Tennessee Business and Economic outlook

Transcription

1 Tennessee Business and Economic outlook The State s Economic Outlook Spring 2008

2 Tennessee Business and Economic outlook Matthew N. Murray, Associate Director and Project Director Center for Business and Economic Research Prepared by the Center for Business and Economic Research College of Business Administration The University of Tennessee Knoxville, Tennessee Center for Business and Economic Research The State s Economic Outlook Spring 2008

3 Center for Business and Economic Research College of Business Administration The University of Tennessee 804 Volunteer Boulevard Temple Court, Suite 100 Knoxville, TN Phone: (865) Fax: (865) William F. Fox, Director Matthew N. Murray, Associate Director and Project Director Donald J. Bruce, Associate Professor LeAnn Luna, Research Assistant Professor Research Staff Chris R. Carty, Research Associate Vickie C. Cunningham, Research Associate Brian M. Douglas, Research Associate Betty A. Drinnen, Program Resource Specialist Matthew J. Harper, Research Associate R. Brad Kiser, Research Associate Julie L. Marshall, Research Associate Carrie B. McCamey, Communications Coordinator Laura L. Ogle-Graham, Business Manager Melissa O. Reynolds, Research Associate Angela R. Thacker, Research Associate Graduate Research Staff Kate Harper Rebekah D. McCarty Zach W. Richards Bryan M. Shone Martin W. Tackie Ann B. Watts Kelly M. Woodruff Yang Zhou The preparation of this report was financed in part by the following agencies: the Tennessee Department of Finance and Administration, the Tennessee Department of Economic and Community Development, the Tennessee Department of Revenue, the Tennessee Department of Labor and Workforce Development, and the Appalachian Regional Commission. This material is the result of tax-supported research and as such is not copyrightable. It may be freely reprinted with the customary crediting of the source. UT Publication Authorization Number E copies. This public document was promulgated at a cost of $4.50 per copy.

4 The U.S. Forecast Introduction Economic conditions continue to deteriorate, raising concerns about a potentially deeper and more prolonged downturn. Throughout 2007 as oil prices were climbing, analysts indicated that relief was on the horizon. Rather than improving, prices have continued to climb. The setbacks in residential housing continue with little or no improvement in sight. The ripple effects of the weak housing market have now spilled across the entire economy, and prices especially food prices are up sharply. The depths of the problems confronting the economy can be seen in the aggressive steps taken by the Federal Reserve, including reductions in the federal funds and discount rates, and loans to nonbank financial institutions. The Tennessee economy has seen its own setbacks in the face of slower national growth. Nonfarm jobs were down 0.8 percent in the first quarter of the year following on the heels of anemic 0.5 percent growth in The unemployment rate in March spiked to 5.6 percent compared to the 4.5 percent unemployment rate in March The state s fiscal situation has deteriorated, and the revenue outlook for the next fiscal year is bleak. Governor Bredesen has indicated that layoffs are likely. It is difficult to find a bright spot at this point in the current business cycle. Even seemingly positive news loses its luster when one probes beneath the surface. Export growth has been very strong as it continues to benefit from the falling dollar in international currency markets. Unfortunately the falling dollar introduces its own problems including higher prices of imported goods for producers and consumers alike. Moreover, export strength has not averted further significant declines in manufacturing employment. (Admittedly, manufacturing would be in much worse shape absent the dollar s fall.) The recent report on inflation-adjusted gross domestic product (GDP) for the first quarter of 2008 also appeared to offer good news by registering a 0.6 percent gain, ahead of expectations. (This release occurred as the current forecast was being finalized.) But the gain was driven by inventory accumulation and net of inventories, output was in fact down in the first quarter. Finally, the nation s unemployment rate actually ticked down in April and moved to 5.0 percent. This is relatively good news given that the number of employed people grew while the number of unemployed people contracted. The state and national economies will continue to be worn down by high energy prices and a weak housing sector throughout 2008 and into 2009 and will teeter on the brink of recession. The housing market is expected to bottom out this year, but recovery will be slow. And once again the outlook calls for oil prices to stabilize and eventually fall in 2008 though we have heard this story before. The federal stimulus package will boost growth in the middle of the year, but the economy will slow again in the final quarter. On net, expect U.S. inflationadjusted GDP to advance 1.2 percent for the year and nonfarm jobs to be up only 0.2 percent. In Tennessee, personal income will grow 3.5 percent, and nonfarm jobs will fall by 0.1 percent in Tennessee Business and Economic Outlook 1

