This appendix discusses the possibilities that the central conclusions of this
report are wrong.
PREDICTIONS OF STRUCTURAL DEFICITS
The prediction of widespread structural deficits in state and local government throughout
the next decade is the cornerstone of the conclusions in this report. That prediction
naturally depends on definitions of what constitutes current service spending, which
are discussed in this section. Given the definitions that are common in state budgeting
and similar projections, the prediction of structural deficits depends on demographic,
economic, and federal budget assumptions.
The underlying demographic assumptions reflect relatively stable patterns of demographic
change. One major variable in the population estimates is immigration. But as indicated
below, over time, immigration has somewhat parallel impacts on spending and revenues.
Changes in longevity would have major impacts on total government spending.
Most of the adverse impact, however, would be concentrated on the federal budget,
which bears total responsibility for maintaining safety net income through the Supplemental
Security Income program, for preventing poverty in retirement through Social Security,
and for providing the bulk of medical care for the aged through Medicare. State and
local impacts would be confined primarily to health care spending supplementing Medicare
and, most important, to increased nursing home outlays shared by the federal government
and the states through Medicaid.
Changes in birth rates would not have much impact on state and local spending
during the eight-year projection period of the forecasts in this report. The primary
impact of children on state and local budgets comes only when they reach school age,
so there is about a five-year lead time between birth rate changes and spending impacts.
The predictions assume a long-term rate of real growth in the U. S. economy,
about 2.4% as measured by the total output of goods and services (Gross Domestic
Product or GDP) adjusted by a price index known as the GDP price deflator. Economic
growth in excess of the predicted rate is an unmitigated blessing for government
finances. It adds to revenues because tax collections are closely related to total
economic activity. But it does not add to spending pressures, which are based on
such factors as the number of children in school. More rapid growth than previous
predictions, more than all other factors combined, accounts for turning the federal
deficit into a surplus and for the strong current fiscal position of state governments.
It is possible that national economic growth could continue to exceed what forecasters
view as the long-term trend. The fiscal impacts would depend on how the growth came
about. Total output can be considered as the product of two factors: (1) total worker
hours, and (2) productivity or output per worker-hour. So long as growth resulted
from unexpected gains in productivity, there would be unambiguous gains in private
living standards and in government revenues. However, such gains would be unprecedented
in the nation's economic history. They are increasingly hard to realize because a
growing proportion of economic activity is taking form (e.g., beauty care, most health
care, and many other forms of personal services) where productivity gains are harder
to realize than in manufacturing and construction. If unexpected growth results from
a larger percentage of the nation's population working or a lengthening of the work
day or work week, the fiscal consequences would also be overwhelmingly favorable.
However, output gains that result from immigration of the labor force would not be
favorable, as the unanticipated population growth would soon lead to as many sources
of additional spending as the added revenues.
To the author and many other observers, the downside risks to assumed economic
growth rates seem more serious than the upside risks. Individual forecasters each
have their own favorite causes of concern. The author's is the increasing dependence
of growth in national output on money from abroad. Currently, Americans are able
to spend about $900 per person (including children) per year more than the value
of their production because capital inflows from other nations (the reciprocal of
a negative balance of trade in goods and services) now equal that amount. Centuries
of economic history suggest that other nations will not subsidize the consumption
of one nation to that extent indefinitely.
While the projections assume an inflation rate, the projections of structural
deficits are largely insensitive to assumed rates. Inflation has nearly equal impacts
on spending and revenues.
Federal Budget Assumptions
Assumptions about the federal budget affect higher education planning in two ways.
First, the assumptions affect presumed federal outlays for higher education made
directly in the form of Pell grants and other programs. Second, the assumptions affect
presumed state and local outlays for higher education through the impact of federal
spending on the fiscal position of state and local governments. With the federal
budget supporting nearly 25% of all state and local spending, that fiscal position
is now highly sensitive to what happens to future federal aid.
The outlook for federal domestic discretionary spending -- the category that includes
both direct federal support of higher education and most grants to state and local
governments -- is mixed.
On the one hand, actions in 1998 suggest this report's assumptions in this area
will be easily realized. These projections assume that federal aid to state and local
government will simply remain a constant percentage of personal income. The projections
of federal surplus -- which governed the congressional budget allocations in 1998
and the many decisions in Congress to increase aid programs -- suggest that federal
officials have both the desire to spend more on domestic discretionary programs and
the fiscal capabilities to do so.
