Hobbs vs. Ducey on the state budget

The real culprit is the GOP legislative leadership.

Former governor Doug Ducey, a Republican, is having a spat with current governor Katie Hobbs, a Democrat, over who is responsible for the sorry state of state government finances.

Hobbs says that the flat income tax and universal vouchers have put the state in a hole. Ducey regards those as signature accomplishments of his governorship. And he has barked back that the tax structure Hobbs inherited has produced plenty of revenue. Any fiscal hole, in the telling of Ducey and other Republicans, is due to mismanagement by Hobbs.

Ducey and Hobbs are both partly right, and partly wrong.

While a case can be made that the flat tax, in which the top rate was reduced from 4.5% to 2.5%, will benefit the state’s economy over time, there’s little question that it has reduced state government revenues in the short-term. If the top rate had been left at 4.5%, the state would have more money to spend than is currently projected.

And the extent to which students already enrolled in private schools took up vouchers created a significant dead weight loss to the state budget, totaling hundreds of millions of dollars.

However, even after the income tax reduction, state revenues have increased sufficiently that current programs should have been sustainable with room to absorb the dead weight loss from the voucher expansion, with money left over.

The income tax rate reduction has been fully implemented, so traditional rates of growth in collections should resume. The dead weight loss from the voucher expansion has also largely run its course. Today, most new voucher students were previously enrolled in a district or charter school. The gains or losses from such transfers don’t have a large effect on the state budget. The average voucher amount is close to the state’s per-pupil contribution for attendance at a public school.

So, going forward, current state programs should be comfortably sustainable with room for additions and expansions over time. Instead, the state is looking at serious shortfalls.

The reason for that is mismanagement. But not principally mismanagement by Hobbs. Instead, the primary culprit is the GOP legislative leadership.

This analysis best begins with Fiscal Year 2019, the last arguably normal year for state finances. After that, there was Covid, a bout of sharply elevated inflation, and a big income tax reduction. In FY 2019, same-year general fund revenues exceeded same-year expenses, without relying on a carryforward balance or fund transfers. The budget was balanced by any measure.

Since 2019, ongoing general fund revenues have increased by 54%, or at an annual rate of 6.4%. This vastly exceeds the intervening population growth and inflation of around 33%. So, despite the income tax reduction, there was sufficient revenue growth to sustain existing programs with billions left over for other things.

In the event, state general fund spending has increased by nearly 70% over this period, or at an annual rate of nearly 8%, vastly more than population growth and inflation, and at a pace that outstripped healthy revenue growth. In this year’s budget (FY 2026), same-year expenses are expected to exceed same-year revenues by nearly $800 million. The gap is covered by a $1.3 billion carryforward balance. And the projection for FY 2027, the budget the Legislature will tackle next session, shows the state unable to maintain existing programs.

How, despite ample resources to sustain existing programs, even after accounting for the income tax reduction and the voucher expansion, did the state find itself in the position of being unable to do so? The short answer is that the GOP legislative leadership chronically decided to spend the money on other things without regard to the effect on the sustainability of ongoing programs.

The most dramatic illustration is the FY 2024 budget. The budget begins with a carryforward balance, surpluses from previous years, of $2.5 billion. The GOP leadership decided to spend it all in a single year. The originally adopted budget provided for a contingency fund of just $10 million in a nearly $18 billion budget. The original budget provided an astonishing 15% increase in spending over the previous year.

The budget that year was stitched together by giving every legislator willing to vote for it tens of millions of dollars to be spent on whatever the legislator desired. It was a pork barrel extravaganza.

Revenue collections sagged, and there was a midcourse correction, but not one that abandoned the initial approach. A healthier contingency fund was established and spending somewhat rolled back. But the single year increase was still nearly 12%. A large hunk of it was still for earmarks.

Now, not all of this earmarked spending was on wasteful projects. A lot of it was directed at local transportation improvements. However, historically transportation hasn’t been a general fund responsibility. It has been the responsibility of the state Highway User Revenue Fund and county and city governments.

But, wasted or not, these untraditional expenditures have come at the expense of the sustainability of programs historically, and in some cases legally, a general fund obligation. And now, the general fund is in a world of hurt.

The Legislature’s budget staff projects an ending balance of slightly over $300 million for a barebones FY 2027 budget. But that excludes a lot of stuff that should be considered ongoing programs. The budget staff has identified $580 million in such expenditures.

To make it easier for taxpayers, the state has generally conformed the state income tax to whatever changes are made at the federal level. Conforming to the changes in the recent budget reconciliation bill would reduce collections in the range of $400 million.

There is something else that should be on the agenda, but due to chronically spending surpluses rather than husbanding them to sustain existing programs, probably can’t be. There is a cap on the inflation adjustment to the base level, the beginning point of the primary funding formula for district schools, of 2%. However, inflation has been running above that for five years now, eroding the purchasing power of what the state is providing the schools. Restoring purchasing power for the schools would cost well north of $500 million.

Current state programs shouldn’t be indiscriminately cut. The state should conform to the federal income tax changes. And the state should at least partially restore the purchasing power for the schools. However, doing all that would take more than a billion dollars that the state doesn’t have, but could have had if resources had been managed principally with an eye on the sustainability of ongoing general fund programs.

Hobbs certainly has some responsibility for the state finding itself in this position. Most obviously, she signed the budgets that have produced this result.

She has also started out with political budgets, rather than pragmatic budgets with an eye on sustainability. And it can be argued that she has failed to advocate enough, or skillfully enough, for the sustainability approach when it was obviously being threatened by what the GOP leadership was advancing.

But spending without regard to the effect on the sustainability of ongoing general fund programs wasn’t her approach. That came from GOP legislative leadership.

With regard to the 2024 budget, she was presented a choice: go along with it or face the likelihood of a state government shutdown of indefinite duration. She went along with it.

Hobbs has been an ineffective leader on budgetary policy. The GOP legislative leadership has been a destructive force.

Reach Robb at robtrobb@gmail.com.