What Is Tax and Expenditure Limits?
Tax and expenditure limits (TELs) are statutory or constitutional provisions that restrict the growth of government revenues, spending, or both. These limits are a key component of public finance and fall under the broader category of government finance. TELs aim to control the size and scope of government by capping the amount of funds that can be collected or disbursed. They can apply to state and local government entities, and their design can vary significantly, often tying growth to factors like inflation, population changes, or a combination thereof. TELs are typically designed to enforce fiscal discipline and promote long-term budget stability.
History and Origin
The concept of imposing limits on government fiscal activity gained significant traction in the United States during the late 1970s, often referred to as the "taxpayer revolt." A pivotal moment in this movement was the passage of California's Proposition 13 in June 1978. This landmark constitutional amendment drastically cut property taxes and limited how much they could increase annually. Proposition 13 capped local property taxes at 1% of a property's assessed value and limited annual increases in assessed value to a maximum of 2% or the rate of inflation, whichever was lower, unless the property was sold9. The initiative also required a two-thirds majority vote in the state legislature for any future increases in state tax rates and a two-thirds majority in local elections for local governments to increase special taxes. This measure had a profound impact, significantly reducing local revenue and reshaping the state's approach to fiscal policy. The success of Proposition 13 inspired similar movements and the adoption of tax and expenditure limits in other states across the country.
Key Takeaways
- Tax and expenditure limits (TELs) are rules designed to restrict the growth of government revenue or spending.
- They can be implemented through statutory law or constitutional amendments.
- TELs aim to promote fiscal discipline and prevent excessive government growth.
- The limits often tie budget growth to economic indicators such as inflation or population changes.
- These measures affect how governments fund public services and manage their budget deficit.
Formula and Calculation
While there isn't a single universal formula for all tax and expenditure limits, many operate on a similar principle of limiting growth based on a combination of factors. A common approach for a spending or revenue limit can be expressed as:
Then, the maximum allowable spending or revenue for the current year ( ( \text{S}_t ) or ( \text{R}_t ) ) would be:
Where:
- ( \text{S}_t ) = Maximum allowable government spending or revenue for the current fiscal year.
- ( \text{S}_{t-1} ) = Actual spending or revenue from the previous fiscal year.
- ( \text{Inflation Rate} ) = The rate of change in a relevant price index, such as the Consumer Price Index (CPI).
- ( \text{Population Growth Rate} ) = The percentage increase in the jurisdiction's population.
This formula links the growth of the government's budget directly to changes in the economic environment and the population it serves, aiming to prevent spending from outpacing the underlying economic capacity or population needs.
Interpreting the Tax and Expenditure Limits
Interpreting tax and expenditure limits involves understanding their specific design and how they interact with a government's financial operations. A TEL dictates the maximum amount of revenue a government can collect or the maximum amount it can spend. For instance, a revenue limit might stipulate that the growth of total collected tax revenue cannot exceed the rate of inflation plus population growth. If actual revenues surpass this limit, the "excess" might be refunded to taxpayers or allocated to specific reserves.
Similarly, an expenditure limit caps the growth of appropriations. The stringency and effectiveness of TELs can vary greatly depending on their exact provisions, such as whether they apply to gross or net revenue, or how they define "emergency" spending. Governments subject to TELs must carefully manage their budget projections and actual collections to ensure compliance, which can influence decisions regarding public investment and service provision.
Hypothetical Example
Consider a hypothetical state, "State X," that enacts a tax and expenditure limit. This TEL stipulates that its total general fund revenue cannot grow by more than the sum of the Consumer Price Index (CPI) annual change and the state's population growth.
In Fiscal Year (FY) 2024, State X's general fund revenue was $50 billion.
For FY 2025:
- The CPI increased by 3%.
- The state's population grew by 1%.
Under the TEL, the allowed growth rate for FY 2025 is 3% (CPI) + 1% (population growth) = 4%.
Therefore, the maximum allowable general fund revenue for FY 2025 is:
$50 billion * (1 + 0.04) = $52 billion.
If, due to unexpectedly strong economic growth or an increase in sales tax collections, State X actually collects $52.5 billion in FY 2025, it would have $500 million in "excess revenue" above its limit. Depending on the specific provisions of State X's TEL, this $500 million might be:
- Refunded to taxpayers: Distributed back to citizens, perhaps as a tax credit or direct rebate.
