Today the financial leadership of the House, the Senate and the Governor’s office held their annual “consensus revenue hearing“. In short, the outlook is fair — a continuing moderate budget squeeze with some warning flags about long-term issues.
The consensus revenue hearing kicks off the annual budget process. The idea is that all three players (House, Senate and Governor) should be using the same assumptions in their budget development. The Department of Revenue presents their tax projections, the Treasurer projects lottery revenue and pension costs (which come off the top of revenue before budgeting begins) and then outside experts present alternative views. The analysts all make use of third party economic modeling sources for the economic projections that form the foundation for their revenue projections.
This year, as in most years, the projections lie close to each other with a couple of outliers. All agreed that in the current year, Fiscal 2016, revenues will come in very close to previous projections. No decision was made in the hearing — it was solely an occasion for input — but, based on the testimony, tax revenue growth at roughly 4% seems like a reasonable projection for Fiscal 2017, the state financial year beginning next July 1.
Four percent revenue growth means a tight state budget because so much of the state’s budget is driven by rapidly growing health care costs. We have yet to have hearings on projected MassHealth costs — those will occur in the spring and will importantly shape our options. Pension costs are also scheduled to grow steeply.
Perhaps the most troubling issue is our relatively low level of financial reserves — $1.255 billion or 4.9% of current year tax revenues. Massachusetts ranks well towards the bottom among state governments when its reserves are compared to its revenues. The ratio of reserves to revenues (or, alternatively, expenditures) defines how much of a downturn the state could absorb without making deep cuts in services.
Everyone agrees our reserves are too low. During the recent recession, revenues remained more than 10% below their prerecession level for two years and we drew heavily from the stabilization fund. We had a reserve of $2.3 billion, almost twice our current level, before the shock hit, but we nonetheless had to make deep service cuts at the state level. Given the volatility of the state’s income tax revenues, 10% of tax revenues or roughly $2.5 billion, seems like a responsible goal, although Treasurer Goldberg recommended a higher level — $4 billion which would be a little more than 10% of total state spending (spending is based not only on tax revenues but on revenues from other sources including federal aid).
Getting to $2.5 billion will be a multi-year challenge. The Massachusetts Taxpayers Foundation has suggested prioritizing reserve fund growth by taking roughly $250 million off the top of revenues each year for the next five years and using non-recurring revenues as they become available.
$250 million is a heavy lift and would compromise the state’s ability to increase local aid or transportation funding and to support essential human services. I do believe that unstable funding is very destructive for any institution — it can take years to recover when funding cuts force personnel reductions. So, there is a strong argument for taking moderate pain now to avoid severe pain when the next recession hits.
Choosing rationally between certain near-term pain and greater, but uncertain, future pain is hard for humans and other animals. State budget planners, like most people in their personal financial management, tend to operate with too much hope — hope that the economy will turn up more sharply or hope that health care cost pressures will abate or hope that politics will turn and people will support a tax increase that will ease the squeeze. Based on all available data, none of those is likely to happen in the next couple of years, but then again a recession isn’t expected either.
But those long-term issues mean that the budgetary choices over the next few months won’t be easy.
Your thoughts welcome.
Responding to a recurring theme in the comments — revenue increases:
Many below point to acute needs and advocate raising revenues. There are many approaches to raising revenues that I would support and I know that a majority in my district would support many of those approaches.
Revenue measures need to originate in the House (which has taken them off the table in the last few budget cycles) and would need to be approved by the Governor (who has expressed opposition to tax increases). So, they are not really among our options right now. In media comments following Wednesday’s hearing, house leaders re-affirmed their commitment to a no new taxes approach.
The question raised here is: Do we let our reserves remain low in the hope of different future politics, or do we build our reserves with the revenues we have, making sacrifices in the near term, to avoid the possibility that we will be left with inadequate reserves in the next recession when we might or might not be able to raise revenues.
The whole spending program is roughly $35 billion across hundreds of different line items. We will spend months considering the question of how much to spend and how much to put in reserve. I recognize that, as some below have suggested, it would not be fair to expect anyone to be truly able to answer that question based on the limited information I present here.
Responding to questions about the income tax — automatic rate cuts:
In 2000, the voters approved a schedule of income tax rate cuts that would bring the rate down to 5%. The margin was 59.4% to 40.6%. In 2002, the legislature slowed the schedule for rate decline with a new formula. That formula has resulted in continuing cuts. The rate will drop to 5.1% on January 1, 2016 and, based on the testimony in the revenue hearing is likely to drop again on January 1, 2017 to 5.05%.