Washington Research Council Blog

States will feel the impact of federal deficit reduction

In my column today, I discuss the growing reliance of state governments on federal funding.

In 2008, before the stimulus act, federal funds accounted for about 26 percent of total state spending. With the stimulus, that share rose to nearly 35 percent in 2010, returning to pre-stimulus levels next year, long before state revenues recover. Remarkably and unreliably, a federal government borrowing more than 40 percent of the money it spends will pay for more than one-quarter of state spending.

Nearly half of the federal money going to states is for Medicaid. Clearly, when the feds get around to cutting the trillions (trillions!) that bipartisan leaders, including the president, agree must be trimmed, state and local governments won't be spared.

A related story in today's Washington Post cites testimony by Maryland's chief budget officer, who envisions three possible outcomes from the current debt ceiling discussions, none of them good for the states. I think his third scenario is likely.

Ending 3: The two sides in Washington reach agreement on a broad deal to raise the debt ceiling and reduce the deficit.

“This may be perceived as a happy ending for the federal government – no downgrade, no defaults, and agreement reached on a big deficit-reduction plan,” [Warren] Deschenaux [director of the Maryland Department of Legislative Services] said. “That should keep the market happy, but it’s very likely to be at the cost of putting additional costs to state governments.”

Why?

“Remember, most of what the states receive is in discretionary [funds] – Medicaid, entitlements, etc.,” Deschenaux testified. “Anything [budget] ‘reform,’ in theory, will be touching both discretionary spending and entitlements.”

Eventually unavoidable.

New interstate comparison of business taxes - WA still high

The Council on State Taxation released its annual report on business taxes. The research, conducted by Ernst & Young LLC, is the most comprehensive analysis available. The press release highlights document the lingering effects of the recession (data are for 2010).

Key findings of the study include:

After falling by 0.9% in FY2009, state and local business taxes stabilized at near FY2009 levels in FY 2010, decreasing by 0.3% from FY2009.

Total state and local taxes imposed on both households and businesses remained constant, with total state taxes declining by 1.2% and total local taxes increasing by 2.3%.

Property taxes on business property increased an estimated 1% this year, totaling $249.5 billion in FY 2010, or 40.3% of state and local business taxes.

Sales tax on business inputs and capital equipment totaled $124.4 billion, representing 20.1% of business taxes – a decrease of 2.5% from FY2009.

Corporate income tax collections totaled $44.1 billion, adding up to only 7.1% of state and local business taxes, and the lowest share reported in the nine-year history of this study.

Due to the decline in income taxes, indirect taxes (taxes not based on income) represent 88% of the total state and local tax burden, a larger share than in previous years.

Employer contributions to unemployment insurance were $32.4 billion, up 3.1%.

States are facing large debts to the federal government for loans used to pay unemployment benefits due to a combination of underfunding and the severity of unemployment. Unemployment taxes are likely to continue to rise for several years to cover loan repayments.

COST finds that state and local business taxes in Washington amount to 5.4 percent of Gross State Product, significantly higher than the US average of 5.0 percent. In Oregon the share of GSP is 3.8 percent. In Idaho, 4.3 percent.

ESD Estimates Washington Gained 3,600 Jobs in June, Unemployment Rate Up 0.1 to 9.2 Percent

The state Employment Security Department today issued its monthly estimates of employment and the unemployment rate. The estimated unemployment rate increased to 9.2 percent in June from 9.1 percent in May. Seasonally adjusted, the total number of non-farm jobs increased by 3,600, to 2,827,700 in June from 2,824,100 in May. The state has added 59,200 jobs since February 2010, the cyclical low point, but will need to add another 146,800 jobs to surpass the peak reached in February 2008. From May to June, it is estimated that the state added 6,600 private sector jobs (net) and lost 3,000 government jobs.

 

Underscoring the fact that ESD’s monthly releases are estimates, the figure for April to May non-farm employment change was revised to show a 2,500 job gain rather than the 700 job loss that ESD originally released in June. (See Chapter 4 of the March issue of the state Economic and Revenue Forecast for a description of the methodology that the Forecast Council economists use to improve on the ESD estimates.)

As the chart below shows, job growth in the current economic recovery is closely tracking the experience during the last recovery, which began in April 2003. If we continue track this previous recovery, it will not be until April 2013 that the state surpasses the number of jobs it had in February 2008.

Governors expect tough times to linger

News from the National Governors Association summer meeting in Salt Lake City was decidedly grim. State governments, beneficiaries of stimulus dollars that sustained spending during the worst days of the recession, continue to face ongoing fiscal challenges. As the governors watch the debt and deficit debates in D.C., most acknowledge the end of federal assistance.

In the New York Times, Gov. Gregoire, outgoing NGA chair, summed it up the general sentiment.

“It’s like falling off a cliff,” said Gov. Christine Gregoire of Washington, a Democrat. “And we’re going to be at the bottom of that cliff for a long time in our relationship with the federal government. And whatever they’re going to decide in the way of cuts, I hope they understand the implications to the states and what it’s going to mean on the ground out here.”

