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Fiscal Politics 101

By Francisco Javier Cimadevilla

February 21, 2002
Copyright © 2002 CARIBBEAN BUSINESS. All Rights Reserved.

Last week, Gov. Sila Calderon presented her second State of the Commonwealth address.

"When we met here last year," she opened, ". . . I told you that it was essential to return the country on the road of fiscal, administrative, and social responsibility." Then she proceeded to announce that the Commonwealth will need some more of your money to pay for some more of its expenses next fiscal year (FY).

The governor proposed a FY 2003 consolidated budget of $21.8 billion, a full $1.2 billion or 6.3% higher than the Commonwealth’s $20.6 billion FY 2002 budget. General Fund spending alone will grow by $374 million, or 5%, to $7.8 million in FY 2003.

In addition to spending increases ranging from 5.2% to 11.3% at major government agencies such as the Department of Education, Department of Health, Police and Corrections Administration, the governor decided to spend an additional $180 million to cover a $100/month pay raise for approximately 150,000 public employees.

To help pay for the increases, the governor has proposed increased excise taxes on cigarettes ($0.50 a pack), booze ($0.15 a bottle), and the most popular cars sold in Puerto Rico across income classes, 4x4 sport utility vehicles (SUV) (approximately $1,600 a pop).

She also announced electronic lottery games to generate new income, a postponement in already legislated tax relief—including the repeal in 2000 of the marriage penalty tax—and a three-month grace period during which Individual Retirement Account (IRA) holders may withdraw up to $20,000 of their retirement savings at a lower penalty of 10% with the expressed dual intention of collecting additional tax revenue from those withdrawals and stimulating consumption this year in order to help the economic recovery.

Admittedly, balancing a government budget in an economy still marred by recession aftershock is a tough job. But the job is made much tougher when instead of holding down expenses you decide to spend some more.

Most of Gov. Calderon’s colleagues know this full well. As of Jan. 25, 40 out of 50 state governors were expecting budget shortfalls, totaling $40 billion, for FY 2002.

They are not calling it structural deficits. Nor are they blaming their predecessors. They know that when the economy slows down, and particularly when it hits a recession, tax revenue comes in lower than projected when the budget was prepared, sometimes as much as 18 months earlier. But they just go about it like thousands of business owners and executives across the country, cutting where they can to make sure that their expenses don’t exceed their revenue.

Although their individual recipes vary, some of the governors are implementing measures similar to the ones proposed by Gov. Calderon, including increases in sin taxes on everything from cigarettes to riverboat gambling and postponement of previously legislated tax breaks and others she should have considered, such as government hiring freezes.

But all her colleagues, without exception, are implementing budget cuts—some of them rather severe—this year and continuing through next year.

Alabama: $19 million cut from General Fund budget for next year; Arizona: budget cuts of 4% for two years; Florida: trim more than a billion dollars in spending out of the state’s $50 billion budget; Georgia: agencies must cut 2.5% this year and 5% next year; Illinois: cut $50 million last November and another 2% cut is on the way; Missouri: eliminate $480 million in state programs and the first decline in general fund appropriations since 1992; Nebraska: 4% to 5% across the board budget cuts in some agencies; Ohio: budget cuts of up to 6% over the next two years; Virginia: across-the-board state agency spending cuts of 3% this year, and 7 % in 2003, including foregone pay raises for state employees and school teachers; Wisconsin: reduce state spending in 2002 by 10% and by 11.5% in 2003. . . .

You get the point.

While Gov. Calderon did announce a reduction in General Fund spending on some administrative expenses such as cellular phones, vehicles, Christmas cards, and police escorts, the cuts hardly make a dent when it comes to the proposed overall $374 million, or 5% increase in General Fund spending.

And then, some of the cuts that are in fact being proposed are in the wrong place. Because the reason for the budget crunch is a slow economy, the last place where we should cut is in our economic development efforts. Yet the governor’s FY 2003 budget contains cuts in some of the key economic development agencies, including the Puerto Rico Industrial Development Co. (18%), the export development program Promoexport (14%) and the Tourism Co. (4.5%). Never mind that these are precisely the agencies that promote the creation of jobs that, in turn, would bring in more tax income for the government.

When you’re faced with a budgetary shortfall, you have to exercise fiscal responsibility and cut as much as you can. But you should cut where you should.

And, yes, if on top of that you still have a shortfall, you may have to reach for additional tax revenue. But with a proposed budget 6.3% larger than last year, including a pay raise for public employees that will cost us all $180 million next year, the case simply has not been made to justify the proposed tax increases.

Increased excise taxes on cigarettes and alcohol may be easier to justify politically, but the fact remains that middle to lower income people will bear the brunt of it. They will be the ones who pull a little bit more out of the pocket to play those extra lottery games. The higher taxes on SUV’s cut across the board; they come in all price ranges and are equally popular among consumers of all income levels.

Postponement of previously enacted tax breaks is a prudent fiscal measure. But again, it’s difficult to justify when you have not done everything you can to reduce the spending side.

Furthermore, to postpone the effective date of tax relief that benefits all income brackets, such as the previously legislated repeal of the marriage penalty tax, but keep in place the capital gains tax reduction enacted last year—in itself a good idea but one that will benefit mostly high net worth taxpayers—raises legitimate questions about the social even handedness of the administration’s tax policy.

But the most offensive element in the administration’s recipe to balance the FY 2003 budget is the proposed window to allow taxpayers to withdraw up to $20,000 in IRA savings at a lower rate of 10% in order to generate an immediate, one-time injection of $30 million into the Treasury’s coffers. It’s bad tax policy. As social policy, it’s worse.

Puerto Rico has a pitifully low savings rate. The increased popularity of the IRA since their advent in the market has been a blessing. Contrary to the very purpose of the tax policy that allows for IRA deposits to be deducted—namely, encouraging savings for retirement—the government will actually be enticing people to take it out and spend it now--because of the urgency of having to balance this year’s budget.

We can only hope that the administration might reconsider this ill-advised proposal or that the legislature might live up to its responsibility, defeat that proposal, and either find the $30 million somewhere else or better yet cut the budget by that amount.

This Caribbean Business article appears courtesy of Casiano Communications.
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