The Robert M. La Follette School of Public AffairsUniversity of WisconsinMadison

StructuralDEFICIT

WISCONSINS

The Wisconsin Legislature is cur-rently attempting to close a$1.1 billion deficit in the states200103 biennial budget. The

causes of the deficit most frequentlycited have been the recession and thetragic events of September 11. If theslow economy were in fact the majorcause of the deficit, then as soon as theeconomy recovers, we should expectthat the states deficit problems shouldalso disappear. The sad fact is that thecause of Wisconsins state governmentbudgetary woes are more deep-seatedand will still be with us for a long time af-ter the economy recovers.

In the simplest terms, budgets are indeficit when the amount of money thestate spends exceeds the revenues ittakes in. The state spends money in or-der to provide services to state residents.These services include everything frommaintaining state parks, imprisoningcriminals, and subsidizing health care forpoor families to helping to provide a uni-versity education for our children. In addi-tion, a substantial portion of state spend-ing is in the form of grants to local schooldistricts and to county and municipalgovernments. These grants both subsi-dize public education and municipal andcounty government services and help re-duce the property tax burdens on Wis-consin residents.

To predict what the states budgetwill look like in future years, we need tostart by figuring out how much the statewill have to spend each year in order tocontinue providing the same servicesthat it provides state residents today. Icall this the states current servicesbudget. Spending, at least for some

types of services, will rise over time be-cause the state population rises. Thus, ifthe number of students educated by theUniversity of Wisconsin System rises, thecurrent services budget for higher educa-tion will need to increase. Rising costs for

goods and services purchased by thestate will also result in increases in cur-rent service budgets. For example, steepincreases in energy prices or in medicalinsurance for state employees will in-crease the amount of money needed bythe state to maintain current services.

Wisconsin faces a structural deficitwhenever the amount of money neededto maintain current services exceeds therevenue generated by the states currenttax system. In this article, I show thateven under very conservative assump-tions about budget growth and reason-ably optimistic assumptions about rev-enue growth, the state will face a verylarge structural deficit during the next bi-ennium. If no efforts are made to reducethe structural deficit during the next bien-nium, annual structural deficits will con-tinue through fiscal year 200910.

As I explain in more detail below, thestate has faced a structural deficit atleast since the mid1990s. A series offortunate circumstances, in particular,stronger than expected economicgrowth, have allowed us to put off thehard choices necessary to eliminate thestructural deficit. Although no final deci-sions have been reached, it now appears

Our Fiscal Future at the Crossroads

The Robert M. La Follette Schoolof Public Affairs is a nonpartisan teachingand research department of the Universityof WisconsinMadison. The School takesno stand on policy issues; opinions ex-pressed in these pages reflect the viewsof the author. May 2002.

ANDREW RESCHOVSKYis professor of public affairs and applied economics at the University of WisconsinMadison.

The starting point for these calculations is theamount of state spending through the Gen-eral Fund in the most recently completed fis-cal yearfiscal year 200001, which ran fromJuly 1, 2000 through June 30, 2001. Foreach of the states major spending programs,we determine the minimum amount of moneythat will be needed each year to maintain thelevel of public services provided in the baseyear (200001). The sum of these amounts isreferred to as the current services budget.Next, we calculate how much General Fundrevenue will be collected in each year if nochanges are made in the tax system used in200001. This means that the 200001 taxrates, exemptions, and other features of thetax code remain in force. In any year in whichthe current services budget exceeds theavailable revenues under current laws, astructural deficit will occur. A structural sur-plus will occur in any year when available rev-enues exceed current services expenditures.

The following paragraphs explain the as-sumptions that I made in order to project acurrent service budget and available revenuesfor each fiscal year from 200102 through201011.

