Missouri Faces a Critical Budget Cliff: Ongoing Structural Deficit Places all Services at Risk

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1 Missouri Faces a Critical Budget Cliff: Ongoing Structural Deficit Places all Services at Risk July 16, 2008 Amy Blouin, Executive Director and Tom Kruckemeyer, Chief Economist Ruth Ehresman, Director of Budget & Health Policy, also contributed to this report. The Governor s Office recently announced that the state began the new fiscal year with the largest surplus in two decades. 1 If this sounds too good to be true, that s because it is. While the state does have a substantial carry-forward of unused funding in the new fiscal year that began on July 1 st, the following analysis indicates that the state continues to face a significant structural deficit. In addition, this new analysis demonstrates that by Fiscal Year 2010 (FY 2010) the state will face a budget deficit, which grows to a dramatic level by FY Given that Missouri is constitutionally required to operate with a balanced budget, funding shortfalls will result in further cuts to state services. Proactive policy steps must be taken to overcome the state s ongoing structural deficit, and protect critical state services. Key Findings: Over the past three fiscal years, the state has spent more than what it actually takes in through general revenue growth. This spending has been financed with a significant carry-forward of funds that were not used in FY As Missouri s carry-forward balance is used up to meet the state s ongoing spending obligations, a hole emerges. By Fiscal Year 2011 the loss of the carry-forward funds will result in a substantial budget shortfall of more than $680 million. In addition, state tax policy enacted in the 2007 and 2008 legislative sessions has worsened Missouri s fiscal hole by reducing available general revenue by an additional $250 million per year. State revenue would have to grow by 5 percent per year to make up for the loss of revenue caused by the tax changes and increased tax credits. Conversely, Missouri s general revenue spending today is just slightly above what it was in FY 1999, when adjusted for inflation. Overall, the state general revenue spending increased on average by roughly 1 percent per year after inflation. 1 Politicians Debate Over Use of State s Largest Surplus in Two Decades, David Lieb, Associated Press, July 15, 2008 Page 1 of 7

2 How Missouri Moves from an $800 million Surplus to a $680 million Shortfall: As reported by the Governor s office, Missouri began the new fiscal year, FY 2009, on July 1 st with more than $800 million in unspent revenue. However, this amount has mistakenly been referred to as a surplus. As Table 1 indicates, while $288 million of this carry-forward balance results from revenue that was not spent in the last fiscal year, more than $500 million of it is attributable to carry-forward funds that were not used in FY As indicated in the table, actual general revenue receipts have been lower than total spending for each of the last three fiscal years (FY 2007 FY 2009). Since FY 2006, the state has relied on these carry-forward funds to supplement stagnant revenue growth in order to fund its ongoing spending obligations. Once this $800 million carry-forward is used completely, as expected by FY 2010, a significant hole will be left in the state s pocketbook. By FY 2010 the Missouri Budget Project estimates that the loss of this revenue will leave a sizeable hole in the state s budget, potentially resulting in cuts to critical state services. This inability of state revenue growth to keep pace with the increased spending requirements on state services is referred to as a long-term structural deficit. Table 1: General Revenue Funds Versus Spending FY 2006 FY 2011 (In Millions) GR Budget Five Year Outlook FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY2011 Updated 16 July 16, 2008 Resources 2 Beginning Balance Carry Forward $185.6 $600.6 $597.9 $553.4 $211.3 ( $215.6) Previous Year's Unspe nt Funds $114.7 $94.7 $155.1 $288.0 $140.0 $140.0 Net Revenue Receipts $7,332.2 $7,716.4 $8,003.9 $8,229.3 $8,517.3 $8,858.0 Impact of Federal 2008 Tax Cut ( $92.0) ( $12.0) $0 State Tax Cuts from 2008 Session Transfers of Revenue $188.1 $204.3 $161.0 ( $61.7) $152.3 ($63.7) $150.2 ($67.8) $155.0 Total Resources Available $7,820.6 $8,616.0 $8,917.9 $9,069.3 $8,943.1 $8,869.6 Obligations & Required Increases Base Operating Appropriations $7,138.7 $7,721.7 $8,212.9 $8,638.8 $8,611.0 $8,988.7 Confirmed lapse/withholdings ( $68.8) $0 K 12 School Foundation Formula Higher Education $126.2 $50.0 State Pay plan $46.3 Inflation for Current Services $ Capital Improvements $32.7 $73.7 $72.1 $ $95.0 Supplemental Funding Needs $117.4 $222.7 $79.5 $70.0 $75.0 $ $52.5 $47.0 $ $ $75.0 Total Spending Needs $7,220.0 $8,018.1 $8,364.5 $8,858.0 $9,158.7 $9, The MBP revenue estimates use the state s official Consensus Revenue Estimate to determine revenue growth in FY 2009, projects 3.5% revenue growth in FY 2010 and 4% revenue growth in FY The MBP also makes adjustments to revenue for the state tax cuts enacted in FY 2008 and the loss of state funding due to the 2008 federal economic stimulus corporate tax reductions. Page 2 of 7

