Free cash.
No two words can spark the imagination of a state official more
quickly. An influx of free cash, usually from unanticipated tax revenues, can be used to
pay for road repairs, saved in a rainy-day account or returned to the taxpayers.
It's a pleasant dilemma that Massachusetts has been dealing with as
the economy has soared over the past five years.
Tax revenues have exceeded projections every year since fiscal 1995,
giving the state as much as $1.3 billion more than expected. After years of limiting
spending, officials have welcomed the surplus as a tool to pay for pressing needs and save
for the future.
As the governor and Legislature complete the $21 billion state budget
for fiscal 2000 over the next few weeks, every allocation from the surplus raises the
nagging question of how much of the money belongs to the state and how much belongs to
taxpayers.
"Historically, so much of the budgeting process focused on
allocating resources in a strained environment," said Jay Walder, a professor at
Harvard University's John F. Kennedy School of Government. "But the thrust has
changed recently with the advent of the surplus."
Surpluses have emerged in Massachusetts and every other state for a
variety of reasons that all stem from the strong economy.
Income-tax revenues have been higher than expected in Massachusetts
because unemployment is less than 3 percent. Sales-tax revenue is up because people have
extra money to spend. And more employees are receiving taxable bonuses, according to the
Massachusetts Taxpayers Foundation.
The primary cause of the surplus, though, appears to be unforeseen
increases in capital gains taxes, which investors pay when they sell stocks, real estate
or other assets that have increased in value.
The state does not separate revenue from the capital gains tax from
other income-tax revenue and could not provide specific figures about their growth.
But budget officials insist those taxes have been the key to the
recent yearly surpluses. With the Dow Jones average jumping 86 percent in the past three
years and more people investing in the stock market than ever before, Massachusetts
residents are receiving more dividends and profits than just a few years ago.
"It all boils down to capital gains," said Undersecretary
of Administration and Finance Kristen Keel.
To avoid being saddled with too little money if the stock market
slows, however, the governor, House and Senate have made relatively conservative revenue
forecasts throughout the 1990s and have repeatedly failed to forecast the capital gains
surges.
"Unlike wages, which are built into a base, capital gains are
something people have to achieve every year," said Tim Sullivan, director of finance
for the state's fiscal affairs division. "To build a big capital gains estimate into
our estimate would be dangerous."
Saving for a rainy day
State leaders have demonstrated that same conservatism in spending
the free cash over the past five years.
As soon as the surplus began to appear, Citizens for Limited Taxation
called on the state to use most of the cash to pay for a tax cut. But officials' first
priority was to save enough money so that Massachusetts would never again have to endure
what it went through in the late 1980s and early 1990s.
When hard times hit and tax revenues plummeted, the state had less
than $100 million in its rainy-day account, known as the stabilization fund. Without a
nest egg to support them, Gov. Michael Dukakis and the Legislature borrowed money and
raised taxes to pay daily operating expenses.
They began using revenue from the Lottery to pay for statewide
services instead of dedicating it all to local aid. Fiscal 2000 will mark the last time
the state keeps part of that revenue instead of sending every dollar back to the cities
and towns.
"The reason there was no money in the stabilization fund was
because nobody thought there was a need to save," said former Dukakis Cabinet
Secretary Edward Lashman. "The people who talk about a stabilization fund are also
the first ones to demand money so their pet projects can be funded."
Maybe not this time around.
Gov. Paul Cellucci and the Legislature have stashed $1.2 billion in
the stabilization fund, and the Legislature has twice increased the cap on the fund.
Republican Govs. William Weld and Cellucci and the Democratic
Legislature have also agreed not to use the surplus for new programs. That practice
contributed to a 9-percent annual increase in the budget in the late 1980s because every
new program funded from the surplus invariably needed money to support it the following
year.
"It's just a bad way of doing business," said House
Minority Leader Francis Marini, R-Hanson. "What if next year is a recession year?
Where are we then?"
The state has spent the money on one-time construction projects. Much
of the surplus from fiscal 1999, for example, will likely pay for $300 million in road
projects, including renovation of the Fore River Bridge between Quincy and Weymouth.
If not for the surplus, the state would have borrowed money for that
work and added to the $15.4 billion long-term debt that still looms despite the short-term
surpluses.
Back to the taxpayers
Over the past five years, officials have also used a limited amount
of the free cash for tax cuts and have prided themselves on striking a balance between
paying for construction, saving for the future and giving money back to the taxpayers.
But as the surplus has become a fixture, a growing number of critics
have started to demand tax cuts.
"I don't think the government has
the right to forcibly take money from people for a savings account," said Barbara
Anderson, co-director of Citizens for Limited Taxation and Government. "This money
should be in our saving accounts."
Anderson said the surplus is not the product of a strong economy or
higher-than-expected capital gains revenues, but of a tax rate that is artificially high.
Dukakis and the Legislature raised the income tax from 5 percent to
6.25 percent a decade ago on the promise the increase would be rolled back when the fiscal
crisis had passed.
The rate was dropped in 1992 to 5.95 percent, where it remains today
despite proposals to cut it further.
"It's that extra tax rate of
almost 1 percent that causes the surplus," Andersen said. "The only way they got
that tax hike was they told people it would be temporary."
Even budget-watchers who supported the early efforts to build up the
stabilization fund have begun to question whether the state needs any more money to shield
it from a recession.
They point out that state officials who used to say they needed 5
percent of annual operating expenses in the stabilization fund now have nearly 7.5 percent
stashed away. And they question why the Legislature keeps raising a cap that --
theoretically -- represents the maximum amount ever needed in savings.
"I have a hard time taxing people just to get money in the
state's bank," said Michael Daley, a municipal finance consultant, who helped build
Plymouth's stabilization fund when he was finance director there in the mid-1990s.
"They should start letting that flow back out, either to spur the economy or in tax
breaks."
Last year state officials embraced that philosophy more than they had
in the past. They passed an election year tax cut of $1 billion and used part of the
surplus to pay for about one-third of that.
In so doing, though, they may have hastened the end of the era of
free cash in Massachusetts.
With the tax cuts in place and the economy beginning to slow, the
amount of unanticipated tax revenues has fallen in 1999 for the first time since the early
1990s. It will likely end up between $300 million and $500 million, compared with $1.3
billion last year.
"We must remain ever mindful of the fact that the record revenue
surpluses that the state has achieved the last couple of years are not likely to
continue," warned state Treasurer Shannon O'Brien. "Although tax revenues
continue to come into the state's coffers at a very healthy clip, pockets of slower growth
have already begun to appear."
And the pleasant dilemma could soon begin to disappear.