On Tuesday, the Senate Budget & Taxation Committee was briefed by the Department of Legislative Services (DLS) on our state’s finances and economic outlook. Unfortunately, the news is not good. I wanted to share with you some of the highlights from this meeting. All of the briefing documents are available on-line – just click here. The documents include a detailed summary of the budget reductions approved by the Board of Public Works last week.
While Maryland continues to perform better than other states during this national economic slowdown, we are seeing our revenue sources under perform estimates. Most critically, our two largest revenues accounting for 81% of total revenues, the personal income tax and the sales tax, continue to come in lower than predicted. Through May, the income and sales taxes were down $46.3 million and $23.9 million, respectively. Tobacco taxes have also come in $24 million lower than expected. Cigarette purchases are down by 25%. While this is good health news, it does add to our fiscal challenges.
It looks now as if our official revenue forecast for the fiscal year that began July 1st will also prove to be overly optimistic. If these same patterns continue for FY09, revenues will be off between $100 and $200 million. Fortunately, we have built in buffers in the FY09 budget totaling $226 million. However, every dollar of expected revenue that does not materialize eats into this buffer. As the buffer disappears, the anticipated deficit for the following year grows. Right now, the estimated FY10 deficit is $243 million. Without any excess revenue carryover from FY09, the FY10 deficit would be nearly $500 million.
The only good news is that this deficit is “cyclical” as opposed to “structural.” Our current problem is caused by a cyclical downturn in the economy as opposed to a structural imbalance in our spending and revenues. As a result, deficits are now only estimated for the next two fiscal years (10 & 11) if the slots referendum passes. We could use the $700 million plus we have in our Rainy Day Fund to help get through this cycle. However, without the revenues from slots, we will once again be facing a more than $1 billion structural deficit by FY12, and use of the Rainy Day Fund in this situation would be imprudent.
Perhaps the most interesting observation of our economic slowdown was that we are in a “slow-motion recession.” In 1991-92, the last time our state faced a severe economic crisis, our state experienced a rapid decline in our performance indicators. For example, at their peak in 1991-92, 35,000 Marylanders were making initial unemployment insurance claims per month. In the 2001-2002 downturn, initial unemployment claims were made by 25,000 Marylanders per month. Today, we have roughly 20,000 people making initial unemployment insurance claims per month, but that reflects an 18% rise over this time last year. Rather than a sharp rise in unemployment insurance claims coinciding with a steep set of job losses as we saw in 1991-92, we are seeing a gradual slowing of job growth combined with a steady increase in unemployment insurance claims.
In the short term, we are able to adjust our budget outlook to reflect these changes. In the long term, it seems as though the bottom of this recession will continue to elude us and will present larger budget concerns in the future. Should the recovery also turn out to be slow-motion, than our current revenue estimates for the out-years could also prove overly optimistic.
The housing slowdown is also causing significant economic problems for the state. Home prices are expected to be down anywhere from 5-8% for 2008, with a 12 month supply of homes on the market. While the state government does not use property taxes or transfer taxes for general fund expenditures, the housing market slowdown is impacted sales tax revenues. Construction-related sales tax revenues are down 6% this year. The decline in home sales and prices has a much greater impact on local government finances. The Maryland housing market does not appear close to a recovery and is expected to continue its decline, which is further evidence of the “slow-motion recession” that may stick with us for some time.
The general downturn is also having a significant impact on the Transportation Trust Fund (TTF). Both the gas tax and titling tax are below estimates. Coupled with a decline in sales tax revenues and the $50 million TTF reduction included in the legislation repealing the computer services tax, the TTF is behind $150 million in anticipated revenues. DLS reported that the current transportation program is unsustainable in this fiscal environment. As a result, projects will have to be eliminated from the program plan when the new six-year plan is released in the fall. This could make any new major construction unaffordable.
Compounding our transportation funding problem will be a lack of debt capacity should any new revenue become available. During the briefing, State Treasurer Nancy Kopp reported that the state will exceed its debt capacity guidelines next year for the first time in decades. Maryland has a self-imposed debt limit of 3.2% of total personal income. Thus, the state government’s total debt cannot exceed 3.2% of the total combined personal income of all residents.
Over the past six years due to a lack of surpluses, the state has issued bonds more aggressively to pay for projects such as new schools, roads, and prisons. With a slowdown in income growth, we will now exceed our debt limit. This is an extremely troubling development and one that the mainstream media did not report.
Treasurer Kopp informed the committee that her office will be contacting the credit rating agencies over the next few weeks to determine what effect this situation might have on our cherished AAA bond rating. As you know, Maryland has maintained the highest bond rating (AAA) for decades because of our fiscal prudence. Our excellent credit rating reduces the interest rates incurred for state borrowing, ultimately saving the state, and taxpayers, millions of dollars. In order to retain our rating, we may need to scale back our commitment to capital expenditures dominated by schools construction and transportation improvement to keep our debt within our guidelines. With the rating agencies already concerned about our fiscal situation if slots revenues do not materialize, this confluence of issues could be just the “perfect storm” needed to jeopardize our AAA rating.
I certainly wish I had better news to report. It is often said that timing is everything in life. Last year, we finally took action to correct the state’s structural fiscal imbalance through a number of budget cuts and tax increases. I continue to applaud Governor O’Malley for addressing this issue which had festered for years. Unfortunately, this downturn comes just as we restored balance to our fiscal affairs. Such timing!
As always, I will update you on our state’s fiscal outlook as we get a clearer picture of our revenues.
Given recent developments on the budget, we are not surprised by many elements of the Senator's commentary. But two items he reports have not been generally acknowledged in the mainstream media.
1. The possibility of cancellation or postponement of transportation projects.
Back in April, I made this prediction about the Transportation Trust Fund:
The loss of $50 million from the computer tax repeal, the slowdown of TTF revenue sources and rising commodity prices will greatly reduce the amount of money left for new projects. As a matter of fact, if the state protects tens of millions of dollars in planning money for mass transit projects (like Baltimore’s Red Line and MoCo’s Purple Line and CCT), it is entirely possible that all other new work aside from the ICC will be deferred.This may be dangerously close to reality.
2. The risk of losing the state's AAA rating.
No politician of either party wants to lose this rating and face higher interest payments on state debt. It will be the highest priority of the entire leadership in Annapolis to protect it. That means no spending program is safe.
I would expect slots supporters to attempt to capitalize on this budget news in the near future.
Update: Maryland Moment completely missed the real story on the state's credit rating.