirement benefits primarily through property taxes. A similar state-run system dictates OPEB [other post-employment benefits] like retiree healthcare benefits as well.

What’s happened over the years is that when they first implemented this program—which I believe was in 1911—the number of active employees to retired employees was at least 40-to-1. And that’s what most of these plans were designed on—a high level of active employees with relatively few retired employees. But over time, as the country has aged and people have aged, we in Swampscott are now down to a 1-to-1 ratio.

Most pension experts—and by that I mean academics, as you’ll get different answers from the actuaries involved in the state-run pension system—will tell you that the research has shown that once you get to a 5-to-1 ratio of active to retired employees, you’re really heading for trouble because you just don’t have enough new active employees paying contributions into the system to keep it afloat. There’s a myth that each employee contributes enough to pay for their own pension. Even when you add the projected investment return, the numbers simply don’t add up.

We’re at a 1-to-1 ratio in Swampscott, and it’s only going to get worse, because we have an aging workforce. If you look at the age of our municipal employees, they’ve all been working for 10 to 15 years and there are very few new employees coming into the system. People are working longer because the longer they stay working, the better the pension and OPEB benefits are.

So what I started reading and writing about in other states is what I would describe as the ability of cities to take control of their pension issues and realize that they’re unsustainable, as city and town services are falling by the wayside simply to fund retirement benefits. So what you’re seeing is that property taxes are rising—mine have gone up 50% in six years—but the services in the town have not improved. Almost all of that money has gone to pension or OPEB benefits.

[. . .]

This April, the town will be voting on a home rule petition that says we should have the freedom to decide what retirement benefits are a fit for our financial situation. The reality is that each town is not identical in terms of its fiscal footprint. We’re a small town trying to offer city-like services with few prospects for regionalization. It’s not necessarily saying that we’re going to move away from a defined benefit plan, nor does it say that we’re going to move toward a defined contribution plan. It’s not saying exactly what we’re going to do—all we want is the freedom to pursue options because we’re $38 million underfunded in our pension obligations and close to $80 million underfunded in our OPEB obligations. While those numbers may change a little on a day-to-day basis, they are still significant numbers when you’re talking about a town of only 13,700 people.

So I think that our town has proven that this particular mandate from the state—and I actually believe it’s an unfunded mandate—we need to be able to determine what’s best for us. We’ve proven that the current system doesn’t work for us, so that’s what this issue is all about.

The full interview is well worth a read and is available here. Other articles featured in the Innovators in Action 2013 series are available here.

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Reform California’s Tax System to Boost Economy

Posted on February 13, 2013, 6:26pm | Adam Summers

In my most recent policy study study, co-published by Reason Foundation and the Howard Jarvis Taxpayer Foundation, I analyze what I consider to be some of the more egregious special-interest corporate and sales and use tax carve-outs in California and argue that the state could improve its woeful business climate—and, thus, the economy in general—by eliminating such tax breaks and lowering the general corporate tax rate by an amount equal to that of the "extra" tax revenues that the state might expect to get without these tax breaks.

As I note in the study, the impact of reducing California's corporate tax rate in a revenue-neutral way by eliminating these targeted and unfair tax breaks could be significant. As Howard Jarvis Taxpayers Foundation chairman Jon Coupal and I note in a recent Orange County Register column,

The Franchise Tax Board says the corporate tax rate could be reduced 14 percent across the board, without losing any net tax revenue, simply by getting rid of one tax break—the Research and Development Tax Credit.

Furthermore, the Reason-Howard Jarvis study shows that eliminating other corporate tax breaks for things like movie companies, computer software, timber growing, farm machinery, and the "Accelerated Depreciation of Research and Experimental Costs" credit would allow the state to reduce the overall corporate tax rate by 20 percent or more.

Each time state lawmakers carve out a special tax credit or implement policies that favor certain businesses or industries through the tax code or through regulation, they also harm other industries.

[. . .]

The error of such tax breaks is compounded when one considers that they are effectively subsidizing many business activities that would have taken place even without the tax breaks. It's corporate welfare that California doesn't need and can't afford.

In addition, the state is notorious for its lack of oversight of these tax policies. A Department of Finance analysis of state tax credits concluded that the legislative intent was "not specified" for 70 of the 82 tax expenditures reviewed.

California's terrible business climate—due primarily to its burdensome taxes and regulations—has played a significant role in its economic stagnation and malaise. California has the ninth-highest corporate tax rate in the nation, at 8.84%, and the highest rate in the entire western half of the continental United States (which gives one an idea why so many businesses are fleeing to states like Texas, Utah, Nevada, Idaho, and North Dakota).

According to Chief Executive magazine's Best/Worst States for Business survey, California's business climate ranked dead last for the eighth year in a row. Among the responses from the CEOs surveyed were the following:

  • “California continues to head in the wrong direction as its tax policies will drive more businesses and people to relocate in other states. State politicians feel business and commerce are ‘necessary evils’ that provide the funds to enable pursuit of their misguided agendas.”
  • “California government is difficult to work with and very bureaucratic. Taxes and regulation are high and unruly.”
  • “California is begging for businesses to leave its state.”
  • “California is going in the wrong direction if that’s even possible.”
  • “California is out of control. They have too much government who have nothing better to do than to harass businesses in the state. They need to cut the size of their regulatory bodies in half.”
  • “California is the worst! They are doing everything possible to drive a business out of their state. If the environment in CA was not so good, they would have lost half of their population.”
  • “California regulations, taxes and costs will leave only tech, life sciences and entertainment as viable. If you aren't an elitist no room here for the middle or working classes.”
  • “California’s regulation and specifically labor regulation is a job killer. We will be moving our business out of CA and the State will lose 100’s of jobs simply due to the poor regulatory environment.”
  • “California’s taxes and ongoing changes for regulations are devastating. One never knows from even day to day what new interpretation of an existing regulation or new regulation will befall you and your small business.”

It is time policymakers in California realize the more taxes and more regulations are not getting the job done. If they truly want to jump-start the state's economy and "create jobs" (which, of course, only private-sector businesses—not the government—can do), they should reverse the many years of failed policies by reducing the high taxes and voluminous red tape that are strangling the state's economy. A good place to start would be to level the playing field by getting rid of special tax breaks for politically-favored industries and cutting business taxes across the board.

» See the full op-ed article here.

» The Reason Foundation-Howard Jarvis Taxpayers Foundation California tax credits study is available here.

» See my previous blog post about the California tax credits study here.

