PBPC Budget Watch

Historic Education and Health Care Reforms Remain Bargaining Chips in Budget Negotiations

The calendar is closing in on June 30, the end of the 2007-08 fiscal year with legislators and the Governor furiously trying to reach agreement on a spending plan for 2008-09.

In February, the Governor proposed to increase General Fund spending by 4.2% to $28.3 billion. Major initiatives included:

• Adding $290 million or 5.9% to basic education funding as a first step in helping local school districts achieve adequacy for all students, increasing state funding for Medical Assistance (which provides health care services to the poor, elderly, and disabled populations) to address increased enrollment and rising health care costs.
  
  
• Funding for new programs needed to implement the Governor's "Prescription for Pennsylvania" --a health care market reform initiative to reduce health care costs in Pennsylvania and the provide health insurance coverage to 292,000 uninsured Pennsylvanians.
  
  
• A stimulus package that included accelerating infrastructure improvements and one-time rebates for people who receive Tax Forgiveness in an attempt to soften the impact of the national economic downturn.

On the revenue side of the General Fund budget, only one major change -- temporarily slowing the phase-out of the Capital Stock and Franchise tax in 2009. The reduction of the rate to 2.49 mills from the scheduled 1.89 mills is projected to increase tax collections by $40 million in 2008-09.

Stimulus and response

A lot has -- and hasn't -- happened since February. The Legislature failed to act on the Governor's rebate proposal and so he dropped it. The Senate has developed a plan to invest $850 million in local water and sewer infrastructure to counter the Governor's multi-year bridge infrastructure plan and the two sides are negotiating an agreement. Mass transit funding, which was hammered out in the 2007-08 budget was again made uncertain by the Governor's solicitation of bids to lease the Pennsylvania Turnpike. Then there is the economy. . . but more on that in a bit.

The Democratically controlled House took the Governor's plan and added $149 million in additional state General Fund spending, bringing the General Fund to $28.4 billion. Much of the $149 million is used to restore funding to programs in the Department of Community and Economic Development (DCED) that are popular with legislators and supplementing Medical Assistance funding. Under the House proposal, the General Fund would increase by 4.7% from available 2007-08 amounts.

The Republican Senate created its own spending plan, totaling $27.9 billion in the General Fund, representing a $720 million, or 2.6%, increase from funds available in 2007-08. The Senate plan reduced the DCED budget by an additional $115 million from the Governor's proposal. In the Department of Education, the Governor's plan to increase basic education spending was cut by $118 million and funding for the "Classrooms of the Future" initiative was halved to $45 million. Medical Assistance funding was reduced back roughly to the amounts originally proposed by the Governor and funding for implementing the Prescription for Pennsylvania health care initiative were sharply reduced. Finally, funding to modernize and operate the Department of Revenue was cut by 11.5% (or $24 million) from the Governor's request.

For a Department by Department comparison of the three plans, click here.

For a summary of major differences between House and Senate budgets click here.

While the House passed a bill that would provide health insurance to 88,000 uninsured adults in 2008-09, the Senate has not acted on the bill, and has introduced a plan of its own. Both Houses want to use a piece of the surplus funds in the MCARE program (a fund set up by the state to help medical professionals settle malpractice claims); the House would tap a half of the estimated $500 million surplus in the Provider Retention account, the Senate would take unspent funds directly from the MCARE program. Neither House has adopted the cigarette tax changes needed to implement the adult health insurance program this fall.

So the negotiation between the Houses and the Governor go on . . .

Show Me the Money.

A big question in negotiations is how much money will be available -- in light of the stumbling economy. This question has two facets, the amount of money left over from the current fiscal year (2007-08) and the amount that can reasonably be expected to be collected in 2008-09.

When the 2008-09 Governor's budget was released, the Budget Office projected 2007-08 revenue surplus of $136 million that could be used to help pay for programs in the next fiscal year. Through May, 2007-08 General Fund revenue collections were $294 million over estimate -- exceeding expectations at mid-year. Troubling though is the fact that collections failed to meet estimate in two of the last three months. June is traditionally one of the larger months of collection as many quarterly corporate and personal income tax estimated payments are due. These payments are critical as bellwethers for the state of the economy as businesses are paying based on what they think they will earn over the course of the year. If tax collections in June are close to estimate, the Commonwealth will have more funding than anticipated going into 2008-09 --which is good. If collections fall, the state could lose much of the revenue surplus it accumulated through May.

Projecting collections is not an exact science, particularly when the economy is in flux. While each recession is different in terms of the causes and their effects on Pennsylvania, history shows us that tax collections in the years immediately following a recession often fall from prior levels and take years to recover -- even after the economy has moved forward. None of the plans put forward in the 2008-09 negotiations include general tax increases. However, if the economy is slowing down rather than sinking, revenue collections are likely to stagnate, but not fall precipitously.

On top of this uncertainty, both Houses are offering plans to provide tax cuts for certain businesses. The Senate is touting their tax cut plan as "real stimulus" for the economy. Their plan aims to shift Corporate Net Income Taxes to non-PA based corporations by, increase the amount of accumulated losses corporations can use to reduce taxable income, increase the amount of equipment small business owners can write-off each year, and as an olive branch to lawmakers worried about low-income families -- increase the eligibility levels of taxpayers and their dependents for the state's low-income Tax Forgiveness program. While the projected costs in 2008-09 are relatively small ($96 million), they jump to $246 million by 2010-11 and go from there, as they are permanent.

The House crafted its own, similar tax cut plan. In this plan, the benefit per child in the Tax Forgiveness program is increased aiding families with children more than the Senate plan. Like the Senate plan, the House plan attempts to shift more of the Corporate Net Income Tax to non-PA based companies and allow companies to use more accumulated losses to offset income, but at different levels than the Senate plan. The House plan adds a new employment tax credit to the mix and increases two existing business tax credits.

For a summary of revenue collections for 2007-08 click here.

If revised revenue projections for 2008-09 reflect that PA has entered into a recession and tax collections are likely to fall, some combination of two things must happen. Revenues need to be increased through tax increases or expenditures need to be reduced through program cuts. The state is required to pass a balanced budget -- meaning spending plans cannot exceed estimated collections in a single fiscal year. In times of hardship, the state can tap its Rainy Day Fund, which currently contains approximately $740 million, to help balance the books. While this sounds like a lot, the last recession wiped out more than $1.1 billion in reserve funds when taxes were not raised enough to cover spending.

For a summary of Rainy Day Fund balances click here.

The clouds are gray, but does the forecast call for rain? The Governor and legislative leaders have their eyes on door number 3: using a portion of the Rainy Day Fund to balance next year's budget. Is this a good solution?

One thing is clear: tax cuts are the wrong solution for the coming economy, draining revenue at a time when collections are already shaky, and they contribute little to the struggling economy. (See PBPC analysis of the Senate Stimulus plan.) At a cost of $100 million, the Tax Forgiveness program expansion should be considered when times are better.

Economists have found that public sector spending can be a highly effective way to stabilize the economy and help individuals most adversely affected by the economic downturn.

State government spending didn't cause the recession and cutting spending won't solve it. Smart decisions and continuing investments can help keep the boats afloat on stormy seas.

So . . . tapping the Rainy Day Fund can be a prudent approach, but it has risks associated with it. If the economy sputters but doesn't crash, this wait and see approach, using the funds to maintain program spending, could be a prudent decision. If the downturn is more severe and the economy does not recover in the coming year, the Rainy Day Fund could be drained and the situation faced in 2009-10 could be significantly worse.