March 21, 2006

Repairing the "Ratchet" Will Not Repair TABOR

Coloradoans recently voted to suspend the Taxpayer’s Bill of Rights (TABOR), the nation’s most restrictive limit on state taxes and expenditures, because it has caused a sharp deterioration in services ranging from education to public health to transportation.

Those pushing for the adoption of TABOR-style measures in other states are seeking to dissociate their proposals from Colorado’s experience under TABOR by arguing that Colorado’s problems stemmed entirely from one feature of its TABOR, the so-called “ratchet.”  (The ratchet, part of the formula for determining the state’s annual spending limit, makes it extremely difficult for state services ever to recover from an economic downturn.  See box on next page.)  TABOR proponents further argue that they have fixed the ratchet problem in the TABORs being proposed in other states, so these other states would not experience the problems found in Colorado.[i]


What Is a “Ratchet”?



As a result, it could take a state several years just to return to the level of allowable revenue that existed in the year before the recession.  This “ratchet effect” (so called because the state’s revenue limit is ratcheted down whenever revenues fall short of the TABOR limit) means that a state would have to continue making deep reductions in public services even as the economy recovers and revenue collections return to normal growth.



TABOR Formula Squeezed Services Even Before Ratchet Took Effect


TABOR’s “population-plus-inflation” formula prevents a state from collecting the amount of revenue needed each year to maintain existing public programs and services; as a result, it progressively shrinks state budgets and public services over time.  This is because the formula is an inaccurate measure of the costs facing state governments.  The cost of health care, education, corrections, and other areas of government generally grows more rapidly than the cost of consumer goods.  Moreover, certain segments of the population — such as schoolchildren and the elderly — require more public services than others.  When these segments grow more rapidly than the population as a whole, the cost of government grows more rapidly than the TABOR limits allow. [iii]

Unlike the TABOR formula, which each year reduces a state’s ability to provide adequate public services, a ratchet component of a TABOR formula comes into play only in the aftermath of recession, as explained in the box above.






Thus, even before the ratchet had any effect on Colorado, the TABOR formula had seriously undermined the state’s ability to provide adequate public services.[v] 



Ratchet Exacerbates TABOR’s Problems



Colorado Eliminates the Ratchet, While Other States’ Proposed Fixes Do Not

As noted in the box above, a ratchet occurs when revenues stagnate or decline during a recession and TABOR’s inflation–plus-population-growth formula is applied to that depressed level of revenues (or expenditures supported by those revenues) to determine the subsequent year’s TABOR limit.  This is the way Colorado’s TABOR operated prior to the passage of Referendum C in November 2005.  Referendum C suspends TABOR for five years and modifies TABOR so that when the suspension expires, the population-plus-inflation adjustment will be applied to the amount of allowable revenues in the previous year, not the amount of actual revenues in the previous year.  This means that if Colorado is forced to cut services during a future recession, it will be able to restore some of those services when the economy improves.[vii]


There is a new crop of TABOR proposals referred to as Stop OverSpending Initiatives (or “SOS”) being put forward in at least five state— Michigan, Missouri, Montana, Nevada and Oklahoma.  These proposals often include two provisions aimed at fixing the ratchet.  The provisions are an alternative limit calculation and a budget stabilization fund that is to be used when revenues fall short of the TABOR spending limit.  The SOS limits are expenditure limits, so the following discussion will focus on a spending limit rather than a Colorado-type revenue limit.  The effects of revenue and spending limits are similar.

Alternative Calculation

Under the alternative limit calculation, the TABOR limit for a given year would be set as the greater of previous year’s spending adjusted for inflation plus population growth or the previous year’s limit.  (Note that the second formula is the nominal level of the previous year’s limit, not the new Colorado formula, which is the previous year’s limit adjusted for inflation and population growth.)

Using the previous year’s limit freezes the TABOR spending limit during an economic downturn and keeps it frozen until revenues recover.  

