State Budgets in 2015 and 2016: Most States Show Continued Growth, Some Face Significant Challenges

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1 State Budgets in 2015 and 2016: Most States Show Continued Growth, Some Face Significant Challenges By Brian Sigritz Overall, state fiscal conditions showed modest improvements in fiscal year Revenue growth accelerated, mostly due to strong income tax collections, while total state spending from all fund sources increased at its fastest rate since 1992 due to additional federal funds from the Affordable Care Act. In addition, the number of states making mid-year budget cuts remained low, and states total balances reached an all-time high in actual dollar terms. In fiscal 2016, states expect both revenue and spending to grow slowly. However, some states are facing significant budgetary challenges associated with the decline in oil prices. It is likely that budget proposals for fiscal 2017 and beyond will remain mostly cautious with limited spending growth. By most measures, state finances moderately improved in fiscal year Revenue growth accelerated in fiscal 2015, growing 4.8 percent compared to 1.9 percent growth in fiscal The increase in tax collections was mainly attributable to an increase in income tax collections, partly from the strong stock market performance in calendar year While the vast majority of states experienced at least moderate revenue growth in fiscal 2015, some states heavily reliant on oil and natural gas tax collections experienced significant declines. Total state spending, including general funds, other state funds, bonds and federal funds, also increased in fiscal The year-over-year percentage growth rate of 7.8 percent was the highest rate since fiscal The rise in total state spending resulted from a combination of a rapid increase in federal funds to states due to additional Medicaid dollars from the Affordable Care Act for those states that expanded Medicaid, and modest growth in states own fund sources. 2 Looking only at states general fund spending, elementary and secondary education and higher education saw the largest spending growth in fiscal Other indicators of the improvement in state fiscal conditions include that mid-year budget cuts totaled approximately $1 billion in fiscal 2015, compared to more than $31 billion during the peak of the economic downturn, 4 and that total balances, including both ending balances and rainy day funds, reached an all-time high in actual dollars in fiscal In fiscal 2016, it is projected that both state general fund spending and revenue will increase for the sixth consecutive year, although the growth is expected to be modest. Revenue collections are projected to increase at a slower growth rate than in fiscal Total state general fund revenues are projected to grow 2.5 percent in fiscal 2016, less than fiscal 2015 s growth rate of 4.8 percent, and less than the 38-year historical average revenue growth rate of 5.6 percent. 6 According to appropriated budgets, general fund expenditures are expected to increase by 4.1 percent in fiscal However, general fund spending growth is projected to be slower than fiscal 2015 and also once again remain below the historical average spending growth rate of 5.5 percent. 7 In examining other indicators of state fiscal health for fiscal 2016, states enacted an aggregate net increase of $545 million in tax and fee changes following two consecutive years of net reductions, 8 total balances are projected to slightly decrease resulting from an anticipated decline in ending balances, 9 and it is likely that the number of states making mid-year budget cuts will remain well below the level experienced during the past economic downturn. While most states are anticipating at least moderate growth in spending and revenue for fiscal 2016, some states are facing negative budgetary impacts associated with the declining price of oil. Additionally, a number of states continue to experience budget challenges associated with slow economic growth, the rising cost of health care, pent-up demand for infrastructure, the underfunding of pensions and retiree health care, and federal spending cuts. The Council of State Governments 341

2 The Current State Fiscal Condition Revenues in Fiscal 2015 Revenue growth accelerated in fiscal 2015, growing 4.8 percent compared to 1.9 percent growth in fiscal Part of the reason for the more robust growth was the fact that most states experienced a positive April surprise in fiscal 2015, in contrast to fiscal April surprises often occur in states after taxpayers pay both their federal and state income taxes. The positive April surprise in fiscal 2015 is mainly attributable to an increase in income tax collections, partly from the strong stock market performance in calendar year 2014, and is viewed as a one-time occurrence. Both corporate income taxes and personal income taxes posted strong gains in fiscal 2015, growing 8.7 percent and 8.0 percent respectively, while sales tax revenues increased 5.2 percent. 11 Revenue growth in fiscal 2015 was widespread, with 45 states experiencing nominal revenue increases compared to fiscal In addition, 39 states saw revenues come in above final projections, three states had revenues come in on target, and in seven states revenues came in below projections (one state was not able to report data). 