5 The U.S. Forecast U.S. Forecast Current Economic Conditions You might call it piling on, but the bad economic news just won t go away. Record high gas prices, sharply rising food prices, sagging consumer confidence, falling jobs and a housing crisis the list goes on and on. Some seemingly good news arrived on April 30th with the release showing that inflation-adjusted GDP grew 0.6 percent in the first quarter, beating expectations. Inventory accumulation helped boost first quarter growth which is not goods news for production in the quarters ahead. But the decent showing of GDP given the pervasive weaknesses across the economy has to be heralded as relatively good news since it shows that the national economy has not collapsed. Monetary Policy The aggressive stance taken by the Federal Reserve (Fed) is one of the most notable aspects of the slowdown and is indicative of the risks facing the economy. After peaking at 5.26 percent in July 2007, the federal funds rate now stands at 2.3. The action taken by the Fed on April 30 may be the last rate cut in this cycle if the economy begins to show improvement; the federal funds rate now falls below the rate of inflation and policymakers must be careful to avoid fueling inflationary fires. The way in which the Fed has taken action is also noteworthy. For example, the Fed worked through one weekend outside of the normal meeting cycle to announce a rate cut on a Monday morning to help quell the markets. The discount rate the rate charged by the Fed for overnight lending to banks has been lowered as well in an effort to increase liquidity. The Fed also took the unprecedented step of opening up the discount window to financial institutions other than banks following the collapse of Bear Stearns. The Fed s actions have taken place in an environment of ever-rising prices. The consumer price index was up 2.9 percent in 2007, bolstered by a 5.0 percent spike in the fourth quarter. The first quarter of 2008 offered little relief with prices climbing 4.3 percent. Oil prices at the wellhead have set records surpassing the $120 mark, and gasoline at the pump is at record highs. These high prices reflect the fundamentals of supply and demand, as well as speculation. Extraction and refining capacity are constrained, and output from some oil fields like those in the North Sea is now in decline. Couple this with strong global demand and spotty supply interruptions across the globe and you have a recipe for high prices. Add in speculation, and you have the perfect storm to support a price bubble. Investors are moving to oil (and other commodities) because of the falling dollar and concerns about further dollar depreciation. Supply interruptions, even small ones, send chills across the markets pushing prices up further by speculators. Rising food prices are squeezing domestic consumers while at the same time producing riots in some developing countries. Like oil prices, there are several contributing factors. Most notable in the eyes of many is the move toward biofuels based on food grains though this cannot explain all of the price increases that have taken place. The Fed is walking a fine line as it seeks to stimulate economic growth without adding to inflationary pressures. To date the Fed has clearly viewed the growth threat as more serious than the inflation threat. Many are now calling for no further easing of monetary policy so as to avoid further inflationary pressures. Consumption and the Labor Market Consumer spending is showing signs of retrenchment with the mix of spending turning away from manufactured products and toward services. Nationwide, total retail 2 Center for Business and Economic Research

6 The U.S. Forecast sales fell at a seasonally adjusted annual rate of 0.2 percent in the first quarter of the year. During the same period automobile sales fell at an annual rate of over 20 percent. Consumption was up modestly in the first quarter of 2008, with spending on services offsetting reduced spending on durable and nondurable goods. Consumer confidence is at recessionary levels, which should come as no surprise given the spate of bleak economic news. Nonfarm jobs were able to engineer a 1.1 percent gain in 2007, but like many other indicators there was a setback in the first quarter of In fact, nonfarm jobs were down in the first four months of 2008 for the U.S. as shown in Figure 1, though the setback in April was only 20,000 jobs. It is certainly not clear that exports are booming when one looks at the ongoing job losses in the manufacturing sector; April showed the steepest loss in manufacturing jobs so far this year. And the 2.9 percent seasonallyadjusted rate of job decay in the first quarter was the largest loss in recent quarters. The March unemployment rate of 5.1 percent is the highest in recent history and well above the 4.4 percent rate of unemployment in March of last year. Even though the April rate came in at 5.0, declining payroll employment in the first four months of the year, coupled with slower consumer and business spending, does not bode well for the unemployment rate in the months ahead. Business Investment and Housing Nonresidential investment has helped buoy growth in recent quarters, but unfortunately investment spending is slowing. Spending on structures has been especially strong helping to take up the slack from a weak housing market. Nonresidential fixed investment grew 4.7 percent in 2007, but contracted in the first quarter of Investment in Figure 1: Total Nonfarm Employment, Tennessee and U.S., January 1995 April* ,900 2,800 TN U.S. 140, ,000 TN employment (thous) 2,700 2,600 2, , , , ,000 U.S. employment (thous) 2, ,000 2, , *Tennessee employment data for April 2008 not available. Source: Bureau of Labor Statistics. Tennessee Business and Economic Outlook 3

