Cascade Policy Institute

January, 1997

Finding Common Ground:
Oregon State Government After Measure 47

by Martin L. Buchanan

Executive Summary

In November 1996, Oregon voters passed the second major property tax limitation in six years, Measure 47, "cut and cap," reducing property taxes to the lesser of the 1995-96 tax minus 10% or the 1994-95 tax, and limiting future increases in assessments (except for new construction or additions) to 3% per year.[1] School district property tax revenues will be reduced $450 million below the levels otherwise expected in the 1997-1999 biennium, while local government property tax revenues will be cut $560 million.[2]

Governor John Kitzhaber proposes to replace $459 million in lost property tax revenues for schools.[3 ] His budget proposes $800 million in tax increases, half from keeping income tax money that would otherwise be refunded because it was in excess of revenue forecasts.[4]

This paper proposes reasonable ways to save the state of Oregon $527 million in the next biennium, more than enough to replace all the school losses from Measure 47, or almost all the local government losses, or some combination of the two. The theme of "Finding Common Ground" is that realistic policy proposals must have broad support. Anyone could control the state's budget if made king or queen for a day. It is controlling the budget through a political consensus of three million Oregonians and their representatives that is challenging. These pages contain no service cuts in education, in human resources, or in public safety. The focus is on providing improved public services with lower costs.[5]

Proposal #1: Privatize Selected State Operations

Privatizing all or part of four state agencies can save the state $239 million per biennium, $171 million in the general fund.

Oregonians can save $55 million each biennium if state government removes itself from the wholesale and retail liquor business.[6] A 1994 study by the Oregon Retail Liquor Association [7] proposes abolishing the Oregon Liquor Control Commission (OLCC) and its bureaucracy of over 200 state employees. The study proposes limiting the number of retail liquor licenses, beginning with the existing number of 235. Retailer compensation and margins would become a function of the marketplace and not a state budget obligation. Marketplace incentives will generate improved service to the public, while the private operators' need to protect their licenses will enhance incentives for properly denying service to kids and drunks. Privatization at the wholesale level eliminates the OLCC's receiving, warehousing, and shipping expenses. Wholesale privatization involves few control issues, as public access to liquor is almost non-existent at the wholesale level. Finally, the role of the OLCC's liquor enforcement officers can be replaced by contracting with local law enforcement agencies as needed. The state liquor monopoly produces considerable revenue for the general fund. Privatization can be structured to either lower prices to consumers, increase general fund revenues, or both. This paper assumes that privatization increases general fund revenues by the entire amount, rather than lowering liquor prices.[8]

Oregon's Driver and Motor Vehicle Services (DMV) is another state agency providing a retail function with some regulatory aspects, the sale of drivers licenses, license plates, and vehicle registrations, according to current research by Patrick Hazel.[9] All of these functions can be provided less expensively by private franchisees, as is already done in Ohio and North Dakota. Both for-profit businesses and non-profit groups such as auto clubs handle all normal DMV transactions with the public in these states. Hours of service and quality of service will improve, as franchisees are compensated based on their transaction volume, as in Ohio. Holding franchisees legally responsible for incorrect actions can maintain or improve accountability. Hazel estimates savings of $68 million per biennium, about 50% of DMV's present costs.[10] However, these savings come out of other funds, not the general fund, so are not listed in this paper as general fund savings. Such DMV savings can be used to reduce DMV fees and improve funding for other transportation programs.

The Oregon Department of Corrections is in the incarceration business, locking up some people so they won't hurt the rest of us. ODOC is currently spending $238 million per year [11] to incarcerate about 7,300 prisoners [12], or $32,600 per prisoner per year, which is $89 per inmate-day. A 1994 study by Darren T. Board [13] found admitted costs (at that time) of $57.37 per inmate-day for Oregon's adult medium and minimum security inmates, while private prisons in many states are providing the same service at an average cost of $40.00 per inmate-day, a 30% cost savings. Sixteen states are already using privately operated prisons and there are 20 private companies operating 67 minimum and medium security facilities in those states. With Oregon planning the construction of several new prisons and expecting an increase in prison population (attributed to minimum sentencing requirements enacted by voter initiative in 1994 [14]), this is an excellent time to privatize one or more prisons without threatening existing jobs in ODOC. Privatizing the incarceration of 2,000 Oregon inmates, 20% to 25% of Oregon's prison population in the next biennium, can save taxpayers $26 million per biennium.[15]