3 Ending Balance $600.6 $597.9 $553.4 $211.3 ( $215.6) ( $683.6) Causes of Missouri s Structural Deficit: Spending is not Increasing Significantly Since 2001, Missouri has struggled with its ability to adequately fund critical state services. The 2001 recession resulted in significant loss of state revenue and cuts to state services in four of the last eight years. Many of these services have yet to recover to their pre-fiscal crisis levels; others have barely kept pace with nominal inflation, placing a significant burden on the citizens of Missouri. Some examples: Reductions in funding for Missouri s Public Universities and Colleges has resulted in tuition increases of 75 percent since 2001; More than 200,000 Missourians lost access to insurance due to cuts to Medicaid eligibility. 770,000 Missourians are now uninsured, an increase of 15 percent from ; State aid to local K-12 school districts has increased by just 4.85 percent since 2001, when adjusted for inflation, resulting in a heavier reliance on local funding sources to adequately fund education. Other services have barely kept pace with nominal inflationary needs, as indicated in Table 2. Table 2: Change in General Revenue Funding Over Time for Select Department Budgets FY 2001 FY Department Budget FY 2001 Funding FY 2009 Estimated Funding 4 FY 2009 Funding Adjusted for Inflation 5 Percent Change FY 2001 to FY 2009 When Adjusted for Inflation Elementary and $2.380 billion $3.002 billion $2.495 billion 4.85percent Secondary Education Higher Education $960 million $1.028 billion $854 million 10.99percent Transportation 6 $18 million $13 million $10.8 million 39.96percent Public Safety $54 million $88 million $73.2 million 35.46percent Corrections $445 million $612 million $508.7 million 14.32percent Mental Health $554 million $616 million $512 million 7.57percent Health and Senior $64 million $243 million $202 million percent* Services Social Services $1.173 billion $1.614 billion $1.341 billion 14.38percent *The bulk of the growth in the Health and Senior Services Budget resulted from restructuring in FY 2006 that moved a portion of responsibilities from a different state department in health & Senior Services. At that time, $360 mil was added to fund home health care, respite care, homemaker chore, personal care, adult day care, AIDS and other services for seniors. 3 FY 2001 General Fund Appropriations amounts are from the Missouri Senate Appropriations Committee, 2001 Annual Fiscal Report: Fiscal Year FY 2009 General Fund Appropriations were taken from the Truly Agreed to and Finally Passed Budget Bills (2008 Legislative Session) and DO NOT include reductions for the Governor s vetoed amounts. 5 Missouri Budget Project calculation using the U.S. Bureau of Labor Statistics Consumer Price Index Inflation Measure. 6 Transportation receives the bulk of its funding from earmarked sources and federal funds, not general revenue. The amount here solely reflects state general revenue funding. Page 3 of 7

4 While some positive gains were made to enhance services since the economic recession of 2001, the overall picture of funding for state services is bleak. Missouri s higher education, transportation and mental health general revenue budgets remain lower than their funding levels in 2001, when inflation is factored in. Overall, Missouri s general revenue spending on state services, when adjusted for inflation, is just slightly higher today than it was in 1999, and barely meets the actual level of funding that was provided in As demonstrated in Chart 1 below, the general revenue appropriations in FY 2009 of $8.7 billion has just slightly more buying power than FY Overall, the state general revenue spending increased on average by roughly 1 percent per year after inflation. Chart 1: Missouri General Revenue Appropriations Adjusted for Inflation However, the real cost of providing state services doesn t usually match with general inflation, as measured by the Consumer Price Index. This measurement was developed to calculate the change in cost for what the average consumer, or family, purchases. The cost for state services can increase at much different rates. For instance, the cost to provide critical services such as health care often increases much faster than general inflation; state demographic changes including additional children in need of special education or an aging population create increased need for services and therefore new financial investments; an aging infrastructure demands enhanced funding for services like transportation, road improvements and construction and capital improvements. Missouri s budget requires an increase of at least $350 million per year, or 4 percent, just to meet these needs and keep services at the same level as the preceding year. Page 4 of 7