7 The U.S. Forecast structures grew 12.9 percent in 2007, but also saw a setback in the first quarter of the year. After hitting its peak in the first quarter of 2006, nationwide single-family housing starts have now fallen for eight consecutive quarters, contracting at annual rate of more than 41 percent in the first quarter of Over the past two years, single-family housing starts have fallen almost 59 percent. A rebound in starts in the near term is unlikely since the number of building permits has also fallen drastically. Compared with a year earlier, there were 42 percent fewer single-family building permits issued in the first quarter of 2008, the largest drop in over 25 years. As the economy has been hit with job losses and rising food and gasoline prices, many households have fallen behind on their mortgages. Delinquency rates are on the rise, particularly for subprime and adjustable-rate mortgages (ARMs). In the first quarter of this year, 4.5 percent of all first mortgages were at least 30 days overdue, up from 4.0 percent in the fourth quarter of last year and 3.0 percent a year ago. Five and onehalf percent of prime ARMs were at least 30 days overdue at the end of last year, up from 3.4 percent at the end of In the fourth quarter of 2007, over 17 percent of all subprime mortgages were delinquent. This is up from about 13 percent a year earlier. Even more disturbing is the recent rise in foreclosures. Foreclosure filings increased by 57 percent in March from a year ago and 5 percent from February. As a result, banks repossessed twice as many homes in March of this year than last March. In February 2008, there were 30 and 46 percent fewer single-family homes sold in the U.S. compared with the same month in 2007 and The rise in the number of foreclosed homes, combined with a reduction in home sales, has contributed to a nearrecord inventory of unsold homes. The ratio of homes currently for sale relative to the number of houses sold has risen steadily from under 4 in 2003 to 9.8 in the early portion of At the current pace of sales it will take almost 10 months for all homes now on the market to sell. With a glut of unsold homes available and thousands of potential homebuyers sitting on the sidelines, active buyers have gained a great deal of bargaining power. Sellers are forced to lower their asking prices in order to compete for a small number of buyers. As a result, home prices have experienced unprecedented declines. The median sales price of new homes sold in the U.S. in the first quarter of 2007 was about $229,000 compared with $252,000 a year earlier a drop of over 9 percent. This is the second largest drop since data have been available and the largest drop since Other measures of home prices paint a similarly grim picture. The Case-Shiller housing price index, a popular composite measure of housing prices, decreased by an annual rate of over 19 percent in the fourth quarter of last year, by far the largest drop in its 20-year history. Data for February showed that the problems were getting worse rather than better, with the index suffering a 12.7 percent setback, the largest monthly fall on record. U.S. Forecast Summary The economic outlook is bleak looking forward into Inflation-adjusted GDP is expected to grow by just over 1 percent in 2008, improving to 1.7 percent growth in The projection for this year is ahead of the 0.8 percent rate of growth recorded in 2001 when the nation was in recession. Energy prices are expected to ease in the quarters ahead as slower growth puts downward pressure on consumer and business demand. But as shown in Figure 2, the price of oil at the wellhead will remain above $80 per gallon well into If realized, this will place less pressure on household finances and help free up income that may be put toward other consumer 4 Center for Business and Economic Research

8 The U.S. Forecast purchases. It would also alleviate some of the pressure confronted in the public sector (e.g., school busing and mass transit) and in the business community (especially in transportation). Consumer spending will grow slightly faster than GDP in 2008, benefiting from a spike in the third quarter as federal rebate checks ripple across the economy. Export growth will remain robust at 8.2 percent for the year. Imports will decline due to domestic economic weakness and the falling dollar. The dollar s slide may reach doubledigit percentage losses for the year. The housing market both starts and sales will bottom out in the third quarter and then slowly rebound. But there will be no bounce in this rebound. Even by 2010, starts are expected to be lower than any year in the window. While residential fixed investment will show strong quarterly growth rates beginning in the first quarter of 2009, the annual average rate of growth will be just 0.9 percent. Nonresidential investment in structures will remain in the black in 2008, but will only see a meager 0.8 percent gain. The unemployment rate will rise into 2009 and peak at 5.8 percent. The unemployment rate for 2008 is projected to be 5.3 percent. Payroll employment will grow only 0.2 percent this year and 0.4 percent next year, while manufacturing jobs will see further setbacks in The Fed is expected to lower interest rates another one-half percentage point, bringing the federal funds rate to 1.5 percent as shown in Figure 3. This would maintain negative inflation-adjusted interest rates into Signals of economic stabilization in the weeks ahead may cause the Fed to stand pat on further interest rate cuts to help keep inflation in check. Figure 2: Average Price of West Texas Intermediate Crude Oil: to dollars per barrel Source: Global Insight, Inc. Tennessee Business and Economic Outlook 5

