PBPC REVENUE WATCH

The Commonwealth ended the fiscal year in a very strong revenue position, but there is mixed news behind the numbers. General Fund revenues were up by almost $1.6 billion, or 6.2%, over the previous year and ran $650 million, or 2.4%, ahead of estimates on the strength of personal income tax (PIT), corporate tax revenue, and a series of one-time, non-tax revenues. PIT ended 2006-07 3.0% over estimate and corporate taxes were 5.6% over estimate. However, revenues for several other key categories -- including sales tax and realty transfer tax in the General Fund, and fuel taxes in the Motor License Fund -- came in below estimate. For the year, Motor Fund revenues increased an anemic $25 million, or 1.1%, over 2005-06 collections and came in $32 million, or 1.4%, below estimate.

Adjusted for inflation, using the Consumer Price Index (CPI), General Fund collections increased by 3.5% and Motor Fund Collections decreased by 1.5%. While CPI measures changes in prices affecting households, it does not measure the types of goods and services that governments typically buy.(1) Personal income growth, which tracks overall economic activity, is a better yardstick against which to track state revenue and spending. In 2006-07, General Fund collections increased by 0.4% more than personal income during the same period and the Motor Fund revenues decreased by 3.4%.(2)

Under performing consumption-based taxes, such as sales tax and motor fuel taxes, indicate that consumer spending is not as robust as had been anticipated when the budget was created. Roughly one-third of General Fund and 55% of the Motor License Fund revenues are these consumption-based taxes.

A slow-down in spending could indicate a general slowing of the economy, which would make it difficult to reach revenue targets needed to fully-fund budgeted programs in 2007-08.

Expected Revenue Growth Significantly Lower for 2007-08

The Commonwealth-certified revenue estimate for the General Fund in 2007-08 is $27.8 billion, $311 million above actual revenues for 2006-07. This increase is 1.1% over actual 2006-07 collections in non-inflation adjusted dollars, and if these projections hold true, the General Fund will shrink in inflation-adjusted terms in 2007-08.

Actual collections for the first quarter of the 2007-08 fiscal year are running a scant 1.2% ahead of estimate, and both personal and corporate income tax receipts are lower than expected.

2006-07 Revenue Round-Up

General Fund Grows 6.2% From 2005-06

On a year-to-year basis, General Fund collections have steadily grown since 1991-92, with one exception, 2001-02. That year, the Commonwealth, like other states, collected less revenue than the previous year as a result of the national recession. Since 2002-03, the first year of the current administration, General Fund revenues have grown approximately 6% per year, closely mirroring the growth of personal income in Pennsylvania (Figure 3).

The Making of a Surplus

Revenue for 2006-07 exceeded estimates by $650 million, or 2.4% of the total estimated revenue of $26.8 billion.

When revenues run ahead of estimates in a given fiscal year, as the General Fund did in 2006-07, a revenue surplus is created. This means the Commonwealth has additional funds available to support health, education, transportation, libraries, and other state services. On the flip side, if revenues fall short of estimates; the state may be unable to meet its spending obligations. Just like a family, the Commonwealth can balance its budget by cutting spending on services or dipping into its savings -- the Budget Stabilization Reserve Fund (popularly known as the Rainy Day Fund).

Surpluses also permit greater savings for the future. Act 91 of 2002 requires that 25% of the ending budget surplus be transferred to the Rainy Day Fund. The $650 million surplus in 2006-07 provided almost $140 million to the Rainy Day Fund, bringing its balance to approximately $700 million. At 2.5% of general fund expenditures, the balance in the Rainy Day Fund is significantly below 15% --the level recommended by the Government Finance Officers Association.

Budget deficits and surpluses

The Making of a Surplus in 2006-07

Revenue growth in 2006-07 reflected the general strength of the economy, as the rising stock market in 2006 generated significant income from dividends and capital gains, and corporate profits were high, increasing by 13% nationally. (5) Strong growth in Personal Income Tax collections reflected gains in earnings, as Pennsylvania per capita personal income increased by 5.4% in 2006 and jobs, as Pennsylvania added 53,200 non-farm jobs -- a 0.9% increase -- between June 2006 and June 2007. (6) Although the increase in the state’s minimum wage effective January 1, 2007 contributed a small portion to higher-than-budgeted collections, it is likely that much of the tax collected came from higher-income taxpayers. (7)

The revenue surplus in 2006-07 is primarily from three sources: corporate tax collections, PIT, and miscellaneous non-tax revenue.

