The Maryland Budget: The Experts Speak

St.John’s College, Annapolis, January 6, 2004
Reported by Linda A. Crockett, videotaped by G.Stanley Doore, conference organization by Robert O’C. Worcester

GEORGE W. LIEBMANN, Executive Director, Calvert Institute, Moderator
WILLIAM S. RATCHFORD Director, Department of Fiscal Services, 1974?1997
NANCY K. KOPP Maryland State Treasurer, 2002?; House of Delegates, 1975-2002

ROBERT R. NEALL Maryland State Senate, 1996?2003; House of Delegates, 1975-87;
Anne Arundel County Executive, 1990-1994
JAMES T. BRADY Former Director of Ehrlich Transition Team; Former Secretary of Economic Development
DONALD DEVINE Former Director, U.S. Office of Personnel Management
PETER SAMUEL Editor, Toll Road News
NINA OWCHARENKO Health Care Policy Analyst, Heritage Foundation

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EXECUTIVE SUMMARY

The speakers made both long-term and short term suggestions, among them the following:

Short term changes

Tobacco tax increases, tied to those in Virginia (10)
Enhanced filing fees in civil court cases (11)
Enhanced natural resource user fees (12)
Increases in sales tax, and in minor fees (11)
Phasing introduction of Thornton (12,43)
Tuition increases; a formula for dividing higher education costs between tuition and the general fund (12)
Increased liquor taxes (13)
A 20% increase in the corporation tax (13)
Curtailment of the health insurance program for state employees (16,20)
Higher deductibles and co-pays for employee health insurance (21)
Privatization of the Central Collection Unit (22)
Privatization of janitorial and food service in health department institutions (23,41)
Tolling present HOV lanes (26)
Privatization of airport concessions (28)
Scrutiny of economic development loan and grant programs (29)
Enhanced fees for boating and fishing in natural resource agencies (31)
Scrutiny of the tobacco farm buyout program (32)
Scrutiny of agricultural and seafood marketing programs (32)
Curtailment of housing production programs (32)
Premium bonds as a new lottery game (33)
Greater use of stadiums as conference venues (34)
Curtailment of medicaid eligibility levels (35)
Increase in medicaid co-pays (35)
Cash accounts for disabled medicaid recipients (37,39)
Capitation payments for g-p services in medicaid (38)
Debit cards for medicaid patients (38)
Half-day rather than full-day kindergartens (39)
Improvements in health-care recoveries (40)
Elimination of dubious >prevention and disease control’ programs funded with tobacco money (40)
Consolidation of state mental institutions (39)
Elimination of overlapping umbrella higher education boards (46)
Boards for individual colleges, enhanced private fund-raising (47)
Preparatory programs for traditionally black colleges to reduce dropout rates (47)
Curtailment of four year liberal arts programs at some of the traditionally black colleges (48)
Elimination of huge administrative cohort at University College (49)
Curtailment of newly created administrative and support positions in higher education (50)
Increase in assessments on lawyers (50)
Curtailment of advocacy groups in agency garb (50)
Curtailment of curriculum and exam development positions in State Department of Education (50)
Curtailment of state school construction program (50)
Scrutiny of power plant siting program (50)
Renewed attention to energy audits (51)

Long term changes:

Actuarial funding of health care for retirees (7,20)
Tying use of the rainy-day fund to repayment provisions (8)
A new tax study commission (8)
Scrutiny of higher education tenure and workload issues (9)
Reform of business taxation to tax service industries, possibly through an income VAT like the New Hampshire Business Enterprise tax (10,13)
Shift toward a defined contribution retirement system (15)
Performance standards for state employees, elimination of behavioral assessments (17)
Advanced funding of workmen’s compensation (20)
Enhanced leasing rather than building of office space (21)
Greatly enhanced contracting out (23)
Tolling all new roads (25)
Shift of economic development programs toward workforce development (30)
Focus of park acquisition on flood plains(31)
Improved insurance fraud enforcement(34)
Enhanced restrictions on asset-shifting to secure medicaid eligibility (37)
Subsidies for cooperative old-age clubs, creation of accessory and duplex apartments(36)
Qualitative education reforms, i.e.extra pay for scarce disciplines, changes in certification rules(43)
Return to hard data in budgets in place of >managing for results’ theory introduced by Glendening administration (41)
Shift in control of school spending to building-level (46)
Greater emphasis on University College distance learning rather than community colleges (49)

(3)

MR.LIEBMANN:

Structural Deficit

We will begin with the discussion of the current structural deficit, its reality and what should be done about it.

MR. NEALL: This is deja vu all over again, I think. In a large sense state fiscal policy is only paid any attention to when we have too much money or not enough. Actually, that’s wrong, because when we have too much money or not enough, we’re really not interested in policy; we’re interested in spending the money if we have too much, and avoiding difficult decisions if we don’t have enough. Very little time is spent on long-term financial planning within State government. There are really three things that I think of when you’re talking about what we do in planning government.

First of all, you have to decide what are the things that State government ought to be in the business of. The second thing you do is decide how much you’re going to spend, and the third decision is who pays and in what form. Most of the debate today is taking place on who pays. Unless I’ve been reading inaccurately, nobody says that the government doesn’t need more money. It’s just a question of where that money comes from.

