Connecticut’s Spending Cap: Where are We Now?

March 10, 2005, Briefing

Alison Johnson, Connecticut Health Foundation Consultant

And

Liz McNichol, Center on Budget & Policy Priorities Senior Fellow

Commissioned By:

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How the Spending Cap Works

Limits “general budget expenditures” to:

5-year average growth in personal income

OR

Annual growth of Consumer Price Index (inflation), whichever is greater

3

Exemptions to the Cap

• Aid to distressed municipalities for grants in statute on July 1, 1991 (definition has changed over time)

• Payments of debt

• First-year costs of court orders or federal mandates

4

Cap can be Exceeded

If the Governor declares an emergency or

the existence of extraordinary circumstances

AND

3/5 of both houses of the General Assembly agree

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Connecticut’s Cap is Tougher Than Most

• 27 states have expenditure limitations

• Connecticut’s is one of toughest: - Covers 80 percent of state expenditures, including

federal revenue - Connecticut is only 1 of 2 states using 5-year average

personal income growth - Governor has to initiate exceeding the cap; requires

3/5 majority of legislature to override - Each year’s cap based on previous actual

expenditures vs. allowable expenditures

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Current Tax and Spending Limit Activity in Other States

• Other states are considering caps

• Both proponents and opponents recognize problems with caps when coming out of economic downturn

• There are a number of proposals to create more room under Colorado’s cap – one often cited as a model

The Connecticut Experience: 14 Years Under the Cap

8

State Spending Growth Declined

11.7%

6.2%4.8%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

'87-'91 '91-'95 '95-'01

Average Annual Percent Growth

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State Spending Growth Declined

• Before adoption of cap, spending growth averaged 11.7 percent a year

(FY 1987 – FY 1991)

• After cap, growth was 4.8 percent

(FY 1995 – FY 2001)

• Due to economic downturn, growth slowed to 2 percent annually over the past 3 years

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Amount Actual Appropriations Were Below Cap (excluding surplus)

Source: OFA data

FY 1993 - $120.0 million

FY 1994 - $ 39.1 million

FY 1995 - $ 53.4 million

FY 1996 - $ 20.1 million

FY 1997 - $ 3.6 million

FY 1998 - $ 0.4 million

FY 1999 - $ 2.3 million

FY 2000 - $ 0.4 million

FY 2001 - $ 0.0 million

FY 2002 - $ 78.2 million

FY 2003 - $333.0 million

FY 2004 - $122.9 million

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Cap has been Exceeded When There has been a Surplus

$249 million in FY 1998$591 million in FY 1999$462 million in FY 2000$292 million in FY 2001

Surplus spending minus debt reduction and transfers to budget reserve

Source: CBPP calculations of OFA data

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Surplus Spending and the Cap

• Historically, surplus spending has not been added to the base (at Governor’s discretion)

• There is disagreement over how much the cap has been exceeded to fund ongoing expenditures

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What are the

Unintended Consequences

of the Spending Cap?

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Incentive to Borrow• Debt service grew from 5.4 percent of all state

spending in FY 1990 to 12 percent, or $1.3 billion in FY 2005

• More than budgets of DMHAS, DMR, OHCA agencies combined in FY 2005

• At $6,008 per capita, Connecticut’s debt was 3rd highest in the nation, compared to national average of $2,234 in FY 2002

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Incentive to Use Tax Expenditures

• Not subject to the spending cap

• Targeted tax treatments such as exemptions, credits, deductions, etc.

