March 14, 2002

Invited testimony before the Oregon Senate Interim Budget Committee

By Steve Buckstein, president, Cascade Policy Institute

I appreciate this invitation to talk with you about State Government's Appropriate Role, and alternative ways of balancing Oregon's budget.

I'm Steve Buckstein, president of Cascade Policy Institute in Portland. Cascade is a think tank. We work to educate Oregonians about how free markets and voluntary transactions can lead to more individual freedom, better economic opportunity, and higher levels of personal responsibility.

Since 1991 we've been watching Oregon government and suggesting policies that might better meet the needs of Oregonians.

About two years ago we asked Randall Pozdena to do some research into the cost of Oregon government services. We wanted to know how Oregon compares to other states, and if taxpayers were getting their money's worth. We published his report, Can Oregon Tighten It's Fiscal Belt? , in November, 2000.

Randall Pozdena is one of Oregon's top economists. He manages the Portland branch of ECO Northwest. He's been the chairman of the Oregon Investment Council. Governor Kitzhaber appointed him to both his council of economic advisors and the Quality Education Model Commission.

Before we talk about the results of Dr. Pozdena's report, let's take a step back and ask ourselves a key question: Can we count on the political process to yield up the right size for government?

I probably want a smaller government than most of you and your colleagues. I believe the bulk of what Oregon government does could be done better and cheaper in the private sector. But the reality is that you've authorized spending some $34 billion this biennium in the All Funds budget, doing a lot of different things.

I believe that government's level of involvement in most of these things is either an historical accident, or the consequence of exaggerating the problems of private provision. You can find examples elsewhere in the world where virtually every Oregon public service is provided effectively by the private sector.

Yet most of us are so used to thinking about education, transportation and welfare as public services that we don't question the role of government in their provision. We only sit in this building lamenting their high cost.

Once government asserts a role in the provision of a service, we rely on that same government to represent our interests and keep the costs to a reasonable level. I question whether that arrangement can work over time.

Nobel laureate economist Milton Friendman and his wife Rose argued many years ago that it cannot.

They said that there's a natural tendency for government to become too large, relative to the consensus level.

The reason is that only special interests with a big stake in government spending can afford the cost of lobbying. In contrast, the average taxpayer cannot justify lobbying against these myriad efforts because the lobbying would cost so much more than could be gained by any one person.

The predominance of lobbying power among those who would spend, relative to those who would rather not, causes spending to increase beyond its efficient level.

From this perspective, the ballot measure process can be viewed as a populist check on the tendency of government to grow unchallenged. I think this is why you see most of the measures aimed at spending less, rather than at taxing or doing more.

Other democracies rely even more on this process than we do. In Switzerland, there are not only local ballot measures, but also national ballot measures. And bills passed by the Swiss legislature must be referred to the ballot for confirmation.

One nice consequence of this system is that legislators think hard about bills; few are passed, and legislative sessions are short.

I think that if government was not so easily influenced by special interest politics, we wouldn't need ballot measures to keep its cost down.

Getting back to Dr. Pozdena's report, we asked him to benchmark Oregon state and local government spending against other comparable states. He examined spending data from all fifty states.

Let me summarize what he found. If you simply take spending per capita in Oregon, we didn't look too far out of range. But Oregon's personal income levels are about seven or eight percent lower than in other states. Making only this adjustment, Oregon rose from the middle of the pack to the eleventh or twelfth highest spending state.

I should note that his report was published in 2000 and he didn't have access to the US census data being collected that year. Now we know that based on the 2000 Census data, Oregon state and local governments were spending more per capita than all but seven other states.

But, public spending by its very nature is affected by the particular demographics of the individual states.

The ideal level of education spending per capita, for example, is likely to be very different in a state with a high proportion of young people, such as Utah, than in a state with a high proportion of the elderly such as Florida. Oregon cannot be benchmarked to other states without consideration of such factors.

It turns out that Oregon is very different from other states in a number of ways that may be relevant to spending levels.

The proportion of Oregonians living in non-metropolitan areas is 50 percent greater than the national average.

The rate of foreign immigration is 33 percent lower than the national average.

Average annual wages and salaries in Oregon are the nation's 22nd lowest.

Oregon's minority population is 64 percent lower than the national average; and

The Oregon poverty rate is 18 percent higher than the national average.

Oregon also has significantly more participation in the labor force by females, and it has a lower smoking rate.

When you control for such demographic factors, you find that Oregon State and local governments are spending about 15 to 20 percent more than other states on comparable services.

In other words, if the average US State had Oregon's demographic makeup, it would be spending 15 or 20 percent less than we do to provide major government services. How many dollars might this overspending represent? Fifteen percent of Oregon's all-funds budget is about $5 billion.

