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Deficit looming, solution pending

The Baltimore Sun

Maryland's "structural deficit" - a roughly $1.4 billion shortfall between revenues and expenditures expected to persist for the next several years - can be traced back to two decisions the state government made in the past several years: passage of an income tax cut and a record education spending plan.

Ever since Gov. Martin O'Malley and Maryland lawmakers arrived in Annapolis this year for the legislative session, they have talked almost obsessively about ways to fix the budget gap - a solution that will almost certainly mean higher taxes next year.

Leaders from both parties, as well as independent analysts, say the problem is dire. And they have suggested all sorts of reasons why Maryland's tax revenues aren't keeping up with the rate of spending: an antiquated tax system designed for a manufacturing economy, not one based on services; the loss of potential slot machine revenue to neighboring states; and excessive spending by the last two governors.

Budget watchers inside and outside the state government say those factors played a role in the current fiscal problem. But Maryland's structural deficit can be explained much more simply. In 1997, Gov. Parris N. Glendening pushed for a 10 percent income tax cut, and five years later, he and the General Assembly approved the landmark Thornton education funding plan.

All other things being equal, if those two things hadn't happened, Maryland would be looking at a $700 million surplus next year instead of a $1.4 billion shortfall.

"We are investing dollars at a faster rate than the dollars are coming in," O'Malley, a Democrat, said recently. "The biggest of these investments has been in education, and we compounded the problem by doing a big income tax cut. At the same time we were headed down the road toward a historic investment related to education; we did a stupid and short-sighted income tax cut."

James C. "Chip" DiPaula Jr., who was budget secretary under Republican Gov. Robert L. Ehrlich, Jr., agreed that the structural deficit is real.

Fiscal projections are conservative by design - meaning they understate expected revenue and overstate expected spending - but the gap Maryland now faces is beyond the norm, largely because of Thornton and growing Medicaid expenses, he said.

"Forty percent of the budget is education, and it's growing by 10 percent a year because of Thornton," DiPaula said. "The No. 2 item, 30 percent of the budget, is going to health care, and if unchecked, it grows by 10 percent a year. If 70 percent of your budget is growing by 10 percent and your revenue is only growing by 4 percent, you've got a problem."

Many Democratic lawmakers now regard the income tax cut as a mistake. But they say it made sense then - politically, if not fiscally.

Glendening, a Democrat, began his push for a tax cut in 1996 and succeeded in enacting it a year later, just before he faced a rematch with Republican Ellen R. Sauerbrey, who nearly beat him in the 1994 election with her call to reduce the income tax rate by 24 percent. Then-House Speaker Casper R. Taylor Jr., a tax cut proponent, was also contemplating a challenge to Glendening in the Democratic primary.

Taylor said he still thinks lowering the rate to 4.75 percent and doubling the personal exemption was the right thing to do.

"Our income tax, comparatively speaking, was higher than a lot of our competitors, and [the cut] put us in a much more competitive position for economic growth," Taylor said.

Warren Deschenaux, the General Assembly's chief legislative analyst, said the revenue projections at the time showed the tax cut would push the state into a deficit unless it cut spending or increased other taxes.

But then the late 1990s technology boom took off, and the state became flush with cash - in the first four years that the tax cut was being phased in, the state ran up nearly $2 billion in structural surpluses, most of which Glendening poured into capital projects and land preservation.

When the good times ended, Maryland was hit hard, turning surpluses to deficits. The state went from a structural surplus of more than $500 million in fiscal year 2001 to a structural deficit of nearly $675 million in fiscal year 2002, a swing of more than $1 billion in a year.

Facing an even deeper hole the following year, Glendening in 2002 proposed delaying the last phase of the income tax cut, a move that would have generated a one-time infusion of $175 million. But the legislature rejected the plan and let the tax increase go into effect.

If Maryland hadn't enacted the tax cut at all, its financial problems this decade wouldn't have been nearly as severe. But Deschenaux said such revisionist thinking doesn't jibe with the reality of Annapolis.

"People tend to think that if we just had that money, we'd be fine," he said. "If we had that money, we'd be spending it."

