4. Rules That Do Not Bind
Government policy also often forces resources from the decentralized realm of individual decision making (i.e., markets) to the centralized control of the public sector. The transfer of such resources leads to a process wherein a command-and-control regime, which all too often turns out to be irrational, gradually replaces entrepreneurial discovery. The most powerful checks on this migration of resources are institutional arrangements that constrain elected officials. These include constitutional and statutory rules, which limit spending, and interjurisdictional competition, which encourages governments to compete for citizens, by offering different mixes of goods and services and levels of taxation.
New Jersey’s budget—like all state budgets—is developed under constitutional and legislative rules. The effectiveness of budgetary rules depends on how they are designed and the extent to which those rules are enforced. A well-designed rule may still be ignored through a lack of enforcement. Rules meant to constrain spending growth in New Jersey, such as the state budget spending cap, are weakly designed and contain many exceptions. Strict constitutional rules on the issuance of debt have been relaxed through judicial interpretation, highlighting the problem associated with enforcement. We begin by reviewing the major constitutional and statutory rules affecting the development of New Jersey’s state budget and how these rules have been evaded, contributing to the current crisis.
4.A. Constitutional Rules
New Jersey operates on an annual budget (July 1 to June 30), submitted by the executive to the legislature for approval. The state’s constitution requires a balanced budget.
The debt limitation clause restricts long-term borrowing to 1 percent of total appropriations, unless higher amounts are specifically approved by voters at a general election. Short-term borrowing to cover cash flow needs is not prohibited by the constitution. In December 2008, the constitution was amended to require voter approval for debt issued by public authorities.
4.B. Legislative Rules
In 1990, the legislature enacted a spending cap on the Direct State Services portion of the budget, which accounts for 20 percent of total spending. The cap law excludes the majority of New Jersey’s budget: the Property Tax Relief Fund, state aid, grants-in-aid, and debt. The cap may be overridden by a two-thirds majority vote.
In the same year, the legislature created a Surplus Revenue, or Rainy Day Fund. The fund receives 50 percent of the difference between the amount of revenue certified by the governor in the annual appropriations act for the current fiscal year and the actual collections realized for the year. The fund may be used when anticipated revenue is less than what is certified.
As with the state budget, municipal, county, and school budgets must be balanced annually and are also subject to spending caps. The Municipal Budget Cap Law was enacted in 1976, with the state income tax, as part of the promise to reduce local property taxes. The municipal cap contains numerous exceptions: capital projects, debt service, employee pensions, and health care costs, leaving 25 to 40 percent of a municipality’s budget outside of the spending cap. Counties operate under a similar budget cap.
The school district budget cap instituted in 1995 includes automatic adjustments: enrollment increases, certain capital outlays, courtesy busing, special education in excess of $40,000, and expenditures associated with opening a new school, insurance, and domestic preparedness.
 See Israel Kirzner, Discovery and the Capitalist Process. Only entrepreneurs, operating in the marketplace, are able to respond to individuals’ preferences. Entrepreneurs constantly strive to satisfy consumers’ demands, using market signals to calculate the profits and losses resulting from their activities. Because they stand to profit, entrepreneurs face strong incentives to discover what consumers want (and in doing so, correct past misallocations of resources).
 This is referred to as “Tiebout Competition.” Municipalities compete for citizens and capital by offering different mixes of public spending and taxation. Citizens “vote with their feet” and sort themselves through the process of choosing which municipality suits their preferences. See Charles Tiebout, “A Pure Theory of Local Expenditure,” The Journal of Political Economy 64, no. 5 (1956): 416-24.
 See David M. Primo, Rules and Restraint: Government Spending and the Design of Institutions (Chicago and London: University of Chicago Press, 2007), 4. “Effective rules may be designed in theory, but in practice rules are designed by individuals with interests leading to the enactment of ineffective rules, or such outcomes may arise as the result of political compromise necessary for its enactment.”
 New Jersey Constitution, art. 8, sec. 2, http://www.njleg.state.nj.us/lawsconstitution/constitution.asp.
 The fund excludes income tax revenues which are statutorily dedicated to the Property Tax Relief Fund, and used for school funding, municipal aid, and individual property tax relief programs.
 New Jersey Property Tax Convention report, 52. Municipalities and counties may not increase their appropriations by more than 2.5 percent or the Implicit Price Deflator for State and Local government, whichever is less, over the previous year’s expenditures. The spending cap is raised to 3.5 percent in years when the deflator is greater than 2.5 percent.
 The law also permits localities to “bank” any difference between actual and permitted spending for use as an exception to its appropriation in the next two succeeding budget years.