The authors of “The Zero-Sum Game” are Iris Lav, senior advisor for the Center and an expert on state budget and tax policies, and Robert Tannenwald, a senior fellow at the Center and the former director of the Federal Reserve Bank of Boston’s New England Public Policy Center.

Tax cuts and tax credits both figure into Gov. Jim Douglas’s fiscal and economic development strategies. He proposed cuts to the state capital gains and estate taxes, which he estimated would reduce state revenues by $10 million. Meanwhile, a recent analysis by the Legislature’s economist concluded that the governor’s proposed cuts to the human services budget could result in the loss of 1,000 to 1,400 jobs.

Vermont already provides tax credits to businesses through the Vermont Employment Growth Incentive (VEGI) program. At the governor’s urging, the Vermont Emergency Board, a committee comprising the governor and four legislators, recently agreed to increase the amount of tax credits the state can award annually.

“The Zero-Sum Game” is available from the Center on Budget and Policy Priorities.

But there is no mystery. State funding for education that does not come from property taxes—or from the income-based school tax—has been declining for the last two years.

The bulk of the funding for education comes from residential and non-residential school taxes. However, just five years ago, 39 percent of the funding came from other sources: an annual appropriation from the General Fund, the lottery, a share of the sales and purchase and use taxes, Vermont Yankee, and a bit of federal Medicaid money. This year, these sources are only providing 30 percent of the support for education.

In 2008, these other sources contributed $450 million to the Education Fund. This year, they will amount to only $389 million. Part of decline has been driven by the economy. The sales and purchase and use taxes are down and so are lottery receipts. But the administration and the Legislature also have been shortchanging the Education Fund. This year, they reduced the annual transfer from the General Fund by $18.4 million and used about $6.5 million from Medicaid for other purposes. The transfer is being reduced again next year, and it’s not clear yet whether the Medicaid money will be cut again.

Residential and non-residential school taxes are growing faster than school budgets because they are having to make up for the loss of the other state revenues. If these other revenues were covering the same share of education costs they did in 2005, property taxes today would lower by more than $110 million. Since a penny on the tax rate generates roughly $10 million, that works out to a reduction of about 11 cents on the tax rate.

There shouldn’t be any mystery about what’s causing property taxes to rise as much as they are. The mystery is why the administation and the Legislature are choosing to drive up property taxes when they have other, better alternatives.

It is too soon to know if Oregon will turn out to be a bellwether. But one lesson to take from the Oregon experience is that voters are willing to support higher taxes if they hear a compelling case for maintaining services that residents need and expect. That takes leadership and the courage to tell people the truth about the problems they face and what it will take to fix them.

We need that kind of leadership in Vermont today.

First, we need to hear an honest assessment of what it would mean to cut $150 million out the state’s General Fund budget. That’s the size of the budget gap the administration and legislative leaders say we face next year. It’s really bigger than that if we’re talking about maintaining current services, but even cutting $150 million will cause real problems. We deserve to know what those problems would look like.

How much harder will it be to reach someone in a state office? How much longer will it take to process permits or get a case heard in court? What will it mean to an elderly neighbor to have her dental care cut from $495 a year to $200? How many more businesses will lose business because the bridge down the road has been closed? Will our private health insurance premiums increase or decrease if we make it harder for low-income families to get coverage? How much federal money will not come into Vermont if we fail to appropriate the state matching funds?

We hear vague acknowledgment that the budget cuts will cause some problems or that all Vermonters are going to have to share in the pain. But our elected representatives have an obligation to understand and explain how we, their constituents, will be affected by the cuts being proposed, and they need to talk to us about whether that’s the kind of state we want.

Second, they need to understand and explain to us what the alternatives are. What are the options for generating revenue if we want to avoid some or all of the cuts? Why do we have rainy days funds if we’re not willing to use the money in a recession as deep as this one? What would it mean to various taxpayers to have a temporary tax hike like the one the Snelling administration and the Legislature adopted in 1991?

We don’t need an Oregon-style referendum to decide these questions. We still have good access to public officials in this state, and we elected them to act on our behalf. But they have to do more than pat us on the head and tell us not to worry, they’re not raising taxes. A lot of people are worried about the direction the state is headed and believe the budget ax is not the only solution.

If nothing else, surely the Oregon vote taught us that elected officials don’t have to fear an open discussion of all the options.