Estimating a CurrentServices Budget

In calculating the states current servicebudget for the next 10 years, I have made anumber of quite conservative assumptionsabout the growth of costs of providing publicservices. The specific assumptions are out-lined below. Projecting future costs for everystate government program between now and

2011 would be a Herculean task. The ap-proach I follow here is to make separate esti-mates for each of the five largest GeneralFund programs. I then make the simple as-sumption that the real (inflation adjusted)costs of maintaining all other state govern-ment programs funded through the GeneralFund remains constant between now and2011 with the exception of a proportional ad-justment for projected annual growth in statepopulation over that period.

For fiscal year 200001, the five largestGeneral Fund programs in order of size were:(1) state aid for elementary and secondary(K12) public education, (2) Medical Assis-tance (health care for the needy), (3) the Uni-versity of Wisconsin System, (4) shared rev-enue (state aid to municipal and countygovernments) and (5) corrections. Togetherthese five programs accounted for 74 percentof General Fund expenditures. The assump-tions underlying the real growth in the costsof current services for each of these pro-grams are listed below:

K12 Public Education. In 1996, inaddition to its commitment to fund two-thirds of the cost of K12 education, thelegislature enacted a permanent revenuecap, limiting the annual amount by whichschool districts can increase school rev-enues and hence expenditures. The datashow that the revenue cap has beensuccessful in restraining the growth ofschool spending. During the first half ofthe 1990s, the annual rate of growth ofGeneral Fund expenditures on K12 ed-ucation averaged 3.1 percentage pointsabove the rate of inflation. Between 1995

that the legislature and the governor willsolve the states current fiscal problems pri-marily by using a one-time source of funds(the tobacco settlement). Using non-recurringsources of revenue and budget gimmicksdoes nothing to reduce the underlying struc-tural deficit.

The states economy should reboundstrongly over the next couple years. Even un-

der the most optimistic economic assump-tions, however, economic growth will notgenerate enough extra tax revenue to elimi-nate the structural deficit. We have certainlyrun out of short-term budgetary fixes andone-time pots of money. The day of reckon-ing will come in 2003. We will no longer beable to put off the hard choices that will benecessary to eliminate our structural deficit.

The Robert M. La Follette School of Public Affairs 2

Calculating the States Structural Imbalance

and 2000, average annual expendituresgrew at a rate of 2.5 percentage pointsabove the rate of inflation. A heated de-bate is raging over whether the revenuecaps are preventing school districts frommaintaining the quality of public educa-tion. For the purposes of this exercise, Imake the conservative assumption thatover the next decade school districts willbe able to maintain the current quality ofeducation with an annual real increase instate school aids of 1.25 percenta ratethat is one-half of the rate of real expen-diture growth during the second half ofthe 1990s. Official demographic projec-tions indicate that over the next decade,the number of school-aged children inWisconsin will be declining by a modestamount. The current service budget pro-jections for K12 education also assumethat expenditures on state education aidwill decline proportionately to the pro-jected fall in enrollments.

Medical Assistance. Predicting thecosts of Medical Assistance expendituresis particularly difficult. It is necessary notonly to predict changes in the number ofpersons eligible for Medical Assistance,but also to predict changes in the annualcosts of health care. After a period of rel-atively modest growth in the late 1990s,the rise in health care costs appears tobe accelerating rapidly. Nevertheless, indeveloping a current services budget forMedical Assistance, I have assumed thatthe real annual growth in General Fundexpenditures on Medical Assistance willgrow at a rate proportionate to the pro-jected growth in the population of thestate and the average percentageamount by which the medical care priceindex exceeded the consumer price in-dex during the 19912001 period. Thesecalculations result in a real increase inMedical Assistance expenditures ofaround 2 percent per year.

University of Wisconsin System.As a means of maintaining the quality ofeducation, the Regents of the UW Sys-tem have placed caps on the annualgrowth of enrollment through 2006. Forthe years between 2007 and 2011, Ihave assumed an annual enrollment capincrease of 0.17 percent, a figure that is

the average of the annual growth in theenrollment cap for the years 2002 to2006. In each year, the caps are consid-erably lower than projected growth instate population. In calculating the cur-rent services budget for the UW System,I have assumed that real spending will in-crease by the annual increases in enroll-ment allowable under the caps and bythe average amount by which the gov-ernments higher education price index(HEPI) exceeded the CPI (ConsumerPrice Index) during the 1990s.