The current administration would prefer slot machines. There are others who want to use a more conventional means of financing that government. But unlike previous debates on this issue, I hear very little in the form of we’ve got a bloated bureaucracy and money is flowing out of the State House like the Mississippi River and we have to extend the flow of our tax dollars. Anybody that knows anything about state finances knows that the State has a structural deficit and at least acknowledges in part that most of those expenditures are needed. To dispel a couple of misconceptions:

Unlike local governments and unlike educational institutions and institutions of higher learning, the State government’s budget is not mostly personnel. The gentleman to my right can probably quote it to the percentage point, but if someone put a gun to my head I would say it’s 25 percent or so, give or take a little. In a local government or a board of education, that could exceed 80 percent.

So it’s not people, per se, although the State does employ a lot of people, but not in the same order of magnitude as other organizations. It’s largely a series of transfer payments, one of which is a very large partnership with local government.

Mr. Ratchford, former Delegate Kopp and I were around in the early `70s when the property tax was the worst thing since the plague. I see the former director of Assessments and Taxation, who was a legislative staffer at that time. Tax assessments and money coming from property taxes were anathema to the people of Maryland. We set out upon a very concerted, conscious effort to de-emphasize reliance on the property tax, with tax credits, circuit breakers, aid to local governments so they wouldn’t have to be dependent on the property tax.

I believe the property tax increase last year was the first time probably in two decades or more where the tax rate of the state property tax was raised at all. So that was a policy. Property taxes were bad, local governments needed money, and the State responded.

This last quadrennium you had another initiative where higher education took precedence. And there was a huge infusion of money into higher education.

In fact, that’s usually the precursor to a recession because that happened in the late `90s, there was a huge infusion of money into higher education, the next thing you know the local economy was in the toilet and went to retrench. Funny thing, it happened again. I’m going to be really watchful the next time somebody gets extremely generous with higher education, although I don’t think it will be any time soon.

(4)

Then about 10 or 12 years later the income tax got to be something that everybody perceived as awful. And the legislature went through a very difficult decision and for the first time since it was imposed, the State government reduced its largest revenue source by ten percent.

Mr. Brady played a big role in that as the secretary of economic development. I had played a role in a different life. It looks like this time that we’re not talking about a tax that everybody loves to hate; we’re looking for a revenue source that not too many people are offended by.

I think that begs the question of what we do with State government. State government takes care of poor people; it pays for the treatment of sick people; it supports and helps people who are handicapped and the mentally ill; it makes a large contribution to supporting public higher education, and its principal role, which is embedded in the constitution, is K through 12 education, and right now that seems to be where the full crimp is in this public policy debate, the next large installment on our commitment to our constitutional responsibility to support K through 12 education and eliminate disparities between rich and poor subdivisions is caught up in this debate as to where we get the money.

I think that if it’s not funded in some form, then we’re going to be spending a lot more time in courthouses than most of us would like to do because there are plaintiffs out there who would love to try out the new legal buzz word which is adequacy. For years they fought us on equity, and time and time again we showed that our distribution of funds was equitable. Now they’re taking an entirely different tack, which is what you’re distributing, albeit equitable, is In adequate. That will be the next round of litigation.

Bear in mind we’re coming out of a recession. The tax structure which right now produces a $1.8 billion structural deficit, depending on where you start counting and where you stop counting, is the same tax structure that generated over a billion dollars in surplus just before this last recession happened, and before the income tax cut.

So one of the things that you need to look at is the building blocks of your revenue structure and see what is there and what will continue to be there and what is no longer there and what might have to be replaced. And if you’re not interested in replacing that revenue with what was there before or something else, then you have to look at your spending portfolio and say okay, all things being equal, we have to not do some things that were being done under the old system. And it really is fifth grade arithmetic, ladies and gentlemen.

The problem is it’s a group discussion. I’m sure if we deputized each one of you and gave each of you a piece of paper and pencil and told you to go over in the corner and come up with a solution, everybody could do that. That’s not the way it works.

You’ve got an executive that proposes a budget and a legislature that sets policy. Group decision?making can be pretty ugly and frustrating. That’s what we’re up against, a large rambunctious family discussion over where we get the money, and then once we collect that money, what we spend it on. This is a particularly difficult decision because commitments have been made and the money to support those commitments is not forthcoming.

If you decide not to replace that revenue in some form, a lot of people who thought they had something are going to lose it, and that’s when crowds start to build around the building with the funny dome and that’s when things get real interesting. It’s happened before. I dare say it will happen again, in a couple weeks, people will start to gather. It will be two things. People will go there and try to hold on to what they have. And the ones that are really audacious will go there and say not only do I want what I have, but I want a few other things.

That’s what makes Annapolis so interesting in the dead of winter. I’m hoping that cooler heads will prevail. And most of the financial decisions have always been a compromise. I’m hoping that the State takes this opportunity to look at its operation and its array of services and makes some decisions to curtail some of that, and if not curtail the actual services, maybe change the way they render those services so that they’re more cost effective.

I hope that given the State has shared generously with local governments and cut its largest revenue source, that revenues of any type are not off the table. And I hope that we’re able to forge something that stands the test of time. It seems like one of the problems with the State government is that we ignore the business cycle. It was bad for a while. Then it got better, then it got really good. When it got really good people thought that was a way of life and they started to behave that way.

(5)

Reserves

I threw what I considered a minor temper tantrum near the end of the 2001 legislative session because we spent our reserve. We spent 577 million out of the reserve fund when our little roller coaster was at the top of the economic cycle. I’m not going to say I told you so. But what I did say on the Senate floor is that it’s not our money and we shouldn’t be betting on the come with other people’s money. We have a higher responsibility. And I urged my colleagues to forgo the joy of the present to avoid the pain in the future. I can tell you, as a recovering politician, that that’s not the way to bet.

