By Pegah Jalali

The market helped change the climate. Now can it help save the planet?

We used to think of climate change as a problem for future generations, or something that only affects the Earth’s poles. Not anymore. Climate change is here, and we are experiencing it through extreme temperatures, large and frequent wildfires, air pollution, hurricanes, and droughts. There is a strong consensus among scientists that human-generated greenhouse gases are responsible for the climate changing due to rising global temperatures (Cook et al., 2016). We extract fossil fuels from under the ground, burn them and those gasses become trapped in the atmosphere adding to the thermal energy in the system. This added energy does not leave the atmosphere, and therefore has to manifest itself in one way or the other. If we do not cut our emissions drastically, we will keep adding to the energy trapped in the Earth’s atmosphere, and the results will likely be catastrophic.

In order to soften the blow of climate change and reduce emissions, we will need to change our economic policies to address the problem.

Free market economics is based on the idea that while individuals act in their own self-interests, the market as a whole allocates resources efficiently. The “invisible hand”of the market, or so the theory goes, delivers the best possible social and economic outcomes. There are, however, situations where the market is unable to deliver the most efficient social outcome, which is known as market failure. 

One such market failure occurs when externalities are present. Externalities arise when the actions of one person make another person worse or better off, but the first person neither bears the costs nor receives the benefits of doing so. Greenhouse gas emissions are an example of negative externalities: a factory that emits harmful gases to the atmosphere imposes damages to the whole society; however, this social cost is not reflected in the private costs that the factory owner pays in purchasing materials and labor. Thus, the factory’s cost of greenhouse gas emissions is lower than what it should be given the societal cost of climate change, and the factory has no inherent self-interest in reducing emissions. In this case, government intervention is necessary to fix this market failure.

Economists agree that putting a price on carbon is the most cost-effective way of reducing the greenhouse gas emissions created by burning fossil fuels (OECD, 2013). By instituting a price, governments can try to minimize the gap between the actual costs, or what the free market says it should cost, and the true cost of those emissions to society (social cost). There are two general market approaches for regulating carbon emissions: quantity instruments (cap-and-trade), and price instruments (taxes and fees).

Cap-and-trade

Under a cap-and-trade policy, the government issues emissions allowances (or permits) to facilities. Polluters have to buy allowances equal to the amount that they pollute. Allowances can be traded, and the price of carbon is determined by the market. If the cost of decreasing one ton of pollution is higher than the allowance price, the facility purchases allowances from a polluter with a lower cost of reducing emissions. Cap-and-trade has sometimes been seen as a market-friendly approach because it allows the market to dictate the price of carbon, not the government.

The European Union Emissions Trading System (ETS) has been in effect since 2005 and now prices carbon at about $25 per ton. California is an example of a US state with a cap-and-trade system and their price is currently around $17 per ton. There are important considerations to keep in mind when designing a cap-and-trade program:

• Emissions cap:Many governments choose to distribute all or a majority of the allowances for free to avoid political opposition in the beginning years of the program. In this case, having an accurate estimate of required allowances is critical. The European Union did not have accurate emissions data in the beginning of the ETS program, so allowances were over-supplied and therefore the prices were much lower than what would be needed to meet carbon-reduction goals.

• Initial distribution of allowances: Initial allocation is very important if the allowances are distributed free of charge. The firms that receive more allowances than they need may bank allowances and not enter the market for a long time. A thin market increases uncertainty about allowance price and the perceived fairness of the program. A larger market makes it more difficult for price manipulation to happen and a larger quantity of allowances for sale with more participants increases the quality of the price signal (Burtraw and McCormack, 2017). For these reasons, transparency about the allocation process is very important.
• Auctions: In order to avoid the pitfalls of free allocation (and raise revenue) governments might sell some or all allowances in an auction. Auctions are a fast and efficient way of discovering carbon price; however, they might impose high costs on consumers like utility customers, business owners, and even governments themselves if other regulations are not in place to protect them.
• Banking and offsets: To provide more flexibility and protect industries from overly high costs of reducing carbon emissions, cap-and-trade programs allow for the banking of allowances for future use and purchase of offsets (e.g. planting trees). Since offsets usually do not provide local benefits and do not incentivize emission cuts, cap-and-trade programs only devote a small share of emission reductions to offsets.

Carbon taxes

A carbon tax puts a tax on fossil fuels in proportion to their carbon content and therefore their societal cost. A tax increases the costs of burning fossil fuels, thereby decreasing how much carbon is absorbed by the atmosphere. A carbon tax internalizes the externality by assigning the appropriate cost at the point of purchase and removes the inefficiencies of the market. By taxing carbon, the price is fixed, and the quantity of emissions will be determined in the market.

Economists recommend setting a tax based on the social cost of carbon—the dollar value of long-term damages done by a ton of carbon dioxide emission in a given year (EPA, 2016). The social cost of carbon is estimated to be about $50 per ton in 2020 (GAO, 2020). Revenues from a carbon tax can be returned to individuals in the form of a lump-sum rebate or a decrease in other taxes (such as income or sales tax) or invested in climate change mitigation programs. British Columbia’s revenue-neutral carbon tax reduces other taxes to decrease the burden on workers and employers. On April 1, 2019, BC’s carbon tax rate rose from $35 to $40 per ton of CO₂.