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California Tax Increases are Bigger Than They Look

Posted on February 9, 2013, 6:23pm | Adrian Moore

Richard Rider, who runs San Diego Tax Fighters, had a great letter to editor in the Wall Street Journal about the actual increase in CA state taxes. You can read the original here, but the letter read:

 

Regarding your editorial "The State Tax Reformers" (Jan. 30): Here's what everyone has missed concerning state income taxes. For the really rich (people with over $2 million income), in 2013 the deductibility of state and local taxes (income, property and other taxes) is 80% disallowed. The effect can be dramatic.

Consider the recent flap concerning the hapless Phil Mickelson who spoke out about the new, higher taxes. Between the 29% California income-tax increase on millionaires (to 13.3%) and the loss of the deductibility on federal returns, his 2013 net California income tax will be 12.3%. In 2011, it was 6.7%. That's an astonishing 83.6% increase.

When you make that much income and have relatively few deductions (even when deductions were allowed before 2013), you seldom if ever trigger the Alternative Minimum Tax. Mr. Mickelson earns income with relatively few deductions, tax credits, etc., so he's probably been paying the full rate for many years. It's only the returns where special income (some municipal-bond income, for instance) or massive deductions are used that the AMT is triggered—ironically, mostly for incomes below $1 million.

In 2005, the maximum California tax went up from 9.3% to 10.3% for those with over a million-dollar income. At the time, the state income tax was fully deductible. With a 35% maximum federal tax bracket, that meant that the increase cost the rich a net 0.65%.

With the changes I've discussed, the 2013 net California income-tax increase is 5.6 percentage points—8.6 times higher than the 2005 increase. Only a fool would think that such a massive increase would not motivate many of the wealthy to depart California.

 

 

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New Reason Study Calls for California Tax Reform

Posted on January 30, 2013, 2:04pm | Adam Summers

In his State of the State Address last week, California Governor Jerry Brown asserted, "California is back, its budget is balanced, and we are on the move." Sadly, economic reality belies the governor's optimism. California still has the third-highest unemployment rate in the nation at 9.8%, a rate 26% higher than the national average of 7.8%. It has the highest income tax rate in the nation, the highest state sales tax, the highest gas tax (tied with New York), and the eighth-highest corporate tax rate (and the highest rate west of the Mississippi River, making it even less competitive with its neighboring states). Add to this the fact that California has the worst credit rating in the nation (now tied with Illinois), mainly due to its significant debt and hundreds of billions of dollars in unfunded pension and retiree health care liabilities, and one of the worst—if not the worst—business climates in the country. The passage of Proposition 30, with its roughly $50 billion in new tax increases over the next seven years, last November certainly won't help matters. This is certainly not the track record of an economic powerhouse, or even a state on the upswing.

There are many ways to turn around the California's fiscal and economic fortunes—cutting spending, eliminating burdensome regulations, privatizing government services, ditching boondoggles like the California high-speed rail plan, implementing real pension reform, etc.—but today I would like to focus on how tax reform could help to revitalize the state. In addition to its high general personal income, corporate, and sales tax rates, California's tax code is plagued by numerous special carve-outs for politically-favored businesses and industries. In a new study by Reason Foundation and the Howard Jarvis Taxpayers Foundation, I highlight some of the more egregious corporate and sales and use tax credits, exemptions, and deductions offered by the state and argue that eliminating such tax breaks and using the "savings" to lower the overall corporate tax rate would promote a better business climate, and thus help improve the state's economy.

The results of such tax reforms could be significant. The Franchise Tax Board estimates (see page 10 of this California Senate Office of Oversight and Outcomes report) that if the Research and Development Credit alone were eliminated, the overall corporate tax rate could be reduced by about 14 percent, thus improving the business climate for all industries. If some of the other tax breaks discussed in this report were also eliminated—including the Accelerated Depreciation of Research and Experimental Costs, Double-Weighted Sales Factor, Film Credit, Low-Income Housing Credit, Hiring Credit, Percentage Depletion of Mineral and Other Natural Resources, and Expensing of Timber Growing Costs breaks (see Table 1 on page 14 of the study)—the Reason-Howard Jarvis report finds that California could likely reduce its overall corporate tax rate by more than 20 percent.

The infamous Solyndra case is a perfect example of why tax breaks are a bad idea. In addition to the $528 million in federal loan guarantees that taxpayers lost when the company went belly-up, the company also wasted $25 million in California state tax exemptions from a "green energy" tax credit program. Rather than trying to play favorites or cater to special interests through preferential treatment in the state's tax code, politicians should ensure that the playing field is level, and that tax rates are as low as possible, and otherwise let the free market and the choices of consumers and entrepreneurs—through the forces of supply and demand—determine which businesses and services are most desirable and best meet their needs.

When the state encourages economic activity in one segment of the economy—be it through tax breaks or direct subsidies—it necessarily discourages economic activity in all other segments of the economy by making them relatively less competitive. These opportunity costs are often ignored by policymakers. The error is compounded when you consider that much of the tax breaks end up being used for business activity that would have occurred with or without the tax breaks.

If this were not enough, another negative consequence of such tax breaks is that they breed even more special-interest lobbying. The more industry groups, environmental lobbys, or other special interests see that lobbying "investments" pay off, the more money is directed to lobbying Sacramento and the less is put to productive use in the economy.

If California wants to jump-start its economy and become a place that Gov. Jerry Brown and taxpayers across the state can be optimistic about, a good start would be to simplify and reduce its onerous taxes. The new Reason-Howard Jarvis study offers some recommendations about how to go about this:

 

  • 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.

  • Wherever possible, lower broad tax rates down to tax break levels, rather than raise tax break levels up to broad tax rates.

 

  • 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.
  • Eschew static analysis of state tax breaks and return to dynamic analysis of their effects on taxpayers and the state budget.
  • Establish a sunset commission to periodically evaluate tax breaks and other state regulations. A citizen’s commission would aid the legislative sunset commission similar to the state of Washington model. Adopt legislation requiring that both existing and future tax breaks must be evaluated every 5 or 10 years. Tax breaks not acted upon within this period would automatically be repealed.
  • Adopt a BRAC-style commission (similar to that used to close unneeded federal military bases) to evaluate existing tax breaks and regulations. The two-thirds supermajority makes it difficult enough to repeal existing tax breaks. Under such a process, an independent panel of taxpayers, perhaps with additional representatives from the Franchise Tax Board, State Board of Equalization, and Legislative Analyst’s Office, would be appointed to evaluate and recommend tax breaks for elimination. The recommendations, once approved by the governor, would be submitted to the legislature, which would not be allowed to make any amendments and could only vote up or down on the entire package. A simple majority of both houses would be required to approve the recommendations.

