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THE TAXMAN HAS A WARNING FOR YOU

Larry Fuchs, Florida's chief tax collector and best manager in state government, is delivering a message that some don't want to hear: Florida's tax system is a dangerous mess that could crumble in the face of a recession. Are you willing to listen?

Yes, it's true, nods Larry Fuchs, the state of Florida's chief taxman, the state is enjoying the largest economic expansion in its history. Yes, the state did take in a record $1.05-billion in tax revenues _ in one day _ earlier this year. Yes, he acknowledges, state tax collections have exceeded forecasts in six of the last seven years. Welfare costs are stable or dropping, and prison space is abundant. Corporate profits are up, wages are rising, residents and tourists are spending freely.

But there's one problem, says Fuchs, a man with the earnest, passionate air of a minister. The state is broke, or as Fuchs puts it, "functionally bankrupt."

What he means is this: Florida's finances might hold up fine if the national economy hums along forever as it has for the past seven years. But eventually, he believes, there will be another recession. And the state has created such a rickety, unstable tax structure that even a mild 1990-92-type downturn would exhaust Florida's reserves quickly. Within 12 to 18 months, the state would be $1.5-billion in the hole, Fuchs says. A more severe recession means state coffers will dry up even faster.

Fuchs, who won't deny rumors he will retire soon, isn't pulling numbers out of a hat. The Center on Budget and Policy Priorities, a non-profit research group that studies how policies affect low and moderate-income families, has concluded that if a downturn like the one in 1990-92 hit Florida, the state, after using up its reserves, would have to raise $3.2-billion or cut expenditures that amount to keep providing the services it now delivers. Another study, completed last year for the National Education Association, found that Florida's gap between expected revenues and expected spending _ its structural deficit _ was third worst in the nation, behind Texas and New Hampshire.

The reason? The state relies on the sales tax for about 70 percent of its general revenue fund, and that bedrock is eroding. One trend: Consumers are spending proportionately more of their income on services, which the state leaves untaxed, and less on goods, which are taxable. Another trend: Lawmakers have exempted some 309 products and services from the sales tax _ from advertising to bottled water and ostrich feed _ and they're exempting more each year.

Potentially the most revolutionary challenge of all, Fuchs says, is the exponential growth of the Internet and its ability to shift commerce from traditional retail outlets to cyberspace, which has no tax collection system. Within a few years, e-commerce may cost the state as much as $1-billion annually and could have the same effect as a recession, according to Fuchs. "What we need is a corresponding revolution in our tax scheme," he says.

Meanwhile, the boom in consumer spending in Florida has generated enough sales tax revenue for the Legislature to expand programs in education, criminal justice and social services _ but lawmakers never created new revenue sources to pay for the expansion and never cut any other programs to offset additional costs. So when a recession comes, Fuchs says, the state will be hit with a double whammy: As the economy shrinks and people lose jobs, the state will need to spend more on things like welfare, job training, the courts and prisons. But the needed revenues won't materialize because individuals and businesses will be spending less, and the sales tax won't apply to much of what they buy. The state's reserve funds, although at record levels, may last less than a year.

What will happen then? Legislators aren't likely to raise taxes, but they will have trouble making up the difference by just cutting spending. For one, lawmakers don't have a great deal of choice about which programs to slash, since the Legislature controls only the general revenue account _ money collected from taxes on sales, corporate income, documentary stamps, insurance premiums and the intangibles tax. The general revenue account amounts to $18.8-billion, only 38.5 percent of the total budget. The rest of the state's revenue is locked up in trust funds _ money from the federal government and state tax revenue that the Legislature can't touch because it's earmarked for specific programs by federal and state mandates or court orders.

