Deficit looming, solution pending

School funds, tax cut led Maryland to $1.4 billion shortfall

Deficit looming, fix pending

General Assembly

March 26, 2007|By Andrew A. Green | Andrew A. Green,Sun reporter

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."

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