Which one is best?

A carbon tax is quicker to implement and easier from an administrative point of view. Its implementation requires no extra bureaucracy and no lengthy negotiations like what take place to determine the initial allowances in a cap-and-trade system. It is also more transparent, minimizes government involvement and avoids creation of new markets that raise imperfections and possibility of manipulation. However, under a cap-and-trade system, borrowing, banking and extended compliance periods allow firms the flexibility to make compliance planning decisions on a multi-year basis. Moreover, cap-and-trade is the only instrument that guarantees the desired emission reductions. It is also seen as more attractive politically.

Carbon pollution and carbon prices both disproportionately affect people who earn low incomes. Who is affected by cap-and-trade and tax policies, and how much they’re impacted by them, largely depends on their design and the conditions related to their implementation. A successful carbon pricing mechanism offsets all or parts of these negative impacts on people who are most affected, such as people of color and low-income communities.

Pricing carbon makes polluters pay the cost of their emissions and holds them accountable for the costs they impose on society. By not addressing this issue head-on, we are paying the price of pollution in the form of lost economic opportunities like losing the outdoor recreation, tourism, and ski industries. We also share in the costs of mitigating natural disasters created by climate change like floods and wildfires. Pollution and smoke from wildfires are resulting in increases in respiratory and cardiovascular diseases, and most importantly, people are losing their lives and livelihoods. If we do not price carbon, our society will continue to bear these costs, and we will lose more than just money. We will lose our very way of life.

That’s something you can’t put a price on.

References:

Burtraw, Dallas, and Kristen McCormack. “Consignment auctions of free emissions allowances.” Energy Policy 107 (2017): 337-344.

EPA, Technical Support Document: ­Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis ­Under Executive Order 12866, August 2016. https://19january2017snapshot.epa.gov/climatechange/social-cost-carbon_.html

J. Cook, et al, Consensus on consensus: a synthesis of consensus estimates on human-caused global warming, Environmental Research Letters Vol. 11 No. 4, (13 April 2016); DOI:10.1088/1748-9326/11/4/048002

By Chris Stiffler

1. The economy fell off a cliff, but it would have been much worse without federal stimulus

As we’re all acutely aware, the economy has been in rough shape due to efforts to curb the spread of the coronavirus. 2020 saw the worst quarterly drop in Gross Domestic Product (GDP) on record. A 31.7% drop in the second quarter was four times greater than the Great Recession and largely driven by a collapse of consumer spending (which typically drives two-thirds of the economy). Stimulus checks and boosted unemployment insurance payments kept consumer spending from falling even more drastically than it would have otherwise.  With an additional round of stimulus is still uncertain right now as Congress and the White House struggle to come up with a deal, a lack of additional stimulus will mean a much weaker 2021. 

2. The budget picture is getting rosier, but ballot measures could change that

The FY2019-20 budget finished up $900 million than where we thought it would in June. Due to better-than-expected economic activity in the last several months, as well as 2019 income tax collections that were stronger than originally anticipated, the current budget (FY2020-21) has $540 million more than we thought it would at the last revenue forecast. Add those together and we have about $1.4 billion more than we thought we would back in June. This is welcome news since the 2020-21 budget was filled with historic cuts to schools and colleges after an 11.6 percent drop in General Fund revenue due to the COVID recession, and next year won’t be any easier.

Despite the brighter budget outlook, schools could take another big blow in funding after the November election depending on the outcome of two ballot measures. Proposition 116, which will lower income taxes (with most of the benefits going to the wealthy) could reduce the General Fund by $158 million and force more cuts to schools and other important services. Voters will also be considering Amendment B, which will repeal the property-tax-limiting Gallagher Amendment. If voters don’t approve it, the residential assessment rate will drop 18 percent, and schools will have $500 million less.  

3. Colorado has regained 39% of the jobs lost since the pandemic began

Colorado lost hundreds of thousands of jobs in March and April during the stay-at-home order, and though we’ve regained nearly 40 percent of them, we still have a long way to go before we get back to where we were in February and early March. To put that another way, this recession has still negated a full four years’ worth of job growth. Part of the reason it will be tough to get back to full employment is because state and local government employers are still cutting jobs to help balance their budgets.  Colorado’s unemployment rate dropped to 7.4 percent in July from 10.6 percent in June (the jobless rate never got above 9 percent during the Great Recession). It’s encouraging to see more jobs being created, but we’re still at a level that’s about three times the 2.5% rate we enjoyed prior to the pandemic.