9 The U.S. Forecast Figure 3: Effective Federal Funds Rate and the Consumer Price Index: to Effective Federal Funds Rate Consumer Price Index Effective Federal Funds Rate: Percent per annum Consumer Price Index: =1.00 Source: Global Insight, Inc. 6 Center for Business and Economic Research

10 The Tennessee Forecast Tennessee Forecast Current Economic Conditions As the nation goes, so goes Tennessee. The state saw job growth of only 0.5 percent in 2007, substantially below the 1.5 percent rate of growth recorded in The first quarter offered further discouragement with jobs falling at a 0.8 percent seasonally-adjusted rate; on a year-over-year basis, jobs were up 0.2 percent. Most broad sectors saw job growth sputter in And a significant number of sectors experienced year-over-year and/or seasonally-adjusted losses in the first quarter of The job losses in manufacturing accelerated sharply in 2007 with a fall of 4.7 percent compared to a 2.3 percent setback in Both durable and nondurable goods manufacturing have seen steep declines in employment. The only broad subsectors to see growth last year were miscellaneous durable goods and chemicals. The state unemployment rate has been drifting up since last summer, reaching 5.6 percent in March. The average last year was 4.7 percent, and the rate for the first quarter of this year was 5.2 percent. The number of employed people contracted in the first quarter on a seasonally-adjusted basis which is the first quarterly decline in recent history. The number of unemployed people spiked sharply in the fourth quarter of 2007 and the first quarter of 2008, rising 25.1 percent and 23.4 percent. Despite the fourth quarter spike, the number of unemployed people was down 7.4 percent last year. Personal income recorded a gain of only 4.8 percent in The fourth quarter of 2007 yielded anemic growth of only 2.3 percent on a seasonally-adjusted basis, less than one-half the rate of growth in the previous quarter. Wage and salary income, other labor income and proprietors income all recorded gains of less than 2.0 percent in the fourth quarter. Rent, interest and dividend income was up 4.9 percent and transfer payments advanced 2.5 percent. The weak fourth quarter data heighten concerns over the path of personal income growth and spending for the remainder of the year. In Tennessee, the housing market has fared only slightly better than the nation as a whole. Single-family housing starts are down almost 45 percent in the twelve months ending in February. Single-family housing permits were down about 40 percent in the fourth quarter of last year compared with the end of In the first quarter, 4.6 percent of new mortgages in the state were delinquent, slightly higher than the national rate. This is up from 4.1 percent at the end of 2007 and 3.8 percent a year ago. Despite fewer home sales and rising mortgage delinquencies, home prices in Tennessee rose by 4.1 percent in Taxable sales have suffered significantly as the economy has slowed. The slowdown in residential construction has caused building materials and home furnishing purchases to plummet, while slower income and job growth have dampened spending across the board. Sales were up 4.1 percent in 2007, but growth slowed as the year progressed. The state s budget outlook for next year is bleak, with cutbacks in spending potentially exceeding the one-half billion mark. But Tennessee is not the only state to be reeling from slower revenue growth as is clear from the special section on state revenues that follows this section. Tennessee Forecast Summary Economic conditions in Tennessee will deteriorate further over the course of 2008 and then slowly improve as 2009 unfolds. There appears to be little chance of significant improvement for the remainder of the year, and all the risks are downside risks. Nonfarm jobs are projected to tally a 0.1 percent loss for the year and then show a gain of 0.5 percent in Growth will not begin to trend upward until the first quarter of next year. The setbacks in manufacturing Tennessee Business and Economic Outlook 7