The governor's budget was presented in a front-page Oregonian article [16] as having "about the same buying power" as budgets of the past 20 years, adjusting for inflation and population growth. Ironically, the same issue of the Oregonian reported the well-publicized recent conclusion by a national panel of economists that the consumer price index overstates inflation by 1.1 percentage points each year. Making that correction for a 20-year period means that Governor Kitzhaber's budget is not just $200 million greater (after deducting school property tax relief) than the "current services" budget based on 1977-79, but is $1.4 billion greater.[17] In other words, we could replace the Measure 47 losses to the schools, cut Oregon income taxes by 14%, [18] and still have the same level of public services as in the 1977-79 biennium.

If your broker offered you a $5 annual return on a $1,000 investment, you would laugh in his face. As John A. Charles points out in a current study [19], the state is offering just such a return to Oregon's schools. The Oregon Division of State Lands manages 2.34 million acres of trust lands, valued at $1.1 billion, on behalf of the Common School Fund. These are not park lands, but are predominantly forest, grazing, and agricultural lands. The average return on this investment has been 0.5% per year for the last 10 years. In contrast, the average return on the Common School Fund's financial portfolio of $328 million has been 7%. Selling most trust lands (which may require a voter-approved change in Oregon's constitution) could net $1.0 billion for the Common School Fund. At a five percent real rate of return, these assets would produce $100 million in the next biennium for the schools, instead of the $10 million now produced, for a net increase of $90 million for the schools.[20]

Proposal #2: Use Tax Credits to Reduce Public School Enrollment and Increase Resources Per Student

In round figures, Oregon public schools enroll 530,000 students and Oregon private schools or homeschooling enroll 50,000 students, in grades K to 12.[21] The public schools cost an average of $6,000 per enrolled student [22], the private schools cost an average of $3,000 per enrolled student, and homeschooling costs are much lower still, with the main cost being the labor of the homeschooling parents. Overall enrollment is increasing, with the Portland area alone expecting 81,000 additional children in public schools by the year 2015. At today's prices, building schools for those additional children will cost $1.7 billion,[23] while operating those schools will cost an additional half a billion tax dollars each year. This tremendous cost is inevitable only if those children are in public schools, on average the most expensive education providers. The 91% market share of public schools is not a reflection of superior quality, but of the present structure of costs and incentives to families. That present structure encourages families that use the most expensive education providers, "free" public schools that cost taxpayers $6,000 per student, while discouraging families using other schools, who must pay taxes for public schools and pay a second time for the education they choose.

The great cost differences between public schools and alternative providers creates an opportunity to change the financial incentives in a way that will help both public schools and other education providers. Providing a tax credit of $1,000 per student to those families who use other education providers would move perhaps 50,000 students out of public schools and into independent education. Such a "load-shedding" tax credit would be provided for each student for which a family gives up their right to a free or subsidized public education, subject to the requirement that the family makes satisfactory (according to present law) alternative educational arrangements, whether a private school, a home school, or paying tuition at a public school. The tax credit would be refundable, available even if the credit amount is greater than a household's Oregon income tax liability.

Consider what happens when a family with a child in public school or about to enroll in public school chooses the tax credit and an alternative education provider. The public schools and the taxpayers will save $5,000 per child on average (based on dividing the $6,000 cost per student into $1,000 fixed costs and $5,000 variable costs)[24], or $4,000 after the tax credit cost.

If a $1,000 per child tax credit motivates 50,000 students to move from public schools to private education providers, then the gross savings at $4,000 per student are $200 million per year. The costs of tax credits for children already in independent schools is $50 million per year and the net gain to the public schools is $150 million per year or $300 million per biennium. These savings would allow the public schools to increase spending per child for the remaining 480,000 students by $312 per year, or about 5% above the levels otherwise possible.

Paying people not to use an expensive resource has precedents. For example, electric power companies have sometimes paid customers to adopt conservation measures, reducing demand for their product, because "negawatts," the energy saved, are a cheaper energy source than building additional power plants. For a fraction of our normal public school costs, we can provide sufficient incentives that many families will choose private providers, and the private providers will then incur the capital costs for the new schools.

Each dollar more or less of incentives causes more or fewer people to choose education alternatives, allowing such tax credits to be easily adjusted to achieve desired policy goals. For example, if providing broad accessibility to school choices becomes a goal, not just saving tax dollars, then families below or near the poverty line and students with handicaps could receive larger incentives.