- Transferred to a reserve fund: Set aside in a "rainy day fund" for future economic downturns.
- Used for specific one-time expenditures: Earmarked for non-recurring projects, like infrastructure improvements.
This example illustrates how a tax and expenditure limit directly caps the amount of money a government can keep and spend, impacting its financial planning.
Practical Applications
Tax and expenditure limits are primarily found in fiscal policy at the subnational level, meaning states, counties, and municipalities. As of 2020, 31 states in the United States had some form of TEL in place, which could include limits on state spending, state revenue, or both8. These limits are used to manage government budgets and prevent rapid expansion of the public sector.
A notable application is Colorado's Taxpayer's Bill of Rights (TABOR), enacted in 1992. TABOR is considered one of the strictest TELs in the U.S. and mandates voter approval for all new taxes, tax rate increases, and extensions of expiring taxes7. It also limits the annual increase in state revenue to the prior year's inflation plus population growth6. Any revenue collected above this limit must be refunded to taxpayers unless voters approve its retention5. This has significant implications for how Colorado manages its budget and makes decisions about public services. For instance, in 2015, Colorado voters had to approve the retention of excess marijuana tax revenue that came in above projections4.
The OECD also tracks and analyzes the use of fiscal rules, including TELs, across various countries, particularly for subnational governments. Such rules are seen as a way to promote fiscal discipline, especially in decentralized government structures3.
Limitations and Criticisms
While proponents argue that tax and expenditure limits foster fiscal responsibility and prevent overspending, they also face several criticisms. One significant limitation is their potential to create rigidity in government budgets, making it difficult to respond to changing economic conditions or unforeseen crises. For example, strict revenue limits can prevent states from saving revenues in "rainy day funds" during periods of economic prosperity, leaving them vulnerable during downturns2. This can lead to deeper cuts in essential public services during recessions.
Critics also argue that TELs can shift the burden of financing public services by encouraging governments to rely more on fees or non-tax revenue sources that may not be subject to the limits. Such measures can also lead to underinvestment in critical areas like education, infrastructure, or public health, potentially hindering long-term economic development. Furthermore, some TELs may disincentivize efficient tax administration or create complex financial workarounds to circumvent the limits, which can reduce transparency in financial reporting. The Brookings Institution notes that tax changes not financed by immediate spending cuts could lead to increased federal borrowing and reduced long-term economic growth1.
Tax and Expenditure Limits vs. Fiscal Rules
Tax and expenditure limits (TELs) are a specific type of fiscal rule. Fiscal rules are broader, encompassing a wider array of permanent constraints on fiscal policy, typically expressed in terms of aggregate budget indicators. These can include rules on the overall budget balance, debt levels, or revenue targets.
The confusion between the two often arises because TELs directly regulate taxation (revenue) and expenditure, which are core components of fiscal policy that fiscal rules aim to manage. However, not all fiscal rules are TELs. For instance, a country might have a fiscal rule that mandates a structural budget balance over the economic cycle, but without explicit caps on the growth of specific taxes or expenditures. TELs represent a more direct and often more restrictive approach to controlling government finance, explicitly placing a ceiling on how much a government can collect in income tax, other taxes, or spend in a given period.
FAQs
What is the main purpose of tax and expenditure limits?
The main purpose of tax and expenditure limits is to control the growth of government and promote fiscal discipline by capping how much revenue a government can collect or how much it can spend.
Are tax and expenditure limits always effective?
The effectiveness of tax and expenditure limits is debated. While they can constrain government growth, critics argue they can also lead to budget rigidities, reduce the ability to save for downturns, and potentially shift funding towards less transparent revenue sources.
Who enacts tax and expenditure limits?
Tax and expenditure limits are typically enacted by state or local governments through statutory law or constitutional amendments, often directly by voter initiatives.
How do tax and expenditure limits affect government services?
Tax and expenditure limits can influence government services by restricting the funding available. This may lead to slower growth in public services or, in some cases, cuts, particularly in areas like education, public safety, or infrastructure, depending on how strictly the limits bind the government budget.
What is the difference between a tax limit and an expenditure limit?
A tax limit specifically restricts the amount of tax revenue a government can collect, often tying it to economic indicators. An expenditure limit, on the other hand, caps the amount of money a government can spend or appropriate, regardless of the revenue collected. Some TELs combine both types of restrictions.