11 The Tennessee Forecast will continue to be pronounced with added job losses of 4.2 percent. Durable goods manufacturing will experience losses totaling 5.2 percent while nondurable goods will see a 2.7 percent loss. The natural resources and mining sector has now been combined with the much larger construction sector. Weak but nonetheless positive growth is expected for the year, with construction avoiding a wholesale collapse through the ongoing strength of nonresidential construction. Data for March showed 2,500 new jobs in this sector, which is encouraging. Leisure and hospitality services, along with education and health services, will be the only two broad sectors to maintain decent growth this year. Education and health services jobs are expected to advance 2.1 percent while leisure and hospitality services will experience 1.3 percent growth. The state unemployment rate should come in with an average of 5.6 percent this year and 5.7 percent next year. The number of unemployed people will begin to fall in early Labor force growth will remain weak through 2009 because of lackluster economywide growth. Nominal personal income growth will bottom out in the second quarter and record a gain of only 3.1 percent on a year-overyear basis and 2.2 percent on a seasonallyadjusted basis. Growth for the year is projected to total 3.5 percent which would be the weakest showing since Wage and salary income will be up only 2.3 percent for the year with all the growth coming from nominal wage growth. Proprietors income will be up 2.7 percent in 2008, improving on the performance from last year. But the gains here are back-loaded to the second half of the year. Rent, interest and dividend income will slow because of lower interest rates and the expectation of diminished dividend payouts. Taxable sales growth will contract further as 2008 progresses. Most broad categories of taxable sales have shown weaker growth if not contraction in the months following the first of the year. On an annual basis, taxable sales are expected to decline 2.6 percent in 2008 and then rebound with 5.2 percent growth in On a fiscal year basis, expect sales to decline 0.2 percent in 2008 and then grow 2.0 percent in Center for Business and Economic Research

12 Supplement: The Economic Slowdown and State Tax Revenue The Economic Slowdown and State Tax Revenues A near universal trend of slow growth in tax collections has haunted the states in early When adjusted for inflation and policy changes, state tax revenues across the nation declined by 4.3 percent from fourth quarter 2006 to fourth quarter 2007, the worst yearover-year growth since the first quarter of Even nominal year-over-year growth (which does not take into account policy changes and inflation) remained grim in the first quarter of 2008, increasing by only 1.7 percent from first quarter of 2007 (Dadayan and Ward 2008; Boyd and Dadayan 2008). Total state tax revenue for Tennessee in the first quarter of 2008 showed nominal growth of only 0.6 percent. Although Tennessee underperformed in comparison to the rest of the country, it outperformed the Southeast region as a whole where revenues were down 2.6 percent as shown in Figure 4 1. Figure 5 shows first quarter year-overyear tax revenue growth from 2007 to 2008 by region. The Southeast and the Rocky Mountain regions were actually hit with negative growth of 2.6 percent and 2.1 percent respectively, while other regions of the U.S. saw positive growth in the first quarter of New England saw the largest overall tax revenue growth with a gain of 5.3 percent. Personal income tax collections increased by 4.7 percent from first quarter 2007 to first quarter Each of the other major state taxes the corporate income tax and the sales tax revealed weak nominal growth in year-over-year revenues across the U.S. (Dadayan and Ward 2008). Sales tax revenue was down by 0.1 percent during this time significantly less than its historical average of about 4.5 percent. The weak performance of the sales tax is in part attributable to the housing slowdown and diminished purchases 1 Data were not yet available for Louisiana (Boyd and Dadayan 2008). Figure 4: Nominal Growth in Total State Tax Revenue from to percent United States Southeast Region Tennessee Source: Boyd and Dadayan (2008) Tennessee Business and Economic Outlook 9

13 Supplement: The Economic Slowdown and State Tax Revenue of building materials and home furnishings, as well as weak automobile sales. Corporate income tax collections fell by 3.3 percent on a year-over-year basis. Of the 39 states for which data are available, only 18 recorded revenue gains. Figure 6 illustrates the growth in each of the three broad-based taxes for all states combined, the Southeast region, and Tennessee. The Southeast had lower growth than the U.S. in terms of personal income tax growth (1.4 percent compared to 4.7 percent). In addition, the Southeast suffered a 10.6 percent contraction in corporate income tax revenue and a sales tax revenue dip of 3.8 percent. Budget Deficits in 2008 The sluggish economy has made it difficult for states to maintain a balanced budget. Tennessee s budget shortfall for the fiscal year ending June 30 reached $276 million in March (The Associated Press 2008a). This deficit reflects the sharp deterioration in economic conditions that have impacted revenues. Figure 7 illustrates that projections were overestimated for both of Tennessee s largest revenue sources during the current fiscal year. Sales tax revenues are already $117.7 million less than expected and corporate income taxes are $86.5 million less than expected. Sales tax revenues were $13.2 million lower than expected in March 2008 alone, and the corporate franchise and excise taxes were off by $45 million, representing the largest chunk of the $64 million loss in general collections for the month. With four months remaining in the current fiscal year, the overall budget deficit could reach as high as $384 million according to the State Funding Board. Figure 5: Tax Revenue Growth from to First Quarter New England Southwest Plains Mid-Atlantic Great Lakes Far West Rocky Mountains Southeast percent Source: Boyd and Dadayan (2008). 10 Center for Business and Economic Research

