Curing Misperceptions: The Calvert Cure and the DLS Rebuttal

Though conservatives have long been aware of it, many of Maryland’s opinion leaders seem blissfully unconcerned about the state’s traditionally casual approach to the cost and size of government. State and local combined personal income taxation is among the very highest in the country, a fact that has elicited remarkably little interest among the intelligentsia. This is despite a 1995 warning by the Glendening administration’s own secretary of business and economic development, James T. Brady, that the state’s confiscatory income-tax policy serves as a “red flag” to businesses.1 Regardless of Brady’s efforts, Free State tax critics – long the butt of ridicule among the “in” crowd – have generally been relegated to the sidelines of the policy debate. We are pleased to report that, to a degree at least, this has changed in recent weeks.

In August, the Calvert Institute released a comprehensive guide for reducing personal income taxes in Maryland, a summary of which follows. With fiscal issues returning to a position of prominence in the current gubernatorial campaign, and with considerable media attention having been devoted to the institute’s study, we are pleased to report that tax cuts are back on the agenda.

Called “The Cure,” the Calvert report identified spending reductions and interfund transfers of $870 million in the first year and $634 million annually thereafter.2 We recommended that these savings not be sunk directly into tax reduction. Rather, we suggested that the moneys be used to reduce state general-obligation debt, with the resulting decrease in debt-service payments used to finance tax relief. Many of the program cuts we recommended were cuts or efficiency enhancements already touted by various state entities (usually the General Assembly’s Department of Legislative Services or its predecessor, the Department of Fiscal Services).

Secretary Brady resigned last spring, and virtually no headway has been made on his agency’s recommendation that state income taxes be cut by 25 percent by 2005.3 Governor Glendening’s much-publicized 10 percent cut in the rate of income taxation has turned out to be no such thing. After the General Assembly got through with the bill in 1997, the scope of the rate reduction had been whittled down to five percent.4 The fact is, discussions of fiscal policy in Maryland revolve almost exclusively around questions of revenue. Expenditure reductions are rarely mentioned. The governor’s current, modest tax-cutting program, for example, has been financed entirely through revenue surpluses. No program cuts have been announced. Yet, without structural program cuts, the reduced tax rate will not have been institutionalized, for what will pay for its continuation once the surplus has evaporated?

Meanwhile, the state continues to run up debt on stadiums and the like. By the end of fiscal 1999, the cumulative debt will stand at $3.5 billion, necessitating $418.5 million in debt-service payments. By 2007, the debt will be $4.5 billion, requiring $633.5 million in maintenance payments.5 This is not discussed in polite society, although Maryland’s per capita “full faith and credit” debt is the highest in the mid-Atlantic region and the 11th-highest in the nation6 (and although almost one of every two dollars spent by the state is mandated by law and thus relatively little scrutinized).7 This is the Annapolis way.

By way of a cure, the Calvert Institute’s report serves as a road map for tax relief and a pointer to the program cuts necessary to finance it.

Credit Card

As any credit-card holder knows, paying off your outstanding balance reduces your monthly minimum payment. The Calvert plan works in the same way: Reduce state reliance on debt and return the money saved on debt-service payments to the public in the form of tax cuts. Over the course of eight years, the Calvert plan could leverage funds for cumulative tax cuts of hundreds of millions of dollars, though the precise annual distribution of these cuts would depend on the timing of defeasing (buying back) the debt. This in turn would depend on the schedule by which bonds became callable.

To pay for the plan, the Calvert report identified a series of program cuts and interfund transfers worth $870 million in the first year and $634 million a year thereafter. As mentioned above, many of these recommendations had been previously identified by various government agencies. This was probably the most disturbing aspect of the findings: not that the state annually squanders millions of dollars on programs of doubtful worth, but that it does it in the full knowledge that it is doing so. To be wrong in ignorance is one thing; to be wrong and fully aware of it is entirely another.