Gregoire expresses deep regret for the policy decisions the recession forced on state government, from reducing higher education funding to deep cuts in human service programs.

For Wisconsin Gov. Scott Walker, who acted decisively to curtail compensation costs by pulling back on collective bargaining, the recession taught a different lesson. He tells the Washington Post:

Wisconsin Gov. Scott Walker’s (R) conclusions about the budget fight that prompted outrage in his state and drew national attention are no less personal than Gregoire’s, but far different in how he assesses what was done...

Walker says he did what was necessary, but should have handled it differently.

Walker said he came into office with the mindset of both a county executive and a small-business owner. “Identify a problem. Identify a solution. And you just do it,” he said. He set a fast pace in January with the legislature, without preparing the public. That might have worked in other settings, but it backfired on the new governor.

“We didn’t do enough of a job of making the case for what we were doing and why it was needed,” he said.

The Wisconsin experience was intensely partisan. Yet, governors generally claim to have achieved bipartisan successes. Politico reports on how the governors contrast their accomplishments with the partisan dysfunction unfolding slowly in the nation's capital.

Yet, as the NYT reports, Republican and Democratic governors divide on how they want the debt/deficit crisis resolved. In part, the urgency depends on how deeply states have been affected by the erosion of stimulus dollars. We're among the states most sharply affected, according to Stateline.org.

,,,the drop from the stimulus cliff was steeper for some states than others, according to a recent report by Federal Funds Information for States. Hardest hit was Hawaii, which saw a 16 percent drop in funding. Now, the feds are picking up about 52 percent of the state's $1.3 billion Medicaid program.

The next-most adversely affected were Louisiana (13 percent), Washington State (13 percent), Alaska (12 percent) and Nevada (12 percent). The states with the smallest adjustments were Kentucky and Alabama, at 9 percent each. The variation is primarily due to a disproportionate share of stimulus money going to states with big increases in their unemployment rates.

Hard times indeed.

Minnesota shutdown ending with budget agreement

Minnesota's two-week government shutdown appears to have been resolved. I wrote about it in this column, drawing a comparison with the federal debt ceiling and deficit showdown.

The Republican legislature and Democratic governor travel down a well worn road to covering budget gaps.

The deal raises the revenue Dayton sought -- $1.4 billion -- but without raising taxes, which Republicans opposed. Instead, it reaches back to an earlier GOP offer to rely primarily on more borrowing from schools and from the sale of tobacco bonds.

Washington went the tobacco bond route back in 2002. Here's how that worked out (from Gov. Gregoire's press release earlier this year).Listing bad budget fixes tried earlier, she cites:

The decision in 2002 to borrow $450 million through securitization of tobacco settlement payments. The action will ultimately cost the state $1 billion in principal and interest, and has resulted in the state receiving $100 million less per biennium in tobacco settlement funds.

Apparently they figured they had to do something and quickly. I thought they'd stay stuck a while. I underestimated the importance of getting a cold beer on a hot Minnesota afternoon.

 

Disappointing July Revenue Collections Report

The Economic and Revenue Forecast Council (EFRC) issued its monthly Economic and Revenue Update today. Once again revenue has come in under forecast.

For the month, General Fund–State collections were $22.1 million (1.7 percent) less than the amount anticipated under the forecast adopted in June. Of this $22.1 million, $4.1 million was an unanticipated refund. Revenue Act sources (retail sales, business & occupation, use, public utility and tobacco product taxes, and penalties and interest) were $53.1 million (6.1 percent) below forecast, while non-Revenue-Act sources were $31.1 million (7.4 percent) above forecast. Property tax accounted for most of the positive non-Revenue-Act variance. The Update is available here.

This disappointing state tax collections report follows Friday’s disappointing national employment report. That report showed that the U.S. economy added only 18,000 jobs in June. The estimates of April and May employment were revised down by 18,000 and 47,000 respectively. As a result, the employment growth rate for the 2^nd quarter is now estimated to have been 1.3 1.4 percent (annualized). This is considerably lower than the 2.0 percent assumed in the EFRC’s June forecast.

Arun Raha, the ERFC’s Executive Director, remains guardedly optimistic: “We continue to believe that this soft-patch is transitory, and that economic activity will pick up in the second half of the year, absent a low probability high impact event.” I certainly hope he is correct. The large shortfall in Revenue Act collections is troubling, however. Seasonally-adjusted Revenue Act collections have now fallen for three consecutive months. And as to high impact events, a sovereign default in Europe is not that improbable.

A business perspective on recent legislative session

That's what I try offer in this commentary in Crosscut. Here's how I frame it.

Legislative post mortems generally report that business interests had a good session. That’s a fair but incomplete conclusion. The progress made this year in Olympia will improve Washington’s economic competitiveness. However, much more remains to be done.