14 Supplement: The Economic Slowdown and State Tax Revenue State Responses to Budget Deficits A decelerating economy not only reduces state and local tax revenues, but it also increases the need for many public services (Lav and Hudgins 2008). Since state governments cannot run deficits, there are three measures that can be taken during a fiscal dilemma. First, states can dip into reserves or rainy-day funds that have been stored for periods of weak fiscal performance. Second, states can tweak the expenditureside of the budget by cutting spending or reducing growth in spending. Spending cuts are especially problematic late in a fiscal year when state agencies have already committed most of their funds. Lastly, states may increase taxes by changing the tax rate or the tax base. This path is problematic as well because of concerns that higher tax burdens may aggravate an already slowly growing economy. It is common for states to use these strategies in some combination to diminish the harmful effects of a revenue shortfall. A common quick fix to the deficit crisis is to draw on rainy-day funds and reserves. Rainy-day funds are a relatively new phenomenon, having been developed in response to the wrenching fiscal times of the early 1980s. According to Lav and Hudgins (2008), many states have already begun to use this approach and are beginning to draw upon their reserves. Tennessee has approximately $750 million available in rainy-day funds and other reserves (Rodgers 2008). Of course, rainy-day funds were constructed for the purpose of providing temporary relief when the economy is slumping. However, the longer the economy continues to contract, the more likely it becomes that a state may deplete its reserves. In this circumstance, many states will need to cut spending or increase taxes to balance Figure 6: Nominal Growth in Personal Income Tax, Corporate Income Tax, and Sales Tax Revenue from to percent United States Southeast Region Tennessee PIT CIT Sales *Tennessee has no personal income tax. Source: Boyd and Dadayan (2008). Tennessee Business and Economic Outlook 11

15 Supplement: The Economic Slowdown and State Tax Revenue their budgets. Caution must be exercised so as not to exhaust reserves early in an economic downturn. Approximately 17 states have already responded to deficits in 2008 with proposed budget cuts that may negatively impact vulnerable residents (Lav and Hudgins 2008). Budget cuts often affect children, elderly residents, disabled residents, and families in general through limited funding for education, public health programs, medical and rehabilitative programs, home care and other services popular among low-income residents. Tennessee has already begun to reduce funding for community-based services for the mentally retarded (Lav and Hudgins 2008). Another option that Tennessee may pursue is to drop pay raises for state employees for the next fiscal year. If the budgeted 2 percent pay raise for state employees is cut, Governor Bredesen would be able to put about $30 million towards the growing budget shortfall (Rodgers 2008). Furthermore, Governor Bredesen recently announced that in order to balance the budget, some state employees will lose their jobs in the coming year (The Associated Press 2008b). If rainy-day funds and budget cuts aren t enough, states may respond by increasing taxes. Numerous techniques are available for state governments to generate more revenue. States can raise tax rates, broaden the tax base, or minimize loopholes in the tax system to decrease tax avoidance. According to Lav and Hudgins (2008), Maryland, Michigan, Kentucky, California, New York, and New Jersey have all used tax increases to help close the budget deficit. Tennessee s Revenue Commissioner has had his eyes on closing loopholes in Tennessee. Budget Shortfalls Imminent in 2009 Not only are states scrambling to find ways to respond to budget shortfalls in the current year, but many are facing Figure 7: Tennessee s Revenue Shortfall by Tax Source, Fiscal Year 2008 Sales Tax 42.6% Corporate Income Tax 31.3% Other 26.0% Source: Rodgers (2008). 12 Center for Business and Economic Research