 

See the California tax credits study here.

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California Shouldn't Raise Minimum Wage

Posted on January 28, 2013, 2:31pm | Adam Summers

Democratic lawmakers in Sacramento, emboldened by their new supermajority status, are now tempted to use their added power to push an aggressive legislative agenda. One such effort, which they have tried, but failed, to implement during the past several years is an increase the state’s minimum wage, currently $8 an hour. Assemblyman Luis Alejo (D-Salinas), has introduced AB 10, which would increase the minimum wage to $9.25 an hour over three years and tie additional increases to inflation growth thereafter.

In a recent column for the Orange County Register, I argue that while a minimum wage might sound like a good and compassionate policy, it actually destroys job opportunities for many (not to mention the damage it does to the freedom to voluntarily agree to the price of one's labor).  The recent imposition of a living wage ordinance on large hotels in the City of Long Beach, California, is a case in point.  Consider the following excerpts from the O.C. Register article.

In the November 2012 election, voters in Long Beach overwhelmingly passed Measure N with 64 percent of the vote. The measure, pushed by labor unions such as Unite Here 11 and the Los Angeles County Federation of Labor, AFL-CIO, requires hotels with 100 or more rooms to pay their employees at least $13 an hour and guarantee annual raises.

After the passage of Measure N, Christine Petit of the Long Beach Coalition for Good Jobs and a Healthy Community, which sponsored the measure, crowed, “This ordinance means a lot to the workers, who will get the wage increases just in time for the holidays.” But this was a case of “Be careful what you wish for.”

In response to the measure's passage, some hotels were unable, or unwilling, to shoulder the extra financial burden. Instead of paying their employees more, they announced they'd lay off workers and reduce their number of available rooms so they would not have to comply with the new rules. The 174-room Best Western Golden Sails and the 143-room Hotel Current plan to dramatically reduce their number of available rooms to 99 rooms each to avoid the ordinance.

In December, just before the rules went into effect, the Best Western Golden Sails also reportedly posted a notice that "all employees will be considered terminated after their last shift of duty on or before Dec. 15." The Long Beach Press Telegram reported that "some" of the employees would be rehired but around 75 people were expected to permanently lose their jobs.

[. . .]

When a minimum wage law is imposed, or increased, business owners have a choice to make. They can reduce their costs, usually by laying off employees or cutting employees' hours, or they can try to increase their revenues by hiking prices and hoping customers will pay the higher prices.

[. . .]

Politicians in Sacramento should think long and hard about the fragile economy before pushing a minimum wage increase. For local and state businesses teetering on the edge of survival, the increased costs could be the last straw.

The good intentions of those who propose raising the minimum wage cannot outweigh its unintended consequences and economic reality. Try as they might, politicians can change the laws with regard to the minimum wage, but they cannot repeal the laws of supply and demand.

If the minimum wage was truly a wise and compassionate policy, then why stop at $9.25 an hour, as AB 10 proposes, or $13 an hour, as Long Beach mandated for large hotels? If arbitrarily raising the minimum wage to $13 an hour could magically create prosperity, why not raise it to $100 an hour? Wouldn't we all be rich if the minimum wage was raised to $100 an hour? The answer is obvious: business owners simply could not afford to pay $100 an hour, people would lose their jobs, stores would go out of business in droves, and commerce would grind to a halt. The fact that a minimum wage of $9.25 an hour or $13 an hour will not destroy quite as many jobs and businesses as a $100 an hour minimum wage is hardly reason to support it.

If simply passing laws could create wealth and eradicate poverty, politicians would be the most popular and celebrated people on the planet and people would avoid being poor without even having to work their way up the economic ladder. But take a good look around and ask yourself: Is this the way the world really works?

See the full op-ed article here.

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Innovators in Action 2012, Year in Review

Posted on December 31, 2012, 12:00pm | Harris Kenny

Reason Foundation's Innovators in Action series profiles innovative policymakers in their own words, highlighting good government efforts that are delivering real results and value for taxpayers. In 2012, these thought leaders joined us from across the United States--and even Puerto Rico--to share insight into their process. Check out our year in review, below:

Innovators in Action kicks off again in the new year with my interview with Michael Cheroutes, director, and Nick Farber, enterprise specialist, for the Colorado Department of Transportation's High Performance Transportation Enterprise. Visit reason.org/innovators for the latest content.

 

 

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Understanding Correctional Privatization in Florida

Posted on October 9, 2012, 8:33pm | Harris Kenny

In a recent piece Andrew Marra of The Palm Beach Post ominously warns:

The specter of privatizing more (Florida) state prisons makes many uncomfortable. For-profit companies would want more inmates in prison, despite bipartisan calls for sentencing reform. Then there are questions about security and accountability.

However, Marra's piece misses the mark in several important ways. I submitted a letter to the editor that was not published in print, but is available online here. In short, my piece explains that correctional outcomes in Florida are improving, in part because of privatization.

First, these improvements can be measured in cost savings:

The Florida Department of Management Services recently reported that privately operated facilities cost taxpayers 10-27 percent less to operate than comparable state prisons.

Second, they can be measured in improved quality:

A Florida Chamber of Commerce evaluation of private and public facilities in south Florida finds private partners have four times as many inmates participating in educational, vocational and life skills programming (79.3 percent versus 21.3 percent). 

My piece concludes:

(Privatization) is an effective policy tool that has been thoughtfully integrated into the system over decades; making all Floridians—not only taxpayers and inmates—better off.

For related work, see Reason Foundation's Prisons and Corrections Research Archive.

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Gov. Brown's Pension Reform "Outline" Underwhelms

Posted on August 28, 2012, 6:11pm | Adrian Moore

Governor Brown's pension reform "outline" is out.  California is certainly in desperate need of pension reform. Heck that was true back in 2005 when Reason called out the crisis before anyone was paying attention.

But Brown's proposal falls well short of the mark, in several ways.

First, as John Fleischman quicly pointed out, it does nothing to address the state's huge unfunded pension liability.

Second, some of the proposed reforms appear to require changes to current bargaining agreements, like getting rid of all 3 percent formulas. So the "reform" can pass the legislature, but get tossed by the courts for violating existing bargaining agreements.  Brown can say "I passed reforms, but the courts threw them out."

Third, I agree with John that nothing in the outline appears to be permanent. The next legislative session could overturn any or all of these reforms.  Judging by the state legislature's track record of giving the union's anything they want, and reneging on legislative deals to constrain spending, there is no reason to expect anything different this time around.