Some highlights:

School districts’ “over billing” of Annapolis for intergovernmental funding for nonexistent students. This apparently ranges from $10.3 million by Baltimore City to $28.5 million by Montgomery County, as demonstrated to legislators repeatedly by their own Office of Legislative Audits. The state should audit all school-district claims, for possible annual savings of $179 million.
State agencies’ “over billing” for nonexistent employees. By minimizing expected vacancy rates in their budget requests, agencies receive millions more than they are properly entitled to. Again, this was publicized years ago by some legislators, only to be ignored by the rest. Agencies should be forced to utilize historical precedent to project vacancy rates, reducing annual salary appropriations by some $93 million.
The state’s excessively cautious assumptions about the rate of return on investments held by the pension funds. This forces the state to budget more cash to the retirement funds to “make up the difference.” Calvert suggested increasing the actuarial rate of return – that is, the projected return on investments – from 7.5 percent to 7.75 percent. This would enable lawmakers to reduce the annual appropriation by $152 million a year, which could be used to reduce debt, in turn leveraging tax cuts.
In addition to the regular Maryland State Retirement Agency, the state funds an entirely separate Teachers’ and State Employees’ Supplemental Retirement Agency, even the name of which implies its superfluous nature. This duplicative agency should be terminated, for an annual savings of $1.1 million.
The little-known Maryland Independence, the gubernatorial yacht. There is nary a word about this vessel in the annual state budget. Nonetheless, its upkeep costs Maryland taxpayers over $200,000 a year. Its sale value is only about $150,000, which is less than the estimated cost of the repairs necessary to bring it up to Coast Guard safety standards. The boat should immediately be auctioned off “as is” to the highest bidder.

The list continues. But taxpayers’ patience should not. The path to over $1 billion dollars a year in tax relief is now illuminated. There is no excuse.

Line Items

No excuse, that is, other than that presented by the Department of Legislative Services. In September, the DLS released a 17-page rebuttal to the Calvert Institute’s report.8 The DLS is the legislature’s supposedly neutral accounting agency though, as the Washington Post pointedly observes, it “answers to the Democratic-controlled General Assembly.”9

The DLS rebuttal is instructive in two respects. First, its 17-page length indicates that Annapolis takes “The Cure” very seriously indeed. Second, and perhaps more interestingly, the DLS only really takes aim at five of the institute’s total of 39 recommended actions. It is valuable to parse the five individually.

Local Education Agencies

First, the DLS takes issue with the institute’s claim that local education agencies (LEAs) over bill the state by millions of dollars a year. It is all a big misunderstanding, says the DLS. When the legislative auditor said of the LEAs that his research found “instances of students who were ineligible to be counted as enrolled,”10 that was not what he meant at all. The Calvert Institute “misinterpreted” the auditor.11 The problem, apparently, is missing records, not missing children. It is not that the LEAs are inflating their head counts. Rather, it is just that they do not have records for all the pupils they claim – a different matter altogether, you understand. “For the most part, the auditor’s findings are a documentation issue,” says the DLS.12

This is a generous interpretation of the auditor’s report. It also seems likely to be an inaccurate interpretation. In fact, for school year 1994-95, the auditor specifically differentiates between incorrect enrollments and incorrect record keeping: “The sample results included instances of students who were ineligible to be counted as enrolled as well as students for [whom] necessary documentation was lacking” [emphasis added].13 For its part, the Maryland State Department of Education (MSDE) agrees that the auditor’s report “clearly indicates that there are errors in reported enrollment figures.”14 The auditor encountered instances of students’ being counted twice and cases of students’ being counted who did not meet minimum attendance requirements.15 The auditor also uncovered – in Baltimore City – one instance where a dead student was counted by the city LEA.16 Finally, the auditor concludes that these were not isolated occurrences; his investigations revealed that similar LEA claims had been made in school years 1992-93 and 1993-94.17

So concerned is the auditor over the issue of inaccurate enrollment statistics that he recommends that the state take action to recover moneys distributed to the LEAs on the basis of the figures submitted by them: “The Department [of Fiscal Services] should make applicable recoveries as warranted.”18 If this were truly just a matter of some lost paperwork, it seems unlikely in the extreme that the auditor would request the return of funds. Excerpted from the auditor’s report, exhibit 1 says it all: Considering the “significance of the findings” and the “degree of severity” of the LEAs’ errors, “recoveries” should be made.

