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F I S C A L I M P A C T R E P O R T

SPONSOR Payne

DATE TYPED 1/28/2005 HB HJR 5

SHORT TITLE Limit State Expenditure Limits

SB

ANALYST Taylor

REVENUE

Estimated Revenue

Subsequent

Years Impact

Recurring

or Non-Rec

Fund

Affected

FY05

FY06

See Narrative

See Narrative

(Parenthesis ( ) Indicate Revenue Decreases)

SOURCES OF INFORMATION

LFC Files

Department of Finance and Administration (DFA)

National Conference of State Legislatures (NCSL)

SUMMARY

House Joint Resolution 5 proposes a constitutional amendment that would limit the legislature’s

ability to increase state expenditures and would require refunds of revenue in excess of state ex-

penditure limits.

Expenditure growth would be limited to inflation as determined by the U.S. department of labor

plus population growth in the prior year based upon estimates provided by the University of New

Mexico’s Bureau of Business and Economic Research. The legislature could adjust state expen-

ditures for revenue increases related to the issuance of general obligation bonds, severance tax

bonds or revenue bonds authorized by the legislature prior to January 1, 2007.

Tax revenues that exceed the rate of inflation plus population growth would be refunded to the

citizens of New Mexico.

The proposed amendment would be put to a vote of the citizens at the next general or special

election, if prior to the next general election.

FISCAL IMPLICATIONS

No immediate fiscal impact is associated with this resolution. In the case that it passed, was put

to a vote and approved, the fiscal implications could be large in years where revenues grow

faster than inflation plus population.

House Joint Resolution 5 -- Page 2

TECHNICAL ISSUES

The Department of Finance and Administration submitted the following technical issue:

HJR5 specifies that the formula will use the inflation rate as determined by the federal

Department of Labor, but does not specify which inflation rate will be used. The federal

Department of Labor publishes several inflation indices, including the CPI for all urban

consumers, the CPI for all urban wage earners, and regional indexes. It also does not

clearly state what time period should be used, the prior fiscal year or the prior calendar

year. Using the inflation rate from the prior fiscal year would be impossible because the

prior fiscal year data is not available until about 3 months after the next fiscal year be-

gins. It should also be noted that the Bureau of Labor Statistics routinely revises the

CPI. Would a downward revision require spending cuts in a fiscal year that has already

begun.

The resolution does not clearly define the base on which the expenditure cap is calcu-

lated. The sponsor may have intended "state expenditures" to mean those contained in

the General Appropriation Act (GAA). However, limiting GAA expenditures could lead

to an increase in special appropriations or capital outlay expenditures. Also, the GAA

contains federal funds and other non-state sources.

The resolution does not specify if revenues deposited in the state's reserve funds will

count as expenditures. If that is the case, reserves would be in competition with all other

state spending.

The resolution does not specify how revenues in excess of the expenditure cap should be

refunded to the taxpayers.

The resolution specifies that population estimates will be estimated by UNM's Bureau of

Business Research. The formal name of the intended organization is the Bureau of Busi-

ness and Economic Research.

OTHER SUBSTANTIVE ISSUES

The spending limit proposed by this bill ensures that spending will actually grow at a rate slower

than inflation plus population. This is because revenue growth is not smooth from year to year.

In some years revenues grow faster than the proposed rate and other years by less. Thus, in years

when revenues grow more slowly, spending would naturally be constrained to a rate less than

inflation plus population growth. In Colorado, which has implemented this type of limit, years

of declining revenues forced budget reductions, which could not be made up when revenues

started to grow again.

Situations like the one above are causing the Colorado legislature to re-examine this restriction.

Some advocates of spending limits have suggested an alternative that would cap state spending

to a percentage of state income. This would allow state spending to grow at the rate of income

growth and also allow for the variability in the growth of the state’s economy and revenues. So,

while budgets would still have to be reduced in years of declining revenues, these reductions

could be made up in years when the economy and revenues recovered.