In fact, the whole thing looks fishy. The government worker unions in CA have consistently opposed anything like these reforms. Now going into an election Brown and the legislature are going to stand up to them? When they are most vulnerable to the kind of election pressure the unions bring to bear?

Ahh, but see, there is Proposition 30 on the table, Gov. Brown's big tax increase initiative. Most of the unions support it, and a good show of "reform" buys a lot of credibility with voters for the the arguments that the tax increases will fund a new, reformed state government.  But if those reforms can be unwound by the next legislative session, suddenly union quiescence makes more sense. Get the tax increase passed with some sham pension reforms, then unwind the reforms next year.  Win win for unions and politicians, lose lose for taxpayers.

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To Avoid Massive Tax Hikes, Privatize State Lotteries

Posted on August 23, 2012, 11:59pm | Harris Kenny

Today my colleague Leonard Gilroy and I published a piece on Real Clear Markets entitled, "To Avoid Massive Tax Hikes, Privatize State Lotteries." The piece begins:

As states continue to grapple with ongoing fiscal pressures, some are beginning to explore an innovative new lottery privatization model with the hopes of increasing revenue. To the extent that this trend could prevent tax hikes or cuts in core programs, it is worth applauding.

The piece goes on to highlight several noteworthy developments towards privatization at the state level, including New Jersey, Pennsylvania, Indiana and Illinois. We initially focus on Illinois because it is pioneering this trend, writing:

(Illinois) handed over its lottery operations to Northstar Lottery Group, a private manager, last year. The result? A $36 million boost in net lottery revenues to the state in the first year with hundreds of millions of additional dollars expected over the next five years.

Why is Northstar doing so much better than the government? It's not by scamming customers or cheating. State authorities continue to exercise control and oversight over all of Northstar's significant business decisions because Northstar has to submit its annual business plans for state approval.

Lotteries are unique and many observers are unfamiliar with how they operate. However lotteries are no different than a number of other state-run services that can be adequately, or even better, provided by the private sector. The piece continues:

What privatization does is recognize that lotteries are essentially businesses that are better run by professional firms that have the right mix of incentives, skills and technology to maximize the value of this ultimately state-owned asset. It hands over to the private operator management of day-to-day operations, marketing and other functions in exchange for a portion of revenues (subject to an overall cap).

The upshot is not just increased efficiency but expanded product lines, improved marketing to attract new types of players, and new outlets for lottery ticket purchases across the state, all of which boost the bottom line.

Lotteries are lucrative businesses that generate profits even when not run super efficiently. Hence, even state-run lotteries produce revenues. However, public agencies face very few incentives to maximize efficiency since they don't have to focus on a bottom line and, are rarely held to performance standards.

We go on explain the details of the agreement in Illinois, specifically covering financial terms of the contract between Northstar and the state. We also highlight caveats that will impact similar deals in other states. For example, some states have strict constitutional language limiting the use of lottery revenue. The piece concludes:

 

Although every state has something different to gain from privatizing lottery management, to the extent that money is fungible, by relieving fiscal pressure on some programs, lottery revenues can relieve the overall pressure for tax increases. And its far better that the state pursue new revenue from people voluntarily playing lottery games instead of taking more of taxpayers' income involuntarily through tax hikes and the like.

What's more, many states are saddled with debt and legacy obligations (pension and retiree healthcare costs) that they don't have the funds to pay for. Many of these promises were reckless and should never have been made. But the fact is that governments can't write them all off. They'll have to find a way to pay for some of them. And lottery and other privatization efforts offer one such way without massive tax hikes.

 

Implementing privatization, like any policy tool (and like playing the lottery itself), is inherently risky. But all risk is not created equal, and ongoing fiscal woes suggest the risk of maintaining the status quo in government may be far greater.

It seems far more sensible for policymakers to avail themselves of every opportunity to maximize the return from the state's existing revenue-generating assets through more efficient management, creating another option for cash-strapped states beyond just higher taxes and cuts in core services. Thus far, Illinois' experience partnering with the private sector to increase lottery revenues suggests that maybe privatization isn't such a risky gamble after all.

Read the full piece available online here. For more on privatization and other reforms at the state level see Reason Foundation's State Government Research Archive.

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Defending Limits on State Tax Powers

Posted on July 31, 2012, 6:26pm | Steven Titch

The U.S. Senate holds hearings Wednesday on the so-called Market Fairness Act (S. 1832), which would be better dubbed the “Consumer and Enterprise Unfairness Act,” as it seeks to undo a critical requirement that prevents states from engaging in interstate tax plunder.

In a series of court decisions that stretch back to the 1950s, the courts have consistently affirmed that a business must have a physical presence within a state in order to be compelled to collect sales taxes set by that state and any local jurisdiction.

That meant catalogue and mail order businesses were not required to collect sales tax from customers in any other state but their own. The three major decision that serve as the legal foundation for this rule, including Quill v. North Dakota,the case cited most frequently.

Quill left room for Congress to act, which indeed it is doing with the Market Fairness Act. The impetus for the act has nothing to with the catalogue business, however. Rather, it’s the  estimated $200 billion in annual Internet retail sales, a significant portion of which escapes taxation, that’s got the states pushing Congress to take a sledgehammer to a fundamental U.S. tax principle that has served the purpose of interstate commerce since 1787.

That’s why the Marketplace Fairness Act is so troublesome. While indeed Congress has the power to create an state-to-state tax structure, it may be imprudent to do so.  In seeking to close what it disingenuously calls a “loophole” that allows Internet sales to remain tax-free, it bulldozes a vital element of commerce law that protects consumers from taxation from other jurisdictions.

That year, of course, is when the U.S. Constitution replaced the Articles of Confederation. One of the flaws of the Articles was that it permitted each of the states to tax residents of others. Rather than get the budding nation closer to the nominal goal of confederation, it was endangering the expansion of vital post-colonial commerce by creating 13 tax fiefdoms and protectorates. The authors of the Constitution wisely addressed this by vesting the regulation of interstate commerce in the federal government.

And that protection is as necessary as ever. As the Tax Foundation’s Joseph Henchman will remind Congress today in his testimony, states have every incentive to shift tax burdens from their own residents to others elsewhere. As an example, take all those taxes attached to hotel and car rental bills.