4. Continued high unemployment is creating a huge strain on the Unemployment Insurance Trust Fund

Colorado as seen unprecedented increase in unemployment claims during the COVID-19 recession. In the year before the pandemic, Colorado paid out paid $365.5 million in unemployment benefits. In FY2019-20, the trust fund paid out $1.27 billion and in FY2020-21 benefits paid are expected to peak at $2.62 billion. The drop in fund balance in the UI Fund triggered a move to the second-highest premium rate schedule starting January 2021. The fund is currently insolvent and will remain there for several years. While that sounds bad, the state exhausted the fund during the Great Recession as well, and will be borrowing from the federal government to ensure continued payment of benefits.

5. A ‘square root’-shaped recovery is emerging

The economy fell farther and faster than state economists thought when they released their June forecast, but the initial recovery was also stronger than they originally anticipated according to economic data from May and June. While that was welcome good news, economic activity did appear to be slowing down in August. However, because the initial COVID recession was so pronounced, on a per-capita inflation-adjusted basis, General Fund revenue isn’t projected to get back to pre-pandemic levels before 2023.

By Chris Stiffler and Elliot Goldbaum

The real cost of an income tax cut

This November, Colorado voters will consider whether or not to lower Colorado’s income tax from 4.63% to 4.55%. Before you get your ballot, it’s important to understand who will benefit the most from Proposition 116, and why a tax cut will result in big cuts to critical community services.

First, a little background on Colorado income taxes.

Colorado is constitutionally required under TABOR to tax income at a single rate – meaning a family earning the state’s median annual income of $70,000 pays the same rate as someone earning an annual income of $500,000 (the threshold for the wealthiest 1%).

Because of this requirement, any statutory increase or reduction in the income tax rate can’t be targeted to benefit or protect low- and middle-income families.

In fact, since Colorado’s tax code is tied to federal deductions and exemptions, and because people who earn low and middle incomes pay more of their income in sales and other types of taxes, any income tax cut puts an outsized share of the money into the pockets of those with the most.

Meanwhile, even though the coronavirus pandemic has hit them especially hard, Proposition 116 won’t do much for low- and middle-income workers and their families.

What it will hit hard is funding for our state’s public services. If voters pass Proposition 116, it will have immediate effects on many priorities in the state budget. The measure will reduce state revenue by $158 million in the first year alone.

Because income taxes are the largest revenue source for the General Fund – the part of the state budget responsible for funding K-12 schools, Medicaid, state colleges and universities, courts, prisons, and human services like child welfare and behavioral health – any reduction in the income tax rate directly affects those services.

Here’s a practical example of what happened to education funding when last time we cut taxes: In the late 1990s, Colorado’s income tax rate was 5.0%. When lawmakers cut the income tax rate in 1999 and 2000 to the final rate of 4.63%, it directly affected funding for public services. Colorado’s investments in K-12 education, higher education, and other public services have fallen behind when taking inflation and population growth into account.

The wealthiest see the greatest reduction in taxes

Proposition 116 won’t just result in cuts to important services, it will flow disproportionately to the richest Coloradans. As you can see in the chart below, Proposition 116 will effectively take millions of dollars for education and health care and put more than two-thirds of it into the pockets of those who make more than $100,000 a year.

Contrary to claims from proponents of Proposition 116, it would provide little “relief” to Coloradans hit hardest by the coronavirus pandemic. Our analysis shows the richest 1% would see the amount they pay in taxes fall by a greater amount than the dollar amount of the reduction for the bottom 70 percent of taxpayers.

One in four Coloradans won’t pay any less in taxes

An income tax cut also leaves out many Coloradans altogether. Because a portion of Colorado taxpayers have higher deductions than taxable income (and thus zero income tax liability), an income tax rate reduction has no effect on 25 percent of Colorado taxpayers. Of those 672,000 taxpayers with no income tax liability, more than half have incomes below $25,000, and 80 percent of them make less than $46,000.

And how much would those who do stand to pay less in taxes get to keep? As you can see in the chart below, not much. For someone with an adjusted gross income (AGI) of $60,000, Proposition 116 would be enough for a tank of gas. For someone with an AGI of $25,000, it would buy you a vanilla latte. A millionaire will get $725.

For someone who makes $5,000,000, on the other hand, that’s a nice chunk of change.

The wealthy already pay a smaller percentage of their income in taxes

Regardless of whether voters approve Proposition 116, Colorado’s tax code is unfair and upside down. That’s because sales and property taxes take up a bigger share of income for people who work low- and middle-wage jobs compared to wealthier people.

The sales tax is the biggest culprit. A household making $32,000 a year pays 5.0% of their income in sales tax, whereas a millionaire pays sales taxes totaling less than 1% of their income. Coloradans earning low incomes also pay a higher rate of their income in property taxes compared to wealthier households. Overall, people in households earning $32,000 pay 9 percent of their annual income in state and local taxes. Compare that to households earning $400,000 a year, who pay around 6.5% percent of their incomes in state and local taxes.

If that wasn’t enough, because high-wage earners are disproportionately white and workers who are Black, Indigenous, and people of color disproportionately work low- and middle-wage jobs, income tax cuts like Proposition 116 worsen our already racially inequitable tax code.

