EconSouth (Second Quarter 2001)


State of Flux?

When an economy moves from boom times to slower growth, as the U.S. economy is doing now, businesses and individuals can adjust to the change by cutting their own spending. For governments, though, a slowdown is more problematic — expenses may rise as pressure on unemployment benefits and other economic and social assistance programs begins to build. So for states, revenue collections may serve as a sort of fiscal early-warning system: falling revenues may portend higher expenses — and more budget cuts — in the months ahead.

Gross domestic product (GDP) grew 5 percent in the United States in 2000, capping an extraordinary four-year period in which GDP grew by more than 4 percent annually as unemployment and inflation fell to new lows. While the numbers were recognized as benchmarks for economic performance, they raised expectations accordingly. Investors, businesses and consumers all spent more freely, assured that the economy had entered a new era of upside surprises.

Government expectations changed too. At the federal level, budget surpluses made tax cuts a central issue in the 2000 presidential campaign. And for states, “higher than expected” became the standard-issue boilerplate in revenue collection announcements. Eventually, these expectations began to affect state budget debates as well. Consider the states in the Southeast.

Forecasting revenues
The Tennessee General Assembly had history on its side when it voted to base its fiscal year 2001 budget on revenue projections (see table 1) that exceeded the State Funding Board’s forecasts.

Like most economic forecasters, the State Funding Board offers a range in its predictions of likely growth. Also like most forecasters, its highest likely prediction had fallen short in the past, with the economy generating more tax revenues than expected in three of the previous five budget periods.

So in June 2000 the Tennessee General Assembly departed from its usual practice of basing the state budget on a figure somewhere within the State Funding Board’s range of estimates, which for fiscal year 2001 was from 4 percent to 4.75 percent. Instead, the General Assembly voted to base the 2001 budget on revenue that was 5.15 percent higher than in fiscal year 2000.

As it turned out, both groups missed their estimates. In the first three quarters of fiscal year 2001, tax revenue in Tennessee was only 1 percent higher than in the first three quarters of fiscal year 2000. As a result, Tennessee’s $18.9 billion fiscal year 2001 budget, which ends on June 30, faced a revenue shortfall of nearly $220 million — with one quarter of the year still remaining.

Table 1
General Fund Revenue Growth Projections Incorporated in State Budgets
(At Time of Budget Enactment)
Fiscal Year Alabama1 Florida Georgia Louisiana2 Mississippi Tennessee3
2001 General: 1.5 4.7 7.3 4.9 3.9 5.2
  Education: 4.6          
2002 General: 4.5 4.5 7.3 1.9 3.7 8.3
  Education: 3.0          
1Most tax revenue in Alabama is designated for these two funds.
2For Louisiana’s fiscal year 2001 budget, other sources of revenue were enacted, so the actual budget exceeds the governor’s proposed budget mentioned in the article.
3Tennessee’s fiscal year 2002 budget assumes new sources of revenue.

But revenue shortfalls are not unique to Tennessee. In February, the National Council of State Legislatures reported that fiscal year 2001 revenue was coming in below projections in 20 states. And while the fiscal situation in the states does not begin to approach the level of seriousness of the early 1990s, it stands in dramatic contrast to the last several years, when greater-than-expected revenue growth was routine throughout the states.

As with so many other economic developments, the six states that make up the Sixth Federal Reserve District are representative of the entire nation. While overall fiscal condition cannot be assessed without some consideration of spending levels, revenue collections can provide some preliminary indications about the general direction of state government budgets.

The Tennessee General Assembly was not legally bound to accept the State Funding Board’s revenue estimates, but it is required — like most legislatures — to pass a balanced budget. Critics say this is one reason the legislature based its 2001 budget on higher revenue projections. When revenues came up short, it then fell to the governor and the legislature to bring the budget back in balance through some combination of spending cuts and revenue increases.

In January 2001, Governor Don Sundquist unveiled an initial administrative cost-cutting package intended to generate savings through everything from reduced employee travel to delayed software and vehicle purchases to lower-than-anticipated bond costs.