The Marketplace Fairness Bill puts great stock in the idea that software and technology can relived the “burden” that, according to the courts, state and local tax compliance places on out-of-state business. But even sales tax complexity can’t be solved with the literal click of the mouse. It’s more than just the 9,600 sales tax jurisdictions that need to be factored in. Tax rules differ state to state, city to city and town to town. Sometimes a candy bar is taxed, sometimes it’s not. Every August, some states declare a “sales tax holiday weekend” in hopes of boosting back-to-school business. Dates can vary. Bottom line, there’s no reliable plug-and-play software for this. Overstock.com chairman and CEO Patrick Byrne has said it cost his company $300,000 and months of man-hours to create a solution.

The Marketplace Fairness Bill takes tax policy in the wrong direction, setting up a classic slippery slope that will see states becoming more and more predatory. What’s needed instead is an alternative that respects both state’s rights and the limits set by the Constitution.

But there will be no real progress until state legislators admit what they are trying to do: collect more taxes. That at least makes the dialogue honest. Then the question becomes whether the initiative is necessary to begin with. After that, more reasonable constructs include an origin-based tax system, building on the framework that exists today. When I purchase an item in Sugar Land, Tex, I pay sales tax to Texas and Sugar Land. When I travel to Los Angeles and buy a souvenir from the Universal Studios tour, I pat sales taxes levied there. A more sensible tax structure allows merchants to comply with the tax rules in their own states.

The only objection comes from legislators in high sales tax states who complain origin-based taxation gives businesses that locate in states such as Oregon and New Hampshire, two of five that charge no sales tax, an advantage. My affable reply is “Why yes, it does. Doesn't it?."

A low-tax policy is one way states can compete constructively for commerce and economic growth. Consumers and businesses would be much better off if states looked at e-commerce as an opportunity to boost their economies by welcoming Internet enterprises instead of treating them, and their customers, as just another cash pump.

For more, See "About that Sales Tax 'Loophole'" 

 

 

 

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Sales Tax Funding and Useless Rail Projects are Major T-SPLOST Negatives

Posted on July 26, 2012, 4:00pm | Baruch Feigenbaum

Recently I was invited to an Atlanta Forward forum hosted by the Atlanta-Journal Constitution on a proposed 1% transportation sales tax appearing on Georgia residents’ ballots next Tuesday, July 31. Other participants included Chris Leinberger from Brookings and two metro Atlanta politicians, Bucky Johnson and Steve Brown. The complete video is available here. Among the highlights:

I would offer a nuanced view on (the merits of T-SPLOST). I think it depends on where you live and it depends on the specific project. So, if you're close to the Ga. 400, I-285 project, maybe you live in Sandy Springs and you work in downtown Atlanta, you're going to get a lot of benefit because that project is going to be good for you.

But if you’re in some other parts of the region, if you’re in Gwinnett County and you have only a [transit] planning study and you really don’t have much in the way of highway improvements [or] if you’re in Henry County and you really don’t have much in the way of regional improvements … there’s really not a lot to benefit you. 

And I’m also not a fan of some of the transit projects because I don’t think they go from home to work. So I think the answer is, it depends.

Atlanta is the least dense [metro area] in the world with more than 3 million people. We also know that what really drives development is land use and land use patterns. One of the reasons why Atlanta is not dense is because we have chosen a land use pattern that is basically somewhat friendly to suburbs … . 

Now from my perspective, we should be producing the transportation system that people in this region want. But … by and large, people in Atlanta have not voted for denser development.


More specifically, the T-SPLOST has several problems. Its funding mechanism of a sales tax has no relationship to transportation. A sales tax is not a true user fees such as a gas tax dedicated to highway use, vehicle miles traveled fees, or tolls.

Transit options comprise 52% of the sales tax. Atlanta is a post-World War II city. Its low density and car-oriented development pattern make providing good transit challenging. However, transit is vital in all major cities. And Atlanta’s current transit system has many holes. An extensive BRT transit system could be built using only 25-33% of the total. The project list squanders most of the transit money on three light-rail lines. Worse, two of these lines are terrible projects from every angle. William Millar, president of the American Public Transit Association (APTA) at the time noted that due to the difference between current development and build-out potential, transit may not be realistic until at least 2025. When the President of the American Public Transit Association says a transit project should not be built, that is one powerful message. The proposed light-rail line from the Arts Center station to the Cumberland area in Cobb County also has issues. There is no right-of-way to build this system and the powerful neighborhood is likely to resist eminent domain and building of the rail line through a residential area.

There are certainly many good projects on the list. The critical intersections of I-285 and SR 400, I-285 and I-85N, and I-285 and I-20W receive needed funding. The I-285/SR 400 intersection is the best project on the list. The intersection is adjacent to the Perimeter business district, the largest concentration of jobs in the southeast. During the day traffic backs up in every possible direction. Reconstructing this functionally obsolete intersection is important. Anybody who doubts the need to improve this intersection is simply divorced from reality. But these intersections will get rebuilt even if the tax fails. Seventy-five percent of the I-285/SR 400 rebuild and 50% of the I-85N/I-285 rebuild and the I-20W/I285 rebuild comes from other sources. While the T-SPLOST will speed up construction of these interchanges, they will be constructed anyway. 

There are other important quality projects on the list. Enhancing GRTA’s bus service, enhancing local bus service in Clayton and Gwinnett counties, and returning MARTA to a state of good-repair are all important. And while local bus service would ideally be funded by the local counties and MARTA should be far more efficient, these projects have regional benefits. 

While many of the highway projects are good, some are wasteful. There are a large number of surface road improvements in Fayette County, most of which are not needed now and may never be needed.

Voters on July 31st will choose. The choice is between voting “YES” on a problematic list that contains some good projects or voting “NO” and waiting for a better alternative. Tomorrow I will look at options if the sales tax fails.

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Atlanta T-SPLOST is Complicated

Posted on July 26, 2012, 1:17pm | Baruch Feigenbaum

In a recent Atlanta Journal-Constitution commentary I detailed the complexity of the Transportation Special Purpose Local Option Sales Tax (T-SPLOST) that voters will either accept or reject next Tuesday July 31st. The metro Atlanta T-SPLOST will fund a list of transportation projects in the ten county Atlanta Regional Commission planning area. Residents of each of Georgia’s 159 counties, located in one of 12 different regions, will vote on a local project list. However, regions outside of Atlanta have much more in common with each other due to Atlanta’s greater population, greater tax revenue, and inclusion of rail transit. The other 11 regions have less controversial project lists and fewer transportation needs.

With Georgia ranked 49th in transportation spending, the question should focus not on whether the state needs to increase investment in its transportation network, but what is the best, most efficient and politically realistic way to do so.

Given this framework, there are reasons for voting for and against the Transportation Investment Act. 