During a time when hundreds of thousands of Coloradans are unemployed, seeing their hours reduced, or dropping out of the workforce altogether to care for their families, many of us relying on the public services that income taxes fund more than ever.

Proposition 116 worsens our already unfair tax code, takes funding away from critical services, and gives an outsized share of the money in reduced taxes to the wealthiest 1% of Coloradans.

Voters should carefully consider the costs of this irresponsible tax cut before they turn in their ballots.

By Pegah Jalali

Coloradans are no strangers to wildfires, but this year’s fire season has come with quickness and ferocity not seen in years. A recent analysis of state wildfire history found more acreage burned in the past three weeks than in a 20-year period between 1960 and 1980. With forecasts calling for more hot, dry air in the next few weeks, it’s clear that firefighters from across the state and the country have their work cut out for them.

The drought creating the conditions for such large and destructive fires has been linked directly to climate change. That makes regulations designed to curb climate-warming emissions passed by Colorado lawmakers last year even more urgent and important.

Despite the urgent need felt by communities across Colorado to transition to a low-carbon economy in an equitable way, retrain fossil fuel workers, establish tighter regulations on pollution, and provide incentives for renewable energy investments, Colorado’s constitutional fiscal policy constraints are making incentives for such a transition much more difficult.

While many Colorado voters list climate change as a top issue, many are unaware bad policies baked into the state constitution are creating barriers to Colorado’s goals on climate change. More needs to be done to educate voters on the role tax and budget policies play in climate solutions, and the ways Colorado’s unique constitutional constraints like TABOR make it much more difficult to achieve what strong majorities of Coloradans agree is an important priority.

Last week, state officials from the Colorado Energy Office, the Colorado Department of Transportation (CDOT) and the Colorado Department of Public Health and Environment (CDPHE) took part in a virtual public comment session on the Colorado Greenhouse Gas Pollution Roadmap. More than 200 members of the public participated.

The “Roadmap” is a list of actions that will achieve emission-reduction targets set by the legislature in HB19-1261. That bill established the goal for Colorado to get 100% of our energy from renewable sources by 2040. These goals are projected to decrease emissions to 50% below 2005 levels by 2030 and 90% below 2005 levels by 2050. Some of the most important carbon reduction plans in the Roadmap include energy efficiency and conservation (e.g., building codes, per capita reductions on the number of miles traveled by vehicles); electrification of buildings, transportation, and industry; low-carbon electricity generation (biofuels, solar, and wind energy); and non-energy emissions reductions (non-combustion).

The listening session highlighted the ways climate change affects Colorado in addition to wildfires, including reduced snowpack and warmer streams, drier soil and thirsty crops, poorer air quality, and more severe and frequent floods. Colorado officials are also incorporating a climate equity framework into their work, acknowledging the adverse effects of climate change disproportionately affect people of color, indigenous people, rural communities, and low-income residents. This comes after CDPHE announced this month they are officially declaring racism a public health crisis.

During the public comments section, community members discussed many of the ways climate change is affecting their well-being. The audience held shared concerns on the ways air pollution and excessive heat affects our health (e.g. respiratory and cardiovascular diseases, low birth weight), the economic consequences on industries such as recreation and agriculture, and mental health problems such as anxiety and depression. Many community members reiterated the ways climate change disproportionately affects families who earn low incomes and communities of color.

As firefighters continue to work around the clock to put out the fires currently burning in our state, health officials are still working to stop the spread of COVID-19. Though the pandemic briefly paused some of the harmful pollution driving climate change, it’s not going to be nearly enough to get Colorado to where we need to be.

Drastic action will be needed to get our state, our country, and our planet back on track. We can’t afford to let bad fiscal policy prevent us from doing what’s needed to protect our climate, our communities, and our way of life.

Elliot Goldbaum contributed to this blog.

By Chris Stiffler, senior economist

In late March, stay-at-home orders issued by Gov. Polis in response to the coronavirus pandemic caused a sudden halt to the tourism, travel, food service and accommodations industries. The Colorado Department of Revenue recently released their sales tax collections data for April 2020 (the first month of stay-at-home orders) and total net taxable sales for April were 81 percent of what they were the same month a year prior.

Because Colorado generates much more of its tax revenue from sales tax compared to other states, stay-at-home orders have a huge effect on state and local government budgets. Colorado has the third-highest average local sales tax rates behind Alabama and Louisiana. On average, U.S. states generate about 5 percent of total state and local tax revenue from sales tax. In Colorado that figure is 15 percent. That means local sales taxes are usually the largest revenue source for the General Funds of Colorado cities. 

Accommodations, clothing stores, arts/entertainment/recreation, and food service have been hit the hardest. Hotels and other accommodations businesses had the biggest hit from the virus, taking in only 11 percent of the taxable sales in April 2020 as they did in April 2019. 

Regionally, Boulder’s retail sales in the entertainment/accommodation/food service industry in April 2020 were only 28 percent of what they were in 2019. Denver is even lower at only 25 percent. 