16 Supplement: The Economic Slowdown and State Tax Revenue anticipated shortfalls for fiscal year 2009 as well. At least one-half of all states expect a budget deficit in fiscal year 2009, with a total shortfall of approximately $39 billion (McNichol and Lav 2008). The Tennessee State Funding Board indicates that the shortfall may be as high as $585 in According to McNichol and Lav (2008), reasons for shortfalls in the upcoming fiscal year are analogous to those in the current year a weakening housing market has decreased state sales tax revenues. Not only are building materials and home furnishing sales down, but consumers are retrenching more broadly in the face of declining home equity and sharply rising food and energy prices. The short-term problem in Tennessee is aggravated by the long-term erosion of the sales base as consumers shift increasingly toward services which are largely not subject to sales taxation. Growth in sales tax base exemptions raise further concerns over long-run structural imbalances. Estimates from the Tennessee Department of Revenue suggest that total costs of sales and use tax exemptions will be approximately $2.7 billion in 2009, up $1.0 billion from just five years ago (Emery 2008). This growth is especially problematic for states like Tennessee that depend so heavily on the sales tax to fund services. Local governments may not confront the same revenue problem that the state will because of their reliance on the property tax. But even the property tax, which is commonly characterized as one of the most stable revenue sources, may weaken because of its close linkage to the performance of the housing market. If the housing market remains weak through the end of 2008, expectations are that local governments will need increased support from state governments. If state tax revenues are suffering well into 2009 which may very well prove to be the case finding such support will become a difficult practical and political problem. The Check is in the Mail: Fiscal Stimulus Package During an economic downturn, reductions in government spending and increased taxes put downward pressure on economic growth thereby in turn magnifying the slowdown. State and local governments, unlike the federal government, cannot borrow to finance ongoing services and programs. Federal assistance is one means to reduce the burden on state and local governments and avoid the downward pressures on the economy from higher taxes and/or lower spending. Following the 2001 recession, the federal government provided $20 billion in fiscal relief through an increase in its share of federal Medicaid costs and additional grants to each state based on population (Lav and Hudgins 2008). Providing such relief helped mitigate some of the budget cuts that were made at the state level. Another way the federal government can help is by finding a way to spur business investment and consumption. In anticipation of sharply weaker growth in 2008, President Bush signed into law a fiscal stimulus package that is intended to provide relief to workers and businesses. The package will provide business tax relief and tax rebates to more than 130 million households in the amount of $152 billion in total or about one percent of GDP in hopes of boosting the economy through increased investment and consumption (The White House 2008). By providing individuals with rebate checks and businesses with tax breaks, the federal government hopes to increase the overall demand for goods and services. While the stimulus package will help boost growth Tennessee Business and Economic Outlook 13

17 Supplement: The Economic Slowdown and State Tax Revenue in the near-term, the impacts will be muted for several reasons. First, in weak economic times businesses may be reluctant to make new investments, so tax breaks may simply be provided for investments that would have taken place anyway. Second, consumers are very likely to save a considerable share of their rebate and draw down their debt. This is good for both the economy and for households in the long run, but offers no short-run stimulus to the economy. Finally, many will purchase products that were produced abroad, diminishing the effect of new spending on the domestic economy. Fiscal Outlook With the economy expected to remain in a slump for the remainder of the calendar year, the state and local governments will face a difficult 2009 fiscal year. There is little chance for significant improvement in economic conditions and a good chance that the slowdown will drag on well into Should this be the case, additional budget cutbacks may be required before the close of the 2009 year. References The Associated Press (April 2008a). Tennessee s Budget Shortfall Reaches $276 Million, Knoxville News Sentinel. (Accessed April 8, 2008). The Associated Press (April 2008b). Bredesen: State Layoffs Needed to Balance Budget. (Accessed April 30, 2008). The Associated Press (April 2008c). Oil Prices Jump to New High Near $ msnbc.msn.com/id/ / (Accessed April 15, 2008). The Associated Press (April 2008d). U.S. Seeing Worst Food Inflation in 17 Years. msnbc.msn.com/id/ / (Accessed April 15, 2008). The Associated Press (April 2008e). Greater Number in Tennessee Applying for Food Stamps. (Accessed April 15, 2008). Boyd, Donald (January 2008). What Will Happen to State Government Finances in a Recession? Rockefeller Institute Fiscal Report. aspx?id=13894 (Accessed April 9, 2008). 14 Center for Business and Economic Research

