Budget

Strong Fiscal Rules Lead to Better Tax Policy

By John Hendrickson, Policy Director for ITR Foundation, and
Pete Sepp, President of the National Taxpayers Union

This year is shaping up to be a big one for tax relief. From Mississippi to Kansas to Virginia to Iowa, elected officials are taking many paths to make taxes less burdensome, but they should all bear one thing in mind: without spending discipline, sound tax policy is impossible to maintain over the long term. Government officials at both the state and federal levels have been trying for years to tax and spend their way to fiscal success. This is no way to build a stable fiscal house. Luckily, some states this year are exploring the kinds of strong budgetary rules that create the conditions for prosperity.

Numerous state legislatures across the nation will be considering tax rate reductions. Many states are running large budgetary surpluses, which represent an opportunity to return the money back to taxpayers. Unlike the federal government, most states are required to balance their budgets. Nevertheless, state policymakers are confronted with numerous demands from a variety of special interests arguing for additional or new spending.

Perhaps the best way for a legislature to protect the interests of taxpayers is to consider a tax and expenditure limitation (TEL) measure. More than half the states have some form of TEL in statutory law or (in fewer cases) mandated by the state constitution. A strong limit can help ensure that spending remains under control, especially when fiscally conservative policymakers are absent.

But not all TELs are created equal. “While there are many possible ways to limit a government’s budget, an effective limit will reflect the average taxpayer’s ability to pay for government spending, not an appropriator’s cost of providing provisions,” wrote Vance Ginn, Chief Economist at the Texas Public Policy Foundation.

Colorado has shown how this principle translates into practice. In 1992 voters there adopted TABOR (Taxpayer Bill of Rights), a constitutional amendment that limits government spending to the rate of inflation plus population growth and requires voters’ consent to increase spending and taxes. Over time, TABOR has been weakened and requires vigilance to defend in court, but it remains a powerful taxpayer protection.

Texas also has implemented a strong spending limitation. In 2021 the legislature codified a new spending limit that prevents general fund appropriations from growing more than population and inflation. This measure will not only help rein in spending, but it also creates an opportunity for Texas to lower taxes. “This change effectively puts tax relief on Texas’ permanent agenda. Policymakers can lock in tax relief by tying Texas’ future fiscal surpluses to automatic tax cuts,” wrote Michael Lucci. a Senior Fellow at the Cicero Institute.

“Given that Texas’ new spending limit passed in state law last year covers more than half of the total budget, is based on the growth of population and inflation, and needs a three-fifths vote of each chamber to exceed it, the Lone Star State has the strongest fiscal rule in the nation,” argues Ginn.

Since spending and tax limitations can take various forms, Matthew Mitchell, a senior fellow at the Mercatus Center, contends that the most effective will have the following characteristics:

  • Spending limitation formula is based on the sum of inflation plus population growth.
  • Based upon spending rather than revenue.
  • Require a supermajority rather than a majority of lawmakers to be overridden.
  • Immediately refund revenue collected in excess of the limit.
  • Written in the state constitution rather than in statute.

 

While Colorado and Texas are examples of strong spending limitations, Iowa has a weaker spending limitation in code: the legislature cannot spend more than 99 percent of estimated revenue. Thankfully, under the leadership of the state legislature and Governor Kim Reynolds, the state is following a path of fiscal conservatism and prudent budgeting, which has allowed for significant tax reform. Gov. Reynolds and both the Iowa House and Senate have come out with plans that are aggressive steps in the right direction for a flat tax. But to keep moving in this direction for years ahead, Iowa should consider making their spending limitation more durable.

North Carolina is another state that is demonstrating how pro-growth tax reform can occur if spending is controlled. This past year, North Carolina approved a tax reform measure that will not only lower their individual rate, but also phase out the corporate tax, continuing a trend begun in 2013. The Tar Heel state serves as the gold standard for state tax reform that is balanced with controlling spending.

The economic evidence is clear. States that are keeping spending levels low and reducing tax rates are creating economic growth and opportunity.

Spending limitations are policy tools that are aimed at protecting the interests of the taxpayer, while also keeping spending and taxes under control. “Politicians are forced to abide by the rules that apply to every household and business in the state. In other words, they have to prioritize,” argues  economist Daniel J. Mitchell.

President Calvin Coolidge regarded “a good budget as among the noblest monuments of virtue.” Coolidge understood the need the importance of keeping spending levels low to achieve both lower tax rates and economic growth. A strong spending limitation can help policymakers at all levels of government achieve these goals.

Pete Sepp is President of the National Taxpayers Union and John Hendrickson is policy director of Iowans for Tax Relief Foundation.