Let’s look first at the accomplishments: Unemployment insurance tax relief, workers’ compensation changes to reduce costs, adjustments in employee compensation and pension reform to create a more sustainable budget, and expanded use of competitive contracting to increase productivity and create private sector jobs.

While collectively significant, in most cases these changes were incremental and modest.

The piece goes on to review some national competitiveness studies that assess how Washington fares against other states.

Please take a look at it and give me your thoughts.

Protecting state pension funds

Following up on Jay Inslee's proposal for the state to invest a small part of pension funds in start-up companies, Erik Smith examines the issue at Washington State Wire. We've been skeptical of the idea in the past. The simple, singular goal of the investment board is, well, Smith has a good quote from the board's executive director:

“I think oftentimes people confuse economic development with investing,” said director Theresa Whitmarsh. “Our primary duty is to invest at a prudent amount of risk, maximizing return at a prudent level, and so we are not in a position to take into consideration collateral benefits like economic development in our investment decision-making process.”

Makes sense. I'm quoted in the story. And while we're talking about pensions,Harvard economist Edward Glaeser has a great column on how to make state systems solvent in Bloomberg today. No, he doesn't recommend using them as venture capital.

Moving forward, the natural solution is to switch to defined-contribution 401(k)-style plans. The biggest virtue of these plans is that their cost is immediately obvious, which eliminates the hidden cost bias that pushes toward excessive pensions.

Washington, as we've noted previously, is in relatively good shape compared with many states. But the shift to DC plans makes sense here as well.

Washington wins some, falls some in competitiveness rankings

In my column in the Puget Sound Business Journal today (subscriber content), I comment on Washington's favorable ranking in a new study by the U.S. Chamber of Commerce.

Washington ranks 10th on its measure of entrepreneurship and innovation, scoring well on STEM (science, technology, engineering and mathematics) job concentration and job growth. Other high marks were awarded for export intensity, business taxes, family income, high-speed broadband, and educational attainment.

I quote study co-author Joel Kotkin.

Ultimately, there is only one route to sustainable state economies, and that is through broad-based economic growth,” he writes. “The road to that objective can vary by state, but the fundamental goal needs to be kept in mind if we wish to see a restoration of hope and American optimism…”

As we've written before, there's no single measure of economic competitiveness, which varies among industries and regions. Business costs remain high here. And the state fares poorly on the Economic Freedom Index created by the Mercatus Center.

KING 5 reports on our state's drop in the CNBC "best places" list released earlier this week.

Washington was one of the biggest losers in CNBC's annual study ranking the nation's top states for business.  The Evergreen State fell five places dropping to 20th in the rankings released on Tuesday. 

 

One of the biggest reasons the state dropped in the rankings revolves around Washington's low markings in its cost of doing business.  This category includes a company's tax burden, utility costs and costs of wages.  Washington ranks 43rd in this category.

The study is here. Unsurprisingly, the top 5 states include Virginia, Texas, North Carolina, Georgia, and Colorado. (Well, Colorado is a bit of a surprise.)

While Washington took steps this year that will help reduce business costs, it's important to remember that the landscape is not static. All states are working to improve the climate for economic growth. More work remains to be done.

Minnesota fails to reach budget accord; others wrap up on time.

Yesterday we noted that Minnesota, Oregon, Massachusetts, and Iowa had come to the last day of the fiscal year without an approved budget. All but Minnesota managed to get the job done. (h/t Stateline.org)

The Star Tribune reports on the Minnesota shutdown. It's a familiar face-off. Democratic Gov. Mark Dayton wants to raise taxes. Republicans don't.

Dayton largely won election on a promise to preserve cherished state services by increasing taxes on the richest 2 percent of Minnesotans. But Republicans won control of the Legislature for the first time in decades with a pledge not to raise taxes. The deep rift ignited a political fistfight that spilled past the regular legislative session in late May and dragged the state to the current precipice.

The Boston Globe reports on the Massachusets deal, leading with the collective bargaining news.

House and Senate negotiators reached agreement yesterday on a $30.6 billion state budget that will limit the collective bargaining rights of teachers, police officers, and firefighters in an effort to ease the cost of health insurance for cities and towns.

The Research Council counterpart in the Bay State likes it.

“This is a very constructive compromise which appears to strike a balance between the best of the House and Senate plans,’’ said Michael J. Widmer, president of the Massachusetts Taxpayers Foundation, a business-backed budget watchdog group. “Municipalities will save tens of millions of dollars, critical services and jobs will be protected, and municipal employees and retirees will continue to receive generous health benefits.’’

Iowa managed to close the budget gap, but property tax reform may prompt a special session, according to the Des Moines Register.

And the Oregonian reports a remarkably congenial conclusion to a productive, "business-like" session.

As the washboard economy bumps along, expect more down-to-the wire budget debates. The showdown between those who prefer tax hikes and expanded spending to preserve services and government jobs and those who want spending reform and tax relief to spur recovery will intensify.

Notably, while Wisconsin got the ink, Democratic governors in Massachusetts and New York have also stepped in to the politically-charged environment of collective bargaining reform.