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Total $1,600 million
Governor’s Prior Actions: In response to the economic slowdown and the ensuing mounting red ink in the general fund the Governor acted quickly to reduce spending by $439 million. He did this in two rounds of budget cuts in the areas of state government that are under his control. On October 30th he announced spending cuts of $311million. Most of these cuts came from across the board reductions of 4.25% from all appropriations. There were exceptions to this level of cuts as agencies dealing with public safety, education and health were reduced only where prudent. A hiring freeze was instituted at this time to help achieve the expected reductions. On December 3rd additional budget cuts totaling $128 million were announced. The attached printout details all proposed cuts. Two items that will be part of these cuts is that non-union employees will not receive a scheduled cost of living increase in January and a scheduled cost of living increase for the Governor and cabinet officials will be returned net of federal taxes.
Governor’s Proposed Actions: The table above also lists the additional proposals of the Governor to close the budget gap. There are additional expenditure cuts of $162 million, of which $36 million is to come from agencies outside of the Governor’s control. These would be primarily the row offices and the General Assembly.
The Governor proposes transferring one-half of the rainy day fund to this year’s shortfall with an eye on the other half being needed next year. He also proposes transferring most of the royalty payments ($174 million) received by the Commonwealth for natural gas drilling on state lands in the Marcellus Shale gas field.
The Governor expresses confidence that there will be a federal payment plan to the states from the new president. In discussions with President-elect Obama, at the National Governor’s Conference, the Governors were told that the new president hopes to sign a stimulus package to aid the states on his inaugural day.
The remainder of this report will detail the effects of the Governor’s actions and the other effects that the Governor discussed in his mid-year briefing for the state government.
Economic Outlook: The Governor’s mid-year budget briefing painted a dire portrait of the nation’s economy. That will not be a surprise to anyone who has been paying attention. The economy has now officially been declared in a recession since December of 2007. There is no rebound in sight yet. The Governor was correct when he said that while Pennsylvania is not immune to the national trend so far much of the economic pain has not hit here yet. Last Friday, the latest jobless report was released: 533,000 jobs were lost in November alone following a loss of 240,000 in October, for the nation. Experts were predicting losses of 320,000 for November, so the much larger number was a bit of a shock. The job losses were broad based as nearly every sector lost jobs. Two ominous developments were in the bad November jobs report: The hospitality and leisure sector shed 76,000 jobs and professionals and technical services lost 17,000 jobs. Both of the sectors have been mostly spared in the last couple of recessions. The unemployment rate is now estimated to be 6.7%.
Consumer and business spending is down. Real consumption declined 3.7% for the year to date and that should be repeated in the last quarter of this calendar year as well. Global Insight expects consumer expenditures to grow only .2% for 2009. This will have equally dismal impacts on both jobs and sales tax collections for the remainder of this fiscal year. While in Pennsylvania home prices have not had the dramatic reductions that other states have had they have still decreased instead of increased and the spending boom that came from the housing bubble is no longer there.
Global Insight is predicting 4 consecutive quarters of negative real GDP growth that started in the 3rd quarter of 2008. They are predicting this recession to be the worst one since 1982. They are predicting an unemployment rate of 9% by the end of 2009. The 1982 recession had an unemployment rate of 10%.
While consumers have had some of the pain from $4 a gallon gas dissipate, the collapse of oil prices is in reality a harbinger of more bad news. The decrease is the direct result of lower demand from the rest of the world following the United States into our recession. Back in the summer when Global Insight and many economists thought that a recession was avoidable, exports was expected to be one of the areas that could sustain the business sector until the U.S. economy got going on its own again. That opportunity is gone now.
The Governor, in his briefing, seems to be willing to accept Global Insight’s prediction that the recession will be less severe than the one in 1982 and that growth will return in the third quarter of 2009. Global Insight even suggests that once the economy starts to recover the recovery may be “fairly strong”. They suggest four reasons for a strong recovery. The two most compelling of those are the swift and coordinated action by the governments of the developed nations and the rapid drop in commodity prices which should free up consumer dollars for other purchases once the job market rebounds. But Global Insight has had trouble finding the bottom of this cycle. In December of 2007 they were predicting that there would not be a recession. When the budget passed in July, the prediction was for the stimulus package to pump up the third quarter and then the fourth quarter would feature a contraction with a rebound for the beginning of 2009. The chart below shows Global Insight’s baseline prediction for the percentage change in real GDP for the time frame of this budget and the next budget. It shows the predictions that the Governor and General Assembly had available when the budget was being crafted and debated and passed.
The change of the estimate between September and November is striking but not surprising. The wild gyrations of the economy in October as the credit market seized up and some of the mainstays of the world economy sought protection or collapsed was dramatic and it really did demonstrate that things were going to be worse than anyone had thought. This chart should also serve as a reminder that the recovery predicted in the third quarter of 2009 is just, that a prediction.