But the shortfall has also become entangled in the Tennessee General Assembly’s ongoing tax reform debate. As one of a handful of states that does not tax individual salaries or wages, Tennessee is deprived of what state revenue analysts at the State University of New York’s Nelson A. Rockefeller Institute of Government have called “the engine driving this extraordinary growth” in state revenue. The primary engine driving Tennessee’s revenue, the sales tax, has sputtered in fiscal year 2001, especially compared to the gains in outlays generated by healthcare and education programs. As EconSouth went to press, the Tennessee General Assembly was still considering tax reform, as well as the 2001 and 2002 budgets.

State income tax no certain fix
Mississippi and Alabama are also in budget-cutting mode despite the presence of a personal income tax (for revenue sources, see table 2). Like Tennessee, revenues for fiscal year 2001 have come in below expectations in those states.

Through March 31, revenues to Mississippi’s general fund were $148.8 million lower than anticipated in its $8.9 billion budget. The legislature had assumed revenue growth of 3.9 percent for fiscal year 2001. Through the first three quarters of the year, however, revenue grew only slightly over 1.5 percent more than in the same period for fiscal year 2000. As of mid-April, Governor Ronnie Musgrove had already cut more than $130 million from the fiscal year 2001 budget.

Fiscal year 2002 may very well hold more of the same for Mississippi. In March, the legislature overrode Governor Musgrove’s veto and adopted a budget based on general fund revenue growth of 3.7 percent. The governor had favored general fund revenue growth assumptions of between 1 and 2 percent.

In Alabama, revenues in the first seven months of fiscal year 2001 — Alabama’s fiscal year begins Oct. 1 — actually declined, falling just over 0.1 percent compared with the same period a year ago. However, combined fiscal year 2001 appropriations for the state-tax generated portion of the State General Fund and its Education Trust Fund grew 8.2 percent from fiscal year 2000.

Table 2
State Tax Collection by Source, 1999 (Percent)1
  Alabama Florida Georgia Louisiana Mississippi Tennessee
Property   2.7   4.0   0.3   0.4   0.0   NA
Sales 27.3 58.3 34.9 37.6 48.8 58.6
Selective Sales 24.5 17.0   8.2 15.9 17.4 18.4
Individual Income 31.6   NA 45.7 25.5 21.5   2.2
Corporate   3.9   5.3   6.4   4.7   5.0   7.9
Other   9.9 15.3   4.5 15.8   7.2 12.9
1Because of rounding, figures may not total 100 percent.
Source: Stateline

Alabama’s government is operated by five funds, the revenues for which are dictated by statute. Of these five, two major funds provide appropriations for the vast majority of state government operations. The General Fund provides for the operations of the state’s Medicaid, health care and criminal justice systems, among other critical functions. The Education Trust Fund provides for the funding of K-12 education, colleges and universities, public libraries, and other cultural and educational programs.

Because the state constitution designates nearly all income tax revenue for teacher salaries, and because state law designates most sales tax revenue for educational purposes, the risk of a shortfall lands disproportionately on the Education Trust Fund, since revenue cannot be re-allocated between funds. The impact is even greater considering that state-generated tax revenue accounts for more than half of Education Trust Fund spending, compared to around 15 percent for the General Fund. (The balance in both funds comes from the federal government and other sources.)

Consequently, programs in the General Fund, the state-generated portion of which grew over 25 percent in fiscal year 2001, have not been cut. Payments from the Education Trust Fund, however, which grew at a much more modest 4.4 percent in fiscal year 2001, have been prorated 6.2 percent.

By many accounts, Alabama has the lowest state taxes in the United States, so the school-funding crisis has been the primary impetus for the latest round in Alabama’s ongoing tax-reform debate, which is itself related to a state constitutional reform debate. And while the legislature had not adopted a fiscal year 2002 budget as EconSouth was being published, Governor Don Siegelman is taking no chances with his own proposal: the Alabama-generated portion of the Education Trust Fund is actually lower than the 2001 appropriation.