Tourist towns and ski towns were also some of the hardest hit areas of the state. In Copper Mountain, with the ski resort closed in April 2020, hardly any retail sales occurred. Copper Mountain collected 7 percent of the sales tax in April 2020 than it did in April 2019. The cities of Vail, Winter Park, Keystone, Breckenridge, Black Hawk, and Aspen top the list of cities who saw the biggest year-over-year drop in sales tax collections from April 2020 to April 2019. 

It’s important to keep in mind that these data are only for April, and while the state did begin to loosen restrictions on travel and business operations beginning in May, the bounce won’t be nearly enough to make up for the lost revenue. Cities and counties will be hard-pressed to do much of anything other than cut their budgets next year to make up the difference, and long-term national projections don’t indicate a full economic recovery any time soon.

With virus cases on the uptick over the past few weeks, it’s possible more restrictions could be on the horizon, which could worsen an already tough situation for Coloradans. Cuts to local government budgets aren’t just numbers on paper – they mean a reduction in the services that families, businesses, and their communities count on.  

By Chris Stiffler & Elliot Goldbaum

1. Cuts are here to stay (at least for 2020-21 and likely 2021-22)

Following up on their special May revenue forecast, Legislative Council only had one extra month of data to work with. Some were hoping the regular June revenue forecast would deliver rosy revenue news that would soften the blow to communities from budget cuts passed in the 2020 state budget. The June forecast is a bit better than May, but not by much. Even with an optimistic outlook for the next two years, the state budget still won’t catch up to where we were prior to the pandemic, and that sober analysis actually understates the damage. That’s because it doesn’t account for growth in student enrollment enter our schools and more people sign up for health care through Medicaid. 

2. Tax policy changes during the session helped

In May, the FY2019-20 budget – which lawmakers passed last year to fund the state through the end of June 2020 – was facing an $896 million deficit. Fortunately, due to tax policy changes from legislation ($321 million), transfers to the General Fund ($145 million), and $281 million from appropriation changes and tapping into the General Fund Reserve (bringing the reserve from 7.25% to 3.07%), the legislature transformed that deficit into a $365 million surplus.

The more than $300 million worth of revenue from tax policy changes – much of it from repealing tax giveaways to the very wealthiest Coloradans that were part of the CARES Act – helped close the gap in revenue from this current year (FY2019-20). It also added badly needed revenue for closing the $3.3 billion shortfall we learned about in the special May forecast.

3. Square root-shaped recovery

During the last two recessions in 2001 and 2009, the general fund saw a 17.3 percent decline in the following two years. Legislative Council is predicting that this recession will result in a 14.2 decline. This might seem counterintuitive given the unprecedented nature of the economic response to COVID-19.

But just like the recession looks completely different than any we’ve ever seen, the recovery probably will look different too. This recession hit far more quickly than past recessions and caused a rapid decline in economic activity. Quarterly GDP fell by 5 percent in the first quarter of 2020, and the U.S. officially entered a recession in March 2020. However, some recent indicators are pointing to a correspondingly quick economic uptick as retail sales have rebounded this past month and mortgage applications for home sales are back up. Despite this swing, economists are still predicting it will take years for the economy to fully recover. Even with an optimistic forecast in the out years, don’t expect state and local government budgets to look like they did in 2019 for a while.

4. Much higher unemployment rates in big tourist towns

Colorado lost 16,500 job in March and another 323,500 jobs in April, with the leisure and hospitality sector comprising the largest share of layoffs. In a continuing trend, the counties in Colorado that rely heavily on tourism have been the most affected. While the unemployment rate in Colorado as a whole was 11.3% (the 15^th highest among the 50 states), Pitkin, Gilpin, San Miguel, Summit and Eagle counties have rates that exceed 20 percent. The most recent data show a slight halt in the amount of job losses, but the decrease in tourism is reflected in travel data: vehicle miles traveled were down 22 percent compared to April last year. Even as towns begin to reopen, it’s likely consumer activity will remain subdued.  

5. We still need more revenue, and Initiative 271 is the best solution 

Even during the boom years of 2017-2019, when Colorado had one of the best economies in the country, the state budget still wasn’t able to fully pay back. Today, we’re continuing to dig a deeper hole in our commitment to education. The Budget Stabilization Factor (the annual shortfall in funding for K-12) is back to its largest-ever dollar value. We’re not just cutting education either. 

Initiative 271, which lowers the income tax rate for 95% of Coloradans and asks the top 5% to pay more, will generate about $2 billion that will offset a big chunk of the coming state budget cuts. If we want better roads, well-paid teachers, and the resources we need to get all of our communities through the pandemic and its aftermath, we need more revenue. Initiative 271 is the most impactful way we can get Colorado on the right track.

By Chris Stiffler

As the state works hard to recover from the COVID-19 pandemic, it’s important we use the best economic strategies available to make sure our communities can come back strong. Unfortunately, much of the debate over how we do that has focused on trickle-down economics. If we make sure there’s plenty of money in the pockets of those with the most, we’ll all benefit down the line, or so advocates claim. In practice, however, it’s a different story.