Shared Revenue. General Fund alloca-tions to the shared revenue program pro-vide all county and municipal governmentsin Wisconsin with grants. In general, largerper capita grants go to local governmentswith the smallest property tax bases. TheKettl Commission and others have sug-gested that there are good reasons to re-form the formulas used to allocate sharedrevenue among local governments. De-spite these criticisms, there is little questionthat reductions in the real value of sharedrevenue allocations leads to either cuts inlocal government public services or to in-creases in local government property taxesand fees. A reasonable argument can bemade that, on average, the real costs ofproviding municipal and county servicesgrow proportionately with the growth ofpopulation. Thus, in calculating a currentservices budget for shared revenues forthe 2002 to 2011 period, I assume thatreal per capita shared revenue spendingwill remain constant, i.e. real spending onshared revenue will grow at the same rateas the states population.

Corrections. Starting in the late 1980s,the legislature took a number of steps de-signed to increase the prison sentencesof convicted criminals and to reduce theiraccess to parole. As a result of these gettough on crime policies, between 1987and 2001, the number of inmates in stateprisons grew at an average annual rate of9.36 percent. This rapid growth in prisonpopulation was reflected in a steady in-crease in state spending on corrections.In projecting a current services budget forcorrections for the 2002 to 2011 period, Iwill make the conservative assumptionthat the real growth in corrections spend-

Wisconsins Structural Deficits 3

ing can be kept to the projected growthrate of population over this perioda ratethat averages less than one-half of 1 per-cent per year.

All Other Programs. I assume that thereal cost of all other programs financedthrough the General Fund will grow at theprojected rate of state population growth.This is equivalent to assuming constantreal per capita spending between 2002and 2011. Again this is a quite optimisticassumption. Between 1996 and 2000,real per capita spending financed by theGeneral Fund grew at an average annualrate of 1.27 percent. Thus, the assump-tion that current services can be main-tained with no growth in real per capitaspending requires that the state increasethe efficiency in the delivery of services byenough to offset any growth in state em-ployee wages and benefits or in the costsof other inputs, such as fuel, that exceedthe growth in the consumer price index.

Figure 1 combinesactual data on GeneralFund expenditures be-tween fiscal years 1989and 2001 with my pro-jected current servicebudgets for fiscal years2002 to 2011, all ex-pressed in constant2002 dollars. The datashow that during the1990s the largestgrowth in spending (af-ter controlling for theimpact of inflation) oc-curred in state expendi-ture on K12 educationand in spending on cor-rections. The big jumpin education spendingtook place in fiscal year1997 when the stateimplemented its com-mitment to finance two-thirds of educationcosts. The data in Fig-ure 1 also show thatduring the 1990s therewas almost no real ex-penditure growth instate funding for Med-

ical Assistance, the UW System, and forshared revenue.

The assumptions outlined above result ina current services budget that is projected togrow at an annual average rate of only 0.83percent above the rate of inflation. The datain Figure 1 shows that the average annualrate of real growth of General Fund spendingbetween fiscal years 1989 and 2001 wasequal to 2.9 percent per year. This pattern ofspending growth suggests that continuing toprovide current levels of public services overthe next decade while constraining the realrate of spending growth to under one percentper year will require substantial gains in theefficiency with which public services are deliv-ered. To the extent that these efficiency gainscannot be achieved, the current servicesbudget will grow at a faster rate than as-sumed here, and the structural deficits re-ported below will be underestimated. For ex-ample, if the real current services budgetwere to grow at an annual rate of two per-cent over the next decade (instead of 0.83