Metro Atlanta needs to solve its congestion issues: Residents waste a significant portion of time — and money — stuck in traffic. Transit service is inadequate; frequency and coverage are below cities of similar size. 

Competitors, including Charlotte, Dallas and Houston, have comprehensive transportation strategies, while other Southern states such as North Carolina and Texas have approved local sales taxes for transportation. 

Funding transportation infrastructure with a sales tax is not optimal, primarily because such a tax has no relationship to the usage of the transportation system. 

It is politically easier to increase a single tax, especially a tax where tourists contribute a significant amount, but it is arguable that a mix of taxes and user fees would be a better solution. 

Transit is important for metro Atlanta’s future and deserves some regional and state funding. 

But increasing transit service, a laudable goal, should not come at the expense of developing and maintaining a quality highway network — the overwhelmingly preferred travel mode in the region. 

Read the entire commentary here.

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About that Online Sales Tax 'Loophole'

Posted on July 23, 2012, 3:30pm | Steven Titch

Proponents of higher taxes have taken to calling the exemption that out-of-state online shoppers enjoy a "loophole," as if it were an unintended flaw in two established court rulings that addressed the power of one state to tax residents of another.

My latest commentary at Reason.org looks at the so-called Marketplace Fairness Act, a bill that the House Judiciary Committee has scheduled for hearings tomorrow. The bill aims to help states collect sales taxes on out-of-state purchases, typically made via catalogue or, to an ever-greater extent, the Internet. Two Supreme Court decisions, Quill vs. North Dakota and National Bellas Hess vs. [Illinois] Department of Revenue, both of which pre-date Internet shopping, protect out-of-state consumers from the taxman's reach.

As I write:

Editorials and op-eds supporting the bill, such as in the Arizone Daily Star and the Chicago Sun-Times, say it will close a "loophole" that allows Internet purchases to escape taxation.  This is akin to saying the Supreme Court's Miranda decision is a loophole for defendants to escape prosecution. No doubt some overzealous prosecutors may think so, but in truth, Miranda sharpened and affirmed the right of due process already present in the Fourth and Fifth Amendments. Likewise, in Quill and Bellas Haas, the courts sharpened and affirmed the Constitution's commerce clause that prevents one state from taxing residents of another.

Seeing it as counterproductive to an interdependent economy, the Founders did not want states plundering each other's residents and enterprises with taxes. Yet that's exactly the environment the Marketplace Fairness Act sets up. New York State can tax residents of Illinois and the Prairie State can tax Hoosiers.

In doing so, the Marketplace Fairness Act ignores the constitutional underpinnings of the Quill and Bellas Hess decisions and treats the Internet sales tax issue as a procedural issue when the in fact the constitutional bar is set much higher. The giveaway, however, is the portion of the bill that requires states to simplify their state tax collection procedures before launching cross-border taxation. It's an unusual quid pro quo, perhaps because Congress has to offer states the prerequisite of a buy-in. That's because any attempt to impose a tax collection structure wholesale on the states would likely face a constitutional challenge on 10th Amendment grounds of state's rights.

In reality, the states, struggling as they are with debt crises of their own making, are angling for a greater piece of the $200 billion Americans are spending with Internet merchants each year. Of course, not all of this goes untaxed; on-line retailers who have brick-and-mortar stores within a state must collect tax from residents in that state. Besides creating a mess of competing state tax grabs, this law stands to increase paperwork and complexity for thousands of small online businesses and catalogue firms, who would now be obliged to calculate taxes on some 11,000 sales tax jurisdictions throughout the country. Whether or not it's "simplified" in line with some Congressional definition, it still stands to be the burden as noted in Quill and Bellas Hess.  

But all the talk of loopholes, level playing fields and what does or does not constitute a "burden" diverts attention from the real issue. The Marketplace Fairness Act is not about the Internet, e-commerce, the marketplace or fairness--it's about what the Constitution says about the power of state governments to tax citizens beyond their borders.

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Task Force Report Warns of Darkening Clouds for State Finances, Absent Reforms

Posted on July 19, 2012, 5:19pm | Leonard Gilroy

An important new report this week by the State Budget Crisis Task Force—an independent panel of experts convened by former New York Lt. Gov. Richard Ravitch and former Federal Reserve Board Chair Paul Volcker—concludes that states are on an unsustainable fiscal path and will face a worsening fiscal storm absent major budget and policy reforms. Ravitch and Volcker created the task force "because of their growing concern about the long-term fiscal sustainability of the states and the persistent structural imbalance in state budgets, which was accelerated by the financial collapse of 2008."

There's little new information in the report for those that track state budget issues closely. Rather, it leverages the clout of authors to convey the seriousness of state fiscal crunch to a mass audience, and it synthesizes in one report a wide range of analyses of the major fiscal threats states continue to face. According to the report:

To understand the threats to fiscal sustainability, we examined six states - California, Illinois, New Jersey, New York, Texas, and Virginia—in depth. While all states are different, these states reflect important geographical and political differences within our country. They account for more than a third of the nation’s population and almost 40 cents of every dollar spent by state and local governments. All six states face major threats to their ability to provide basic services to the public, invest for the future, and care for the needy at a cost taxpayers will support.

While the study states differ along many dimensions, including politics, policies, economies, and demographics, they share many problems, including these six major fiscal threats:

• Medicaid Spending Growth Is Crowding Out Other Needs
• Federal Deficit Reduction Threatens State Economies and Budgets
• Underfunded Retirement Promises Create Risks for Future Budgets
• Narrow, Eroding Tax Bases and Volatile Tax Revenues Undermine State Finances
• Local Government Fiscal Stress Poses Challenges for States
• State Budget Laws and Practices Hinder Fiscal Stability and Mask Imbalances

These threats to fiscal sustainability create risks to essential state functions such as investments in education and infrastructure, and they affect the ways in which states are likely to issue debt. Addressing these threats will not be easy. States must address these threats through the budget process, which reflects each state’s own culture, institutions, and politics. The effort to achieve an annual or biennial balanced budget is a major political and governing event in the states, made by elected officials in an environment that breeds caution, encourages short-term budget- balancing contrivances, and discourages investment for the future.

The report goes into significant detail on each of these threats and is worth a read even for the well-initiated. For example, the "Underfunded Retirement Promises" section details the latest estimates on unfunded public employee pension liabilities and retiree health care plans, which tally in the trillions of dollars in aggregate. And the "Eroding Tax Bases" section covers a range of topics from the economic sensitivity of various types of taxes to the steadily erosion in motor fuel taxes that is increasingly limiting states' ability to invest in roads, bridges and other public infrastructure.