Fuchs says there's almost no fat to trim: In 1991 and 1992, the state cut more than $1-billion from the general revenue budget, hitting social services and education hardest. It took until this year to restore the education budget to its pre-recession spending level. "This is a lean and mean government," Fuchs says. "It has benefited by the attempts of Gov. Martinez and Gov. Chiles to reduce the cost, intrusion and complexity of government _ which means there isn't room to make any significant cuts in the face of a recession without elimination of programs."

Against the stream

In raising the tax issue, Fuchs knows that he's swimming out of the mainstream. "You've got to understand something," he explains, "I am not in favor, personally, of increased taxation." He supported the Legislature's efforts to lower taxes and helped work out details of the retail tax holiday that began last year and continued this year. He doesn't favor an income tax, and he says the state's politics and constitutional prohibition of the income tax make the issue moot anyway.

Fuchs is leery of talking in terms of policy options because he says it makes him feel like a politician. But one approach that makes sense, he says, is "the kind of proposal that Jim Smith made when he was running for governor." Smith, the former secretary of state, recommended flattening the tax base by eliminating many of the exemptions already in place and using the revenue to lower the total sales tax rate and require local governments to roll back property taxes. This kind of "revenue-neutral" approach is also advocated by TaxWatch, a Tallahassee-based public interest research group, which recommends phasing in any changes.

Fuchs says the point is not to find ways to take more money from taxpayers, anyway. Instead, he says, Florida simply needs a tax system that will let it weather economic ups and downs without lurching between frantic budget-slashing and mad scrambles for money. For the last year, Fuchs has been quietly arguing that the time to act is now, while the state is financially healthy. Last year, he told then-candidate Jeb Bush: "In your term as governor, and certainly if you are re-elected, Florida will suffer a financial crisis of enormous consequence and you will be put in the uncomfortable position of having to try to find the funding to keep us afloat." After Bush's election, Fuchs followed up that warning with a letter to the governor, the members of the state's Cabinet, the speaker of the House and the president of the Senate.

The response has been the same one given to the boy who yelled out that the emperor has no clothes: Uncomfortable adults look the other way and pretend not to notice. With the 2000 elections approaching, legislators are tiptoeing around the problem. They've asked legislative analysts to estimate how a recession would affect Florida's revenues but have taken pains to make sure no one thinks they're worried. The title of the Senate project is called "Fail Safe: Impacts of Economic Downturn on Florida Revenues." Bush also has his economists checking Fuchs' claims. But Donna Arduin, the governor's budget chief, says the administration is not ready to say there are problems with the state's tax base until it has challenged all the spending assumptions on which the budget is built, including the automatic appropriations to trust funds.

Still, the governor's actions say more than he does: Bush has built his budget with the wariness of someone fearful that the earth could open up beneath him. After Bush vetoed some $313-million in proposed spending, the state's reserve accounts stood at a record $2.36-billion _ 4.7 percent of the total budget and 12.2 percent of the general revenue budget.

Bush also sought to protect a handful of social service programs from the fluctuations of an economic downturn by creating an endowment fund with a substantial portion of the state's tobacco settlement money. And when he announced his $1.2-billion tax cut plan, he asked lawmakers to allocate half of it on one-time rebates that would not slice into the tax base year after year. But legislators refused. The governor also asked TaxWatch to look into the impact of the growing volume of untaxed commerce on the Internet. "I'm very concerned," responds Bush, via e-mail. "We are informally studying this."

Credentials

To understand why Fuchs is saying what he's saying _ and why Bush and others in power take him seriously _ you must understand this: Fuchs, a lifelong Democrat and long-time bureaucrat, could be the poster guy for the oft-heard plea to "run government like a business." In seven years as head of the Department of Revenue, Fuchs has turned around one of the most hated agencies in state government by de-politicizing the agency and applying business practices and state-of-the-art management that many corporations would envy.