The Robert M. La Follette School of Public Affairs 4

FIGURE 1

General Fund Expenditures in 2002 Dollars

$0

$2

$4

$6

$8

$10

$12

$14

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Fiscal Year

Billio

ns o

f 2002 D

ollars

K-12 Public Education

Medical Assistance

UW System

Shared Revenue

Corrections

Total GPR ExpendituresNumbers beyond 2002 are projected

2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

REVENUEOpening Balance $207.5 $138.1 $137.2 $131.1 $134.9 $137.9 $140.7 $143.5 $146.4 $149.4

Estimated Revenue $10,610.1 $10,951.7 $11,058.9 $11,379.6 $11,633.4 $11,867.0 $12,105.2 $12,348.2 $12,596.1 $12,849.0

Available Revenue $10,817.6 $11,089.8 $11,196.1 $11,510.7 $11,768.4 $12,004.9 $12,245.9 $12,491.7 $12,742.5 $12,998.3

APPROPRIATIONS

K-12 Public Education $4,594.7 $4,763.6 $4,799.7 $4,836.1 $4,885.9 $4,936.2 $4,987.1 $5,038.4 $5,090.3 $5,142.7

Medical Assistance $1,106.7 $1,024.3 $1,046.7 $1,069.6 $1,091.0 $1,112.8 $1,135.0 $1,157.7 $1,180.9 $1,204.5

UW System $1,058.3 $1,115.6 $1,124.7 $1,135.0 $1,145.4 $1,155.1 $1,165.3 $1,175.5 $1,185.9 $1,196.3

Shared Revenue $1,047.8 $1,062.4 $1,068.5 $1,074.5 $1,078.7 $1,082.8 $1,087.0 $1,091.1 $1,095.3 $1,099.5

Corrections $770.9 $786.1 $790.6 $795.0 $798.1 $801.2 $804.2 $807.3 $810.4 $813.5

All Other Programs $3,010.4 $3,069.9 $3,087.4 $3,104.9 $3,116.8 $3,128.8 $3,140.8 $3,152.9 $3,165.0 $3,177.1

Total Current Service Appropriations $11,588.8 $11,821.9 $11,917.5 $12,015.2 $12,115.9 $12,216.9 $12,319.4 $12,423.0 $12,527.8 $12,633.7

Annual real growth in appropriations 0.81% 0.82% 0.84% 0.83% 0.84% 0.84% 0.84% 0.85%

BALANCESRevenue - Appropriations -$771.2 -$732.1 -$721.4 -$504.4 -$347.5 -$212.0 -$73.5 $68.7 $214.7 $364.6

Required Reserves (1.2%) $138.1 $137.2 $131.1 $134.9 $137.9 $140.7 $143.5 $146.4 $149.4 $152.4

Net Balance -$909.3 -$869.3 -$852.5 -$639.4 -$485.5 -$352.7 -$217.0 -$77.7 $65.4 $212.2

Annual Structural Deficit -$909.3 -$1,007.4 -$989.7 -$770.5 -$620.4 -$490.7 -$357.7 -$221.2 -$81.1 $62.9(estimated revenues - current services-reserves)

Structural deficit/estimated revenue 8.6% 9.2% 8.9% 6.8% 5.3% 4.1% 3.0% 1.8% 0.6% -0.5%

In current dollars In 2002 dollars

TABLE 1

Wisconsin's General Fund Structural Imbalance, 2001-02 to 2010-2011(In millions of dollars)

percent), the structural deficit for the next bi-ennium would be 25 percent greater than thedeficit projection in this report.

Estimating FutureRevenues

The best way to predict the amount of rev-enue our tax system will generate is to lookat the historical relationship between tax rev-enue and personal income growth. Largelybecause of Wisconsins relatively heavy re-liance on the individual income tax, tax rev-enue tends to grow at a faster rate than per-sonal income. Although precise calculationsare difficult, a careful analysis of data on per-sonal income growth and tax revenue growthover the past decade led me to assume arevenue elasticity of 1.115. This means thateach 1 percent increase in real personal in-