The DLS originally took this matter seriously, as evidenced by its March 1997 assessment of the auditor’s report that “numerous students were improperly reported as enrolled (e.g., never attended school, counted twice).”19 Despite the gravity of auditor’s report and the DLS’s initially solemn spin on it, the two task forces appointed by the legislature to examine the issue were dominated by representatives of the LEAs (nine out of seventeen and six out of ten members).20 No financial recoveries have ever been made.21 John W. Johnson, chief of the MSDE’s audit office and a member of one of the task forces, declined to comment to the institute.22 He referred us ultimately to A. Skipp Sanders, deputy superintendent for administration. According to Sanders, a pilot program will be started this year in Allegany, Charles, Frederick, Montgomery, Prince George’s, St. Mary’s and Wicomico counties, whereby the LEAs will experimentally have to adopt a new method for counting enrollment.23 There has been no other action. Figure 1 shows that there have been no noticeable dips in enrollment trends since the auditor’s report. (The black lines represent the LEAs’ reported enrollment. The gray lines represent the approximate dip that would result if adjustment were made to account for the auditor’s minimum estimates of LEA overstatement.)

Just a matter of paperwork? You decide. If there has been a misunderstanding of the auditor’s report, we suggest that it has not been on the part of the Calvert Institute.

Pension Benefits

The DLS next addresses the institute’s recommendation that the projected rate of return on pension-fund investments should be increased from 7.5 percent to 7.75 percent, thereby reducing annual appropriations needed for the fund by $152 million. The DLS does not dismiss the idea out of hand. Instead, it points out that a similar action was taken by the legislature in the 1998 session to pay for Governor Glendenings’s election-year pension-benefits enhancement for state employees and retirees.24 The assembly raised the return assumption even beyond Calvert’s suggested level of 7.75 percent, taking it to 8.0 percent. In colloquial terms, the DLS’s contention is: Calvert’s was not a bad idea, but we’ve been there, done that and spent the money. (The institute itself noted the increased benefits, though our contention was that the state’s taxpayers were a “more deserving case.”)25

However, the DLS’s implication is that the pension-benefits increase devours all the funds freed up by the increase in the actuarial assumption, thus leaving none to leverage tax cuts through Calvert’s debt-reduction plan. In fact, this is inaccurate. The DLS predicts that the cost of the pension increase will be $121 million a year.26 The Calvert Institute calculated that raising the actuarial assumption from 7.5 percent to 7.75 percent would release $152 million. So raising it to 8.0 percent, as the assembly has done, should release about $304 million a year. Therefore, even after subtracting the $121 million necessary for the pension increase, there should still be $183 million available every year for debt reduction ($31 million more than Calvert’s original plan). In short, contrary to the DLS’s implications, the money has not all been spent. If it is not going to debt-reduction or tax relief, we would like to know where it is going.

Police Merger

The DLS next calls into question the institute’s recommendation that the state police force and the Department of Natural Resources police force be consolidated for savings of up to $34.9 million a year.27 Our savings projection was based on a similar merger recommendation made in 1993 by the then-speaker of the House of Delegates, Democrat R. Clayton Mitchell, Jr.28 The DLS objects that the merger would be (a) difficult and (b) not as cost-efficient as anticipated by Speaker Mitchell. This may very well be, but it is not clear why either “a” or “b” represents a sufficient reason not to try.

Department of Aging

Of all the institute’s recommended cuts, none has engendered more impassioned outcries than the suggestion that the Department of Aging have its responsibilities transferred to the Department of Health and Mental Hygiene (DHMH). One need only look at the “Letters to the Editor” section of this publication. Most of the uproar has revolved around the institute’s claim that the Department of Aging has the highest average salaries of any state agency. Apparently, this is not in fact the case. However, asserting that the agency should be retained simply on the strength of its not having inordinately high salaries is, as the Scots say, “a shoogly nail to hing yer jaiket on.” In fact, the whole thing is largely irrelevant.