5 When the state is unable to meet these critical funding needs, an increased burden is placed on Missouri citizens. The burden is felt through elevated tuition costs, increased numbers of uninsured families, and decreased investments in economic infrastructure. Causes of Missouri s Structural Deficit: an Eroding Revenue Base Missouri has made significant reductions in its tax base in recent years that has eroded the state s funding structure. In the 2007 and 2008 legislative sessions, state lawmakers passed sizeable tax cuts. These changes were phased in over a number of years, so their impact will not be fully felt until FY Table 3: Impact of State Tax Cuts Passed in 2007 and 2008 Legislative Sessions Year Enacted FY 2008 FY 2009 FY 2010 FY Legislative $75.5 million $124.6 million $167.9 million $195 million Session Tax Cuts 2008 Legislative N/A $61.7 million $63.7 million $67.8 million Session Tax Cuts Total Cost Per Year $75.5 million $186.3 million $231.6 million $262.8 million In addition, over the last decade the amount Missouri spends on tax credits each year has more than doubled. In fiscal year 1999, the state issued $182 million in tax credits, growing to $417 million in While certain tax credits may serve a useful purpose, the growth of credits has been dramatic during the same period that critical services have been reduced in Missouri. Spending on tax policy and tax credits must instead be balanced with the Missouri s other needs such as education and health care. To make up for the loss of these revenues, state general revenue would need to grow by $450 million, or 5 percent, per year, eroding the state revenue base at a higher level than the cost to maintain services. Combined, the tax policy changes and the inflationary needs just to maintain current services will require 9 percent growth in state general revenue per year. In the recently completed fiscal year 2008, the state reached only 3.7 percent net general revenue growth. 7 Missouri Senate Appropriations Committee, 2000 Annual Fiscal Report, August Page 5 of 7

6 Chart 2: Annual Cost of State Policy Change by FY 2011 When the Best-Case Scenario is Bad: Economic Downturn Could Increase the Size of the Deficit The Economic Conditions in the state and nation are deteriorating. Several indicators point to a protracted downturn, including: From January 2 nd, 2008 through July 16th, 2008, the S&P 500 Stock Index has fallen from 1447 to 1245, a decline of 14 percent this year. The U.S. economy lost 62,000 payroll jobs in June and has lost 438,000 payroll jobs since last December. Missouri lost 21,406 jobs in the last five months, resulting in the Unemployment Rate increasing to 5.7 percent. 8 Chrysler recently announced the closing of a major production facility in the St. Louis region and the layoff of 2,400 employees. The bleak economic outlook already started to impact state revenue collections, particularly in the fourth quarter of the 2008 fiscal year: 8 U.S. Department of Labor, Bureau of Labor Statistics: figures from January 2008 through May Page 6 of 7

7 Table 4: Recent Trends in the Main Sources of State General Revenue Annual Figures FY 2008: Sales Tax Collections declined by 1.2 percent in fiscal year 2008 as compared to the previous year. Net Corporate Income tax grew by only 0.2 percent Growth rates in the 4 th quarter of FY 2008 were: Individual Income Tax Withholding +2.8 percent Sales Tax Collections ( 2.0 percent) Corporate Income/Franchise Tax ( 12.3 percent) Net Overall General Revenue Collections +1.6 percent The annual decline in sales and use tax, coupled with the significant drop in corporate income tax during the fourth quarter of FY 2008, are indicators that the negative economy is beginning to impact state revenue. If these trends continue, the projected State general revenue shortfall could grow significantly. In fact, during the most recent economic recession of , and the stock market decline of approximately 17 percent, the loss of capital gains led to a substantial decline in state income tax collections. The state completed fiscal year 2008 on June 30 th with net general revenue growth of 3.7 percent. The Missouri Budget Project used the State s agreed upon Consensus Revenue Estimate to estimate revenue growth in FY 2009 and increased this amount to 4 percent revenue growth in FY However, given the recent decline in state revenue collections, and the deteriorating economic outlook, attaining this level of revenue growth may be optimistic. As a result, the projected shortfalls in FY 2010-FY 2011 may be much larger than currently estimated. Additional State Transportation Funding Shortfall Maximizes Concern The projection of the general revenue shortfall does not take into account the additional pending shortfall in the state s transportation funding. The Missouri Department of Transportation announced recently that the state transportation budget faces a decline in earmarked revenue sources of at least $700 million by FY While this analysis focuses on the general fund, the transportation funding needs are also considerable. The general fund clearly will not be able to make up for the transportation deficit. The Mission of the Missouri Budget Project is to advance public policies that improve economic opportunities for all Missourians, particularly low and middle income families, by providing reliable and objective research, analysis and advocacy. Contact the MBP through our website at 9 For more detail on the Transportation Funding Shortfall see Missouri Transportation Funding Under Strain, August 13, 2007, Missouri Budget Project, available at: Page 7 of 7