Certain tax exemptions to blame for budget woes

Once again, budget adjustments towards the middle of Louisiana’s fiscal year have had to be made, illustrating a particularly problematic part of the state’s fiscal structure that hampers ability to budget accurately and to capture revenues efficiently without hampering economic growth.

The Gov. Bobby Jindal Administration announced it wrung cost savings of around $50 million from government operations, involving noncritical services and mostly from a spending freeze, vacant job eliminations, and contract curtailment, of which about five-eighths must be approved by the Joint Legislative Committee on the Budget, and cobbled together about $130 million more revenues to close the gap of $181 million. Of the revenues, about $24 million comes from a funds sweep, around $74 million from underestimating revenues dedicated to other purposes that could be repackaged into the general fund, and the remainder was bonus tax amnesty receipts. None of the revenues found can be counted upon to show up in the future.

The sixth of these in seven years begs a few questions, starting with why the powers that be involved in revenue determination, essentially the staffs of both the Governor’s Office and Legislature Fiscal Office, seem to miss on revenue projections. In fact, from the first budget over which Jindal had control, fiscal year 2009, through the last fiscal year for which data are complete, FY 2013, the average overestimation was about $375 million – and FY 2009 actually turned out to be underestimation of about that magnitude, meaning successive years had much higher overestimations. And in reality the estimations usually are pretty good on the general fund side, which is mostly income and sales taxes, where over the FY 2009-13 period all but one year had forecasts barely under the actual results, that being FY 2010 when the forecast overshot the actual by nearly $1 billion.

Each year’s revenues disappointments are a different story – this one’s primary culprit appears to be lower mineral revenues in part because of declining worldwide prices – but regardless of the specific causes, something always seems to come up. And the net effect is that Louisiana’s state revenues from then until now never seem to grow to the level predicted, year after year.

Although FY 2013 revenues of $14.689 billion are not that far below the FY 2009 total of $15.038 billion, in the earlier year the tax cut enacted in Jindal’s first year in office had only kicked in half way, the growth-dampening fiscal policies of Pres. Barack Obama were yet to come into effect, and vestiges of the hurricane recovery bonus influx of federal dollars still remained. So between those years, state revenues fell below $14 billion for each in that period.

One explanation for the misfires is that jobs created have been on the lower end of the income scale, explaining why the individual income tax component of revenues seems to come up short relative to forecasts. However, this doesn’t seem a likely candidate for a shortfall because it’s only been in the last year that non-farm employment really has picked up – there were 1.926 million such jobs at the end of 2009 and 1.937 million at the end of 2013, while now they have surged this year to 1.99 million – and because state government jobs have decreased from a full-time equivalency of 93,239 at the end of 2009 to 66,930 at the end of 2013.

Further, total wage earnings in Louisiana’s private sector have risen over this period from $83.8 billion to $90 billion – a 7.4 percent increase exceeding the rate of inflation by a couple of points while state-generated revenues decreased 2 percent. And to make matters even more interesting, state gross domestic product has catapulted upwards during this time from $184.2 billion to $196.9 billion in inflation-adjusted dollars, a 6.4 percent real increase (and even with large personnel cuts in state government, total government in the state GDP has increased about as much from $23.5 billion to $24.9 billion).

With population only inching up throughout this time, obviously the state is wealthier and better off in a per capita sense. Yet state government revenues have failed to keep up, indicating a problem in translation. Logically, given that wage earnings and GDP have risen smartly, that disconnection would be at the income and sales tax levels but, here again, in this time frame except for FY 2010 when things were way off, the typical error on these was overshooting by $100 million or fewer.

Another is that tax exemptions, which typically amount to half of the entire revenue actually collected, have grown disproportionately, sucking out revenues that would have been thought to materialize. But in fact they have pretty much tracked state revenue generation changes, being $7.193 billion in size for FY 2009 and $7.084 billion’s worth in FY 2013 and proportionally changing about as much as revenues collected in between those dates.