Louisiana gets more than it expected
It’s a situation the Louisiana legislature and Governor Mike Foster faced last year as they prepared the fiscal year 2001 budget. The state’s Revenue Estimating Conference assumed general fund revenues of $5.57 billion, a drop of $238 million — or 4.1 percent — from anticipated fiscal year 2000 revenue (the budget was prepared, of course, before fiscal year 2000 ended).

More than $300 million of the fiscal year 2001 revenue loss projection was attributable to the expiration of some sales taxes at the end of fiscal year 2000. The governor’s budget noted, “If the current sales tax base is restored, then sales tax collections are expected to increase by 1.1 percent and general fund revenue . . . by 1.5 percent.” Severance and royalties taxes accounted for more than $50 million of the revenue loss, assuming “an expected decline in oil prices to $20 per barrel.”

Fortunately for Louisiana, though, oil prices have not fallen much. The Revenue Estimating Conference’s latest revision forecast fiscal year 2001 revenue at $6.17 billion, nearly $500 million higher than the initial estimate for the year and 5.4 percent ($314 million) higher than final fiscal year 2000 collections.

The legislature did extend the expiring sales taxes, but at an estimated 8 percent growth — $166 million — sales tax revenues are increasing much faster than anticipated. Royalties and severance taxes are now projected to produce over $100 million more in fiscal year 2001 than last year, with royalties growing 32 percent. Corporate income taxes are also expected to surge, generating nearly $42 million — 19 percent — more than last year.

What accounts for revenue increases that were previously unanticipated? A sentence in the state’s fiscal year comparative statement states it plainly: “All the revenue gains are consistent with increased economic activities in the state’s economy, due partially to increases in prices of oil and natural gas.”

As for fiscal year 2002, the governor’s proposed budget assumes revenue growth of $115.9 million, or 1.9 percent, above the official revenue estimate for 2001, consistent with the “mediocre growth” expected in the state’s economy.

Piggy Bank

On target in Florida and Georgia
Considerably less anxiety attended budget sessions in Florida and Georgia, where revenues are on target. While both economies are considerably more diverse than the rest of the Sixth Federal District’s, it may very well be that Georgia’s revenue grew fastest because its tax code draws from a much broader range of economic sources.

Florida, of course, is the Goliath of the Sixth Federal Reserve District, with 16 million people and an economy to match. Without an income tax, however, most of its revenue — about two-thirds — is generated by the state’s 6 percent sales tax. Through the first six months of fiscal year 2001 (the latest period for which figures were available) total state taxes in Florida were up 3.8 percent over the same period in fiscal year 2000. Florida’s recently enacted fiscal year 2002 budget assumes revenue growth of 4.9 percent.

In Georgia, the legislature adopted Governor Roy Barnes’ 7.3 percent revenue growth estimate for its fiscal year 2002 budget. This estimate assumes a slight increase of revenue growth over fiscal year 2001, which through March was 6.9 percent higher than the first three quarters of fiscal year 2000. That figure would have been significantly higher, however, had revenue collections not declined 8.5 percent in March from year-ago levels. Not surprisingly, perhaps, Governor Barnes announced in April that he was preparing a list of potential budget cuts should revenue come up short in fiscal year 2002.

What slower growth means for states
The United States’ record 10-year expansion has generated extraordinary gains at every level of economic activity. For individuals, employment growth and wages grew at a rapid clip. For companies, profits soared as productivity increased and unit costs declined. And for governments — federal, state and local — surpluses accumulated as economic gains for individuals and firms generated revenues beyond expectations.

As U.S. economic growth slows, individuals, firms and governments will have to tighten their belts some. Governments could face big adjustments as they may need to pay out more for economic and social assistance programs while bringing in fewer revenues. State governments in the Southeast are already grappling with these challenges — and keeping close track of the economic forecasts as they manage their budgets.

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