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MR. RATCHFORD: Let me focus on how the public sometimes looks at government and try to put that in some perspective. When the State faces a fiscal crisis, as it does now, the quick perception is that State government should be like a business or the State government should be like a family and live within its income. And there’s a certain compelling logic to that. But it overlooks one factor. In a business, there’s usually some connection between your revenues and your expenditures. If your business is making money, if you’re making a product and you’re selling that product, you employ enough people to make the product and you add a little bit for profit and you keep selling it; your costs are there, and you have a gap between your sales and your expenses. And so that’s good. Your product doesn’t sell, you start to cut back on the production.

In government there’s an absolute disconnect between the revenues and the expenditures. The state’s revenues are driven by the economy. When the economy is strong, the revenues are strong. You can hit this bubble that Senator Neall spoke about in the late `90s, the tech bubble that drove Maryland revenues way up artificially by capital gains, stock options and large bonuses, that suddenly disappeared. But the expenses of government have no relation to the economy. In fact, government is counter-cyclical. When the economy is good, the State expenses do not rise as much because such a large part of the State expenditures underpin the social safety net.

(6)

Whether it’s Medicaid, public assistance, food stamps or other parts of this vast array of health and social programs that the State government offers, in strong economic times the case loads go down. And what happened in the bad economic times since 2001, the case loads have gone up.

So you have this disconnect between what government does and where it gets its money. You even see it in some subtle things. The economy goes bad, more people show up in public institutions of education, be they K through 12 or higher ed. More people show up at Sandy Point State Park out here at the end of Route 50 in bad economic times because it only costs a couple of bucks to swim as opposed to going to the beach and having to pay for a room for a night. And every sort of activity the State government is involved in usually changes inversely to the economy.

So you have this disconnect between where government gets its revenues and where government does its expenditures. To reiterate what Senator Neall said, when government has a problem, the choices are pretty difficult. Do you say to the people who are taking care of foster children, we’re going to cut your stipend, because that is certainly one option that you have. Do you say to people on medical assistance, your optional services are going to be withdrawn? Do you say, as we’ve been saying to the students in the public institutions, we’re not increasing taxes, but we’re going to increase your tuition by a significant sum.

We’re shifting the cost of education to the user. Obviously if you don’t have a child in the public institutions, that may have appeal to you. But if do you have a child in the public institutions, it doesn’t. I think a lot of people overlook this total disconnect between revenues and expenditure patterns in government.

The second thing that I always hear is that government should operate like a business. But the public sector and the private sector are different. The risk/rewards that are part of the private sector do not exist in the public sector. And while the public sector should emulate the good business practices that exist in the private sector, to say that you can run government like a business is I think a false illusion that unfortunately some people tend to focus on.

To quantify something that Bobby mentioned, when you look at State government, 25 percent of the costs are salaries and benefits.

The other 75 percent of the costs are money given to other entities to provide services. As for the billion dollar deficit, what makes up 800 million of it, is aid to education, medical assistance and the other community health and social programs. That’s where 800 million of this billion dollar gap is. The personnel costs are probably under a hundred million dollars. As indicated, that’s exactly the reverse of the local level where when you pull everything together somewhere between 75 and 80 percent of costs are salaries and benefits.

So when you talk about controlling local costs, you talk about controlling personnel cost. When you talk about controlling State costs, you talk about are you going to continue to fund aid to education; are you going to continue to fund the health and social programs? In other words, it isn’t what more you’re going to do for somebody; it’s what commitment are you going to take back?

So it sets off a totally different dynamic than that which says well, if we do not give the employees as much of a salary increase or if we can shift further the health insurance costs from the government to the employee, we can solve our budget problem. It doesn’t work at the state level. It does work at the local level, notwithstanding you have the relationships of the various entities. At the state level it isn’t what we’re not going to give you; it’s what commitment has been made either in policy, or in statute, that we going to renege on in order to get costs down to match revenues.

MS. KOPP: I was going to stress, as Bill and Bobby did, this difference between A, a business and B, the State, and the fact that much of our market goes up when our revenue goes down because our market is for people who need public education, public health, local governments with all of their services, or the court mandates, and those are clearly disconnected from revenue.

(7)

There are a few documents that might be of interest to you that I would urge you to look at if you want a more full picture of where we are at this very moment. Since I’ve become treasurer I’ve had the honor of serving on a number of committees.

One of them is the Board of Revenue Estimates, which just put out its report December 17th. It gives you a good picture of both the national economy and the state economy and the impact of that economy on our revenue and our anticipated revenue.

Second, which is tied to that, is a committee that I used to chair and on which Bobby used to serve and Mr. Ratchford used to run, the Joint Spending Affordability Committee, that also this last month came out with its report. Its report is both historical and prospective and has a lot of nitty-gritty specifics about the state, and the parts of the general fund, particularly those which are subject to spending affordability, and a lot of good strong information which all adds up to the same picture but fleshes it out significantly more.

Capital Budget

Third, the report of the Capital Debt Affordability Committee, which I chair, on recommended debt authorizations. In California or a number of other states, if you don’t want to raise operating money through taxes and fees, you can borrow it. We don’t do that in Maryland. And we’re not going to do that in Maryland, and that’s one of the reasons we’re still one of only seven triple A rated states. But this report does give you some background on what our borrowing trends are and what we are recommending and where the money goes.

And one of the clear things is that we are borrowing money for things which were in the operating budget in past years because when we had the revenue bubble, we did two major things with it, one was the tax cut, which was an ongoing structural change, but the other was one-time-only pay-go capital.