However, looking at these in aggregate may mask the impact of those that disproportionately bleed revenue from the state. In other words, certain trends in recent years may have exaggerated the impact that particularly inefficient exemptions had in elevating disproportionately the total amount of exemptions observed. Data from 2009 through 2013 point the finger at a few possibilities.

One is the exemption granted to mineral exploration involving fracking through horizontal drilling. If such a well gets drilled, which accounted for the vast majority of new activity since 2008, it is exempt from severance tax from two years from production commencing or at recapture of qualified costs, whichever comes first. As a result of this, gas production doubled from 2009 to 2013 to 2,712 million million cubic feet, but because the average severance take almost halved to 14.8 cents per MCF, due to the average price dropping by a quarter but the remainder due to the exemption which went in this period from $14 million to $228 million, this total amount of revenue available hardly has changed over the years. Worse, gas wells of this nature typically peak in production quickly, so the non-exempt phase misses much of the production over the life of the well.

Another one is the birth of Louisiana’s Earned Income Tax Credit, which only began in FY 2009 at $38.5 million and had risen steadily by FY 2013 to $46 million. Essentially it works as a negative income tax for those that draw wages; not only do low-income earners not pay income taxes that would be miniscule at best at their wage levels, but they get money given to them. While it can help out low-wage families, it also discourages pursuing full-time work or striving to become more productive to earn promotions and it also makes it more likely that people qualify for transfer payments, some of which would be supplied by the state and thereby increase its costs on the other end of the deficit equation.

Then there’s, in terms of its net cost to the state, the Moby Dick of tax exemptions, the Motion Picture Investor Tax Credit. Unlike almost every other one on the books, it and its companion entertainment activities actually have a legal requirement to report their costs and benefits (every two years). Since FY 2009 the levels of these nearly have doubled as well (though the latest reporting year FY 2012) and are estimated to go a couple of dozen million higher to $258 million certified for FY 2014, but are extremely inefficient as historically they only return one dollar to the state treasury for every seven that go out. The latest FY 2012 figure showed a $168 million net cost to the state. Worse, in last year’s tax amnesty these credits were used to prevent the state from collecting $67 million, a loophole closed for this year’s.

To summarize, large growth in these least productive and significant-sized tax exemptions over the past few years likely dampened revenues and accounted for a significant proportions of forecast error. Without these, it’s possible that just in the past year the state might have taken in some $500 million extra in revenues, and forecasters would have undershot on the revenue side.

But undoubtedly some also is the fault of Obama economic policies. For example, the loosening of qualifications for disability payments – Supplemental Security Income – just like the state (and federal) EITC creates incentives for people to quit or reduce work instead of acting to supply tax revenue inputs and to grow the economy, and provides incentive for them to access welfare programs that cost the state. This combined with the general malaise induced by the Obama program of higher taxes, increased regulation, and bigger government crowding out the private sector is reflected nationally and in Louisiana by a decline in the workforce participation rate. Reflecting the nation, Louisiana’s has tumbled to its lowest point in 35 years, helped along in part (the general malaise also discouraging people from seeking work) by an increase in SSI recipients in the state for disability from about 155,000 in 2009 to around 169,000 in 2013, with almost all of that net increase occurring the working age population of 18-64.

So some of this is out of the state’s control. But the main reason why improving state wealth and productivity has translated into flat revenues would appear to be injudicious choices in tax exemptions granted. Fortunately, this is a problem that can be fixed by reducing in size or eliminating the offending items mentioned above, and others, and constitutionally the Legislature may do so in the 2015 regular session.

Unfortunately, being that it will happen just prior to state elections, legislators will be reluctant to involve themselves with powerful economic and ideological lobbies that would fight to prevent these kinds of alterations. So too will they get opposition for any spending cuts right before many run for reelection or to sit in the other chamber that could allow continuing affordability of these items to keep placating the special interests behind these. Funds sweeps are uncertain, amnesties are too episodic, and luck of the revenue draw can’t be depended upon to salvage budgets forever. A combination of tax exemption reform and permanent spending cuts would constitute a first step in making for a sounder fiscal structure to state budgeting.