Fifteen percent of just the General Fund budget is $1.8 billion. That's a lot of possible overspending, and that's just at the state level.

Drilling down into individual programs, you find that Oregon State and local governments spend significantly more in four out of the five major spending categories.

We spend 14 percent more than comparable states on Kindergarten through higher education. We spend 30 percent more on health care. 13 percent more on welfare. 19 percent more on corrections and police.

Oregon is only spending less than other states when it comes to highway transportation. We spend 3 percent less on that.

We got to this point, in my opinion, not by accident or gross inefficiency, but through specific policies that Oregon's legislatures and voters knowingly adopted. The Oregon Health Plan was adopted specifically with the goal of providing health insurance to more Oregonians.

We made K-12 education spending the responsibility of state government, where it's been much easier for special interests to lobby for greater spending. On a side note, that funding centralization was, in my opinion, a negative consequence of Measure 5.

We have a larger proportion of Oregon students enrolled in public versus private colleges and universities, and we subsidize those student's tuitions to a greater extent than other states.

We voted for more certain and longer prison sentences, which have required greater spending on corrections.

In the case of highways, the underspending in this area is an echo of Oregon's anti-automobile attitudes and our planners' telling us that we can be happy living stacked like cord wood within tight urban growth boundaries.

I think its time that we question whether we're getting what was promised from these explicit policies. For example, our kids do very well on the SATs, but perhaps only because we have one of the nation's highest dropout rates. In fact, the Rand Corporation found that after adjusting for demographics, Oregonians aren't getting very much for our high level of education spending compared to other states.

The Oregon Health Plan did increase the number of people with health insurance, relative to some other states, but demands on it have exploded, in part because our very restrictive insurance regulations have made it hard for individuals to get private coverage.

Our crime rate is still much higher than our demographics would suggest.

Our anti-road, pro-transit and pro-land use policies haven't kept our highway congestion rank from deteriorating, even relative to other US cities, but it has made our housing the 5th most expensive in the nation. And we now have the 41st lowest home ownership rate in the nation.

The real question may be less the level of spending than whether we're getting the services we want from government provided in the most cost-effective way.

There are at least two approaches you might consider when addressing the results of Dr. Pozdena's study. One is to look for more efficient ways of providing the level of services that this and previous legislatures have authorized. Another is to look for ways to move services out of government where they can be provided better and cheaper.

Dr. Pozdena addressed the first approach in his report.

Let me mention some of his suggestions, and then conclude with some of my suggestions for principles that might help you eliminate the future budget shortfalls that most observers see staring us in the face.

In his report, Dr. Pozdena stated what he called the mantra of economists: that efficiency requires competition and consumer involvement.

In competitive markets the buyers of goods and services have sovereignty. They choose their vendors, and they take their money elsewhere when they're not satisfied. In government, however, we rarely have a choice. When we think the service is shoddy, or too expensive, we might complain, but we can't easily take our business elsewhere.

The result is almost certainly a lower level of quality and a higher cost for government services than we should expect in a competitive environment.

Here's how Dr. Pozdena applied his competitive mantra to the major areas of spending in the state:

Education

In the K12 area, the miracle from an economists' perspective is that we're getting anything at all from the system. There is almost no parental or local influence over the school system, because power follows funding, and the State now determines funding levels.

This allows the education lobby to enjoy the opportunity of one-stop lobbying.

And though the lobbying is always in the name of the children, the reality is that parents and students aren't able to play much of a part in decision process.

Teachers are protected by labor agreements, and no public school, however poorly it performs, is ever shut down. There's no serious competition because it's increasingly hard to take your business elsewhere, and the choice of private school requires you to pay both taxes and tuition.

The system is run for the system… and thus the only part that's allowed to fail… is the student.

Another factor in our high education costs is, in my opinion, the legislature's misguided requirement that school districts consolidate.

Contrary to the common wisdom, consolidation does not lead to economies of scale in a non-competitive industry.

It more likely leads to what economists call dis-economies of scale; things get more expensive as the agencies get bigger. It's competition that forces costs down when companies get bigger in the private sector. But competition is distinctly lacking in our public school system

Is there an alternative? The obvious one is to increase competition and give parents the ability to take their students and their state school dollars to a school that serves them better -public, private religious or secular. Holland has been doing this for 80 years and has the highest performing students in Europe. It has spawned 1000 separate schools for the handicapped, and the best immigrant education record in Europe.

But, in Dr. Pozdena's words, self-serving propaganda from special interest groups has kept this important innovation from entering the American mainstream.

Health Care

Health care in the US now consumes 14 percent of GDP. Why? Economists argue that it's because government health policies have perverted health insurance to the point that it's functioning more like a tax scheme than an insurance system. Let me clarify.

