June 6 marked the 25th anniversary of one of the most successful state tax reforms, California’s Prop. 13, which helped launch reforms in other states and continues to influence tax reforms today.
Tax expert Michael New of the Cato Institute explains how Prop. 13 brought economic growth to California and tax relief to millions of workers. Similar measures have produced similar results in other states.
New shows how California’s current economic problems stem largely from excessive state spending, which strongly indicates that enacting spending limits would be an excellent strategy for reducing the size of state government over the next 25 years.
During the late 1970s, anti-tax activists enjoyed considerable success limiting property taxes. However, Prop. 13 easily became the most well-known of those efforts. Indeed, Prop. 13 was a tremendous short-term success, reducing taxes by a staggering $6 billion. Prop. 13’s impact, however, went far beyond tax relief. The economic boom that followed Prop. 13 gave credence to the idea that tax cuts were economically beneficial. Furthermore, Prop. 13 generated nationwide momentum for tax reductions. Even President Carter and the Democrat-controlled Congress were motivated to reduce capital gains taxes in the wake of Prop. 13.
As a long-term tax limit, however, Prop. 13 has had a legacy that is decidedly mixed. Though it reduced property taxes, Prop. 13 did not place limits on other forms of taxation. Indeed, after California’s expenditure limit was raised in the early 1990s, spending soared, nearly doubling between 1990 and 2001.
As a result, California has had to raise the income tax, the sales tax, and taxes on beer, wine, gasoline, and cigarettes to keep pace with these rising expenditures. In fact, during the early 1990s, Gov. Pete Wilson (R.) even proposed hiking taxes on snack foods.
This cycle of spending and taxing is the root cause of California’s current fiscal problems. Indeed, California’s recent fiscal history clearly demonstrates that low taxes can only be preserved when spending is restrained.
In fact, during the past 25 years fiscal conservatives in California and elsewhere have attempted to enforce fiscal discipline by enacting Tax and Expenditure Limitations (TELs), which establish limits on expenditure growth. Many studies find TELs to be ineffective. However, in the early 1990s two states, Colorado and Washington, were able to restrain spending by enacting TELs with especially low limits.
The success of Colorado’s TEL, the Taxpayer Bill of Rights (TABOR), is probably the most dramatic. TABOR was unique because in addition to setting a low expenditure limit, it mandated immediate taxpayer refunds of surplus revenues.
Shortly after TABOR was enacted, revenue began to exceed the limit. As a result, Colorado taxpayers received a tax rebate every year between 1997 and 2002. During that time, Colorado reduced taxes more than any other state, issuing tax rebates that have totaled more than $3.2 billion.
Additionally, TABOR has also forced Colorado residents to see the costs inherent in government programs. In other states, residents often support higher spending because they can see the benefits of a particular program, but remain blissfully unaware of the costs that they and other taxpayers will be forced to bear.
However, in Colorado the annual tax rebates bring these tradeoffs into focus. In every year from 1993 to 1999 there was a proposal on the ballot to either raise taxes or increase spending in excess of the TABOR limit. Knowing those initiatives would reduce the size of their annual tax rebate, voters defeated them.
In 2001, an initiative to increase spending for Colorado schools did pass. However, Colorado taxpayers still received tax rebates totaling more than $900 million from fiscal 2001 revenues.
Overall, Prop.13 enjoyed a great deal of success at lowering taxes, both in California and across the country. However, it has been less successful at keeping taxes low. Indeed, soaring expenditures over the last 25 years have resulted in sharp tax increases in the Golden State.
Still, one important lesson from the 1990s is that well-designed expenditure limits can both effectively restrain spending and provide tax relief. Indeed, spending limits modeled after Colorado’s Taxpayer Bill of Rights may well be the best strategy for those seeking to reduce the size of government during the next 25 years.