To some extent that capital is being picked up through borrowing last year, this year, and next year. But we can’t borrow as much as we were spending during the time of the bubble. And one of the impacts of that clearly is going to be a reduced school construction program since a very large portion of the operating funds, the pay-go, or borrowed capital goes into school construction. That’s just one more way that things are a lot more complicated than people think.

I saw an article in the newspaper which said the Capital Debt Affordability Committee had just recommended an extra $300,000,000 to go into school construction. I don’t know if any of you come from jurisdictions which are planning on using that for school construction, but don’t do it. Because what in fact happened was the Capital Debt Affordability Committee recommended an increase of a hundred million dollars more than had been anticipated last year in order to cover a good portion of the general funds which would have gone into pay-go and cannot go into pay-go. In other words, the capital budget was not increased, the source of the capital expenditure was changed and not all of the capital expenditure will go through. That was one hundred million for this year and each of the next two years. A, there’s no 300,000,000; B, there’s no increase in the capital budget; C, there is a continued diminution of funds that can go into capital expenditures. So just in case there’s anyone here that believes everything you read in the newspaper, don’t do it.

The current structural deficit looks like 700 million, basically for the reasons that have been said before. Education funding and Medicaid, mental health. You can say that’s not true; it’s all because of the environment and a lot of other things and if you cut out all of those other programs, that’s probably true. But in fact, the rising costs and the costs that were not anticipated a few years ago are elementary-secondary education and the significant increase in Medicaid.

Reserves

Let me also say that there are other future costs which have not been built into the budget projections which ought to be, including health care for retirees which is paid now on a pay-as-you-go basis, and ought not to be, it ought to be actuarially funded; and a lot of other costs less in size, but significant, nonetheless, that are tied to demographic change in Maryland. So there are a significant number of costs that are not the result necessarily of people wanting to spend a lot of money, but are the result of having an ongoing enterprise and responsibilities tied to running that enterprise, like your employees. The rainy day fund is still where it should be. It has not been depleted.

(8)

The Spending Affordability Committee recommended that the rainy day fund is there to spend. It is not there simply to be there. But it is to be spent only under certain limited circumstances, one of which is as a bridge to ongoing spending, because it’s one-time-only, and secondly, tied to repayment provisions. I believe that if it is used in that context going into it will not impair the triple A bond rating and will be seen as prudent, but only under those circumstances.

Unfortunately at the moment we don’t seem to be in that situation. Most of the reserves beyond the rainy day fund, have been cleaned out. There’s not a lot of other places to look at. One of the reasons I believe that the University System of Maryland’s bond rating has been put in question now is because significant reserves were removed from the University in the last two years in budget actions, and they are now holding back and going to the bond market and borrowing money because they don’t want to do it at an increased cost.

The spending affordability guidelines are just out. They have been set this year at 4.37%, which is less than we anticipate the increase in personal income to be. That’s 4.6%. But it still allows for an increase of about $630 million, on an amount of $15 billion which is that part of the budget which is covered by spending affordability. I would be surprised if the governor comes in with a budget that is under spending affordability. I would also be surprised if the legislature does not pass a budget that is under spending affordability. That has been the pattern for the last 21 years.

There’s only one year since 1982 in which the budget that was passed was above spending affordability, and that was 20 years ago. I don’t think that’s going to happen. But it’s going to be very difficult and if in fact revenue estimates come in higher in March than they are now, and that is a distinct possibility, although it probably won’t be a lot higher, that may change the dynamics somewhat. The general picture for the state is that the economy is improving. The economy was never as bad as the national average. But nonetheless, while sales tax is somewhat up and seems to be on an incline and income tax has leveled off and seems to be on an incline, this does not necessarily translate into significant state level increases. Unfortunately we had a commission that was looking at the state revenue structure two years ago, and was supposed to have another year of continued life, and it was ended before that second year. And I think that’s unfortunate. Because as we come into the 21st century, clearly the economy is changing. The structure of the economy has been and is changing.

It seemed to me appropriate to look at how the tax structure that we’ve inherited reflects change in the economy. I think that’s going to happen. It’s just not reasonable for it not to happen. But when it’s going to happen is not clear. At any rate, our tax structure does not track the economy as closely as it used to. And that’s one reason why you are going to see the improved economy not reflected fully in tax revenue, and therefore, not an answer in and of itself. You can’t just say wait and the economy will come back and everything will be fine.

The other complication in terms of our budget is we’re not the only ones who decide it. The governor and the legislature, and the courts are involved too, and while people can say let’s halve Thornton public school expenditures, at some point it is quite possible that it will be back in the courts again and somebody else will decide for us.

I say this not only because the Bridges to Excellence bill was passed in the context of a court situation, but also because this is happening in many other states across the nation. And it’s just part of modern American educational life that you don’t just go to the classroom; you go to the courtroom also.

Capital debt affordability I did mention. We have two guidelines for capital debt affordability. One is that the amount of money outstanding shall not go above 3.2 percent of state income, and the other is that debt service should not exceed 8 percent of the general fund budget. We are significantly under both of those guidelines.

MR. LIEBMANN: In organizing this program I endeavored to center it on three people who have been a large part of the explanation for the fact that Maryland, very unusually among the states, has in the past been a very liberal state in its economic and social policy, and at the same time has been able to maintain fiscal soundness. Jim Brady and I are here to ask questions about what in the past has been a consensus position in Maryland and to inquire as to whether there are things that need to be changed of a more fundamental nature than simply patching up for another year and waiting for the turn of the business cycle, or attempting to adjust broad-based taxes to whatever deficits may appear to exist.

(9)

Let me call on Jim, and then after he says a few words, what I would like to do is put up on the screen the main revenue sources and have the panel’s reaction to the prospects for each of them.