That’s basically how Governor Douglas’s plan for reducing property taxes would work. He wants local school districts to cut their school budgets. He’ll take the savings, give people a little of their own money as a property tax cut, and keep the rest.

Here’s how the governor does his sleight of hand. He wants to use money from the Education Fund to help close the gap in the state’s General Fund budget. Using money this way from the Education Fund necessarily drives up property taxes, but the governor wants people to think they’re getting a tax cut. His plan would force local school districts to reduce their spending—that’s like asking them to hand over $100 from the cash register. Then he gives them a tax cut—that’s like paying for the drink and leaving a tip. But the tax cut is much less than the reductions local districts would be forced to make, and the difference is the amount the governor wants to keep—like the change from the $100.

The governor’s plan would reduce payments to schools by about $60 million—$18.4 million the Legislature already has diverted to other General Fund uses; $37.1 million in assumed “efficiency” savings; and $5.3 million from reductions to small schools grants, adult education, and reimbursement for state-placed students. In addition, he would take money for teachers’ retirement ($10 million) and school construction ($5 million), which used to be General Fund obligations, out of the Education Fund. In all, the governor’s plan would reduce money available to local schools from the Education Fund by over $80 million.

Of that $80 million, the governor wants to give back $20 million as tax cuts: $4.2 million for primary residences, $3.4 million for renters, and $12.4 million for vacation-home owners and businesses. Not all residential taxpayers would get a cut, though. The governor would actually increase taxes on middle-income families with household incomes between $60,000 and $90,000 who now pay school taxes based on income. The residential tax cuts would go to families with incomes greater than $90,000.

Like the scam in the bar, this trick takes two players. Let’s hope the Legislature doesn’t go along.

“Today, I am proposing to close another tax loophole—one that penalizes working Vermonters.

“Our current tax structure taxes earned income—that is, your hourly wage or salary—at a higher rate than it taxes unearned income.

“What this means is that a working man or woman in Vermont making $50,000 a year pays nearly 50 percent more tax than someone who does not work and simply lives off investment or trust fund capital gains income in the same amount.

“Our state is one of only a few that has such an unfair penalty for doing an honest day’s work. This is grossly unfair. We must close this loophole and eliminate this working tax penalty.”

The Legislature didn’t change the captial gains tax that year, but in 2009, recognizing the need for additional revenue, lawmakers decided that most—although still not all—of capital gains should be subject to the income tax. Governor Douglas didn’t like the change, and in his Budget Address last week, he called for the loophole to be restored. Here’s the governor’s current view on capital gains, as explained in his budget book, “Our Commitment to a Stronger Tomorrow”:

“Favorable treatment of capital gains income encourages entrepreneurship and investment, protects the retirement income of seniors, and eases the transfer of small, family-owned businesses from one generation to the next.

“Governor Douglas proposes to sunset the capital gains tax changes made by the Legislature last year.

• Effective January 1, 2011, long-term capital gains will again be eligible for the 40 percent exemption, as they were in tax year 2008.
• The individual income tax rate decreases effective in 2009 and 2010 will remain in effect.

“Removing the capital gains exemption could be justified if all the revenues were used to lower tax rates for working Vermonters. However, using a sizable portion of the proceeds to support spending, as the Legislature did, amounts to a tax hike on already over-taxed residents.”

Two years ago, the governor recognized that Vermont’s treatment of capital gains amounted to “an unfair penalty for doing an honest day’s work.” Whether the money raised from closing this loophole is used for tax relief or covering the cost of services that Vermonters need doesn’t change the essential fairness of the policy. The Legislature did the right thing last year and shouldn’t reinstate a loophole that is, as the governor’s so aptly put it, “grossly unfair.”

The second part is a structural problem, which started long before the recession, and is the result of the unsustainable growth in health care costs and the failure of certain taxes—like the sales tax and gasoline tax—to keep pace with the economy. We need a thorough study of Vermont’s structural budget problems so everyone can understand where we should be focusing our energy.

The governor’s solution to the temporary decline in revenue is to permanently reduce services to Vermonters. Instead, he should be working to build a bridge to the recovery.

The governor said nothing about the structural problems, and until they are addressed, we’ll just keep slashing away at programs and doing permanent harm to services that Vermonters need, without getting any closer to having a sustainable budget.

When you plot those figures on a chart, you see a steeply rising line. Economically, this growth in the cost of health care is unsustainable.

