Study findings may discourage legislators’ budget tinkering

Study findings may discourage legislators’ budget tinkering
Washington’s revenue stability is the best among the West Coast states. It also has a balanced budget requirement and a budget stabilization fund, two budgetary mechanisms recommended in a new study by the Tax Policy Center. Photo: Environmental Finance Center Network

Washington benefits from one of the more stable revenue streams in the nation, and the best among the West Coast states. That’s according to a new study by the Tax Policy Center that examined all 50 state budgets and revenue over an 11-year period.

As part of the study, the think tank made recommendations for state budgeting that would ensure revenue security, including measures that state lawmakers may want to consider before tinkering this upcoming session with the state’s balanced budget requirement (BBR) or dipping into the budget stabilization fund (BSD), a.k.a. the “rainy-day fund.”

Between 2005-2016, Washington and nine other states’ revenue streams had a 4.4-5.5 standard deviation in percent change. That’s less than Oregon, which had a 5.5-6.5 standard deviation change, and half of California’s 8.5+ standard deviation.

Both those states have income taxes and a capital gains income tax, which Washington Research Council (WRC) Research Director and Senior Economist Dr. Kriss Sjoblom says provokes greater revenue volatility. “Most of them (capital gains) apply to the top slice of the taxpayers, and they’re taxed at a higher rate than everyone. The progressivity accentuates the volatility of an income tax. It’s very hard to forecast capital gains, because you have to forecast the stock market, and you know how poorly people are at forecasting the stock market.”

But in Washington’s case, the volatility has generally favored higher-than-expected revenue. Between the 2015-2016 fiscal years alone, it increased by 8.8 percent – or $18.7 to $20.3 billion. Last week, the Economic and Revenue Forecast Council (ERFC) announced it now anticipates $304 million more in revenue for the state’s primary operating budget account during the 2017-19 budget cycle, and another $186 million for the 2019-21 biennium.

Meanwhile, 33 other states are struggling to make up for less-than-anticipated revenue, according to a recent fiscal survey by the National Association of State Budget Officers.

Washington is among the few states that does not impose an income tax. Instead, it relies primarily on a sales tax that is among the highest in the nation, which in the 2016 fiscal year generated half of the revenue the state took in.

While some argue this is a “regressive” system in need of change, tax policy experts have highlighted the sales tax’s reliability that prevents massive budget deficits. Unlike other types of taxes, it generates revenue from a large swath of state residents for engaging in many day-to-day transactions, both big and small.

That stability is critical not only for accurate ERFC predictions, but also for state lawmakers whose purse strings are tightened or loosened based on those estimates as part of the Balanced Budget Requirement (BBR). That fiscal stipulation was first implemented during the 2013-15 biennium, by restricting budgeted state spending to four-year revenue forecasts.

The state’s budgeting practices have helped Washington maintain high credit ratings. According to the latest reports, Fitch gave Washington a rating of AA+ with a stable outlook, Moody’s rated Washington an Aa1 with a stable outlook and Standard & Poor rated the state an AA+ with a stable outlook.

As reported by the Office of State Treasurer Duane Davidson, Moody’s rating praised the “state’s sound management practices such as its quarterly consensus revenue forecasting process, multi-year revenue and expenditure projections, timely budget adoption, and demonstrated willingness to address budget shortfalls. The rating also reflects an economy that is growing and expected to outperform the nation over the long term.”

A balanced state budget is also among the top tax and fiscal priorities for the Association of Washington Business, which includes nearly 8,000 members representing 700,000 employees.

Despite this, some lawmakers say the continued surplus revenue causes the BBR to artificially restrict state spending. With a power transition in the Senate, its future role could be up in the air.

Sjoblom says the BBR helps prevent the state from spending based on assumed growth that doesn’t materialize. “In a world in which your annual revenues move up and down, but where you knew 100 years into the future what revenues are going to be year by year, you might very well choose to borrow and lend to stabilize your spending and then deal with surpluses and deficits that can meted out over in the long run.”

“But the trouble is, you don’t actually know what’s going to happen in the revenue,” he added. “You can’t count on revenue going up so you’re able to pay back loans.”

The Tax Policy Center’s take on it strikes a nuanced middle ground by noting “research suggests that BBRs have a beneficial disciplinary effect on state budget balances. States with strict BBRs respond more quickly to deficit shocks. However, some research also suggests that BBRs make it more difficult for states to respond to revenue shortfalls during a recession without exacerbating the business cycle and volatility.”

Yet, this perceived flaw is made up for with the rainy-day fund, according to the study, though it adds: “they have their limitations and may not be able to prevent deep program cuts during multiyear recessions, but they can be designed to smooth the relationship between cyclical revenue streams and more constant spending needs.”

Ultimately, it recommends that states seeking greater budget stability use both tools in tandem. “States should consider their institutions as tools that work together to promote long-term sustainability, not as singular institutions that function in isolation.” Though their revenue streams are more volatile, both Oregon and California have BBRs and rainy-day funds.

Injury to either one can make it harder for the other to fulfill its function. Under state law, the rainy-day fund can be authorized by a majority vote on emergency spending; non-emergency appropriations require a supermajority. For the 2017-19 operating budget, $925 million was taken from the rainy-day fund to cover pension-related spending. The current balance is $1.6 billion, and only $100 million will be added by 2021.

For comparison’s sake, that’s less than four percent of the operating budget’s total spending.

“When you get to the really big downturns, the budget reserves just postpone the pain,” Sjoblom said. “We blew through the budget reserve in the Great Recession.”

The relatively low reserve was noted by Rep. Terry Nealey (R-16), a ranking member of the House Finance Committee and member of the House Appropriations Committee. In a statement, he wrote: “I’m concerned our state’s rainy-day fund is only $1.7 billion compared with the state operating budget of more than $44 billion. If there’s a dip in the state’s economy, as we’ve seen in the past, it won’t take much to quickly evaporate that savings.”

“It’s my hope legislators don’t view this as additional money they can book for spending in the coming 2018 session in January,” he added. “Let’s not allow this increase to burn a hole in budget writers’ pockets. Instead, let’s do the wise thing and sock it away for any unanticipated expenditures or future downturns in the economy.”

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