The Department of Revenue, with 5,400 employees in 72 offices in nine states, processes as many as 35,000 pieces of mail a day, taking in some $23-billion in revenues each year. Under Fuchs' leadership, it's become the most efficient division of state government, exceeding the performance goals set by the Legislature for the fourth straight year. The Revenue Department has pulled in more management awards than any other department in state government and last year became the first state agency to win the coveted Sterling Award, Florida's equivalent of the national Malcolm Baldrige award for organizational excellence.

In the process, Fuchs has established a nonpartisan identity so unshakable that no one thinks he's grandstanding. His warnings are "a good indication of how seriously he takes his job," says Sen. Jim King, R-Jacksonville, a Fuchs fan who credits him with being "one of the most business-oriented agency heads that we have." Not immune from a little self-righteousness, Fuchs takes some pride in being the voice in the wilderness. "Somebody needs to do it," he says. "I would be derelict if I didn't attempt to raise a hue and cry."

Timing

Legislators and others point out that doomsayers have been wrong before. In the mid-1990s, some predicted gloom for the state because of its mismatch between revenues and spending. The Legislature always manages to respond to crises, lawmakers say. For example, in 1997, they reacted to the statewide shortage of classroom space by approving a plan to borrow from future lottery dollars to pay for K-12 construction.

But at least one state senator agrees with Fuchs. Sen. Jim Horne, a Jacksonville Republican and CPA by trade, believes a recession as severe as the one in the early 1980s would "bankrupt the state." Horne, the Senate Fiscal Resources Committee chairman, is one of the few legislators who believe there is an urgent need to update the tax system before Florida faces a recession. "We ought to look at our tax system and build a new model," he says. "It's the industry groups who are going to bring those solutions to the table."

Other legislative leaders appear less eager to take on taxes without a crisis. House Speaker John Thrasher, R-Orange Park, and Senate President Toni Jennings, R-Orlando, wouldn't even agree to be interviewed about tax reform. While Sen. John McKay, R-Bradenton, the designated Senate president after the 2000 elections, acknowledges the state's tax system is dysfunctional and vulnerable to the evolution of the Internet, he wants to wait for the governor's lead.

Bush is clearly not ready to discuss it. "The tax base issue can be dealt with by strong reserves, which we now have and will continue to build on," he says. He has also indicated that large reserves make it possible to finance another round of tax cuts next year, and the House Finance and Tax Committee has launched an interim project to explore the options. The budget reserves are, however, only a temporary fix. The Budget Stabilization Fund, the reserve account, which equals 5 percent of the total budget, can be used to offset fluctuations in the revenue stream, but state law requires that it be paid back over time.

House budget chief Rep. Ken Pruitt, R-Port St. Lucie, says that while Fuchs is right to raise the tax issue, he doubts the impact of electronic commerce "will be as draconian as (Fuchs) describes." As for tax reform, Pruitt also believes it will be a long time coming. "Jeb Bush has a long time to get the confidence of the citizenry. It will be a gradual plan. This Legislature is not prepared to handle this."

Dominic M. Calabro, president of Florida TaxWatch, also says Fuchs' timing is bad. "It's a good time to academically discuss it, but it's not likely to change anything soon. People are not going to make difficult decisions until they absolutely have to."

Fuchs acknowledges that a fiscal disaster may be the only thing that moves leaders to change the tax system. "Crisis, that's the only way government moves," he says. But Fuchs, who fought in Vietnam, says his instincts tell him that the time for battle is better now than it may ever be: The state is flush with cash to cushion the pain of change. And the Legislature has 64 of its 160 members leaving because of term limits in 2000. These lame ducks have little to lose by attempting the politically unpalatable and many have a good historical grasp of the inadequacies of Florida's current tax system.

Fuchs acknowledges that "there is no immediate imperative for the legislators to deal with the issue." But he adds: "Which is precisely why I'm attempting to draw attention to it."

Mary Ellen Klas is the Tallahassee editor of Florida Trend.

This article was reprinted with permission of Florida Trend Magazine. For Trend subscription information, call 1-800-829-9103.

1999, Trend Magazines Inc.

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