Now contrast health care with education. Between 1992 and 2009, Vermont’s total expenditures for K-12 public education fluctuated between 5.5 percent and 6 percent. On a line graph, education expenditures are flat. Unlike health care, education costs are not becoming an ever-larger portion of the economy. In other words, they are sustainable.

In his final State of the State Address earlier this month, Gov. Jim Douglas touched on both health care and education. Care to guess which he called the bigger problem?

He uttered the words “health care” just three times, and the context was either congratulatory or neutral. Nowhere did he mention that one of the main reasons Vermont is having trouble balancing its budget—and has had for several years—is the unsustainable growth of health care.

“Education,” on the other hand, appeared 36 times in the governor’s speech, and the references were mostly negative. Only one other noun—the word “state”—crossed the governor’s lips more frequently.

The first step to solving Vermont’s budget problems is to understand what’s causing them. Controlling health care costs is a big task, and one Vermont probably cannot solve by itself. But making education a scapegoat diverts Vermonters’ attention from the real issue we need to address: galloping health care costs.

That’s because Vermont doesn’t prepare annual estimates of the cost of providing the services and programs that it’s currently expected to deliver: a current services budget. What we’ll get is a budget that represents what the governor thinks Vermonters can afford. But we can’t make intelligent judgments about what we can afford if we don’t have a full and honest assessment of what things cost. A current services budget takes into account anticipated changes for things like inflation, increases in human services caseloads, or new eligibility rules.

Unless people can see the projected cost of services next to the level of funding the governor is proposing, they can’t really understand whether or not existing services will be cut. Their priorities could well be different from the governor’s.

Douglas has been arguing for years that Vermonters can’t afford their school budgets. But even in these difficult times, when voters have been given a choice between higher school taxes and reduced educational opportunities for their children, they’ve taken the former. They’ve concluded what they can’t afford to is to short-change their kids’ education.

The state isn’t giving us the kind of information that most local voters get about their school budgets: What will it cost to keep doing what we’re doing right now and what will we have to give up if funding is less than that? Without adequate information, we don’t know whether the governor is proposing to give departments 70 percent of the resources they need, 90 percent, or 40 percent.

We’ll get the new budget next week. We’ll probably be able to tell whether it proposes to spend more or less than this year. But we won’t know whether it moves us any closer to becoming the state we want, a state that works for all Vermonters.

If it comes to pass, it will be a welcome change from across-the-board budget-cutting the state has suffered the past two years. Services have become an afterthought; the bottom line has ruled.

It’s hard to argue with the goal of better public services at lower cost. But Challenges for Change is thin on details, so it’s also hard to gauge how effective the plan will be.

The cuts—or rather “savings”—appear to be a given:  ”The savings are taken in the FY11 and FY12 budget process. There is no argument about money. The money isn’t there to spend.” it says.

Then the report repeats the challenge: “deliver the same or better result with the money available.” It doesn’t say how we’ll know we’ve gotten that better result.

In fact, the section on “challenges” in human services suggests we can expect worse outcomes: “Aging demographics and reduced public resources may be requiring Vermont to reconsider its expectations about whom it can afford to serve.”

In other words, elderly Vermonters and Vermonters with disabilities may get less. This doesn’t sound like a better outcome, unless you think cutting services to vulnerable people is efficient and likely to improve their quality of life.

Efficiency and better outcomes are one thing, cutting services to vulnerable people is quite another.  Vermonters clearly support the former.  There will be pushback – and there should be – about the latter.

When it’s eventually over, this recession could well be worse than the recession of the early 1990s in how it’s affected Vermont’s budget. But unlike 20 years ago, there is federal stimulus money, which has reduced the size of the problem Vermont has to solve on its own. For next year, both the administration and the Legislature’s Joint Fiscal Office are projecting a budget gap—after accounting for the federal funds—of about $150 million. (The actual gap may be bigger, as we explained in our report, Reducing State Services: The Wrong Fix.)

But using the current consensus estimate, next year’s gap—$150 million on a budget of approximately $1,350 million—is about 11 percent of the budget. In 1991, the projected gap was a little more than $160 million on a budget of about $660 million—24 percent of the budget.

Twenty years ago, both the administration and the Legislature understood they couldn’t cut their way out of the problem. They did make cuts. But they also raised $90 million in new taxes, which would be more than $140 million in today’s dollars.