Regardless of the salary question, Calvert’s principal contention was that half the agency’s $33 million budget is federal pass-through money that could as well be distributed to the recipients by the DHMH as by the Department of Aging. That leaves the remainder of the department’s budget, some $16.5 million in state funds. The DLS says that Calvert should not claim this as a savings for taxpayers because, with the abolition of the department, $13.8 million would still need to be passed through to subgrantees. Thus, Calvert should only be able to claim $2.7 million in savings (16.5 minus 13.8).29 This is an interesting point, though it assumes that the expenditure of the state pass-through funds should be maintained. If this spending is an absolute must then, true, Calvert’s savings claim needs to be shrunk. But the argument for retaining the Department of Aging is also reduced further still. Do Maryland taxpayers really need a $2.7 million middle man to pass through $30.3 million in state and federal grant moneys?

Agency Vacancies

The other big-ticket item in the Calvert report singled out for criticism by the DLS is our claim that state agencies increase their budgets for salaries by minimizing position vacancy rates more than is justified. On any given day in any given agency, there are a number of vacant authorized positions as, for example, when someone has retired and a replacement has not yet been found. State agency directors are supposed to take this into account when they make their beginning-of-year budget requests and reduce their salary requests accordingly. For obvious reasons, no director wants to overstate his anticipated vacancy rate, in case he is left without enough salary funds to pay all employees. In fact, agency directors have every incentive to minimize vacancy projections.

Calvert’s claim in “The Cure” was that agencies excessively minimize such projections, leading to larger salary appropriations than are truly warranted. We suggested that, in sum, state agencies annually bill the state for some $93 million more than should be expected. This calculation was made by comparing the agencies’ aggregate projected vacancy rate for FY 1998 of 2.71 percent with their actual vacancy rate for FY 1997, which was 6.60 percent. The 6.60 percent figure was derived from a “snapshot” of vacancy rates taken for one day in FY 1997. Calvert assumed that the snapshot findings – the 6.60 percent vacancy rate – could be generalized to the whole year.

The DLS claims, first, that the legislature does sometimes force agency directors to increase their vacancy projections and, second, that only general-fund positions should be counted in the Calvert analysis, not federally funded positions. These two points are relatively minor.

The DLS’s most important claim is that the snapshot method is not a legitimate method for calculating agencies’ actual vacancy rates. This, says the DLS, “leads to some faulty analysis” by Calvert.30 The problem is, the DLS only points to one example of such faulty analysis, involving a small agency called the Office of Children, Youth and Families (OCYF). For FY 1998, the OCYF claimed an anticipated vacancy rate of just 4.58 percent. The Calvert snapshot for the FY 1997 revealed a vacancy rate of 25.6 percent. The DLS claims an actual vacancy rate for OCYF of 4.65 percent (derived from another snapshot, incidentally), close to the agency’s projected rate for the following year of 4.58 percent. The problem is that this is the sole example given by the DLS, out of Calvert’s total list of over 100 agencies and offices. So while the DLS may take issue with our 6.60 percent vacancy assumption, it is not prepared to suggest an alternative figure. Until it does so, our assumptions should stand.

The DLS really only makes two other “line item” criticisms of the Calvert report. These involve relatively inconsequential questions over (a) whether or not the state’s annual $10 million giveaway to the horse-racing industry is on-going or not and (b) whether or not a small and little-known state tax-reduction fund is used for its intended purpose.

Macro Analysis

The DLS’s other critique of the Calvert study is more “macro level.” The DLS claims, essentially, that the Calvert plan to buy back the debt would not be anything like as easy as we made it out to be. This is a reasonable point, though it is hardly cause to call the whole exercise off. We have no doubt that, even if the legislature followed our prescription to the letter, the resulting savings would not match up dollar for dollar with our projections. Nonetheless, we contend that the trends we predict would occur – to the benefit of taxpayers.