On the other hand, the spending caps of the 1997 budget agreement remain in place
and both the President and the congressional leaders have indicated that these agreements
will not be violated. These caps were not seriously restrictive in 1998, as they
were designed to avoid pre-election budget trauma for members of Congress. But they
bite heavily in 1999, with consideration of the fy 2000 budget. The caps will require
that domestic discretionary outlays be reduced by about $28 billion from the fy 1999
levels. Appropriations needed to maintain federal domestic discretionary spending
as a constant share of personal income would need to account for this $28 billion
reduction. Similar problems will arise as federal officials consider budgets for
fy 2001 and subsequent years.
The conflicting perspectives on future federal spending for domestic discretionary
programs create choices that will provide the basis for debates on the federal budget
in 1999 and the years beyond. Those debates could result in federal spending in support
of state and local spending (and direct federal support of higher education) that
could vary substantially, up or down, from the growth assumed in this paper.
REMEDIES FOR STRUCTURAL DEFICITS
Running Unbalanced Budgets
The financial picture that this report paints for higher education presumes that
state and local governments will continue to maintain balanced budgets, as they are
required to do by many constitutional provisions and statutes. These laws and the
traditions behind them withstood the intense fiscal challenges of the Great Depression
(circa 1929 to 1938) and appear likely to withstand the lesser challenges predicted
by the projections in this report.
Because of balanced budget requirements, state officials will not allow a structural
deficit of the magnitude described in the projections to occur. Instead, in the states
where these deficits occur, state officials will deal incrementally with the mismatch
between revenues from current taxes and the spending needed to maintain current services
-- that is, they will respond to projected deficits as they become apparent.
Although the text of the report does not predict this, the discussion of fiscal pressures
on higher education suggests that most of the adjustments will be made by reductions
in spending below the level required to maintain current services.
In fact, many adjustments are likely to be made by increasing taxes. Increases
are particularly likely in the taxes with the least responsiveness to economic growth
-- particularly the per-unit taxes on motor fuels, tobacco, and alcoholic beverages.
For various reasons, increases in these taxes are not as politically formidable as
increases in general taxes. Increases are also more likely in states combining rapid
growth and inelastic tax systems, with Texas providing a good example. Reflecting
public attitudes toward growth-oriented spending, the willingness of elected officials
in those states to raise taxes is substantially greater than is found on average
throughout the nation.
For the past two decades, state and local taxes have taken an almost constant
percentage of personal income. This means, on balance and over the business cycle,
tax increases have predominated over tax cuts enough to overcome the less-than-unit
elasticity of state and local tax systems. That pattern may well continue, thereby
reducing somewhat the impact of structural deficits on spending in general and higher
education spending in particular.
The text of the report and Appendix B suggest that all possibilities for providing
increases at less-than-current service level requirements have major policy consequences
and thus major political consequences. Particularly over the short term, this is
not entirely true. In many but not all state and local activities, small structural
deficits can be handled by spending constraints with no immediate policy consequences.
Current service budgets presume that major ratios of governmental inputs to governmental
outputs will remain constant. Examples of such ratios are faculty members to students
in higher education, teachers to students in public schools, caseworkers to clients
in social services, police officers and firefighters to population in local governments,
and guards to prisoners in corrections. Such ratios can be allowed to inflate somewhat
by holding spending increases to slightly below the levels that would be required
to maintain them. Of course, there are consequences in each field paralleling the
consequences most readers would understand for such ratio changes in public higher
Current service budgets also presume that the relationship between the compensation
of public sector employees and the compensation of private sector employees will
remain constant. As a result, the projections presume the same increase in real (inflation-adjusted)
compensation of all workers, which, by definition, is roughly equal to the annual
improvements in productivity assumed in the economic projections.
Given the assumptions of this report, this means university faculty members, public
school teachers, and other public workers would be seeing annual average increases
in purchasing power of about 1.5% a year. In the long run, providing smaller increases
in compensation for public sector workers creates no apparent problems. For example,
annual pay increases matching inflation would be readily defensible for many elected
officials and would cut 1.5% a year from the wages and salary component of state
and local outlays. The wage and salary component of state and local spending is so
large that an inflation-matching compensation salary policy would, by itself, eliminate
(on a national average basis) the structural deficit predicted in this report.