13 While the vast majority of states experienced at least moderate revenue gains in fiscal 2015, some states heavily reliant on oil and natural gas tax collections experienced significant declines. Alaska, the state with revenues most significantly affected by the declining price of oil, saw revenue collections decline from $5.4 billion in fiscal 2014 to $2.2 billion in fiscal Overall, state general fund revenue collections totaled $765.4 billion in fiscal 2015, up from $730.3 billion in fiscal Revenues in Fiscal 2016 Revenue growth is projected to increase in fiscal 2016 for the sixth consecutive year but remain slow and below the historical average. In addition, revenue collections are projected to increase at a significantly slower growth rate than fiscal Total state general fund revenues are projected to grow 2.5 percent in fiscal 2016, less than fiscal 2015 s growth rate of 4.8 percent. Since 1979, general fund revenues have increased on average 5.6 percent, according to NASBO s Fiscal Survey of States. 15 Overall, general fund revenues are projected to grow by $19.2 billion in fiscal 2016 from $765.4 billion to $784.7 billion, with sales taxes increasing by $8.8 billion (3.9 percent), personal income taxes growing by $10 billion (3.3 percent), and corporate income taxes declining by $227 million (-0.5 percent). 16 Through the first part of fiscal 2016, revenue growth has been near or slightly above projections for most states. According to the Rockefeller Institute of Government, preliminary figures show state revenues growing 4.3 percent during the first quarter of fiscal 2016 (July September 2015). 17 Additionally, according to NASBO data collected in the fall of 2015, 20 states were seeing revenues coming in on target for fiscal 2016, with 16 higher and six lower (not all states were able to report data). 18 While most states have seen stable revenue growth so far in fiscal 2016, some have experienced significant revenue difficulties most notably states heavily reliant on severance taxes generated from resources such as oil, natural gas and coal. In addition, income tax collections in fiscal 2016 may be impacted by the poor stock market performance in calendar year Tax and Fee Changes in Fiscal 2016 Twenty-two states enacted net tax and fee increases in fiscal 2016, while 18 states passed net decreases in fiscal 2016, resulting in an aggregate net increase of $545 million. Fiscal 2016 contrasts with the previous two fiscal years when states enacted net revenue decreases. States with the largest increases in taxes and fees in fiscal 2016 include Connecticut and Louisiana, both of which modified certain provisions and reduced tax breaks across a number of revenue categories; Georgia, which increased taxes and fees to fund transportation projects; and Nevada, which enacted various tax increases to enhance funding for K-12 education. Texas enacted the largest net tax decrease with its property tax relief and reduction in the business franchise tax rate, followed by Ohio s personal income tax cuts. 19 It should be noted that while states enacted more than $500 million in net tax and fee increases in fiscal 2016, the overall net increase only represents 0.07 percent of total general fund revenue. In fiscal 2016, personal income taxes saw the largest enacted decrease, reduced by $1.3 billion; much of the decline in personal income taxes came from actions taken by Ohio, California and North Carolina. The second largest decline was in other taxes at $239 million, with much of it attributed to decreases enacted by Texas and Florida. Additional revenue sources that experienced a net decrease include fees (-$19 million) and alcohol (-$9 million). A number of revenue sources saw similar-sized moderate net increases including 342 The Book of the States 2016

3 corporate income taxes ($576 million), cigarette and tobacco taxes ($535 million), sales taxes ($494 million) and motor fuel taxes ($472 million). 20 State Spending in 2015 Total state spending 21 sharply increased in fiscal 2015 with the year-over-year percentage growth rate of 7.8 percent the highest rate since fiscal The rise in total state spending resulted from a combination of a rapid increase in federal funds to states, and modest growth in states own fund sources. The acceleration of federal funds to states in fiscal 2015 was almost solely due to states receiving significantly more federal Medicaid dollars as part of the first full year of Medicaid expansion under the Affordable Care Act, or ACA. Over the past several years, spending from states own fund sources has moderately grown as states revenues have slowly rebounded from the most recent recession and the national economy has gradually improved. Spending from state funds including general funds and other state funds, but not federal funds or bonds increased 4.6 percent in fiscal 2011, 3.8 percent in fiscal 2012, 2.6 percent in fiscal 2013, 4.0 percent in fiscal 2014 and an estimated 5.9 percent in fiscal In fiscal 2015, spending from state funds was partly bolstered by strong growth in personal income tax collections. While the level of spending growth from state funds has been relatively stable in recent