We don’t have to look very far to see a perfect example of the failure of this philosophy. In 2019, after years of tax cuts designed to spur growth resulted in catastrophic budget cuts, Kansas  was named the most-improved state for doing business by CNBC, their headline proclaiming: “Kansas economy rebounds from tax-cutting disaster.”

Other states aside, there’s plenty of evidence from right here in Colorado that shows designing tax policy to favor the rich isn’t the right move for policymakers who want the state to recover as quickly as possible. We can see the relative economic effects of keeping or ending preferential tax treatment for high-income business owners when we look at how people with different income levels spend their money.

Economists use the circular-flow-of-money model as a metaphor to describe how money is earned and spent. In a well-functioning economy, people earn an income through work and then spend it, which in turn becomes income for someone else who then goes out and spends it and so on. More money flowing means a stronger economy. In this way, one dollar spent can turn into multiple, which economists call a “spending multiplier.” A dollar saved doesn’t have the same consumption-boosting effect as the same dollar spent in a local restaurant. The biggest “injection” into the circular-flow model is government expenditures because they are, for the most part, buying salaries of moderate-income workers.

To see the net impact of a dollar paid in taxes by a high-income earner compared to a dollar of budget cuts, we need to explore what happens to a dollar held by an upper-income household and compare it to what happens if it’s paid in taxes.

Plenty of recent research demonstrates that the amount of a family’s income they spend, also known as their Marginal-Propensity to Consume (MPS), differs across incomes. Johnson, Parker, and Souleles (2006) find that the consumption response to the 2001 tax rebates were larger for households with low income.[1] Carroll et al. (2017) show that low-wealth households consume a higher portion of their income than upper-income households.[2] These differences in MPS are important in order to examine the impact of government fiscal policy, as suggested by Krueger (2012).[3]  Fisher et al. (2019) show the rich spend a smaller share of their income than households in lower-income quintiles.[4] 

Table 1 above shows middle-income households spend a bigger portion of their earnings in the local economy than high-income households. The average household spends 88 percent of their after-tax income in their local economy and 12 percent on life insurance, retirement, and savings. Meanwhile, a household making more than $200,000 only spends 55 percent of its after-tax income on expenditures like food, transportation, and entertainment. The reason for this difference is simple: someone making a low or moderate income is still paying the same price as a rich person on expenses like groceries and car repairs, so a larger share of their income goes towards those types of purchases, with less left over for them to save.

$1.00 in taxes paid by a household earning more than $200,000 a year reduces spending in the economy by $0.55 (the other $0.45 is either saved or used on life and disability insurance). When that $1.00 is re-injected in the form of the salary of a snowplow driver, teacher, or other public employee, the local economy gets $0.76 worth of spending. 

How is that spending injection calculated? According to the State of Colorado Annual Compensation Report, 78.9 percent of a state employee’s compensation is base salary.[5] The remaining 21.1 percent goes to benefits (health and dental insurance) and retirement. Additionally, the state saves a bit, so we subtract an additional $0.03 to account for the state’s current general fund reserve. That leaves us with $0.76. This analysis suggests that re-injecting revenue from taxes on the wealthy into the economy as wages for public employees like teachers can increase aggregate consumption and boost economic growth. Conversely, it also suggests that preserving tax loopholes for the wealthy, and the corresponding budget cuts necessitated by that special tax treatment, is a net economic negative.

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[1] Johnson, David, Jonathan Parker, and Nicholas Souleles. 2006. “Household Expenditure and the Income Tax Rebates of 2001.” American Economic Review 96(5): 1589–1610

[2] Carroll, Christoper, Jiri Slacalek, Kiichi Tokuoka, and Matthew N. White. 2017. “The Distribution of Wealth and the Marginal Propensity to Consume.” Quantitative Economics 8(3): 977–1020.

[3] Krueger, Alan B. 2012. “The Rise and Consequences of Inequality in the United States.” Council of Economic Advisers Address, January 12, 2012.

[4] Jonathan D. Fisher & David Johnson & Timothy Smeeding & Jeffrey P. Thompson, 2019. “Estimating the marginal propensity to consume using the distributions of income, consumption and wealth,” Working Papers 19-4, Federal Reserve Bank of Boston, revised 01 Feb 2019.

[5] Available at https://www.colorado.gov/pacific/sites/default/files/FY%202019-20%20Annual%20Compensation%20Report%20%26%20Director%27s%20Recommendation%20Letter.pdf

By Chris Stiffler and Elliot Goldbaum

Note to readers: This special edition of our usual Forecast Five has been expanded due to the size and scope of the revenue reductions created by the COVID-19 pandemic.

1. Lawmakers will start work on the budget with 25 percent less than they had last year

Hundreds of thousands of workers have been laid off by their employers in the last two months, many businesses remain closed, projects and deals have been delayed, and with all of that comes a drastic reduction in state tax revenue. Revenue that provides services and pays wages in communities across the state.

To put this revenue decline into perspective, $3.3 billion is roughly one-fourth of the entire state General Fund. The General Fund is where most of the funding for state support of K-12 education, Medicaid, and colleges and universities comes from.