18 Supplement: The Economic Slowdown and State Tax Revenue References (continued) Boyd, Donald and Lucy Dadayan (). State Revenue Flash Report: Sales Tax Declines in Most States. Rockefeller Institute Fiscal Features. showcontent.aspx?id=14784 (Accessed May 1, 2008). Bureau of Economic Analysis (April 2008). (Accessed April 10, 2008). Bureau of Labor Statistics (April 2008). (Accessed April 10, 2008). Dadayan, Lucy and Robert B. Ward (March 2008). State Tax Revenue Weakens Still Further, While Costs Rise Sharply, State Revenue Report No showcontent.aspx?id=14556 (Accessed April 9, 2008). Emory, Theo (April 2008). Sales Tax Applies to Less and Less. apps/pbcs.dll/article?aid=/ /news0201/ /1009/news02 (Accessed April 15, 2008). Lav, Iris J. and Elizabeth Hudgins (March 2008). Facing Deficits, Many States are Imposing Cuts that Hurt Vulnerable Residents, Center on Budget and Policy Priorities. org/ sfp.htm (Accessed April 9, 2008). McNichol, Elizabeth C. and Iris J. Lav (March 2008). 22 States Face Total Budget Shortfall of at Least $39 Billion in 2009; 6 Others Expect Budget Problems, Center on Budget and Policy Priorities. (Accessed April 9, 2008). Rodgers, John (April 2008). Bredesen: Shortfall means state employee raises likely cut, Nashville City Paper. (Accessed April 14, 2008). State Policy Reports (January 2008). The Rockefeller Institute at SUNY Albany. State Policy Reports, Volume 26, Issue 2. The Economist (April 2008). Time to Turn Out the Lights. displaystory.cfm?story_id= &fsrc=rss (Accessed April 15, 2008). The White House (April 2008). Jobs and Economic Growth. economy/ (Accessed April 14, 2008). Tennessee Business and Economic Outlook 15

19 2008:1 to 2010:3 Quarterly Table 1: Selected U.S. and Tennessee Economic Indicators (SA)* Table 2: Selected Per Capita U.S. and Tennessee Economic Indicators (SA) Table 3: Personal Income Components (SA, 2000$) Table 4: Personal Income Components (SA, Current) Table 5: Employment, Nonfarm by Sector (NSA)* Table 6: Employment, Durable Goods (NSA) Table 7: Employment, Nondurable Goods (NSA) Table 8: Employment, Nonfarm by Sector (SA) Table 9: Employment, Durable Goods (SA) Table 10: Employment, Nondurable Goods (SA) Table 11: Average Wage and Salary Rate by Sector (NSA, 2000$) Table 12: Average Wage and Salary Rate by Sector (SA, 2000$) Table 13: Average Wage and Salary Rate by Sector (NSA, Current) Table 14: Average Wage and Salary Rate by Sector (SA, Current) Table 15: Civilian Labor Force and Unemployment Rate (NSA) Table 16: Civilian Labor Force and Unemployment Rate (SA) Table 17: Taxable Sales (NSA, 2000$) Table 18: Taxable Sales (SA, 2000$) Table 19: Taxable Sales (NSA, Current) Table 20: Taxable Sales (SA, Current) *Key: SA=Seasonally adjusted NSA=Non-seasonally adjusted Baseline Forecast as of Tennessee Business and Economic Outlook 17

20 18 Center for Business and Economic Research Table 1: Selected U.S. and Tennessee Economic Indicators, Seasonally Adjusted History 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1 2009:2 2009:3 2009:4 2010:1 2010:2 2010: US GDP (Bil2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US GDP (Bil$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr CHAINED PRICE INDEX, GDP (2000=100.0) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US PERS CONSUMP DEFL (2000=100.0) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN PERSONAL INCOME (MIL2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US PERSONAL INCOME (BIL2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN PERSONAL INCOME (MIL$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US PERSONAL INCOME (BIL$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN NONFARM JOBS (THOUS) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US NONFARM JOBS (MIL) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN UNEMPLOYMENT RATE (%) US UNEMPLOYMENT RATE (%) BANK PRIME INTEREST RATE (%) (CONTINUED ON NEXT PAGE)

21 Table 1: Selected U.S. and Tennessee Economic Indicators, Seasonally Adjusted History 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1 2009:2 2009:3 2009:4 2010:1 2010:2 2010: CONSUMER PRICE INDEX, ALL-URBAN (82-84=1.000) FEDERAL FUNDS RATE (% per annum) YEAR FIXED MORTGAGE RATE (%) TN MFG JOBS (THOUS) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US MFG JOBS (MIL) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN TAXABLE SALES (MIL2000$) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr Tennessee Business and Economic Outlook 19 TN TAXABLE SALES (MIL$) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN AVG ANNUAL WAGE, NONFARM (2000$) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN AVG ANNUAL WAGE, NONFARM ($) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr

22 20 Center for Business and Economic Research Table 2: Selected Per Capita U.S. and Tennessee Economic Indicators, Seasonally Adjusted History 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1 2009:2 2009:3 2009:4 2010:1 2010:2 2010: US GDP (2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US GDP ($) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN PERSONAL INCOME (2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US PERSONAL INCOME (2000$) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN PERSONAL INCOME ($) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr US PERSONAL INCOME ($) SAAR % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN TAXABLE SALES (2000$) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr TN TAXABLE SALES ($) % Chg Prev Qtr SAAR % Chg Same Qtr Last Yr