It would work as follows.  If expenditures in any year are lower than the TABOR limit — because revenues are down and the budget stabilization fund is not available or not used (see discussion below) — then under the alternative calculation, that year’s limit would continue into the subsequent year without adjustment for inflation and population growth.  The frozen limit would continue to apply until there is a year in which the previous year’s actual expenditures adjusted for inflation and population growth are higher than the frozen limit.  The frozen limit might remain in place for two or three years, since fiscal crises have lasted for a number of years in many states in recent downturns.  If the limit were frozen, public services would fall substantially behind even the standard of need recognized in the TABOR formula; the population would continue to grow and inflation would continue to push up the cost of services over those years, but the limit would not be adjusted to reflect this growth.


Budget Stabilization Fund




    In recent years, state fiscal crises have been deep and have lasted for two, three, or even four years in some states.  For example, the states together entered the most recent downturn with reserves equivalent to 10.4 percent of a year’s expenditures.  While this is much more than was on hand in either of the previous two downturns, it turned out to be far from sufficient.  Indeed, it constituted only one-fifth of states’ cumulative budget gap over the multi-year fiscal crisis.  This history suggestions that a cap at 5 percent or 10 percent of annual spending is likely to be insufficient.



  • Budget Stabilization Fund Transfers.  The BSF transfers must count toward the spending limit.  In other words, the amount transferred from the BSF must be counted as expenditures so that the subsequent year’s limit would be the amount of expenditures including expenditures from the BSF, adjusted for inflation and population growth.  If the transfers do not count toward the limit but only allow the state to spend up to the limit in the year of the transfer, then there is no effect on calculating future years’ limits and the ratchet would not be fixed.  As Figure 2 shows, there are at least three states — Michigan, Montana, and Oklahoma — where the language of the initiative is not clear on this point.



Size of BSF

Filling the BSF

Use of BSF to Offset Budget Shortfalls

Transfers Count Towards Calculating Next Year’s Limit?


10% of limit

     Excess first goes to BSF

     BSF can only receive up to 50% of excess


Probably - language not clear


10% of limit


     BSF can only receive up to 50% of remaining excess




Not specified

Not specified

Not specified

Probably - language not clear


5% of limit


     BSF can only receive up to 50% of remaining excess




10% of limit


     BSF can only receive up to 50% of remaining excess





TABOR’s main problem is its “population-plus-inflation” formula, which starves a state over time of the funds it needs to maintain current services for residents and severely limits the state’s ability to meet new challenges as they emerge.  The ratchet effect exacerbates the funding shortfall caused by TABOR, but it comes into play only in the aftermath of a recession, so fixing the ratchet would not fix the problems inherent in the TABOR formula.  



End Notes:

[i] Referendum C, which suspends TABOR refunds for five years and permanently fixes the ratchet effect, passed by referendum on November 1, 2005.  Not all TABOR advocates think the ratchet needs to be fixed.  A recent Heritage Foundation report argues that, “a better alternative [to eliminating the ratchet effect] is to take advantage of the ratchet effect to force state government to seek the same types of innovation that the private sector relies on to achieve a competitive edge.” Alison Acosta Fraser, Colorado’s Taxpayer’s Bill of Rights Should Not Be Breached, The Heritage Foundation, No. 1873, July 28, 2005.


[iii] For additional information on the problems with the population-plus-inflation formula, see David H. Bradley, Nicholas Johnson, and Iris J. Lav, The Flawed “Population Plus Inflation” Formula: Why TABOR’s Growth Formula Doesn’t Work, Center on Budget and Policy Priorities, January 2005.








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 The main problem with tax and expenditure limits like Colorado’s TABOR is the arbitrary formula used to limit revenues each year. Fixing the “ratchet” (a feature of TABOR that worsens revenue shortages after a recession) would not avert the sharp decline in public services Colorado experienced under TABOR.

 Services in Colorado deteriorated severely even before the ratchet took effect — evidence that the ratchet is not the major problem with TABOR.

 The current set of TABOR proposals — known as “SOS” — claim they fix the ratchet through an alternative formula for annual adjustments; the change moderates the ratchet but does not eliminate it.

 The SOS proposals also include Budget Stabilization Funds. A BSF could fix the ratchet in the context of these limits — but only if it is designed and used properly. The evidence suggests that would be unlikely in most states.