Such a policy is untenable in the long run because the public sector must compete
for workers, particularly at the entry level, with the private sector.
Spending Shifts Out of the Public Sector
Nearly all discussions of government spending and taxes presume the same accounting
conventions used to prepare and present budgets and fiscal statistics. These exclude
those extractions of funds from the public that are "off-budget" in the
jurisdiction(s) under consideration, and they often exclude the spending financed
by those revenues. Major examples are public university tuition and fees, charges
by state toll road authorities, and charges levied for services of public institutions
with functions that parallel those of the private sector, including providing hospital
services, recreation, electric power, and natural gas.
The projections in this report presume that such charges will finance the same
proportion of total spending in each function that they currently finance. For example,
if a particular state's higher education institutions are defraying 33% of their
spending through tuition at the beginning of the projection period, then they are
presumed to defray 33% at the end as well. This means that the projections presume,
for example, tuition increases per student equal to increases in spending per student.
In times of fiscal adversity, such as those forecast for state and local governments
in the early years of the next decade, state and local officials often find many
ways to shift spending from financing by tax collections to financing by user charges.
One example is the tendency to increase tuition to offset the impacts of appropriation
freezes on institutions of public higher education.
Achieving Public Purposes by Requiring Private Spending
Government budgets and financial reports are imperfect indicators of the impact of
government on the freedom of citizens to control the uses of their resources. By
mandating private sector spending, governments can achieve the same objectives as
are achieved by public sector spending and taxes. For example, supporting the consumption
of low-income individuals is currently accomplished by tax-financed spending for
cash welfare payments and subsidized health care.
It is also accomplished by subsidized low rates for phone service. Those rates,
often called "lifeline" service, do not fully compensate telecommuni-cations
providers for their costs of services. The offsetting extra revenue is collected
from all other customers. While the payment of extra costs by the other customers
is a government-mandated reduction in consumer purchasing power, it does not count
as a tax. While the subsidies to low-income households are government-directed spending,
they do not count as spending.
There are constantly growing examples of such devices. Two that have drawn public
attention recently are: (1) the extraction of impact outlays from housing and commercial
property developers for such purposes as building public streets and roads and constructing
public schools, and (2) the funding of a multi-billion dollar federal program to
provide telecommunications access to schools through charges built into telephone
MAJOR REALIGNMENTS IN THINKING ABOUT GOVERNMENT ACTIVITIES
The analyses in the text and appendices of this report presume that the attitudes
of the public and of elected officials toward government spending and taxes and toward
major public programs will remain relatively constant over the projection period.
The projection methodology simply applies these constant attitudes to changed circumstances
dictated by the economic, demographic, and fiscal environments predicted during the
projection period. As summarized at the end of Chapter Two, "With attitudes
and decision-making procedures unchanged, and with the impacts of strong and weak
state fiscal circumstances on higher education spending well known, forecasting state
approaches to higher education spending becomes simply a matter of forecasting the
state fiscal circumstances likely to prevail in the next decade."
The conclusions in this report are thus sensitive to any major changes in attitudes.
Several such changes are possible.
Role of Government
One possible change is a major revision in thinking about the role of government
and thus its size, scope, and cost. One possibility is that more people will believe
that government does too little, much improving the outlook for higher taxes. On
the other hand, another possibility is that more people will believe that government
does too much, creating an environment for reductions in taxes and spending.
Redefining Baseline Spending
There are areas in which changes in attitudes and resulting changes in policy could
substantially redefine baseline spending. Accepting a public obligation to finance
fundamental health care would be one such change, with enormous fiscal implications.
So would redefinition of the scope of free public education to encompass the education
of three and four-year olds and/or grades 13 and 14. Likewise, certain activities
now viewed as part of baselines could be defined as outside the traditional responsibilities
of government. This has been happening with one major outlay in federal budgets (housing)
and one in state budgets (recreation). As these examples suggest, movement in either
direction tends to be gradual, almost glacial. As a result, such changes are not
built into the assumptions used in this report.