If Global Insight is optimistic about the depth of the recession and the recovery they also provide an alternative estimate, which they give a 25% chance of occurring – it is called “Meltdown”. Under the meltdown prediction the credit markets remain frozen long enough to push the drop in GDP twice as low as in the November baseline estimate shown in the chart above. Positive growth only begins in the second quarter of 2010 instead of the third quarter of 2009 as in the baseline projection.
The economic outlook for Pennsylvania is a little better than the national outlook, at this point. While the nation has a 6.7% unemployment rate, Pennsylvania’s rate is a much lower 5.8%. While home sales have declined steeply in Pennsylvania the dramatic reductions in home values has not hit most areas of the Commonwealth. Global Insight projects that Pennsylvania’s income growth and unemployment rate will mirror the U.S. averages for 2009. It would not be surprising if Pennsylvania did a little better than the U.S. averages during this recession, assuming areas that have less boom in the good times have less decline in the bad times.
Economic Stimulus Programs: The final budget enacted in July funded a $3 billion Economic Stimulus plan to make substantial capital investments in local communities, public infrastructure, alternative energy investment, and transportation programs.
The package included an increase in the Redevelopment Capital Assistance (RCAP) authorization ceiling by an additional $800 million, $350 million in additional borrowing for bridge projects, $650 million for energy efficiency and alternative energy development, and $1.2 billion for water and sewer infrastructure investments. Given the current turmoil in financial markets, it is uncertain whether the implementation of some of these investments may be impacted.
Bridge Repair Program- The budget agreement authorized $350 million in bridge borrowing during the current fiscal year. The Governor’s original plan presumed an additional $200 million for each of the next 10 years to deal with the large inventory of bridges remaining structurally deficient. Given the likelihood of transportation infrastructure funding that may become part of a stimulus package enacted by our newly elected Congress in Washington DC, it is unclear if additional state borrowing may be necessary.
Water & Sewer - The budget agreement included the dedication of $800 million in Gaming Economic Development and Tourism Fund support for water and sewer grants, dam repair, and flood control, along with $400 million in additional water and sewer infrastructure financing through PENNVEST. The PENNVEST borrowing was required to receive public referendum authorization during the November election, which voters approved overwhelmingly. Both the Commonwealth Finance Authority (CFA), administering the gaming fund grants, and PENNVEST, administering the $400 million grant and loan program, hope to complete program guidelines and seek applications for funding early in 2009.
Energy Programs – The CFA will issue bonds to fund $500 million of the planned $650 million energy investment program. The balance of funds will be provided through the General Fund during the next 8 years, with $20 million available during the current fiscal year. The general fund program will make funds available for tax credits and weatherization programs, while the bond funded programs will fund a broader array of consumer and business incentives to encourage solar development, green buildings, and other renewable energy alternatives. It is hoped that most of these programs will be ready for launch early in 2009, assuming credit markets will support planned CFA borrowing this spring.
Tax Revenues: At his mid-year budget briefing the Governor estimated that the year- end tax revenue deficit will be $1.6 billion. The slowing economy continues to reduce the commonwealth’s tax collections. As the Governor reported in the mid- year budget briefing, as of the end of November, collections are $657 million or 6.8% below the official estimate. What is even more chilling is that collections are 4.3% below the amount collected last year. Below is a chart showing the shortfall compared to the official estimate for the general fund taxes.
None of the significant taxes are outperforming the official estimate made in July. As the chart shows the business taxes, sales tax and the income tax are all well below estimates. That trend will continue. The credit crisis and slow economy will make businesses cut back in their spending and their hiring. That will continue to drag down the tax receipts for the rest of this fiscal year. Unfortunately, that will continue through much of the 2009-10 fiscal year as well. When the economy begins to bounce back in the second half of 2009, receipts from the sales tax and the income tax will continue to be sluggish for a while as businesses usually wait to hire until they are assured that the economy is truly on solid footing.
The general fund receipts from interest on securities have suffered a double fall. First the assets are not earning any positive income due to the stock market’s fall and even worse the assets, usually equities, are now being marked down in their worth as the value of the shares plummets. There is some hope that the worst asset devaluation is over; but with the volatility that the stock market has shown it is unknown whether further asset markdowns will be necessary. The total estimate of interest revenue from securities for the current fiscal year is $285 million. Only $21 million on interest earnings was anticipated by the end of November so more shortfall in interest income is likely.