The economic purpose of insurance is to protect us from the cost of unexpected, serious events. Yet we insure completely normal and predictable events, such as coughs and flues, the costs of normal pregnancies, etc. It's as if your automobile insurance policy were required to cover not just major accidents, but pay for the cost of your weekly gas fill-ups, 3,000 mile engine tune-ups and new tires.

The problem with this approach is that these small and normal medical events make up 85 percent of all health visits.

By covering these with insurance, we close off the single largest avenue of consumer cost discipline. This drives up the unit cost of health care, and makes it more and more difficult for people without health insurance to afford even routine care.

The effects come full circle when those without insurance increase the burden on public health systems like The Oregon Health Plan. This burden spawned systems of managed care -where the consumer is second-guessed by the insurer or provider about whether they need care or not.

In our sincere efforts to help people, our political solutions have actually made health care even less affordable, and have taken away much of the cost discipline that otherwise would help us all afford care.

If you respond to this problem like legislators have in the past, you'll only make the problem worse. More rationing will not contain costs. If it did you wouldn't be worried about how to afford the rising costs of The Oregon Health Plan.

Again, from Dr. Pozdena's perspective as an economist, he sees American health care policy devolving into what he calls "… a completely predictable cost and service death spiral."

His solution, and mine, is something like medical savings accounts, where you or your employer set aside money each year into an account that you can chose to spend on routine care, or save tax free for later use. Only catastrophic health events would be insured in the conventional sense.

This is the system that Singapore and Hong Kong have adopted. In Singapore, only 4 percent of GDP goes to health care, compared to 14 percent here; but infant and teen mortality, life expectancy, and other health indicators are similar to or better than ours.

Medical savings accounts are available experimentally under a federal law, but Oregon's insurance regulations make it very difficult for most Oregonians to get them.

Dr. Pozdena's report has other specific suggestions in the areas of welfare, corrections and transportation, but let me now move on to some general budget principles that might help you.

In 1993 Oregon was faced with relatively much bigger budget deficits than you're dealing with today. Measure 5 was requiring the legislature to replace school funding lost to property tax reductions.

In that year Cascade published a paper titled Seven Principles of State Budget Reform . Let me quote from the Executive Summary of that paper:

"Broad principles can sometimes be more helpful than technocratic details in solving large problems like a $1.2 billion budget gap.

An incremental, piecemeal, and tactical approach to dealing with the state's budget problems leads to endless hours in hearing rooms listening to well-organized parades of witnesses testifying about the sea of unmet needs. How the XYZ program helped them, that the agency will have to cut a good program, and so on.

A piecemeal approach gives pressure groups time to organize and subject the Legislature to what one powerful lobbyist calls the "Chinese torture' of organized phone, mail and protest campaigns by large special interests.

A piecemeal approach requires using up political capital and mustering majorities for unpopular votes again and again, for relatively small gains each time.

A piecemeal approach leaves even principled legislators vulnerable to pressure as they are bargaining for a dollar more or less here or there, rather than staking out and standing on clear principles. In the piecemeal approach, a legislator becomes focused on the false dichotomy of either fewer essential services or higher taxes. Possible savings from restructuring government are overlooked.

A principled, comprehensive, and strategic approach to dealing with Oregon's budget crisis views the current debate as an opportunity to transform government and the provision of government services. Such an approach selects a small number of principles that can be readily embodied in legislation or in the Oregon Constitution.

Taken together, these principles could help solve Oregon's budget crisis without new taxes. These principles are designed to be clearly understandable to the people at large and to win widespread popular support. While these principles will lead to more economical government, they are not distinctly conservative or liberal and will help government maintain and improve a wide range of public services for Oregonians."

We said that in 1993, when the projected budget deficit was more than twice as large as you're dealing with today.

I'll briefly discuss several of the principles.

The first principle says that State Government should focus on its core businesses. It seems that this principle has been at least partially adopted already as you've dealt with the current budget shortfall.

Rather than approve across the board spending cuts, you've tried to prioritize based on the perceived importance of various state services. This is a good start, but you should go much further.

Government must set priorities. Some services are essential, although we can debate which ones. Others are questionable. One big question mark is the State Department of Economic Development. Charged with promoting Oregon's economy, it has tried to direct funds toward industries and companies it deemed most desirable. But picking winners and losers in the economy is not an easy task, and is not a proper function of government.

What happened to the level playing field? And if the government is so good at promoting the economy, why did Oregon recently have the highest unemployment rate in the nation?

Cutting the bulk of the three hundred million-dollar plus economic development budget will not only help balance the budget, but should also help the economy.

Remember, just because a service may be essential to some Oregonians doesn't mean the state should provide it.