House Joint Resolution 5 -- Page 3

Public finance theory suggests no consensus as to the “correct” rate of spending growth. Spend-

ing restrictions such as the one proposed here would require spending to grow by a rate lower

than that for the state’s economy. The alternative discussed above would have state spending

and the economy (as measured by income growth) grow at the same rate. Letting spending in-

crease at a rate faster than economic growth is another alternative.

New Mexico’s revenue structure used to be thought to be modestly elastic. That is, revenues

grew a little faster than income. In large part this was due to the personal income tax, which

typically—prior to the income tax cuts--grew by about 1.4 percent for each 1 percent growth in

personal income. Once income tax cuts are fully implemented, the personal income tax will be

considerably less elastic and is likely to grow at a rate only slightly faster than personal income

growth. Elastic revenue growth from the personal income tax revenues has typically been at least

partially offset by other slowly growing revenues. For example, gross receipts taxes grow at

about 85 to 90 percent of the rate of income growth, e.g. income growth of 5 percent might im-

ply gross receipts revenue growth of 4.5 percent. Selective sales taxes as a group grow relatively

slowly as do most other revenues. The wild card is energy related revenues, which display no

discernible pattern. Recent revenue growth for the state has been linked to energy related reve-

nues, but these are expected to decline in future years.

DFA provided this analysis

The table below shows inflation rates (Consumer Price Index for all urban consumers;

Global Insight, January 2005) and population growth rates (BBER, January 2005).

These figures suggest the expenditure growth limit would average about 3.5 percent an-

nually.

CPI-U Population Growth TOTAL

1997 2.3% 1.3% 3.6%

1998 1.6% 1.1% 2.7%

1999 2.1% 0.8% 2.9%

2000 3.3% 2.6% 5.9%

2001 3.4% 1.6% 5.0%

2002 1.3% 1.5% 2.8%

2003 2.2% 1.5% 3.7%

2004 2.8% 1.5% 4.3%

2005 2.1% 1.5% 3.6%

2006 1.5% 1.4% 2.9%

2007 1.9% 1.4% 3.3%

2008 1.9% 1.4% 3.3%

2009 2.3% 1.4% 3.7%

Limiting expenditure growth to inflation plus population growth leaves little space to

create new programs or expand existing programs. Further, the costs of many existing

state programs will grow faster than allowed under this expenditure limit: Medicaid's

costly disabled and elderly populations are already a substantial pressure on the state's

budget, and as the baby boomer generation ages, this pressure will grow. Medicaid ex-

penditures grew by 19.4 percent in FY 2005. Similarly, the state's overall population

growth may not reflect population growth in our school systems, or increased use of our

roads. Public education grew by 6.3 percent in FY 2005. Many of these expenditures are

House Joint Resolution 5 -- Page 4

federally mandated.

Colorado's Taxpayer Bill or Rights (TABOR) is similar to the measures found in HJR 5,

except that it limits revenue collections to the previous year's population growth rate and

inflation instead of expenditures. TABOR also requires that revenues in excess of this

limit be refunded to taxpayers. As a result of TABOR, Colorado's fiscal crisis has been

among the worst in the nation. In FY 2002, facing a $933 million budget shortfall,

TABOR forced the refund of $927 million in excess FY 2001 revenues to the taxpayers.

Unlike some states, Colorado's budget crisis forced painful budget cuts, including termi-

nating Medicaid services for legal immigrants and pregnant women.

An expenditure limit of this type could have devastating effects on the state budget if

New Mexico experiences a sharp revenue decline in the future. If revenues decline

sharply, necessitating a year-over-year expenditure decrease, the state would begin eco-

nomic recovery from a permanently reduced expenditure base. This risk is high consid-

ering the volatility of New Mexico's oil and natural gas revenues. In Colorado, in an ef-

fort to protect the revenue base in FY 2002, the legislature raided $487 million from

various trust funds and transferred them to the General Fund as revenue. In New Mex-

ico, the expenditure limit could create an incentive to spend the maximum each fiscal

year to protect the expenditure base.

The refunding mechanism contained in the expenditure limit would eliminate New Mex-

ico's ability to build and maintain prudent reserve balances in years of high revenue

growth. Lower reserves would exacerbate the problem of permanently reducing the ex-

penditure base in years when expenditure cuts are necessary.

BT/yr