years, the level of growth in federal funds to states has fluctuated. Due to the wind-down of funds from the American Recovery and Reinvestment Act of 2009, also known as the Recovery Act or stimulus, federal funds to states only grew 1 percent in fiscal 2011, declined 9.8 percent in fiscal 2012 and decreased an additional 2.6 percent in fiscal However, federal funds rose by 4.7 percent in fiscal 2014 as some states began to receive additional Medicaid funds through the ACA in January In fiscal 2015, it is estimated that federal funds to states rose 12.2 percent during the first full year of the optional Medicaid expansion under the ACA. It should also be noted that while federal funds to states rose sharply in fiscal 2015, the increase was almost solely due to increased Medicaid dollars. Federal Medicaid funds to states increased 22.5 percent in fiscal 2015, while all other federal funds to states only grew 2 percent. 22 Looking in greater detail at fiscal 2015, total state expenditures general funds, federal funds, other state funds and bonds combined grew from $1.74 trillion to $1.87 trillion. 23 Medicaid remained the largest category of total state spending in fiscal 2015, representing 27.4 percent. Other categories of total state expenditures include elementary and secondary education (19.3 percent), higher education (10.3 percent), transportation (7.7 percent), corrections (3.1 percent), public assistance (1.3 percent) and all other (30.9 percent). 24 All areas of total state spending experienced increases in fiscal 2015 with the exception of public assistance, which declined 7.3 percent; public assistance figures only include cash assistance and not other forms of public assistance such as child care, housing or employment programs. Medicaid experienced the largest gains at 15.1 percent, followed by all other (6.2 percent), higher education (6 percent), elementary and secondary education (5.1 percent), transportation (4.4 percent) and corrections (4 percent). 25 General fund spending is estimated to be $748.7 billion in fiscal 2015, a 4.9 percent increase from fiscal General funds typically receive their revenue from broad-based state taxes such as sales and personal income taxes. As with total state spending, all program areas saw at least some general fund spending growth in fiscal 2015 with the exception of public assistance, which declined 6.6 percent. Higher education grew fastest at 7.7 percent, followed by K-12 (5.6 percent), Medicaid (5.1 percent), corrections (3.9 percent), all other (3.9 percent) and transportation (3.1 percent). 26 Elementary and secondary education remained the largest category of general fund expenditures in fiscal 2015, accounting for 35.2 percent. Medicaid represented 19.3 percent and higher education accounted for 10 percent. Combined, education (both K-12 and higher education) and Medicaid comprised nearly two-thirds of general fund spending. Other categories of general fund spending included corrections (6.8 percent), public assistance (1.2 percent), transportation (0.7 percent) 27 and all other (26.7 percent). 28 State Spending in 2016 According to appropriated budgets, general fund expenditures are expected to increase by 4.1 percent in fiscal 2016, the sixth consecutive year of modest general fund spending growth following back-to-back declines in fiscal 2009 and fiscal Despite increases in fiscal 2016, general fund spending growth is projected to be slower than fiscal 2015 and also once again remain below the 38-year historical average of 5.5 percent. 29 In total, The Council of State Governments 343

4 general fund expenditures are estimated to be $790.3 billion in fiscal 2016, a $30.9 billion increase from the prior year. Forty-three states enacted a fiscal 2016 budget with general fund spending levels above fiscal 2015, with 30 states reporting general fund expenditure growth between 0.1 and 4.9 percent, and 13 states reporting growth greater than 5 percent. 30 Although the vast majority of states enacted fiscal 2016 budgets with general fund spending growth, in eight states general fund spending levels remain below fiscal 2008, with several of these states facing negative budgetary impacts associated with the declining price in oil. 31 Budget Cuts A clear indicator of the current improvement in state fiscal conditions is that the amount of midyear budget cuts has sharply declined since the most recent national recession. During the midst of the economic downturn, 41 states made net midyear cuts in fiscal 2009 totaling $31.3 billion, and 39 states made mid-year cuts in fiscal 2010 totaling $18.3 billion, demonstrating the widespread impact of the recession. Similar to the past several years, mid-year budget reduction amounts were minimal in fiscal 2015, with 14 states making net mid-year budget cuts totaling $999 million. While the number of states with net mid-year budget cuts in fiscal 2015 is a bit higher than has been observed in recent years, most of these reductions were relatively small in value. Also, these reductions do not always reflect fiscal stress or even true spending cuts, but sometimes are the result of technical or accounting changes. The largest program areas of net mid-year cuts in fiscal 2015 include K-12 (17 states), Medicaid (14 states), corrections (13 states) and higher education (13 states). 