• Reduce revenue collected by the state, creating built-in losses to revenue stream

• Example: $20 million tax exemption for advertising services

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Disincentive to Obtain New Federal Funds

• All federal dollars count toward cap (unless they are “federal mandates”)

• Currently at cap limit in FY 2005

• An additional $10 million forces State to go over the cap (needs Governor’s declaration & 3/5 majority vote)

• Disincentive only happens when State near cap limit; will be true for at least the next few years

• Example: State has declined to pursue Medicaid Adult Rehabilitation Option; could bring in $10.5 million a year

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Governor Proposes to Exceed Cap• Governor proposes nursing home provider tax to

obtain $237.7 million in federal matching funds

• Would exceed the cap by $244 million; needs approval by 3/5 vote of General Assembly

• Would be $45.3 million under the cap in FY 2006, and $63.6 million in FY 2007

• First time a Governor has proposed including excess spending in the base

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The Current Budget Situation

• For the last few years, revenues have been more of a constraint than the cap

• From 2002 to 2004, state spending was less than the amount allowed by the cap

• This has served to lower the spending base for future cap calculations

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Recession Squeezed State Budget

Average Annual Percent ChangeInflation Adjusted Spending Per Person

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

FY01 FY02 FY03 FY04

Source: CBPP calculations of data from OFA, U.S. Census Bureau,

U.S. Bureau of Labor Statistics, and Connecticut DPH

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Lower Base May Prevent Return to Normal Service Levels

• State budgets were tight during the economic downturn starting in 2001

• Nominal spending increased an average of 2 percent a year, well below average and the amount that the cap would have allowed

• This results in a low base for FY 2005 — the starting point for allowable growth for FY 2006 and beyond

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Growth Allowed by Cap is Below Projected Economic Growth

4.1%4.4%

3.5%

4.5%

3.0%

4.5%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

FY06 FY07 FY08

Annual Percentage Growth

Allowable Spending Personal Income

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Cost of Maintaining Current Services will be Well Above Cap

FY 06 FY 07 FY 08

Spending Cap $15,071 $15,719 $16,321

Current Services $15,894 $16,669 $17,419

Amount over/

Under cap$ 823 $ 949 $ 1,098

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Possible Adjustments to the Cap

• Exempt additional types of spending

• Rebase

• Change calculation of growth factor

• Revisit the cap

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Changes to the Base

• Base could be increased to amount allowed in prior year rather than amount actually spent to address ratcheting down problem

• Base could be adjusted upward to allow room for restoration of services cut during recession or for new initiatives

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Changes to Allowable Growth Factor

• Use more current measure of personal income growth

• Reduce number of years in growth factor calculation

• Add AGI as additional growth factor to account for growth in capital gains

• Adjust for growth in specific populations such as the elderly

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Changes to Growth Factor or Base(in millions)

Change FY 06 FY 07 FY 08Add 0.5 percent to growth factor

+ $57

+ $120

+ $186

Current Personal Income + $38 + $149 + $349

Allowable Spending as Base + $127 + $151 + $201

Source: CBPP calculations of Governor’s budget data

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Additional Types of Spending Could be Exempted

• Medicaid

• New federal programs

• All federal funds

• Education Equalization Grants

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Basic Principle for New Exemptions

• If fast growing programs are removed from the base, additional room under the cap will be created

• If slow growing programs are removed, the spending cap will be tightened

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Effects of Additional Exemptions(in millions)

Exemption FY 06 FY 07 FY 08

Medicaid + $111 + $157 + $279

Medicaid (with Medicare changes) + $81 + $62 + $178

All federal funds - $242 - $293 - $270

ECS + $5 - $48 - $94

Source: CBPP calculations of Governor’s budget data

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Could Eliminate Cap by Constitutional & Statutory Changes

• If General Assembly and voters agreed

• Eliminate incentives to borrow and use tax expenditures

• Remove disincentive to obtain federal funds

• Could tempt state to spend beyond its means

• Create opportunity to more closely match budget growth with state’s economic condition

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Where Are We Now?

• Cap is one of most restrictive in the nation

• Will be over cap limit for some time

• Current structure of cap will cause spending to lag behind economic growth

• Cap has unintended consequences

• State can cut programs or make cap adjustments to stay within spending limits

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For More Information

• Visit www.cthealth.org

• Email CHF’s Monette Goodrich at monette@cthealth.org or call 860.224.2200 to receive copies of the report and/or one-page highlight sheet