Two major categories of revenue – sales tax and other taxes -- failed to meet budget estimates in 2006-07. Sales tax fell short of estimate by $15 million, or 0.2% less than what was projected for 2006-07. Within other taxes, Realty Transfer Tax (RTT) and inheritance tax both collected slightly less than what was estimated at the beginning of the year. RTT, a tax that is collected when real estate is sold, was $41 million (6.7%) below estimate, reflecting the weakening of the housing market. Actual inheritance tax collections ended the fiscal year $22 million lower than projections (2.8%).

How each category of General Fund revenue performed in 2006-07 is summarized in Table 1 and Figure 5.

Other Funds

In its inaugural year, 2006-07, the State Gaming Fund collected $456 million. Over $200 million of this amount is to be transferred to the Property Tax Relief Fund.

The Lottery Fund collected $1.5 billion net of prizes, commissions, and expenses. This is a $39 million or 2.7% increase over receipts in 2005-06. Adjusting for inflation, collections in the two fiscal years are virtually equal.

2006-07 revenue collections in the Motor License Fund were $32 million (1.4%) less than estimate. Fuel tax collections increased $29 billion (2.4%) over 05-06 but fell behind estimates. Adjusting for inflation, 2006-07 fuel tax collections had less overall purchasing power (0.3%) than collections in 2005-06.

Revenue Growth Accerlates Over the Year

Expected Revenue Growth Significantly Lower for 2007-08

Some of the lower growth can be attributed to the earmarking of 4.4% of sales tax collections, approximately $390 million or 1.4% of the General Fund to the newly created Public Transportation Fund. Prior to 2007, less than one percent of sales tax revenues were designated for this purpose. When the $450 million “lease payment” from the Turnpike Commission is removed from the Motor Fund, that fund is expected to increase by a mere 0.7% in non-inflation adjusted terms.

The historical trend in collections of the General and Motor Funds, including estimated collections in 2007-08 can be seen in Figure 7.

Reasons for Concern

There are signs of vulnerability ahead. Troubles in the housing market could cause revenue from the realty transfer tax to fall further than expected and adversely affect collections from financial institutions. Decreasing consumer confidence and dropping housing values could lead to decreased spending – causing consumption taxes to dip. As sales slow for Pennsylvania businesses; profits, wages, and job growth decrease, further limiting corporate and personal income tax collections.

Pennsylvania is not alone in these worries. States such as Florida, Michigan, Maryland, Arizona, and Virginia are already dealing with collections not meeting expectations. (8)

Collections for the first quarter of the 2007-08 fiscal year are running a scant 1.2% ahead of revenues, and both personal and corporate income tax receipts are lower than expected. Overall, General Fund collections are up 2.5% from the prior year.

The revenue picture is particularly worrisome for transportation investments that are funded through fuel taxes and motor licensing fees, and, beginning in 2007-08, through a greater share of sales tax revenue. In 2006-07 sales tax growth slightly outpaced inflation, growing 0.4% in real terms. Over this same period, Motor Fund receipts decreased 1.6% when adjusted for inflation. Slower or negative growth in sales and motor fuel taxes over time, then, will undermine the transportation funding gains made in 2007.

Through the first quarter of 2007-08, Motor Fund receipts are $8 million lower than estimate (1.4%). As compared to the prior year, collections are down significantly -- $78 million (12%) due to a large deposit of liquid fuel taxes that occurred in July 2006 that was not anticipated in 2007.

At this early point in the fiscal year, it is difficult to determine how actual revenues will compare with estimates.

Expectations for 2007-08

The 1.1% projected increase in General Fund collections in 2007-08 over 2006-07 reflects expectations that the economy will slow and in part is due to the redirection of funding for transportation and other earmarked revenues.

Within the General Fund, tax collections are estimated to increase by $435 million or 1.6%, and non-tax collections are expected to decrease $124 million or 16.2%.

Corporate tax collections are estimated to decrease slightly, $32 million or 0.6%, as the continued CSFT rate phase-out and other business tax reductions more than offset predicted growth in CNIT and gross receipts tax in 2007-08. Sales tax revenues are projected to decline by $62 million or 0.7% from 2006-07 levels, Growth in the overall sales tax base is projected to increase over 3% in 2007-08, equaling or exceeding growth in 2006-07, but much of the additional revenue will be redirected to Public Transit Fund.

