A Revenue Reservoir to Achieve Fiscal Stability

February 1, 2010By Steve Robinson

Volatility happens, be it in nature or in state government revenue systems.

During Oregon’s fall and winter, snow piles up in the Cascades, but the summer is mostly dry. Even so, farmers and communities enjoy fresh water all year round. That’s because our predecessors addressed the volatility in Oregon’s precipitation patterns by building reservoirs to store the runoff of the melting snowpack for the inevitable summer dryness.

Unfortunately, we haven’t had similar wisdom with regard to the state’s fiscal system. If the current economic crisis has taught us anything, it’s that Oregon’s fiscal system needs stability to weather downturns in the business cycle. And to achieve it, we must build an adequate revenue reservoir — an emergency reserve fund sufficient to maintain public services that are even more vital during economic downturns.

Some Oregon politicians and pundits decry the volatility that accompanies corporate and personal income taxes, Oregon’s primary sources of revenue. They pin their hopes on a sales tax.

But a sales tax is no cure for volatility, which is inherent in all revenue systems. Washington, a state with a sales tax and no personal income tax, is grappling with a shortfall of a magnitude similar to Oregon’s for their two-year budget period.

Any call for a sales tax distracts from the principal issue: adding stability to our fiscal system.

It’s no secret how Oregon can engineer fiscal stability. As a state task force on revenue system restructuring concluded in 2008, we need to save the unanticipated revenue collected during good economic times for revenue droughts during the inevitable downturns.

The biggest impediment to stability is Oregon’s practice of spending, not saving, unanticipated revenues. We spend money on an automatic tax cut — one that primarily benefits the most well-off households and large corporations — triggered when revenues come in at 2 percent or more above the amount predicted by the state economist two years earlier. That’s an exceedingly narrow margin of error, considering the many events that can happen over the course of two years and considering that Oregon’s relatively small economy — just 1 percent of the national economy — is subject to national and international economic forces.

True, the legislature can suspend the automatic spending — commonly called “the kicker” — with a supermajority vote, but that’s an unreliable mechanism for achieving fiscal stability. In 2007, the legislature did nothing to block the tax cut for households, opting to spend $1.1 billion rather than save the money for an economic downturn. The legislature did, however, partially suspend the smaller corporate payment and put the savings into a newly created Rainy Day Fund.

While an important first step, the new reserve fund proved too meager. As the state was spending $1.1 billion giving unanticipated revenues to households, the Great Recession was starting to descend upon Oregon and the nation. Oregon’s revenue collections ultimately plummeted far in excess of the new Rainy Day Fund, forcing deep cuts in public services and necessitating tax increases in the form of Measures 66 and 67.

Until Oregon develops more ample emergency reserves, we will continue to suffer more than necessary during recessions. At such times, the only options are raising taxes or cutting government spending. Tax increases are politically tough to enact anytime, especially in a recession. Budget cuts, which choke the flow of state dollars into the economy, make a recession deeper and longer. They also magnify the pain for families and communities, since the need for public services grows dramatically during recessions.

Unfortunately, lawmakers meeting in Salem this month have announced that they will not put up for a vote a plan for a better emergency reserve fund, even though many of them recognize the urgent need for such fiscally conservative reform. Whether that political decision was correct may not be readily apparent, but the need for a better reserve is still obvious. Meanwhile the clock on the next business cycle ticks away.

An adequate emergency reserve won’t end the inherent volatility in our revenue system, any more than a water reservoir prevents summer dry spells. But it will alleviate a great deal of the pain that a fiscal crisis would otherwise engender.

Steve Robinson is a policy analyst with the Oregon Center for Public Policy