come will lead to a 1.115 percent increase inGeneral Fund tax revenue. The basis of therevenue projections used in this report are thelatest long-run projections of real growth inpersonal income released by the WisconsinDepartment of Revenue. Those projections(dated February 28, 2002) indicate that theWisconsin economy will improve dramaticallyover the next couple years. Projected growthin real personal income will increase from 1.1percent in 2002 to 2.2 percent in 2003 and2.6 percent in 2004. If the economy grows ata faster than projected rate, the structuraldeficits reported below will be reduced. If,however, the economic recovery is slowerthan anticipated, the structural deficits duringthe next biennium will be larger than indi-cated. The detailed spending and revenueprojections through fiscal year 2011 are dis-played in Table 1.

Wisconsins Structural Deficits 5

The Robert M. La Follette School of Public Affairs 6

The Results

In any given year, a structural deficit exists ifthe sum of the current services budget forthat year plus the required 1.2 percent re-serve exceeds estimated general fund rev-enues. As shown in Table 2, the structuraldeficit averages about $950 million per yearover the current biennium. In fiscal year200304, the first year of the next biennium,the state will face a structural deficit of nearly$990 million (measured in 2002 dollars). Ifnothing is done to close this structural deficit,the state will face a structural deficit of about$770 million in fiscal year 200405. Over thecourse of the biennium, the structural deficitwill be $1.75 billion. This amount equals 7.8percent of the total General Fund revenuethat would be raised during the biennium as-suming no changes to current tax law.

The calculations summarized in Table 2also reveal that without remedial action, annualstructural deficits would occur in every fiscalyear through 200910. Because I have as-sumed that General Fund revenues will growat a faster rate than the states current servicesbudget, the projected structural deficits will be-come smaller with each passing year.

As this report is being written, a confer-ence committee of the legislature is trying toreconcile the differences between the Assem-bly and Senate versions of 200103 budgetadjustment bill (formally, the Budget ReformBill.) Because the final bill that is passed bythe legislature and signed by the governor willpresumably include elements of both theSenate and Assembly budget bills, the gen-eral outline of the revised 200103 budget isquite clear. Most of the money needed toclose the current budget deficit will comefrom one-time sources of revenue. By far thelargest source of these one-time fundscomes from the states share of the tobaccosettlement. The multi-state settlement withthe major tobacco companies resulted in anagreement that the states would receive astream of annual payments from 2000through 2032. Wisconsin has decided toconvert this stream of promised paymentsinto a one-time, up-front payment (referred toas securitizing the tobacco settlement). It ac-complishes this by in effect issuing bondswhose debt payments are met by the flow oftobacco settlement payments. Most of the

FiscalYear

2001-02 $10,817.6 $11,726.9 -$9092002-03 $10,951.7 $11,959.1 -$1,007

2003-04 $11,058.9 $12,048.6 -$9902004-05 $11,379.6 $12,150.1 -$7702005-06 $11,633.4 $12,253.8 -$6202006-07 $11,867.0 $12,357.6 -$4912007-08 $12,105.2 $12,462.9 -$3582008-09 $12,348.2 $12,569.5 -$2212009-10 $12,596.1 $12,677.2 -$812010-11 $12,849.0 $12,786.1 $63

* Includes 1.2 percent required reserve.

Source: See text.

StructuralImbalance

TABLE 2

Wisconsin's General Fund Structural Imbalances

Current ServicesBudget*

EstimatedRevenue

(in millions of 2002 dollars)

proceeds of the bond sale are then used tofinance the current budgetary shortfall.

Because the use of one-time fundingdoes nothing to increase future revenueflows or reduce the current services budget,it will have no impact on the size of thestructural deficit. The 200103 budget com-promise will almost certainly include somemodest reductions in the permanent funding

level for existing state programs. Althoughthese spending cuts will reduce my estimateof the structural deficits for the 200305 bi-ennium, it is unlikely that they will reduce theestimates by more than $200 millionleav-ing a structural deficit in 200304 of over$700 million and a structural deficit for thewhole biennium of well over $1 billion.