32 Through December 2015, two states had made net mid-year budget cuts in fiscal 2016 totaling $62.5 million. This figure is expected to rise as fiscal 2016 progresses, although the total will likely once again remain much lower than what was seen during and immediately after the last economic downturn. 33 Balances Total balances include both ending balances as well as the amounts in states budget stabilization, or rainy day, funds. Combined, these reserves reflect the funds states may use to respond to budget gaps or unforeseen circumstances. Forty-eight states have either a budget stabilization fund or a rainy day fund, with about three-fifths of the states having limits on the size of these funds. 34 Total balances reached a recent low in fiscal 2010 due to the severe decline in revenues and rise in expenditure demands tied to the recession. Since that time, states have made significant progress rebuilding budget reserves. In fiscal 2015, total balances amounted to $73.3 billion, representing an all-time high in actual dollars, and 9.6 percent of general fund expenditures. Total balances are projected to decrease in fiscal 2016 to $61 billion, or 8.8 percent of expenditures, resulting from an anticipated decline in ending balances. In addition, the fiscal 2016 figure excludes five states for which data are not available. While total balances are expected to moderately decline in fiscal 2016, rainy day funds, which tend to fluctuate less year-to-year than ending balances, are projected to slightly increase. Rainy day funds were $40.8 billion, or 6.2 percent of general fund expenditures, in fiscal 2015 and are expected to rise to $43.5 billion, or 6.3 percent of expenditures, in fiscal Looking Ahead In many ways, the state fiscal environment has shown measurable improvements since the end of the most recent national recession. States have enacted spending increases in many areas, most notably in education. State spending on Medicaid is currently growing more slowly. Both budget gaps and mid-year budget cuts have significantly decreased. Revenues have grown and remain on target or above projections in most states. Finally, total balances reached an all-time high in fiscal 2015 in actual dollars. However, states face major challenges to their budgets in fiscal 2016 and beyond. Both spending and revenue have yet to surpass prerecession highs after accounting for inflation. There remains a pent-up demand to increase infrastructure spending. States must continue to address the underfunding of pensions and retiree health care. Health care spending is expected to grow faster than state revenues. And states continue to be concerned about future national economic growth levels and uncertainty at the federal level. In addition, some states continue to face very significant budgetary difficulties associated with the decline of oil and natural gas prices, while other states have been particularly challenged by issues associated with slow economic growth, revenue volatility, tax changes, federal cuts and long-term liabilities. Looking forward, it is likely that budget proposals will remain mostly cautious with limited spending growth and an emphasis on ensuring that budgets are structurally balanced and sustainable in the future 344 The Book of the States 2016

5 Notes 1 National Association of State Budget Officers, The Fiscal Survey of States (December 2015), National Association of State Budget Officers, Summary: NASBO State Expenditure Report, (November 19, 2015), National Association of State Budget Officers, The State Expenditure Report (November 2015), 7. 4 The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), 3. 8 The Fiscal Survey of States (December 2015), See note 5 above The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), Nelson A. Rockefeller Institute of Government, State Revenue Report, (November 2015), See note 13 above. 19 National Association of State Budget Officers, Summary: Fall 2015 Fiscal Survey of States, (December 15), The Fiscal Survey of States (December 2015), Total state spending consists of general funds, other state funds, bonds and federal funds combined. 22 Summary: NASBO State Expenditure Report, (November 19, 2015), State Expenditure Report (November 2015), State Expenditure Report (November 2015), State Expenditure Report (November 2015), State Expenditure Report (November 2015), Transportation spending mostly comes from other state funds and federal funds, while general funds only comprise 3.9 percent of total state transportation expenditures. 28 State Expenditure Report (November 2015), See note 7 above. 30 The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), The Fiscal Survey of States (December 2015), National Association of State Budget Officers, Budget Processes in the States, (Spring 2015), The Fiscal Survey of States (December 2015), About the Author Brian Sigritz is the director of state fiscal studies at the National Association of State Budget Officers, or NASBO. He received an M.P.A. from the George Washington University and a B.A. from St. Bonaventure University. Prior to working at NASBO, Sigritz worked for the Ohio Senate and the Ohio House of Representatives. The Council of State Governments 345