A stepped tax credit, lower in the first year, provides time for private providers to expand to meet increased demand. Provide a $500 per child refundable income tax credit for foregoing a free or subsidized public school education in the 1997-98 school year, a $1,000 per child tax credit in the 1998-99 school year, and index the tax credit for inflation thereafter. The estimated savings are $237 million in the first biennium.[25]

How local governments can adapt to Measure 47's limits without raising taxes or cutting services deserves separate analysis. An excellent start is the November 1996 issue of Oregon Business magazine.[26] It describes how the city of Wilsonville opted out of Tri-Met's transit monopoly, got better bus service with all rides free, and cut its payroll tax rate in half; how the city of Gladstone has cut its work force and its tax burden dramatically while still providing good service; and how Yamhill County built a new jail for two thirds less than its original price tag.

Proposal #3: Develop Oregon's Economy Through Free Markets, Not Corporate Welfare

Abolish the Oregon Economic Development Department and save $119 million in lottery funds and general funds each biennium.[27] In doing so, we may relinquish up to $155 million in federal funds, funds that may disappear in the future if Congress gets serious about ending federal corporate welfare.

How can such a proposal be considered moderate or feasible? For several reasons:

* The department does not provide essential services. It does not educate people, or protect them, or feed hungry children. Its core function is corporate welfare, to provide money and tax breaks to businesses, and sometimes to communities. To abolish OEDD is to accept that government's proper functions do not include giving money away to private businesses.

* It is based on false economics. If Oregon had a Department of Unicorn Breeding, we would question the expenditure even if the federal government paid half. As Frederic Bastiat pointed out more than a century ago, government commits the fallacy of the "seen and the unseen." We see the $500,000 of public money given to one company and the jobs "created" there. We do not see the jobs that would have been created elsewhere in the private economy if that money was left in private hands. Government can only "develop" an economy if government is a better allocator of resources for economic growth than private business-people, a premise that both common sense and the science of public choice economics contradict.[28]

* It is unjust. Public expenditures should be for the general welfare, but economic development money, a small fraction of the billions of dollars flowing through Oregon's private economy, goes to the few, to the well-connected, to those who pull strings, to the powerful. Such funds are not evenly distributed on a level playing field. One company gets money; its competitor does not, and is thus disadvantaged, along with its employees.

* It diverts attention from effective economic development strategies. A real economic development strategy develops all businesses and economic sectors, because it involves keeping taxes reasonable, eliminating regulations that create monopolies and restrain consumer choice, and providing high-quality public services at reasonable cost.

Conclusion

These ideas are only the tip of the iceberg, a demonstration that tax restraint and maintaining important public services are compatible, saving $527 million each biennium. Dozens of other major improvements in Oregon government are possible and deserve to be considered.

Endnotes

1. Measure No. 47 in Oregon 1996 Voters' Pamphlet.

2. The Sunday Oregonian, 17 November 1996.

3. There is a minor discrepancy between quoted figures of $450 million and $459 million for the loss to schools. The governor would replace 100% of school losses and none of local government's losses. Anyone comparing school costs and results today versus 30 years ago can make a good case that public schools are overfunded and are crowding out other important local government services.

4. While this paper's ways of saving money can be used to argue against tax increases, the author is not a particular fan of the 2% kicker, which always seemed to be a bizarre tax policy. If the state takes in extra money (for example) during seven fat years, then perhaps the money could go into a rainy day fund or into a permanent endowment to fund public services from the interest, to lighten the burden during the seven lean years that could follow.

5. This paper relies heavily on the excellent work done by winners in the 1994 and 1996 Oregon Better Government Competitions conducted by the Cascade Policy Institute. The author is in their debt.

6. The 1995-97 Adopted Budget allocates $55,680,187 for the Oregon Liquor Control Commission.

7. "Controlled Privatization: Progressive Alcohol Management for Oregon" by the Oregon Retail Liquor Association, published in Renewing Our Pioneer Spirit, Oregon Better Government Competition 1994 Winners by Cascade Policy Institute, pp. 81-98.

8. The savings from OLCC privatization can be captured for the general fund by adjusting alcohol tax rates so that retail prices are at the same general level, with revenue from taxing alcohol rather than from monopoly profits. The authors of the Cascade study also advocate taxing the alcohol content of beer, hard liquor, and wine at the same rate.