Indeed, said Sen. David R. Brinkley, the minority leader from Frederick County, that has always been the Maryland legislature's problem, dating back to the 19th century when the state couldn't decide whether to subsidize the B&O; Railroad or the C&O; Canal. The state funded both and promptly went bankrupt.

"The legislature can't say no," he said.

The prime example of that in the minds of many came in 2002, the same year Glendening was pushing to delay the income tax cut. That was when the Commission on Education Finance, Equity and Excellence - a blue-ribbon panel better known by the name of its chairman, Alvin Thornton - finalized its report calling for a massive infusion of state aid for K-12 education.

That year -before an election - the General Assembly enacted a funding formula that called for an additional $1.3 billion in spending when fully phased in.

What it did not do was find a way to pay for it, either through cuts to other programs or through tax increases. The legislature increased the tobacco tax, generating $70 million to $80 million a year and defraying most of the cost in the first two years. The increase didn't help when the tab for Thornton stretched to more than $1 billion this year.

Republicans criticized that vote as one of the most irresponsible financial decisions the state has ever made. But former Sen. Barbara A. Hoffman, a Democrat who as chairwoman of the Budget and Taxation Committee pushed to enact Thornton, said it was the right move.

"When people ask me about how could you pass Thornton without a funding source, I say, 'You're not asking me how we're going to pay for anything else. Why are you asking me how we're going to pay for this?'" she said.

Ehrlich, a Republican who took office in 2003, agreed that Thornton had to be funded, but he would not accept the sales tax increase many believed was needed to pay for it. He proposed using revenues from slot machine gambling instead, a plan that would have generated as much as $800 million a year when fully phased in. But he was unable to get it through the General Assembly, largely due to opposition from House Speaker Michael E. Busch and leaders in that chamber.

But even if Ehrlich had gotten slots in his first year, the money wouldn't have come quickly enough. The day Ehrlich took office, he faced the need to cut about $550 million from the budget that was then in effect, plus more from the next year's spending plan, DiPaula said. After the legislature went home that year, the administration cut $208 million more.

DiPaula said the problem Maryland faces now isn't as acute as it was then - cash built up during Ehrlich's term gives the state more than a year to find a solution before significant cuts or new revenue is needed.

The state is still enjoying the benefits of two good budget years during Ehrlich's term, when a booming real estate market - as well as spending cuts and increases to the property tax and various fees - allowed his administration to stock Maryland's rainy day fund. But although the state's economy remains relatively strong, the budget shortfalls returned in fiscal year 2007, the budget year that began in July.

House Republicans tried this year to solve the problem on the spending side, eliminating virtually all increases in next year's budget, including Thornton. Senate Republicans tried a similar proposal this week. They said that if the state passed slots and scaled back some spending increases, it could eliminate the deficit.

"We were getting 8 and 10 percent increases for some things in our proposal," said Sen. George C. Edwards, a Western Maryland Republican.

The Republican proposals failed by wide margins in the Democratic-controlled legislature.

Roy T. Meyers, a political science professor and government budgeting expert at the University of Maryland, Baltimore County said spending on Thornton, Medicaid and other programs is part of the problem, but in the long run, so is a tax structure that doesn't match Maryland's economy.

"One of the common criteria used by budget experts is the yield of the system: Does it provide the money you want to provide necessary services? That is inevitably a political issue," Meyers said. "But there are other criteria: As the economy grows, do you receive the same percentage of revenue for the current tax structure?"

Maryland doesn't, he said. The sales tax, which is Maryland's second-biggest revenue source, exempts most services, which are an increasingly large part of state commerce, Meyers said. Dozens of other tax breaks and loopholes in the law mean that government revenues don't keep pace as the state grows, he said.

Lawmakers have been talking about modernizing Maryland's tax code for decades, but the politics of such a move are difficult. This year on the day a House committee heard a bill to broaden the sales tax on services, including manicures, shoe repair and real estate agents, whose commissions would be hit by the proposal, oppenents showed up en masse, clogging every parking garage in Annapolis.

O'Malley has avoided tackling the budget this year, saying he wants time to find efficiency savings in government. But he said he also sees political work to do.

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