Job training is a good example. The economy can change rapidly; government changes slowly. Studies found, for example that in Eastern states when laid off steel workers entered government retraining programs they took longer to find new jobs than workers who didn't enter the programs.

Perhaps the most controversial of our Seven Principles says that government employees should not earn more than the taxpayers who pay their salaries.

We can debate whether government workers earn too much or too little, but it's quite clear that the Oregon PERS retirement system is beginning to cause huge problems for both the state and local governments.

If taxpayers really understood how generous the PERS system is, I think you would find little sympathy for any new tax proposals.

Public sector compensation got out of hand because it's not set in a competitive marketplace. Public employees have more paid holidays, more paid vacation, and more sick leave than typical private sector employees.

Public employees have greater employment security and are laid off only one-fourth as often as private employees.

Given all this, it seems appropriate to look at both reducing the level of government employment and freezing salaries and benefits as ways to reduce costs. The private sector does this when necessary; so should government.

Another principle says that you should contract out services when private providers offer better value. There's ample evidence that people want certain public services, want those services in large quantities, yet don't want to pay higher taxes for them.

There's almost no evidence that direct provision of public services by government employees is the most economical way to provide those services.

Contracting out government services can result in lower costs. Savings of 15 to 30 percent are common, and savings of 50 percent and more are reported in authoritative studies.

Among other benefits, large-scale contracting out can create hundreds of new Oregon businesses and expand existing businesses.

There's no reason that private contractors cannot operate Motor Vehicles Division offices or state Employment Department offices, teach children or administer programs in public schools, or perform many other functions.

Where such contracting is done correctly, its not surprising to see the winning bids come from the very government employees who are performing the services now. They often make the best employees of the private firms taking over the services.

Perhaps the most counter-intuitive principle is the final one: Don't accept federal strings as straightjackets.

Free money isn't really free. It generally comes with strings attached that can end up strangling the recipients. For example, Oregon school districts get something like 7 percent of their budgets from the feds. But that money comes with so many rules, regulations and mandates that it may not be worth the cost. You can't change much in The Oregon Health Plan because most of the money comes from Washington. In an ideal world Oregon taxpayers wouldn't send that money to Washington in the first place; we'd keep it at home and use it much more productively without federal oversight.

Another example is Portland's light rail system, which was built with large federal transportation grants. Supporters argued that it was free money and that some other city would get it if we didn't take it.

Yet such grants are often Trojan horses, concealing large operating losses for decades to come. Again, if that money had stayed at home in the first place we might have made very different transportation choices.

While we're here discussing shortfalls in the General Fund Budget, most Oregonians have little or no realization that the All-Funds budget is three times as large as the general fund. Federal grants restrict much of what can be done in the rest of the budget. Even if, on balance, Oregon gets back somewhat more than we send to the feds, I submit that the restrictions aren't worth the benefits. You can't change that in the short run, but you can resist making the problem worse.

You can also realize that State Government Strings often become Straightjackets for local governments. I recently looked at the new physical education standards mandated on Oregon school districts. Apparently the legislature approved the enforcement of these standards last year.

The first one is a third grade benchmark. It reads that students must "demonstrate mature form of the following basic locomotor patterns: run, gallop, slide, leap, and skip. They must also demonstrate that they can start and stop on command and in control."

I won't repeat what the Superintendent of an Oregon school district told me about the impact these and other standards have on her small district. I'll just say that if 3rd graders are expected to be able to stop on command, I hope Oregon's legislature can demonstrate the same skill and stop imposing such mandates on lower levels of government.

In closing, let me share my thoughts on the possibility of tax increases to balance the budget.

Oliver Wendell Holmes said that taxes are the price we pay for a civilized society. If that's true, a lot of us must think we've got all the civilization we can afford.

But I think Holmes got it backwards.

Taxes are actually the price we pay for failing to build a civilized society… and the higher the taxes, the greater the failure.

A truly civilized society would find ways to meet everyone's needs without requiring involuntary payments from our neighbors. We're a long way from a totally voluntary world, but we should be moving toward it, not away.

This legislature can do Oregonians a favor by working hard to find voluntary solutions before resorting to more coercive ones. Please work hard finding ways to remove government from our lives, instead of working to insert it deeper into our families and businesses.

If you vote for more taxes, at least be able to tell us that you tried as hard as you could to find better ways first.

I hope Cascade's work helps you to find those better ways.

Thank you.

Cascade Policy Institute is a tax-exempt educational organization as defined under IRS code 501(c)(3). Cascade neither solicits nor accepts government funding, and is supported by individual, foundation, and corporate contributions. Nothing appearing in this document is to be construed as necessarily representing the views of Cascade, or as an attempt to aid or hinder the passage of any bill before any legislative body.