MR. BRADY: Whenever the State budget is discussed, the enduring question that seems to come out is the relationship between private sector business and state government. It is a fascinating topic and one that I would posit most business people are fairly naive about. I think Bill Ratchford’s comment about the disconnects is very much on target.

And I think the notion that you can just simply apply classical business concepts to state government, or any government, for that matter, and make it all work, is an illusion that is quite dangerous. Having said that, I would also posit that there are many things that come out of private sector business that can be used very effectively in state government. And I would also argue that in most cases those are not applied nearly with the laser-like effectiveness that one would like to see. And I say that also with the realization that in state government you’re dealing in a political environment that sometimes make laser-like implementation a little more difficult than it might be in the private sector.

But there are real relationships between the private sector and state government that I think need to be dealt with. There have been some comments made about the tax cut from a few years ago and let me be clear on this point, that the purpose of that tax cut was not to try and deal with a budget surplus by distributing it to the stockholders. That cut was all about competitiveness and trying to make Maryland economically competitive in a way that would allow it to produce revenue streams in the future that would be appropriate to fund the needs that the State has as a public entity. That was what it was about, and I would argue, hopefully not defensively, that it actually was quite successful in making all that happen.

I think Nancy made the comment that during this recession or whatever the word of the day is to describe it, Maryland did not suffer as much as other states. And I would argue that the tax cut was a factor, and I don’t mean to overstate that, in making Maryland economically competitive and allowing it to be successful during that period. I think there’s a real relationship there that makes sense. The issue — and Bob touched on this, is this whole issue about cost. Somehow in state government the notion that you can reduce cost is looked upon as an anathema, oh, my God, where are they going with that one?

The fact is one of the lessons that I think comes from the private sector is the fact that when you do have a budget problem, the first thing you look at is the cost side in trying to ensure that the dollars you’re spending are being spent appropriately at the right amounts to accomplish the objectives that you have. A perfect example of that to me is higher education.

Higher Education

I find it almost impossible to understand how anybody could look at higher education and say there is no possibility of reducing the cost of providing public higher education in the State of Maryland. There are a lot of sacred cows in higher education, whether that relates to tenure or professor workload or any of those issues, that somehow are issues that people find it very difficult to address in a meaningful way.

Well, it’s 2004 now. It’s not 1804. It’s time to look at how we deliver those services in the context of today’s world. And I don’t believe that higher education has looked as microscopically at the cost side as it needs to to determine just what the right cost level for rendering those services is. I use that only as an example. Because I don’t think it makes any sense for state government to be in a mode of saying we have a deficit, what revenues are we going to generate to deal with that deficit, until you have looked very intelligently at the cost side and made sure that what you’ve accomplished on that side is everything that makes sense. I agree with Bob a hundred percent, that that’s a piece that really needs to be looked at. When you get down to the revenue generation side, that gets to be a rather interesting argument that we’re going through hot and heavy in the State of Maryland right now.

(10)

Where business concepts do make sense, is in looking at deficits in a very holistic kind of way, looking at the cost side first before you start looking at generating revenues in a way that could ultimately be counterproductive, because when taxes are raised I think there are implications to that. I think there are unintended consequences at times that I think have to be looked at very, very carefully.

MR. LIEBMANN: As I indicated, we will proceed to a discussion of the revenue side. I think the notion has gotten abroad in the land that the strategy of the present administration for narrowing the gap as far as revenues is concerned is composed of a combination of prayer and slot machines.

User Charges

That involves a fundamental misunderstanding of what seems to have already taken place. What one sees thus far is a movement from conventional taxes in the direction of user charges of all types. And you see at least four straws in the wind in that respect. The first is the increased use of tolling for transportation improvements. There has already been quite unobtrusively an increase of roughly a hundred million in annual bridge tolls and the possibility of those even on existing structures have not been exhausted. You see increased resort to tuition revenue.

And what’s happened in Maryland lately rather closely parallels a debate that’s taking place now in Britain, where the government, in this case a Labor government, has come to the conclusion that the consequence of having mass higher education is that higher education takes it in the neck in the budget in every recession unless it’s funded by users, and for that reason, to preserve the quality of their universities, they are turning to tuition payments to a degree that they haven’t before.

There are two other areas. There’s the so-called sewer surcharge or flush tax that the administration has proposed. And there is in addition the proposal of the Hellmann Commission for a surcharge on traffic tickets. And I don’t think you’ve heard the end of user charges as a revenue source. I would be very surprised if there aren’t more of them in the budget. And as we move through the discussion today, it will be interesting to speculate where they might be imposed. But it seemed to me that it would produce some understanding to put on the screen the major state revenue sources so that you get some idea of where the possibilities for increase are and get our panelists’ reaction to the use of each.

Business Taxation

As was said, the state property tax is quite limited in this state. And the property tax on business personal property resembles a piece of Swiss cheese; it’s full of exceptions, it’s expensive to assess and no one thinks that it is the wave of the future.

Another rather striking thing is the relatively limited income from business taxes, including the corporation tax. The yield of the corporation income tax last year was about 440 million. It has become less important over time. It rather closely tracks the federal tax and for a variety of reasons the federal tax has become less important over time.

There’s also one other feature that I think may be important, and that is that it tends to bear more heavily on manufacturing than on service industries, and I think maybe one of the things that needs to be looked at is how the State can more adequately tax service industries, given the movement of the economy in the direction of service industries. Your typical service business can regulate its affairs to have no income at the end of the year. Your typical manufacturing business finds that more difficult.

