The State's Budget Outlook

The state’s finances are looking up as the economy picks up — that was the main message at the annual “Revenue Hearing” today.  At the same time, all who spoke cautioned against over-confidence.

Every December, lead budget writers for the Governor, the House and the Senate convene to hear presentations from leading experts on the state’s economy and tax revenues.  The main goal is to develop a consensus on revenue projections that will define the budget options for the coming fiscal year.  The budget writers also consider the state’s balance of assets and liabilities and how hard they should be squeezing to improve that balance.

Revenue is coming in solidly above projections for the current year.  Last year, budget writers projected 3% revenue growth for the current year, Fiscal Year 2014, yielding a projected total of $23 billion in tax revenues for the state.  The Commissioner of Revenue is now expecting revenues to come in a percentage point or two (more than $300 million) above that level, despiteour repeal of the “software tax“.

For the coming year, FY15 which begins next July 1, fiscal  baseline growth is expected to be even healthier — roughly 5% or $1 billion over FY14.  One expert forecast 7.9% growth.

Warnings came in four categories.  First, most speakers emphasized uncertainty about the economy.   Continuing austerity and/or gridlock in Washington might diminish the confidence of consumers and businesses.  Additionally, continuing poor economic performance in Europe might weaken export markets for Massachusetts products — the Eurozone accounts for roughly 40% of Massachusetts exports.  The Massachusetts Taxpayers Foundation expressed the view that even if things go well the state should not expect revenue to continue to accelerate over the long term.

Second, many emphasized that the state should be seeking to add to reserves this year and should definitely not be drawing on reserves.  The state’sstabilization or “rainy day” fund is the third best in the country.  However, many other states have badly depleted their reserves.  Although over $1 billion, our fund is still at roughly half its previous high.  The state does not have the cushion that it needs to be able to withstand a future economic downturn — this is of particular concern because the federal government’s political deadlock might render it incapable of making fiscal adjustments to counteract a future downturn.

Third, several speakers emphasized that the state has relatively high debtand high unfunded pension obligations.  The state is working to bank enough in its pension fund to cover future obligations.  The state is committed to a funding schedule which stretches out to 2040.  It is time for periodic adjustment of that schedule and the Massachusetts Taxpayers Foundationencouraged the budget writers to accelerate it.

Controlling debt levels and funding our pension obligations are both important, but the heavy emphasis on pension funding increases our exposure to financial risk.  To achieve the investment returns necessary to sooner reach “full funding” of pension obligations, the state places fairly risky bets in the stock markets and in even riskier asset classes.  Arguably, we would do better to emphasize reduction of our debt, which has the same net balance sheet impact while reducing our exposure to market movements.

Fourth and finally, health care costs are likely to continue to create pressure that will make it difficult to accommodate increases in other areas.  We’ll see the Governor’s draft budget in mid January and it will give useful additional guidance about agency needs.

That is also when we’ll get a first good read on where local aid numbers are headed — so far, there is cause for cautious optimism.