The DLS assessment indicates that state general-obligation debt cannot be retired as quickly as our study indicated. The department states that “only $1.5 billion [of the outstanding general-obligation debt] is callable” and that this debt has “a first call date of July 15, 2008.”31

When we prepared our analysis, we did not attempt to account for timing differences – that is, to account for questions relating to the schedule for defeasing debt – because we were unable to locate a callability schedule. (The DLS does not reference one in its report, either.) We agree that not being able to pay the general-obligation debt in advance would delay the tax reductions suggested in our report. Nor will we argue the DLS’s contention that the debt could not in fact be paid off in its entirety by FY 2007, as we originally suggested. Nonetheless, the basic concept stands. The Calvert budget savings should be applied to capital and other costs with a view to precluding most of the need to issue new debt.

In this way, the cumulative debt would be reduced by paying off old (non-callable) debt at the previously scheduled rate while not adding to it by making new bond issues. Even the DLS concedes that, under the Calvert plan, the debt outstanding would be $1.9 billion at the end of FY 2007. This is only 44 percent of the $4.5 billion cumulative debt currently predicted for that year. Reducing the debt even this much would in itself be an outstanding achievement.We do, however, take issue with the DLS’s claim that the Calvert plan would be unable to produce income-tax savings of $1 billion a year by FY 2007. Even utilizing the DLS’s worst-case-scenario analysis, tax cuts could be restructured as shown in our revised figures in table 1.

It is unlikely that legislation to reduce the income-tax rate would be introduced or passed in the first legislative session after an election (e.g., in 1999), therefore we realistically estimate zero tax reduction in fiscal 2000. However, legislation phasing in an income-tax rate reduction could be passed effective in FY 2001. Funding set aside for tax reductions could start at $100 million and be phased upward after that, as shown in the table. Under this scenario, annual tax cuts of $1.2 billion would be reached by FY 2007. (Note that this does not even take into account the $31 million extra for debt-reduction described above in the section about pension benefits.)The DLS report summarizes the Calvert position as concluding that “state income taxes are too high and that the state relies too heavily on debt financing for its capital program.”32

Though the DLS has accurately pointed out some flaws in the details of “The Cure,” our basic contentions still stand. Indeed, the DLS concedes as much when it says, “To the extent steps are taken to slow the growth in or to reduce outstanding debt, there will be general-fund savings that could be used for other purposes.”33 Such as tax cuts.

Messrs. Ballou, Miles and Munro were the authors of “The Cure.”

End Notes

[Top] 1.State of Maryland, Department of Business and Economic Development (DBED), Maryland Economic Development Commission, Strategic Directions for Increasing Maryland’s Competitiveness ([Baltimore, Md.]: DBED, [no date]), ch. II, p. 9.

[Top] 2.Paul O. Ballou III, William R. Miles and Douglas P. Munro, “The Cure: How Tackling Waste and Abuse in Annapolis Could Eliminate the State Debt and Release a Billion Dollars a Year for Tax Cuts,” Calvert Issue Brief, Vol. II, No. 3, August 1998.

[Top] 3.DBED, Strategic Directions for Increasing Maryland’s Competitiveness, ch. III, p. 9.

[Top] 4.State of Maryland, General Assembly, Department of Fiscal Services (DFS), The Sine Die Report: A Summary of Major Legislative Action, 1997 Session (Annapolis, Md.: DFS, April 8, 1997), p. 69.

[Top] 5.State of Maryland, Capital Debt Affordability Committee (CDAC), Report of the Capital Debt Affordability Committee on Recommended Debt Authorizations for Fiscal Year 1999 (Annapolis, Md.: CDAC, September 10, 1997), p. 44. See also State of Maryland, General Assembly, Department of Legislative Services (DLS), Analysis of the Maryland Executive Budget for the Fiscal Year Ending June 30, 1999, Vol. IV (Annapolis, Md.: DLS, March 1998), p. 654.