Sales Tax

There is a sales and use tax. The United States and Canada are the only places in the world which have sub-national sales and use taxes. And the reasons most countries don’t is the border problems. We are surrounded by states which have varying practices with respect to sales and use taxes which rather severely limits what Maryland can do in that area. In addition to that, there’s the new problem of the Internet which erodes that base. The income tax, also as Jim indicated, is somewhat constrained by our neighbors. The Virginia levels are lower; Pennsylvania has what is essentially a flat tax. The Maryland tax is now essentially a flat tax, but at a higher level than that in Pennsylvania. So there are constraints which operate there.

Tobacco Tax

The tobacco tax, which has been increased in recent years, has been constrained to some extent by the fact that the State of Virginia has the lowest tobacco tax in the country and the only thing that has preserved us against massive bootlegging may well be the congestion on the Washington beltway. But the Virginia governor is now talking about a 25 cent increase in the Virginia tobacco tax and about allowing localities to impose 50 cents beyond that. What Maryland can do will in large part depend on what Virginia does.

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The beverage taxes have a very limited yield. So that’s your array of major taxes. And what the administration has been doing, leaving aside the transportation area that we will discuss later, is looking at a variety of other revenue sources that generally are not thought of as major sources of revenue, that essentially are user charges of one sort or another. And as I’ve said, I don’t think that that exercise is by any means over.

Court Filing Fees

Let me give one rather humble illustration. The filing fees for civil cases in this state are $80. The filing fee for a civil case in Pennsylvania is $160. In Virginia it’s somewhat higher than in Maryland. In California it’s approximately $300. The national average is around $160 or $170. There were 178,000 circuit court civil cases filed last year. A hundred dollar increase would yield somewhere between 15 and 20 million dollars. There are a variety of other fees that just haven’t been adjusted over the years.

The Department of Natural Resources used to be more substantially funded by user fees than it now is because many of the user fees just haven’t been adjusted for inflation. Some of the bridge tolls that remain unchanged have not been adjusted in recent years. It will be interesting, as we go through, to discuss those possible revenue sources.

Having made that point, let me turn to the panel and let us have their reactions to the various major State taxes and other revenue sources which might usefully be increased and which might not.

MR. NEALL:

Broad-based Taxes

Well, before we get into a rhetorical, let’s try to be factual. The sales tax rate was last raised when I had all my hair and Nancy’s was distinctly a different color. We were both freshman delegates in the General Assembly. Let me tell you, that wasn’t yesterday. That was 1977. And on top of that, as I think George alluded to a little bit, the legislature has made that tax somewhat Swiss cheese from a series of things as important as exempting manufacture and equipment from sales tax, to the ridiculous not taxing medicated pet food, and everything in between.

On the income tax, the income tax was imposed when Mr. Ratchford was a young man and traipsing around the State House complex, and that’s been changed once in its history, downward in the 1997/1998 time frame. The gasoline tax, which I understand you’re going to talk about later, but the gasoline tax historically has been raised every four or five years, largely because it was a per gallon tax not based upon the price of the commodity.

So you ended up having to raise it from time to time just to recover the purchasing power of the money. If my memory serves me correctly, it was last raised in 1992 in the middle of the last recession. And I think it was raised in `87 as well, a nickel a pop, I believe. So it’s been over a decade since that revenue has been adjusted. And I would suggest to you that two things have made that possible. One is the invention of the sports utility vehicle which costs significantly more than a typical four-door sedan, and I dare say consumes considerably more gasoline. Gasoline consumption in this state flattened out which meant that our revenue flattened out. These vehicles consume considerably more fuel, hence you pay more tax.

People always go to fees in the absence of having to step up and face the “T” word face to face. And even so, there are lots of fees that get neglected over time. When I was running a nearby local government there were fees that hadn’t been raised since the inception of the government. We had a lot of $5 and $10 fees. We took care of that and we raised them and there was a lot of sticker shock. Just as a general fundamental principle, a fee is supposed to cover some portion of the cost of the service being provided. If it provides more than the cost, then it’s not a fee; it’s a tax. So you have to balance what you’re charging against the value of what’s being provided. But you should look at them regularly and raise them regularly.

And I can assure you that a five or ten percent increase from time to time is a lot more palatable politically than saying we haven’t raised this fee, we’re going to raise it ten percent. That gets into long range strategic planning to know where you’re going and how you’re going to get there.

Corporation Tax

The corporation tax is low, I think by national standards, and it isn’t all credited to the general fund. 25 percent gets taken right off the top and is given to the transportation trust fund.

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Gasoline Tax

So a lot of times it isn’t the State tax per se; it’s what happens to it once it’s collected. The gasoline tax and some of the other transportation revenues are good examples. We get somewhat less than two-thirds of that. I say we, the State, because the rest of it is distributed to local governments to help them with their transportation programs. One of the less charitable suggestions I had when I served on the Hellmann Task Force is maybe the next gas tax should be a State gas tax, and the State should keep all the money because it needs it. That was not met with universal affection by the folks at MACO and the Maryland Municipal League. They want their 35 percent or whatever it is.

And then what happens when the money gets distributed? It seems to me that in the `80s Money Magazine was calling us a tax hell. I didn’t agree with it entirely then because they were using some of the most ridiculous comparisons. But, you know, perception is reality. I don’t think that Maryland is per se a high tax state, and further, when you consider what we do at the state level to reduce local governments’ dependence upon the property tax, (and property taxes create state tax hells in other states), when you combine the two, we don’t look so bad and it’s balanced and fair and to a large extent progressive.

