Almost six months into his administration, Governor Wolf faces his most difficult task: Getting an ambitious budget through a Republican controlled legislature.

This is the new Governor’s first budget and it is not timid. It changes our tax structure and responds to popular concerns over education funding.

The budget negotiation represents the first major opportunity the Governor has to demonstrate his ability to effectively move from campaign to governance mode.  Everything else up until this period was stagecraft. Now the rubber hits the road.

Candidate Wolf spoke about his ideas of government, but he did not speak very much about governance. Except, that is, to tell everyone that he would be a different kind of politician, a phrase with less meaning as time passes.

Governor Wolf is transitioning from candidate to executive, and there are some good and bad signs emerging from that process.

On the positive side there is Wolf’s easy temperament and willingness to speak and listen to rank and file legislators, including Republicans. He has a roll up the sleeves style that is a welcome change from the past Governor who did not communicate well with his own party, let alone the opposition.

On the negative side, he has a partisan leadership team, especially Chief of Staff Katie McGinty and policy chief John Hanger, that may too easily alienate the opposition.  Let’s hope that the Governor’s secretary of legislative affairs, Mary Isenhour, is a dealmaker, because it is not clear that the others fit that bill.

Wolf has a partisan leadership team, especially Chief of Staff Katie McGinty and policy chief John Hanger. Let’s hope that the Governor’s secretary of legislative affairs, Mary Isenhour, is a dealmaker, because it is not clear that the others fit that bill.

The issues at stake are huge: what to do about unfunded pension liabilities which take a larger portion of the state and school operating budgets; what to do about the state controlled liquor store system; how to best increase the state contribution to local schools; significant changes in the tax system, and the level at which natural gas companies ought to be taxed.

When a deal gets done nobody will get everything they want. But the Governor has to be able to go back to his constituency and say he fought the good fight and accomplished certain key goals. Similarly the Republicans have to be able to say that they held back what they believe to be the most onerous parts of the Governor’s proposals.

There is broad support within the Commonwealth for increased funding for schools, broad support for property tax relief, and support for taxing the gas industry.  How those get done is at issue.

While Pennsylvania places at the bottom in terms of the social equity of its school funding formula, its overall per pupil allocation is not bad. So the issue will come down to how we allocate as much as how much we allocate. It’s an issue that will not be resolved immediately no matter what the budget number turns out to be.

Wolf’s plan to use increased state aid to reduce local property taxes is popular but it cannot happen unless the tax burden is shifted to sales and income, along with new taxes on natural gas. There is support for a gas severance tax, another Wolf proposal, but the gas industry is pushing back by saying that Wolf’s 5 percent (on top of existing impact fees) proposal would make us much less competitive, a statement disputed by the Democrats.

While there is support for Wolf’s proposal to reduce corporate net income taxes, this proposal only works within the context of other revenue adjustments. It will be an important part of the negotiation, one Democrats can use as trade bait.

There is much less support for raising the personal income and sales taxes, both of which are significant parts of the budget proposal. After all, nobody wants to pay more taxes, particularly flat tax increases that are inherently regressive.

Under the Wolf plan the sales tax goes up from 6 to 6.6 percent and the personal income tax takes a 20 percent hike, from 3 to 3.7 percent. There are fewer exemptions in the sales tax proposal than existed previously; including for items that some Democrats are nervous about.

I prefer taxing consumption (with exemptions for the basics) over income. It all depends on where you think incentives ought to reside. The Wolf plan helps property owners by increasing tax rates on both consumption and income.

One of the difficulties of judging the Governor’s tax proposals is the ability to measure its direct impact on an individual household. The Governor views it as a net reduction for middle class residents and the Republicans see it differently.

Because of the breadth of the proposals, its effects depend on how you make your living, what school district you live in, whether you rent or own a home, your consumption patterns, and household composition. And what you believe a middle class income to be.

The Wolf budget does very little to change the current pension fund trajectory, nor does it really touch the liquor store system, two big Republican items, both of which have public support for more significant changes but both of which are third rail issues for many Democrats.

In what was perhaps the most poetic of budget proposals, Governor Wolf linked the state stores and pensions without giving the Republicans what they wanted. I cannot tell whether this was an intentional bargaining ploy.

The Governor proposes borrowing $3 billion in pension obligation bonds and linking repayment capacity to increased revenue from liquor store modernization (better wholesaling, extended hours, etc.). He also said he wants to save money by getting rid of high fee fund managers.

We may very well do the wrong thing in the way we hire fund managers, but the issue is always return net of fees. Both passive and active investing has a place given the return expectations we have set for the funds and changing market contexts. The populist call to rid the pension funds of Wall Street managers makes for a better political script than investment strategy.

As for those pension bonds, I am very dubious. In effect, we’d be borrowing money to fix the borrowing we have already done by not paying properly into the pension funds in the first place.  It could work but the risks are significant and they allow us to avoid problems of our own making (not paying into the fund, using accounting and actuarial assumptions that are inherently unstable, etc.).

Meanwhile, the Republican dominated legislature is busy passing bills —which the Governor will never sign —that privatize liquor stores and more dramatically change the pension system. They are also unanimously and symbolically voting down all of the proposed Wolf tax changes.

The pension fund negotiations will be a big deal for the state’s position in the capital markets. While Pennsylvania is not Illinois, it is among the most distressed states in terms of unfunded liabilities and our bond rating is suffering. Moreover, the recent Moody’s downgrading of Chicago municipal debt may signal that rating agencies will start to pay more attention to pension issues going forward.

For Philadelphians the state budget battle has enormous stakes. It will effect the school budget including the direction of local property tax levies, and the impact of school pension fund expenses on school budgets.

If the two sides are unable to reach a deal prior to the end of June, a temporary funding arrangement will likely be forthcoming to fund essential services. There is precedent for long budget delays in Pennsylvania including the 101-day delay in 2009 when Ed Rendell was Governor.

In a 1985 interview in The New Republic then Governor of New York Mario Cuomo famously noted, “you campaign in poetry and govern in prose.” In contemporary America it is just as common to campaign in poetry and then govern in really bad poetry.  Let’s hope that does not happen in Pennsylvania.