[Top] 6.DLS, Maryland in Perspective: Comparative Rankings of Maryland and Its Neighbors (Annapolis, Md.: DLS, June 1998), p. 10.

[Top] 7.D. Bruce Poole, “When Our Fiscal Hands Are Tied: How Maryland Lost Control of Half Its Budget,” Calvert News, Vol. II, No. 4, Fall 1997, pp. 10-11.

[Top] 8.DLS, “Assessing the Calvert Institute ‘Cure,'” unpublished and undated document distributed by the DLS in September 1998.

[Top] 9.Charles Babington and Manuel Perez-Rivas, “Even Tax Reports Compete,” Washington Post Montgomery Weekly, Oct. 1, 1998, p. 1.

[Top] 10.DFS, Office of Legislative Audits, Performance Audit Report: Maryland State Department of Education (Annapolis, Md.: DFS, August 1996), p. 2.

[Top] 11.DLS, “Assessing the Calvert Institute ‘Cure,'” p. 8.

[Top] 12.DLS, “Assessing the Calvert Institute ‘Cure,'” p. 8.

[Top] 13.DFS, Performance Audit Report: Maryland State Department of Education, pp. [1]-2.

[Top] 14.State of Maryland, Maryland State Department of Education, “Response to Legislative Auditor’s Performance Audit Report: Validation of Student Enrollment,” reprinted in DFS, Performance Audit Report: Maryland State Department of Education, pp. 71-81, at 73.

[Top] 15.DFS, Performance Audit Report: Maryland State Department of Education, pp. 17, 18, 21, 24, 27, 28 and 30.

[Top] 16.DFS, Performance Audit Report: Maryland State Department of Education, p. 18.

[Top] 17. DFS, Performance Audit Report: Maryland State Department of Education, pp. 17, 21 and 27.

[Top] 18.DFS, Performance Audit Report: Maryland State Department of Education, p. 2.

[Top] 19.DFS, Analysis of the Maryland Executive Budget for the Fiscal Year Ending June 30, 1998, Vol. IV (Annapolis, Md.: DFS, March 1997), p. 22.

[Top] 20.State of Maryland, Task Force on Funding Equity, Accountability and Partnerships, Technical Supplement, Vol. II (Annapolis, Md.: Department of Legislative Services, December 1997), pp. 268, 271.

[Top] 21.John W. Rohrer, Senior Manager, Office of Policy Analysis, DLS, conversation with one of the authors, October 13, 1998.

[Top] 22.John W. Johnson, Chief, Audit Office, Division of Administration, MSDE, conversation with one of the authors, October 13, 1998.

[Top] 23. A. Skipp Sanders, Deputy Superintendent for Administration, MSDE, conversation with one of the authors, October 14, 1998.

[Top] 24. DLS, “Assessing the Calvert Institute ‘Cure,'” p. 10.

[Top] 25. Ballou, Miles and Munro, “The Cure,” p. 39.

[Top] 26. DLS, The 90 Day Report: A Review of Legislation in the 1998 Session, Vol. I (Annapolis, Md.: DLS, April 17, 1998), p. C-24.

[Top] 27. Ballou, Miles and Munro, “The Cure,” pp. 57-58.

[Top] 28. R. Clayton Mitchell, Jr., Consolidation of Selected State Functions and Services: A Proposed Realignment of Maryland’s Government, Meeting the Fiscal Realities of the 1990s (Annapolis, Md.: General Assembly, Office of the Speaker, January 22, 1993), pp. 68-70.

[Top] 29.DLS, “Assessing the Calvert Institute ‘Cure,'” p. 12.

[Top] 30. DLS, “Assessing the Calvert Institute ‘Cure,'” p. 14.

[Top] 31. DLS, “Assessing the Calvert Institute ‘Cure,'” p. 5.

[Top] 32. DLS, “Assessing the Calvert Institute ‘Cure,'” p. [1].

[Top] 33. DLS, “Assessing the Calvert Institute ‘Cure,'” p. 3.

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