So as long as you look at the big picture and as long as Mr. Brady so correctly put it, be mindful of unintended consequences and not make your decisions in a vacuum, notwithstanding all the political hot air that goes on about not raising taxes and everything else, you can make a sound fiscal decision by raising revenue. And you can do it strategically and smart and effectively. But the legislature finds that it’s a lot more fun to give money back than to ask people for it. If you just take the Annotated Code, the tax section, you can look at some of the things the legislature has done probably advocated by a lot of people in this room which has eroded the amount of money that the State could collect fairly.

Income Tax

Now George mentioned Pennsylvania and said that they have a lower tax rate than the State of Maryland. Well, I don’t follow this stuff as closely as I used to or I should, but I believe that theirs was 2.8 percent on your gross income before all those deductions. Ours tracks the federal tax form. You do your federal taxes first and when you get to your taxable line, that 4 percent or whatever the charge is applied to that. Well, I would submit that 2.8 of the gross may in fact be more than 4, 4 and a half percent of what you get when you get through all of the deductions and allowances.

So you have to compare apples to apples or you’re going to do like Money Magazine and declare somebody an excessive tax environment and have to spend a lot of time and effort dispelling that. It’s awfully hard to disprove something that gets published over and over and over again and sent to millions of households.

MR. RATCHFORD: When you’re looking at, whether you are going to increase taxes, part of the issue becomes what are you trying to sell? If you’re dealing with a $50 million issue, you can visit fees; you can take a look at a variety of ways of getting there. The situation the State finds itself in as it looks at the `05 budget is you have this big hole, but looking ahead, this hole continues for two more years — actually, three more years. And the reason is Thornton is a stepped-up program until fiscal `08.

You look at fiscal `09 and the State literally lives within its means, so to speak. Because once Thornton is fully funded an annual increase will be driven by enrollment and probably some factor for inflation which will probably make the increase in the magnitude of 2 percent or 3, at best. Whereas now in this year and next year the increase is up around 9 and in one year 10 percent.

So if you’re talking about trying to find a plan that focuses on solving the long-term situation, you’re not going to make it on fees, on small adjustments in modest taxes. You’re looking at the sales or income tax and gambling; the slot machines. You can reduce spending to some extent, but these numbers are of the magnitude that you can’t get out of it, and you can’t get out of it with slot machines alone if you assume slot machines are going to generate somewhere around 600 million a year, which was sort of the ball park number that was being used last year when the debate was on.

Tuitions

So part of it looks at what it is — what you’re trying to solve, or else you have to come back into the other side of the equation and say — yes, we’re going to constrain cost in higher education, but we’re also going to have a policy of altering the current sharing between tuition and State funds .If it is somewhere in the magnitude, let’s say for sake of argument it’s 50/50, you’re going to move it somewhere. You’re going to move it from 50/50 to 40/60, or somewhere like that.

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But your problem looking long term is not going to be solved by either the fees or increasing the liquor tax or increasing even the corporate tax by 20 percent, which would bring in some money, but it doesn’t bring in the magnitude you need.

Interestingly, the last time the legislature was embroiled in something of this magnitude goes back into the `60s when it totally revised aid to education. It increased taxes by 350 million dollars. You say, well, that’s not such a big number. That was 25 percent of the then budget. So you would be talking about increasing taxes by 25 percent of the general fund, that’s 2 and a half billion dollars. No one is talking about that. That, believe it or not, was done under a Republican governor, too. Strange how history rolls around if you’re around long enough to roll with it.

Internet Sales Tax

MS. KOPP: Let me make one point. There is action going on now across the country to establish a compact among states, a simplified sales tax directed at Internet sales.

But the point of it is to simplify the application of the sales tax to get perhaps a single tax per state. Maryland is a lot closer to that than most states because we don’t have a local sales tax. And a single set of definitions of things to which the tax is applied, which is a very tricky thing. But very significant progress has been made on that. A number of states have joined the compact. So I’m not sure that we’re not going to see some action, not in this year, and certainly not in Maryland alone, but some action on the sales tax, despite the problems that you pointed out.

Income VAT

MR. LIEBMANN: Let me just throw out one question and that is there is a tax in New Hampshire, the Business Enterprise Tax, that was conceived in part as a substitute for the business personal property tax, which as you said is full of holes. And essentially it is a gross receipts tax or income VAT which applies to wages, profits, and dividends. It’s a very simple tax. It picks up the corresponding lines of the federal return.

It was imposed at a quarter of one percent initially and I think it’s up to three quarters of one percent. It’s a payroll tax plus a profits tax. The one great advantage it seems to have is it’s a way of taxing service industries, and the sales tax is not effective with respect to service industries. Any effort to extend the sales tax to service industries would as a political matter produce a deafening uproar. While I appear to be a low tax person and from what I’ve said thus far, it seems the whole area of business taxation is an area that requires more careful study than it has received.

There’s one further point that deserves to be made about user charges. That is, the capacity of all governments and particularly sub-national governments to engage in redistributive taxation isn’t what it once was, both because of improvements in transportation and communications which render competition from other states more feasible and perhaps more important, again, the movement of the economy toward service industries which makes it very feasible to outsource to the other end of the country, let alone the other end of the world, the rendition of services of all kinds.

So we are under constraints with respect to redistributive taxation which didn’t exist 30 or 40 years ago.

MR. BRADY: I’m not sure whether the New Hampshire model is the right one or not. But I do think that what we have now is tax policy as it relates to corporations which is based upon a business model that is outmoded. I mean, it just doesn’t exist in the same fashion it existed when that public policy was first devised. I think what we really need to do is make sure that there is a connection between taxation and what the realities of the business world are.