Personal Income Tax revenue is expected to grow a robust 4.8% from strong 2006-07 collections, indicating an expectation of strong business-related personal income. RTT is expected to decrease $136 million or 23.9% as the real estate market continues its downward trend.

Non-tax revenue in the General Fund is expected to decrease dramatically, $124 million or 16.2%, from 2006-07 collections, reflecting the lost of several one time payments in 2006-07.

Including the $450 million due from the Pennsylvania Turnpike Commission, 2007-08 Motor Fund collections are estimated to increase by $467 million or 20.4%. Existing Motor Fund revenue sources are expected to increase by $17 million or 0.7% of 2006-07 collections. Motor fuel taxes are expected to increase 1.5%, indicating a slight increase in demand for fuel in 2007-08. Licenses and fees are estimated to increase 2.3% over 2006-07.

Conclusions

General Fund revenue collections in 2006-07 were surprisingly robust, exceeding estimates by $650 million. This represents an increase of almost $1.6 billion from the previous fiscal year. The $650 million can be used in several ways -- to pay for unanticipated expenses incurred in 2006-07, to supplement 2007-08 programs, and to add to the Rainy Day Fund.

In order to provide similar levels of programs to help Pennsylvanians, revenues must be able to increase over time. Wage, healthcare, and general price increases, coupled with changes in federal assistance, necessitate a funding system that increases over time, at a rate greater than the overall rate of inflation. In 2006-07, revenues met these growing needs.

However, clouds on the economic horizon -- the troubled housing market, wage stagnation, decreased access to credit, and fears of inflation -- could suppress General Fund collections in 2007-08. In the new fiscal year, a significantly larger portion of sales tax collections will be used to help fund transportation initiatives. This tax has been relatively flat in terms of growth and can be particularly sensitive to changes in discretionary spending. Corporate profits have been rising, but are notoriously volatile. Particularly in light of Pennsylvania’s porous corporate income tax system, growth of CNIT collections could be less than anticipated. In terms of revenue collections, 2007-08 could be an interesting year.

Endnotes

1. See David Bradley, Nicholas Johnson, and Iris Law, The Flawed “Population Plus Inflation” Formula, Why TABOR’s Growth Formula Doesn’t Work,” Center of Budget and Policy Priorities, Washington, DC, January 13, 2005.

2. In Fiscal Year 2006-07, Personal Income in Pennsylvania increased by 5.8%. Over this same period, the CPI increased by 2.6%.

3. Budgetary figures, as well as many of the figures in this document, are not adjusted for inflation unless otherwise noted. If budgeted amounts do not increase from year to year, the real ability to pay wages and purchase goods and services decreases.

4. These include interest income and income from the collection and disbursement of unclaimed property by the Pennsylvania Treasury, an increased transfer of profits from the state liquor stores and the repayment of the General Fund for expenses incurred by the Gaming Control Board.

5. US Bureau of Economic Analysis, Table 16.6D. Corporate Profits by Industry. (downloaded 8/21/07).

6. 2006 per capita personal income data from the US Bureau of Economic Analysis, State BEARFACTS 1996-2006: Pennsylvania (downloaded 9/25/07) <http://www.bea.gov/regional/bearfacts/stateaction.cfm?fips=42000&yearin=2006>. Employment data from the US Bureau of Labor Statistics, “State and Areas Employment, Hours, and Earnings”, Seasonally adjusted non-farm employment, Series ID SMS4200000000000001 (downloaded 9/21/07).

7. Analysis of Pennsylvania PIT collections by income group indicates that between 2001 and 2005, three-fourths of the growth in taxable income accrued to taxpayers with incomes greater than $150,000. It is likely this trend continued in 2006. For a more thorough analysis of recent trends in income in Pennsylvania, please see the Keystone Research Center’s State of Working Pennsylvania 2007, available online at: <http://www.stateofworkingpa.com/index.html>.

8. Pamela Prah, “State budgets tenuous heading into ‘08”, Stateline.org, October 10, 2007.

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2006-07 Round-Up and a First Look at 2007-08

Strong 2006-07 General Fund Revenue Growth, But Trouble Looms Ahead

Expected Revenue Growth Significantly Lower for 2007-08

2006-07 Revenue Round-Up

General Fund Grows 6.2% From 2005-06

The Making of a Surplus

Budget deficits and surpluses

The Making of a Surplus in 2006-07

Other Funds

Revenue Growth Accerlates Over the Year

Expected Revenue Growth Significantly Lower for 2007-08

Reasons for Concern

Expectations for 2007-08

Conclusions

Endnotes