While the report devotes significant attention to the fiscal impact of federal deficit reduction on state and local governments, it also rightfully chastises state policymakers' use of gimmickry and budget "sleights-of-hand" to give the illusion of budget balance. Examples cited include delaying payment dates into future budget cycles, taking on debt to fund current operating expenses intend of financing long-term capital projects and more.

Last, the report makes an initial stab at some policy recommendations, including increased financial transparency, budget process reforms to replace cash-based-budgeting and enact multi-year budget forecasts, strengthening rainy day funds, reforming and increasing the transparency of pension systems, broadening the tax base and adopting multi-year capital budgets.

While these are useful ideas to consider as a start, the recommendations just begin to scratch the surface of what will really be necessary to put state budgets on a sustainable path. To supplement this report, I would also recommend that readers branch out further to check out additional works by independent groups, including this State Budget Reform Toolkit (a collaboration of many think tanks, including Reason Foundation), as well as the many ideas discussed over at www.statebudgetsolutions.org. And be sure to visit Reason's state budget policy archives to review our long-running work in this area.

Overall, the main takeaway from the Task Force report is a stark—and correct—warning:

The conclusion of the Task Force is unambiguous. The existing trajectory of state spending, taxation, and administrative practices cannot be sustained. The basic problem is not cyclical. It is structural.

The time to act is now.

The full report is available here, and a summary version is available here. For more details on this report, visit the task force website at www.statebudgetcrisis.org, and see the recent coverage by The New York Times, Governing and Stateline.org.

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New at Reason.tv: Public-Private Partnerships in Puerto Rico

Posted on July 10, 2012, 5:25pm | Leonard Gilroy

Yesterday, my Reason.tv colleagues posted a new video on Puerto Rico's laudable program to entice private investment in public roads, schools and other infrastructure via public-private partnerships:

"At the end of the day, we are benefiting from savings," explains David Alvarez, executive director of the Puerto Rico Public-Private Partnerships (PPP) Authority. "The government is not dedicating more resources to (infrastructure) and the taxpayers are receiving value."

Although vital public projects such as schools, roads, and airports have traditionally been the domain of the government, Alvarez tells ReasonTV "it's important that we incorporate private investment into the infrastructure." He add that PPP projects add nothing to the public debt and are completed faster and more efficiently than traditional government-administered ventures.

The video, featuring Alvarez, is available at both Reason.tv and YouTube, or it can be viewed directly via the link below.

As I detailed in this May post, Puerto Rico's PPP program is one of the most robust out there at the moment. For more details, see:

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TIFIA Changes In Transportation Bill Are a Step In the Right Direction

Posted on July 10, 2012, 8:53am | Robert Poole

The National Journal's Transportation Blog asks if there are any benefits from Congress' recent modifications to the Transportation Infrastructure Finance and Innovation Act (TIFIA) program? 

Various smart growth and transit groups are upset about the changes Congress made to the federal TIFIA program, in particular, changing the criteria for TIFIA loans from a laundry list of factors (including livability and sustainability) to primarily financial feasibility. But these changes restore TIFIA to what it was originally intended to be-not an all-purpose transportation loan program but a way to leverage limited federal dollars to support big-ticket infrastructure improvements.

The large increase in TIFIA's budget (from $122 million per year to $750 million next year and $1 billion the following year) is a response to demand from state Departments of Transportation (DOTs) greatly exceeding the program's capacity in recent years. And the streamlined criteria will make USDOT's decisions about which projects to fund more straightforward and less subject to politicization based on inherently subjective factors introduced by the Obama administration that Congress has now deleted.

I had to laugh at the suggestion by Tri-State Transportation Campaign's Steven Higashide that the reformed TIFIA program will likely fund "roads to nowhere." Most state DOTs these days are so strapped for funding that they are hardly building any new roads. And the ones that they hope to build with TIFIA assistance are anything but boondoggles. That is thanks to the basic financial feasibility requirements that are unchanged in the expanded program. Specifically, a project can only qualify for a TIFIA loan if it has (1) a dedicated revenue stream, and (2) an investment-grade rating on its senior debt.

Most of the highway projects TIFIA is funding are either new toll roads or the addition of congestion-priced express toll lanes to existing expressways (such as those nearing completion on the Capital Beltway outside Washington, D.C.). The projected toll revenue stream is intended to pay back the investment-grade senior debt and the TIFIA loan, and (if there is any revenue beyond that) to provide a return to the equity investors in the project.

This kind of revenue-based financing is something of a revolution in highway funding, compared with the historic tax-and-grant system that is increasingly becoming unsustainable, as fuel tax revenues lag ever further behind the costs of building, maintaining, and modernizing highways. And TIFIA is now poised to spread this revolution, thanks to the increased budgetary authority Congress has provided.

My only real concern about Congress's changes is that it increased the fraction of a project's budget that can be funded by a TIFIA loan from the previous 33 percent to 49 percent. The purpose of TIFIA has been to provide "gap financing" for economically and financially sound projects that could not quite make their budget numbers work with conventional debt. Upping that fraction to nearly half may well reduce the pressure on state DOTs and metropolitan planning organizations (MPOs) to commit their own resources to candidate projects, potentially reducing such projects' financial soundness and thereby increasing the risk to federal taxpayers. Were I a part of the USDOT credit council reviewing TIFIA applications; I would give preference to projects requesting loans at or below 33 percent.

At a time when the handwriting is on the wall for conventional fuel tax-based highway grants, the shift to loans and financial soundness criteria is an important step in the right direction.

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Rahm Emanuel and Big City Democrats Embrace Privatization

Posted on July 6, 2012, 10:19pm | Leonard Gilroy

Harris Kenny and I have a column in tomorrow's Wall Street Journal:

We often hear that America's infrastructure is crumbling, but did you know that tens and possibly hundreds of billions of dollars in private infrastructure funds are waiting to be spent? It's money that Chicago Mayor—and Democratic Party powerhouse—Rahm Emanuel has spotted, rightly calling it "a tool here that takes some of the pressure off taxpayers."

In April, the Chicago City Council overwhelmingly approved Mr. Emanuel's $7 billion program to "rebuild Chicago" by constructing two new runways at O'Hare Airport; replacing 900 miles of water pipes and 750 miles of the sewer system; creating special routes for rapid bus transit; modernizing schools, transit stations and city buildings; and building 12 new parks and 20 playgrounds.