The Governor’s estimate of a revenue deficit of $1.6 billion may be too low, but it is a reasonable estimate and by dealing with such a large amount now the Commonwealth will be in a good position if the deficit is a bit higher. With the highest tax collection months yet to come and the increasingly dismal fiscal news, particularly regarding employment, the deficit will clearly be above a billion and a half dollars. Next fiscal year’s estimate will also be affected. The accompanying chart is updated from last year’s report but it offers a graphic vision as to how large the deficit may be come June 30. The chart compares the surplus/ deficit in November of each year to the final surplus/deficit. This does not suggest a happy ending to the fiscal year. Clearly the size of the November deficit is not an absolute predictor of the final deficit but the current shortfall of $657 million is the largest shortfall for the last 25 years.
Department of Community and Economic Development: Last week’s employment report provided another stark picture of our deteriorating national economy. Payroll employment fell by more than 533,000 jobs in November, the worst decline in 34 years, as the nation’s unemployment rate rose to 6.7 percent, with more than 10 million Americans now out of work. The October unemployment rate in Pennsylvania was modestly lower at 5.8 percent.
The slowing economy continues to reduce state revenues, forcing cuts of nearly $53 million in state community and economic development financing programs, including a $14.7 million cut in Opportunity Fund grants. Other significant cuts include $1.2 million for World Trade PA, $1.5 million for Customized Job Training, $1.5 million for Infrastructure Development, $3.8 million for Housing & Redevelopment and New Communities assistance, and more than $17.3 million for discretionary grant programs.
Much recent attention has been fixed on Washington in anticipation of further economic stimulus spending that may help states make new investments in transportation, energy, water and sewer infrastructure projects. The good news in Pennsylvania is that the state should be well positioned to maximize these investments.
The final budget adopted in July included an ambitious state stimulus plan to further spur our economy. New bond authorizations will provide $500 million for alternative energy development and energy efficiency programs through the Commonwealth Finance Authority (CFA). An additional $800 million will be raised by the CFA through the securitization of economic development set-aside funds from the Gaming Fund for water and sewer projects, high hazard dams, and flood control plans. Another $400 million was authorized through a voter referendum in November to fund Water and Sewer investments through PENNVEST.
The challenge now faced by the commonwealth is how quickly these commitments can be implemented to provide real stimulus for the state economy. The hope is that significant investments can be launched during the next few months to put this money to good use.
Department of General Services: The Governor’s Mid-Year briefing emphasized cuts to the budget that are necessary to pull the budget back in line fiscally. One such measure is putting a freeze on the purchasing of new cars. The Governor estimates that this will save $30 million in the 2008-09 state fiscal year. Using the general figure of $20,000 per new car, it is expected that the number of new cars that will not be purchased this year will be 1,538 cars.
The Governor pointed out that the Department’s “strategic sourcing” program is expected to save the Commonwealth $280 million in the 2008-09 fiscal year. The Department has achieved this goal by leveraging the commonwealth’s procurement operation, reducing inventory and making the buying process for the commonwealth more efficient. Another action that the Department has taken is the sale of the State office building in Philadelphia. This will bring an extra $20 million to the commonwealth to help close the shortfall hole in the 2008-09 budget.
Education: Spending cuts to deal with the current shortfall will necessitate many reductions in education appropriations. A total of more than $120 million in education cuts were recommended by the Governor. Among $52 million in basic education funding cuts are reductions of $3.4 million for Early Intervention programs, $11 million in capital construction reimbursements, $2.5 million in aid to non-public schools, $2.8 million for teacher professional development, and $9.8 million for the development of new high school assessment exams. Funds for basic and special education subsidies were not impacted by the Governor’s spending cuts.
Higher Education subsidies were reduced by $68.6 million, including 6.0% in cuts for the four state related universities and the state-aided institutions, and a 4.25% cut for the State System of Higher Education. With the reductions, these sectors are receiving less state money than in the prior fiscal year. Funds for community colleges were not affected by the Governor’s spending cuts. PHEAA has frozen $1.8 million of the funds it receives for the small special programs it administers. This does not affect the state grant program.
Since 2003 the commonwealth has made unprecedented new investments in public education programs totaling nearly $2.8 billion. These increases have included $600 million in targeted investments in early learning programs, tutoring assistance, science and math instruction, classroom technology, and high school restructuring. The new budget for the 2008-09 fiscal year provided a $274.7 million increase in the basic education subsidy to begin what the Governor hopes will be a six year state phase in of a new funding formula to address adequacy spending goals for all local school districts. The worsening fiscal climate will make it difficult to fully fund a second year phase-in cost of more than $400 million.
Transportation: Motor License Fund (MLF) revenue is currently 9.8% below the Governor’s estimate, based upon total receipts through the end of November, a $112 million deficit. While liquid fuel tax collections are down by more modest amounts, reduced vehicle traffic and sharply lower auto sales have significantly lowered fees received from vehicle registrations and other motor vehicle fees. Reduced interest earnings have also negatively impacted deposits into the Motor License Fund. In anticipation of a year-end revenue deficit the Governor has identified $41 million in MLF budget cuts for the current year.