As hard as that number is to fathom, it’s still understating the real size of the problem. Even during the best economic times, growth in population and the cost of government services mean even level funding is effectively a cut. During this current crisis, the need for services will be much higher than it would have been if COVID-19 never existed.

2. Reduced income tax collection is driving the decline in revenue

Since income taxes are 61 percent of the General Fund, any time the state isn’t collecting as much of them it means we have less to invest in education, health care, transportation, and other priorities. Even before the current crisis, those collections haven’t been enough to adequately fund our investments.

Compounding this problem is Colorado’s constitutionally mandated single income tax rate of 4.63 percent, which hasn’t changed since the year 2000. During the last two decades, income gains for those at the very top have grown substantially, but that hasn’t translated into similar gains for education or transportation. Overall, the wealthiest Coloradans pay the lowest share of their income in state and local taxes.

3. The CARES Act helped, but contained unfair tax provisions

The CARES Act, the most important of several federal relief laws passed since March, is providing some relief to Coloradans through increased unemployment benefits, one-time cash payments, and loans to some small business owners.

However, other less-noticed provisions from that legislation are worsening the state budget picture. Legislative analysts are now predicting those changes, which overwhelmingly benefited the wealthiest people, will mean over $255 million less in revenue the state will have to make up for elsewhere in order to balance the budget.

For more on this, be sure to read this blog on those provisions by Carol Hedges from April.

4. The Gallagher Amendment continues to negatively affect the state budget

Revenue reductions will be worse in the future as Constitutional provisions mean less property tax revenue to support all kinds of local public services. State officials predict the residential assessment rate used to determine the amount of property tax owed by homeowners will fall to 5.88 percent from its current 7.15 percent level. This won’t be felt until the 2022 tax year and will result in $500 million less for schools. (Note: some of this is in dollars from local mill levy overrides and some will have to be backfilled by General Fund dollars)

This means even more pressure on emergency fire and medical services which rely on property taxes, many of which were already facing budget challenges created by Gallagher and TABOR. Local fire protection and other districts will have difficult decisions to make about how to cut services and balance their budgets. 

5. Bottom line: Colorado needs more revenue

Cutting $3.3 billion from the state budget will be devastating. Because Colorado was already barely keeping up with the demand for all the services our tax dollars pay for before the crisis, there isn’t much lawmakers can cut that won’t make life harder for many.

One way lawmakers can act is by passing a temporary emergency tax, which is authorized under TABOR to deal with the effects of a public health emergency like the one we’re in currently. Carol Hedges wrote about the emergency tax in a blog post last month.

They can also look to tax loopholes that overwhelmingly benefit those with the highest incomes as a way to protect some services. However, there is not nearly enough wiggle room in the tax code to make up for the entire $3.3 billion needed to fill in the gap in the budget created by the pandemic.

Finally, Congress can provide aid to the state beyond the emergency funds they already authorized. New funds specifically designed to help state budgets, rather than just deal with the immediate need of fighting the virus, would go a long way towards reducing the impending budget cuts.

6. It won’t just be the General Fund that gets hit hard

Revenue the state raises when we buy things like gasoline, along with severance taxes paid on the extraction of natural resources, don’t flow to the General Fund. Instead, they go to Cash Funds, which are only authorized to pay for specific purposes. Collections for those funds are projected to fall by an additional $250 million.

Because of decreased demand (analysts said demand for fuel plummeted by more than one-third during the stay-at-home order) gasoline taxes are expected to drop substantially. 

There has also been a substantial reduction in supply due to the steep drop in oil prices because of global market shifts and the pandemic. Severance taxes, an already volatile part of Colorado’s tax code, closely track the price of oil, and analysts predict as much as a 90 percent drop compared to last year. Those taxes, almost all of which are paid on the production of oil and natural gas, help fund many important functions of state government including the Department of Natural Resources and the Department of Local Affairs.

7. The broader economy is headed for a “swoop-shaped” recession

Though there is significant disagreement among economists about how bad the coming recession will be, state legislative analysts predict a 5.6 percent contraction in 2020. That number is double the size of the Great Recession and, while there is some immediate anticipated recovery, it will be years before the state economy fully recovers.

And despite problems with the CARES Act, it provided a boost to the state’s sputtering GDP. The declines in GDP growth would have been worse without the federal stimulus payments and other provisions like expanded unemployment. The national economy would be $1.8 trillion smaller without the federal investments made in the CARES Act.

8. Some industries and geographic regions have been more affected than others

While everyone has been affected by COVID-19, unemployment is not being spread out equally among workers and communities. Workers in the hospitality, food service, and recreation industries are the most likely to have been laid off. To read more about the analysis of job losses to date, check out Jeremy Albright’s blog from March.

Mountain communities have twice the unemployment claims as those on the Front Range, with average claims at 11.5 percent along the Front Range compared to 21.6 percent in the mountains. One reason for this difference: spending from tourists is down 80 percent from the same time last year.