To pay for these projects, Mr. Emanuel is turning in part to private firms including Citibank and Citi Infrastructure Investors, Macquarie Infrastructure and Real Assets Inc., J.P. Morgan Asset Management Infrastructure Investment Group, and union-held Ullico. These firms say they are ready to provide at least $1.7 billion to help build the "new Chicago." (Though the details are not yet set, the likely arrangement would have the private firms putting up capital and then recouping their investments through user fees over a set period of years or decades.)

"This model of private financing for public infrastructure is happening all over the world, but not here in America," said Mr. Emanuel, who served from 2009-10 as President Obama's chief of staff. "I can't get from here to there on the old model—it's broken."

There are decades of major public-private partnership success stories in the United Kingdom, France, Italy, Spain and elsewhere. The Reason Foundation's Annual Privatization Report finds that partly or fully privatized airports—such as Heathrow and Stansted in London, and Leonardo da Vinci-Fiumicino Airport in Rome, which make money from airlines and especially from passengers in stores, parking lots and the like—handled 48% of European air travel passengers in 2011. That's one reason Chicago is considering privatization plans for Midway Airport (which would ultimately require approval from the Federal Aviation Administration).

Mr. Emanuel's new infrastructure plan is bolstered by the privatization success he's already experienced in Chicago. Last summer he launched a large-scale competitive bidding process in which two companies compete with each other—and head-to-head with city workers—to provide cheaper curbside recycling for Chicagoans.

The competition forced government workers to find better ways to do their jobs, and Chicago reported reducing costs by $2 million in the first six months alone. "The City's crews have worked to close the gap between the private haulers' $2.70 price per cart by reducing their costs by 35 percent from $4.77 to $3.28 per cart," the city government reported in April.

Also privatized by Mr. Emanuel: Chicago's water-bill call center, airport and library custodial services, and the city-worker benefits-management system. Hiring private companies that could manage these services at lower costs led the city to lay off over 600 employees, so the mayor came under predictable fire from government unions. "My duty as mayor is to protect our city's taxpayers and be their voice—not to protect the city's payroll," he responded.

Mr. Emanuel is doing what sensible leaders do: focusing resources on the core functions of government and using competition to lower costs on the rest. When government agencies are forced to compete with the private sector, it saves taxpayers money and makes government more responsive to its customers. Performance-based contracts that set clear standards ensure that high-quality services are delivered by private firms that are held accountable.

Other prominent Democrats are joining Mr. Emanuel in embracing privatization or nonprofit funding for the countless nonessential services that drain city coffers.

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Stockton Begins Legal Battle in U.S. Bankruptcy Court Today

Posted on July 6, 2012, 12:53pm | Harris Kenny

Updated on Friday July 6, 2012 at 1:28 PM Eastern.

Last week Stockton, California became the largest city (by population) to file for bankruptcy in U.S. history. The initial hearing is today in U.S. bankruptcy court in Sacramento. The trial is especially significant because the city’s lawyers are attempting to use bankruptcy to impose losses on its bondholders, which include private financial institutions and the state of California. Steven Church of Bloomberg reports:

No U.S. municipality has used bankruptcy to force bondholders to take less than the full principal due since at least 1981, and possibly as far back as the 1930s, according to lawyers and court records.

Church reports the city’s three largest creditors include:

  1. California Public Employee Retirement System (CalPERS), $147.5 million;
  2. Wells Fargo Bank NA as trustee for $124.3 million in pension obligation bonds; and
  3. Wells Fargo Bank NA as trustee for three other sets of bondholders owed $107 million.

One of the most interesting subplots will be the legal battle between CalPERS, and Wells Fargo Bank North America and Assured Guaranty Ltd. Cate Long, a guest contributor to Reuters’ MuniLand blog, speculated on Twitter today whether or these calculations are accurate though. Assured Guaranty Ltd. insured $161 million of Stockton’s bonds. Meanwhile, National Public Finance Guarantee, which has insured about $224 million of Stockton's debt, is owned by MBIA Inc. Combined, MBIA Inc. and Assured Guaranty Ltd. hold approximately $385 million in Stockton's debt, and at this point they are allowed to argue together in court. In the case of principal reduction, these parties arguably have the most to lose.

This morning, Church wrote:

Bondholders will be limited to two main options if they are to block Stockton in court, said Lee Bogdanoff, a bankruptcy attorney: get the case thrown out or defeat the city’s reorganization proposal.

“The most important power they have is a seat at the negotiating table,” Bogdanoff, a founding partner of Klee, Tuchin, Bogdanoff & Stern LLP in Los Angeles, said in a telephone interview. “They can try to influence the decision makers.”

Today’s hearing will differ from a typical corporate case, Bogdanoff said. Unlike a company, the city doesn’t need to ask U.S. Bankruptcy Judge Christopher Klein for permission to pay any bills it ran up before filing for court protection, such as wages, utility bills or rents. As a result, creditors won’t be able to use the hearing to pressure the city on its spending habits, Bogdanoff said.

The first legal question today is about the city's mediation process. California Assembly Bill (AB) 506 passed earlier this year requiring distressed municipalities to enter mediation before declaring bankruptcy. While Wells Fargo Bank NA was awarded three city parking garages and city hall, the parties failed to resolve their differences. The intention behind AB 506 was for future cities filing for bankruptcy to avoid the flurry of lawsuits that ensued after Vallejo, California’s filed for bankruptcy several years ago.

Scott Smith of The Stockton Record reports:

Marc Levinson, the lead attorney hired to represent Stockton, will ask U.S. District Judge Christopher Klein to unseal a 790-page document at the heart of a three-month-long, closed-door mediation process that attempted, yet failed, to avert bankruptcy.

Levinson argues in court papers that this massive document, which resembles a bankruptcy plan, lays out in detail what the city in mediation asked its major creditors to give up...

Proving in court that a municipality first tried to avoid bankruptcy and that it is, in fact, broke are basic facts that must be established before moving ahead with a bankruptcy case...

(U.S. District Judge Christopher Klein) is expected to rule from the bench today on two other motions that Stockton filed:

  • First, the city wishes to set an Aug. 9 deadline for any challenges to the legitimacy to Stockton's bankruptcy.
  • Second, the city has asked to maintain a website designed to tell each of the 6,000 stakeholders of upcoming hearings and filings, rather than having to send each a notice by overnight mail, which would be costly and labor intensive."

For more on California municipal finance issues, see my previous posts on Stockton and Mammoth Lakes. For the latest on Detroit, Michigan, see Detroit and Michigan: A Fragile Bargain and Detroit and Its Unions Fight Over Work Rules from Melissa Maynard of Stateline.

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