The structural deficit projections made inthis report are based on the assumption thatthe states economy will begin recoveringthis year, with the economic recovery contin-uing over the next couple years. By 2004,real personal income is projected to grow ata rate of 2.6 percent. During the second halfof the 1990s, the states economy grew atan extremely fast rate, with the rate of realeconomic growth peaking in 1998 at 4.2percent. During the three-year period, 1997through 1999, personal income grew at anaverage annual rate of 3.6 percent.

Although economists think it is highly un-likely that the Wisconsin economy will be ableto grow at anywhere near that rate, what ifsuch a rate of growth was in fact sustainablein both 2003 and 2004? If the economy grewat an annual rate of 3.6 percent (in real terms),would this rapid economic growth solve ourstructural deficit problems? The answer is de-cidedly no. The structural deficit would declineby about $150 million in 200304 and byabout $275 million in 200405, but the totalstructural deficit over the course of the bien-nium would still add up to $1.3 billion.

It is not difficult to identify the major elementsthat have contributed to the current fiscal sit-uation. In 1994, in response to a growingpublic frustration with rising school propertytaxes, the legislature committed the state topay two-thirds of the cost of primary andsecondary public education beginning in the199697 school year. To fulfill this promise,the state had to increase grants to schooldistricts by a total of $1.2 billion in fiscal year1997. During the early and mid1990s, thelegislature was also getting tough on crimeby instituting longer sentences on convictedcriminals and restricting access to parole.Largely as a consequence of these stiffenedsentencing rules, the states prison populationgrew from nearly 6,000 in 1987 to nearly21,000 at the end of 2001.

While both of these policies committedthe state to substantial increases in spending,the legislature failed to reduce spending onother state programs or to make changes inour tax system designed to fund these newcommitments. During the latter half of the1990s, the legislature was able to avoid mak-ing these difficult choices because the boom-ing economy was producing unanticipatedadditional tax revenue with which to balanceeach biennial budget.

During the late 1990s, most states wereusing at least a portion of their unexpected taxrevenue to invest in so-called rainy dayfunds. Wisconsin, however, was one of onlyfive states that chose to put nothing away fora time when the economy stopped growing.Although legislation authorizing the establish-

Wisconsins Structural Deficits 7

Can Economic Growth Solve Our Structural Deficit Problems?

Why Does Wisconsin Have a Structural Deficit?

ment of a stabilization fund has been on thebooks for a number of years, no money hasbeen deposited in the fund. In fact, during thelate 1990s, the legislature enacted a multi-yearindividual income tax reduction, exemptedsome additional goods and services from the

sales tax, authorized a sales tax rebate, andinstituted a number of business tax breaks.Regardless of the merits of these tax policychanges, their net effect was to increase thesize of the states structural deficit.

Over the past few biennial budgets, the legis-lature has been able to put off making the dif-ficult choices that are required to eliminatethe structural deficit. First, the extraordinaryeconomic growth during the late 1990s andthen the ability to use up the tobacco settle-ment have allowed the state to balance thepast few biennial budgets. It is hard to imag-ine, however, any source of revenue suddenlymaterializing to bail out the state once again.Come 2003, the legislature and the governorwill have no choice but to address the statesstructural deficit.

State government in Wisconsin has awell-deserved reputation for innovation over awide range of policy areas. It is widely recog-

nized as a leader in a number of areas suchas welfare reform, environmental protection,mental health, social services, and higher ed-ucation. The citizens of the state are used toreceiving high quality public services. Ar-guably, both individuals and businesses areattracted to the state because of the leveland quality of services provided by its stateand local governments. The existence of astructural deficit means that as a state wemust choose whether we want to reduce theexisting level of public services or whether weare willing to collectively pay more money intaxes and fees in order to continue receivingthe public services to which we have becomeaccustomed.

The Robert M. La Follette School of Public Affairs 8

Conclusion

La Follette School of Public AffairsUniversity of WisconsinMadison1225 Observatory DriveMadison, WI 53706