9. "Privatize the Oregon DMV"by Patrick Hazel, part of Cascade Policy Institute's 1996 Oregon Better Government Competition.

10. The 1995-97 Adopted Budget provides $130,939,172 for "Driver and Motor Vehicle Services."

11. The 1995-97 Adopted budget provides $656,856,775 for the Department of Corrections. However, $179,465,836 for the Snake River facility expansion has been excluded as a capital expense, leaving a net of $477, 390,939.

12. 1995-97 Governor's Recommended Budget, page C-3 gives this estimate of Oregon's prison population as of January 1997, using the "midpoint estimate" given. Note that Darren Board's paper cites 4,650 adult medium and minimum security prisoners, leaving out the maximum security prisoners.

13. "Private Prisons in Oregon: A Good Idea" by Darren T. Board, published in Renewing Our Pioneer Spirit, Oregon Better Government Competition 1994 Winners by Cascade Policy Institute, pp. 57-79.

14. Ballot Measure 11, enacted in 1994.

15. Conservatively assuming savings of $18 per inmate-day, times 365.25 days per year, times 2 years per biennium, times 2,000 inmates = $26,298,000 per biennium.

16. "Kitzhaber's budget may not be big leap" by Gail Kinsey Hill, The Oregonian, 15 December 1996.

17. The article subtracts property tax relief from the $9.6 billion general fund budget, to arrive at an adjusted budget of $6.4 billion. The 1977-79 general fund budget (adjusted for a very small amount of property tax relief) was $1.8 billion, which adjusted for population growth and CPI becomes $6.2 billion. However, an error of 1.1% per year in the CPI, compounded over 20 years, yields an error of 24.46%, so the correct adjusted budget is $5.0 billion (rounded to the nearest hundred million dollars, as the newspaper article figures are). Discussion of the general fund budget also ignores the all funds budget, in which the state will spend more than twice as much, in excess of $25 billion during the biennium.

18. The Governor's proposed budget is more than $400 million in deficit, relying on a large beginning balance of $536.3 million, which would be reduced to $114 million. Accordingly, income taxes could only be reduced 14% ($1.0 billion), not 20% ($1.4 billion), to maintain a balanced budget.

19. "A Market-Based Proposal for Financing Oregon Schools" by John A. Charles, part of Cascade Policy Institute's 1996 Oregon Better Government Competition.

20. The projected net is one billion dollars rather than 1.1 billion dollars because some lands may be encumbered by the Endangered Species Act or otherwise be environmentally sensitive. Property tax revenues for schools and local governments could also increase by as much as $30 million per biennium, assuming a 1.5% property tax rate. However, different tax policies towards agricultural or forest lands could reduce that amount.

21. The 1995-96 Oregon Report Card shows fall enrollment of 527,914 students in Oregon public schools (available from the Oregon Department of Education).

22. This very conservative figure is used to avoid the frequent side arguments over how much schools really spend. The in-depth article "Where School Dollars Flow" in The Sunday Oregonian of January 5, 1997 documents Oregon per ADM student spending of $7,486 in public schools for the 1995-96 school year. ADM is average daily membership, a measure of students attending school.

23. "New Schools: Who Pays?" in The Oregonian, 9 December 1996, page A-1.

24. See the author's prior paper, "Oregon K-12 Education: Can It Withstand State Budget Cuts?", published by Cascade Policy Institute for information supporting this ratio.

25. 25,000 students moving in the first year x ($5,000 - $500 = $4,500 savings per student) = $112.5 million minus $25 million tax credits for existing students outside public schools = net savings of 87.5 million in the first year, plus $150 million in each year thereafter as described in the main text.

26. "Competition Comes to City Hall" by John M. Grund, and "Whoever Lays Bricks, Raise Your Hand" by Shirleen Holt, in the November 1996 issue of Oregon Business magazine.

27. 1995-97 Adopted Budget. Up to an additional 160 million dollars would be saved in bonds and property tax give-aways related to OEDD projects. These savings are not claimed, because the author lacks a detailed understanding of the financial mechanisms and details.

28. For more information about this fascinating branch of economics, see Beyond Politics: Markets, Welfare, and the Failure of Bureaucracy by William C. Mitchell and Randy T. Simmons, Westview Press, 1994.