I’m very concerned about manufacturing well beyond the State of Maryland. I think it’s a fundamental question for the entire country to deal with. And what we have created through our tax system is almost a disincentive to manufacture. Obviously the economy, with the information age, has become a service-based economy. And I’m not sure there’s any state that has adequately addressed that. I think some have tried. But I don’t know that any of them have adequately addressed it. It does get to the whole competitive issue, without question, but I think someone has to take the lead in looking at this and coming up with answers that make sense.

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As to the issue about where Maryland stands as a high tax or low tax state, the only thing I can tell you with absolute certainty is that Maryland ranges somewhere between 1 and 50 in terms of where it stands from a tax standpoint. And I can tell you, whatever number you pick between 1 and 50 someone can come up with a very apparently intelligent analysis that would tell you that it’s 47 or 7.

But I will tell you the one thing that is clear to me that comes out of all that analysis is that anyone who comes to the conclusion that Maryland is not in the top quarter of states in terms of taxation I think has gone through a flawed analysis; whether the number is 1 or 12 is another question. But this state historically has been a high tax state and that is something that we have to deal with from any number of points of view.

As Nancy indicated, we have to fund important things that the people of this state have committed to, and we have to come up with ways to do that. But we also have to retain a competitive situation in a world that is increasingly competitive. And that balance is what we all struggle with. But whatever we do, however we look at all of this stuff, I think we have to continue to keep in mind that how we are perceived is not unimportant in the last analysis. It doesn’t mean that that drives every decision we make. But it has to be a very important element in whatever decision you do make.

MR. LIEBMANN: We’re now going to be talking about some government-wide issues, issues relating to things such as pensions, collective bargaining, the health insurance program for State employees, State procurement, State policy with respect to collection of accounts, property management and disposition, leasing, and so forth. And in order to develop some perspective on this, some perhaps unfamiliar perspective from a Maryland point of view, we have as our first speaker Don Devine, who was head of the U.S. Office of Personnel Management during the Reagan administration, was heavily involved with the redesign of a number of federal employee programs, including the program of health insurance for federal employees. He has held a number of academic positions, originally at the University of Maryland and is a resident of Maryland.

MR. DEVINE: Coming from a totally different level of government, I am by no means an expert on Maryland personnel. But I do have a 30-year-plus experience in Maryland, and as a sacrificial lamb for State Comptroller many, many years ago, almost as much a sacrificial lamb for Steny Hoyer a few years back. This is the state I love and I do follow it somewhat.

Personnel Policies

The personnel items in the [2004] budget, which I guess is our jumping-off point, are pretty simple to summarize. First, there are no pay or merit increases in the proposed budget for the State employees. Second, there’s going to be no State match for the employees’ contributions to the [State Deferred Compensation Plan], which I guess employees will look at as negative. On the more positive side, there was a proposed 115 million dollar contribution to the health benefits plan without any increase in employee contribution.

The next item was a pledge of no job losses, continuation of the hiring freeze, and proposals to eliminate 1387 vacant positions. That’s pretty much the outline of it and I guess if you’re an employee or a union head it probably doesn’t look too positive.

I will start where Bill did earlier, on the question of government being different than the private sector, and although I would have some different conclusions, I think it’s very clear that it is different from the private sector. Bill talked about the demand side, and it is different there. But on the management side it’s extremely different.

Roy Ash, who is a former Fortune 500 chief executive and also Director of the Office of Management and Budget several years back said that government management is fundamentally different From that in the private sector. He said going from the private sector to the public sector isn’t like going from softball to hardball in baseball; it’s more like going from baseball to ice hockey. It’s a lot more of a contact sport, a very different kind of game.

It’s very simple; it’s politics. It’s driven by political forces rather than driven by forces to make a profit or any other kind of human motivation. The most different parts of it, Ash said, are two things. First, your competitors serve on your board of directors, that is if you’re the governor your competitors serve in the State legislature, which from the private sector looks like a board of directors and we know in some ways is much more powerful than a board of directors. In Maryland that’s compounded by the fact that your opponents actually have a majority in both houses of the State legislature, so that obviously is going to make how you run the system very different.

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And the second major difference, the one I’m going to focus on today, is that your employees are on your board of directors too in the sense that they vote, and not only do they vote, but they’re among the most active citizen participants in the state. I remember when I ran for office it always amazed me, I would go to a community forum and it would turn out that about 60 or 70 percent of the audience were either State employees or State contractors or federal employees or federal contractors, or local. Why? They’re the ones that are most interested in what’s going to happen with the government. It’s a very important part of what they are as human beings.

So this fact that they are part of your governing system explains a lot about how the government actually operates. It’s the same, although with different degrees, whether it’s federal or state government. For example, let’s look at the budget claim that there is a freeze, a hard freeze, as it says, on employment. Well, you read through it, you actually find out there are going to be 431 new positions added, public defender, University of Maryland, the State Department of Education, and you might leave it there, but then you go a little further and you find there are going to be 412 new contract employees.

So, as a matter of fact, there’s going to be 843 new employees added, whereas we talk about having a freeze. Also, if you look at the figures on the hiring freeze, it’s supposed to save $26 million It isn’t any real saving from where you were or where you’re going. And the cutting of the positions saves $9 million . Cutting 1387 positions, well, of course those positions weren’t budgeted for before, almost all of them, so you are really not saving very much money.

So the first thing is that the hiring freeze isn’t quite a hiring freeze. And of course, it doesn’t count at all, the private contractors and their employees who do State business, or local employees who are being paid by State funds in effect as distributions to the local government, and many of the county governments are adding employees. So the picture is not quite as dim as first per

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