New federal aid could soon cushion some of this bad news. Last week the Governor hosted more than 40 of the Nations Governor’s in Philadelphia to impress upon President-elect Obama and Vice-President-elect Joe Biden, the desperate need for money to repair and maintain our state infrastructure. There was unanimous support for a new multibillion dollar package expected to provide significant new funds for transportation improvements. Meanwhile, the Turnpike Commission continues to fully fund its obligations under Act 44. A planned 25% toll increase will take effect in January and the Turnpike will provide $1.3 billion in new funding for highway, bridge and transit programs in the next year and a half, as required by Act 44. These funds will augment current highway and bridge programs to fund improvements over 40,000 miles of roads and 1,800 badly deteriorating bridges.
The Turnpike Commission must decide whether to resubmit its application for federal approval to toll Interstate 80. Without this federal consent annual lease payments to the commonwealth from the Turnpike Commission will be reduced by more than $450 million beginning in the 2010-11 fiscal year. This potential revenue loss would cost transit agencies more than $150 million annually in capital support. The Department of Transportation would lose more than $300 million for highway and bridge improvements.
Department of Insurance: Healthcare funding is the significant issue facing the Governor and the United States as a whole. Currently, over 1.9 million Pennsylvanians are eligible for some type of medical assistance. Caseloads have increased due to a growing elderly population and a growing trend by employers to cut back on employer sponsored health insurance. Increases in healthcare costs are a growing national trend. While it has been a policy position of this Administration to sustain all those currently receiving health and social services, the escalating healthcare costs will require the Administration to find new funding sources to maintain the status quo and to accommodate those who will need the services in the future. In addition, the Administration is striving to put in place a new healthcare program, Access to Basic Care. While the Legislature agrees with the policy of “covering all of the uninsured,” it is how we pay for such a policy that has divided the Legislature from the Administration.
Pensions: The Governor did not mention the upcoming crisis in the two main pension funds; PSERS and SERS. Both of the state’s pension funds as well as municipal pension funds suffered severe losses in the economic turbulence of the last year. SERS has lost 14.3% on investments through the first three quarters of calendar year 2008. PSERS’ losses will be similar. That fund lost 16% on its investments from September 2007 through September 2008. These lower returns will require a higher amount of state and local contributions to the pension funds in 2009-10. There was already an expected spike in contribution payments coming in 2012. The loss of investment earnings will exacerbate the size of the problem expected in 2012. Both pension funds have an actuarially expected return of 8.5% annually, and clearly, with losses around 15% those goals will not be met.
Local government pensions have also been hit hard from
the decrease in fund earnings from the slide in the real estate
market and the stock market. While the commonwealth has no
obligation to make up any of these losses, the fiscal stress on
local governments may have them looking to the state for additional
aid. Department of Public Welfare: One of the most significant issues in the Department’s budget relates to Medical Assistance. Medical assistance (MA) is a comprehensive health care program that provides federally-supported healthcare to eligible individuals, along with a state-funded health care program for general assistance clientele. This is part of a NATIONAL TREND. When the economy is bad, the social service demands grow. More and more people will turn to their government for safety net coverage, especially the elderly and the disabled. This program already has federal and state governments carrying a huge economic burden. In Pennsylvania alone, the Department will serve approximately 34,478 new MA clients during FY 08/09, bringing the total number of individuals served through MA to approximately 1.94 million.
The total amount appropriated to the Department of Public Welfare for FY 08/09 was $10.3 billion. Since then, the Department’s budget has been reduced by $152 million or 1.5%. During Round 1, most of the $72 million in budgetary freeze was due to compliment adjustments. Another $80 million was recommended in a second round of cuts, of which Long Term Care took the most significant hit for $21 million; Community Mental Retardation $12 million; County Child Welfare an additional $10 million; and the Childcare Services and Assistance appropriations $8 million collectively. Additional detail for Round 2’s budgetary freeze measures will follow at a later time.
During his mid-year briefing, Governor Rendell hinted that the federal government may look to adjust the Federal Medical Assistance Percentage (FMAP). FMAP is the share of the Medicaid program paid for by the federal government. Small changes in a state’s FMAP can have a significant impact on state budgets. In 2003, when Congress stepped in and gave the states’ $20 billion, Pennsylvania’s FMAP adjustment (2.6%) and additional block grant funds netted $900 million in federal fiscal relief. While the Obama/Biden federal relief package has yet to be determined, any additional federal support to the States will help them during their challenges to balance their budgets and fund essential services and programs. |