It’s also important to note the revenue forecast only looks at state government, and doesn’t address the drastic decline in city and county government revenue as local sales tax collections have plummeted.

9. Budget reserves won’t make much of a dent

Because of TABOR, Colorado lacks a true “rainy day” fund like the ones most states have. Instead of banking revenue over a certain amount, the state constitution requires that money be refunded. While lawmakers have set aside enough every year to build a 7.25 percent budget reserve, it won’t be nearly enough to balance the budget.

10. Uncertainty in the forecast

The biggest question mark for the state budget is the same one that’s on all of our minds: how long will the COVID-19 pandemic last? No matter how the pandemic plays out, it’s clear we’ll be feeling its economic effects for a long time.

Another source of uncertainty is the lack of hard data. The last month of actual collections calculated by the state is for March. Everything else, including April, is being modeled. The governor’s decision to follow the lead of the IRS and delay tax payments until July also makes the future murky. Because businesses have deferred tax payments, they don’t know how much less they’ll be paying.

The next revenue forecast is scheduled for June, and economists were quick to point out that we will have only a slightly clearer picture of the revenue situation, if not the pandemic. 

By Carol Hedges

On Monday, the Joint Budget Committee (JBC) staff released recommendations for balancing Colorado’s first state budget since the onset of COVID-19 (FY2020-21). Those recommendations are terrifying. Every department document outlines the kinds of cuts necessary to balance a budget that anticipates a 10 to 20 percent reduction in revenue. The approved FY2019-20 budget outlined spending $12.2 billion collected from the variety of state taxes. A 20 percent reduction from last year would mean $2.4 billion less in revenue and even more in cuts now that the COVID-19 pandemic has increased demand for a variety of publicly provided services.

The severity of the budget slashing needed to balance the FY’21 budget, should revenue impacts of the health emergency equal a 20 percent reduction, is startling:

• Stripping health insurance from 76,000 kids in the middle of a health crisis.
• Repurposing funding that is currently propping open the doors of rural hospitals.
• Increasing health insurance premium costs for Coloradans across the state.
• Forcing decisions about closing higher education institutions in rural Colorado.
• Slashing 25 percent of funds for medical services for Coloradans with intellectual disabilities.
• Increasing waiting times for services for Coloradans with physical disabilities.
• Pulling back on funding for affordable housing.
• Forcing all school districts to increase class size, shorten school weeks or both.

And it’s not like the legislature will get to pick and choose. All these proposals may be necessary in order to bring the budget into balance. Nothing state government provides seems exempt from cuts. 

And what will all these cuts mean? Less services and fewer jobs. The state employs thousands of workers in every community in Colorado. Jobs performed by public employees provide vital community services like teaching our kids, maintaining buildings on state university campuses, providing medical care in health centers, plowing snowy highways, and cleaning and maintaining our state parks. And workers then spend their salaries at local businesses, buying food, cars, furniture, and other products and services that employ even more people. Budget cuts mean job cuts, and with hundreds of thousands of jobs already lost in Colorado, our communities can’t afford to lose either the wages or the public services brought on by these massive budget cuts, let alone both.

It’s common knowledge that I’m no fan of TABOR, the country’s most restrictive tax and budgeting limit. But even TABOR recognizes that during emergencies there can be a need for additional community investments. It actually outlines the specific conditions under which the legislature can authorize emergency, temporary taxes. Because TABOR is so strict, the conditions when an emergency tax is a possible option for legislators are extremely limited. It requires a two-thirds vote of both chambers of the legislature, full depletion of emergency reserves, and whatever revenue is raised can only be used for emergency costs. These conditions are daunting but not nearly as daunting as the prospect of extending the pain of COVID-19 beyond what is absolutely necessary.

The emergency tax could be crafted to help provide relief for low- and middle-income families while generating more dollars to support the public services that build and maintain our communities. An emergency tax that lowers the income tax rate on the first $250,000 in income and then increases the rate incrementally on income above $250,000 would mean we could all share the costs of this pandemic more equitably than we are now sharing the costs for providing our public services. Under our current rules, those making the most pay the smallest percentage of their income to support the government-provided services that will be on the chopping block without additional revenue. By analyzing data from past recessions, we’ve also learned that those with the most income and assets are the first to regain lost income and wealth in recovery. An option that provides economic relief, new revenue, and a more equitable tax system for the future deserves serious consideration.

What do Gunnison and Alamosa become without Western Colorado University and Adams State University? What does Sterling look like without a hospital? What do early childhood classrooms in Commerce City look like without state funding for preschool? These are the imponderable questions raised by the possible cuts outlined in the JBC staff recommendations. That speculation doesn’t have turn into reality, and for a state with as many resources as Colorado, it shouldn’t need to.

While the federal government has authorized badly needed assistance, it will not only be insufficient to shield our state from the long-term effects of the pandemic, it’s not the Colorado way to leave our fate to Washington. Colorado elected officials can act now to ask Coloradans with the means to do so to do the right thing, to step up when it’s needed, and pay a little more to make sure all of our communities can get through this together.