Virginia Finances: Looking Forward

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Virginia Finances Looking Forward

• VAR Leadership Academy
• July 2007
• Wintergreen, Virginia
• John Petersen, Professor, School of Public
  Policy, George Mason University

2
Past and Future

• Lets look first at all states where they have
  been and are now heading.
• State spending has changed greatly in last
  half-century, but the basic revenue sources have
  stayed much the same (except that many bases of
  tax have been constricted).
• After looking at the past, I muse on the
  challenges of the next few years especially
  for Virginia.

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The Setting The Roaring 1990s

• The states, as the U.S. economy, had an amazing
  run in the 1990s
• What a deal! Tax rate cuts along with spending
  increases it worked!
• A philosophy took hold and drove the state fiscal
  agendas Smaller state government that cuts taxes
  and gets out of the way of private sector.
• Abiding faith in market-driven growth

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Early 2000s Sharp Reversal in State Fiscal
Fortunes

• In 2000, stock markets dropped, then economy
  slumped, and revenues fell
• Legacy of the 90s was increased elasticity in
  tax revenues
• Personal income taxes capital gains
• Sales tax narrowing the base
• Estate Tax a key target
• Corporate income tax diminished
• Fees charges fair game

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State Stresses in early 2000s

• In FY 2002, states had sharp revenue declines.
  State budget shortfalls reached 50 billion
  nationwide, about 1 billion in VA.
• Early steps to close budget deficits had many
  one-shots and cosmetic cures.
• By FY 2003, serious spending cuts started Higher
  education, welfare, local schools took spending
  cuts.

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Post 2003 Relief Recovery?

• After the depths of 2003, state revenues have
  climbed strongly.
• Recovery due to economic rebound rather than
  tax rate raising or tax base expansion.
• State tax collections up by 10 for 2004-05, now
  growing at 6.
• Spending growing at a bit slower rate. States
  have built reserves.

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Some History How States Have Financed Themselves

• The next few charts review changing state
  revenues structures
• The big revenue dip of the early 2000s
• How states have legislated tax changes over the
  past 20 years (changing the tax base or rates)
• Role of federal aid

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Composition of State Own Source Revenues
1950-2004
100
90

80
70
60
50
40
30
20
10
0
1950
1960
1970
1980
1990
2000
2004
Sales
Ind. Inc
Corp Inc
Gas Tax
Other
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Volatility of State Taxes

• Over time, states have squeezed tax bases and
  increased the rates on those restricted bases.
  Greater use of fees.
• Reliance on fewer taxpayers and transactions for
  most taxes. This has shifted systems to
  teeter-totter effect
• Small changes in economy have greater impact on
  revenues.

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State Tax Systems More Volatile
14
Volatile State Tax Revenues
15
Changes in State Spending

• Health care costs have come to dominate state
  budgets
• Education struggles for position
• Public support waning, NCLB quandaries
• Costs keep going up
• Higher education moves to a fee basis
• Transportation slips to the back of bus
• Pressure of costly public employees

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State Spending By Purpose Percentage
Composition 1950-2004
100
1/ Other includes

90
public safety, natural
resources, general
80
administration.
70
60
50
40
30
20
10
0
1950
1960
1970
1980
1990
2000
2004
Education
Soc. Serv.
Highways
Other 1/
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Health Care Medicaid

• A rapidly growing, persistent cost issue.
• High-cost Medicaid users are the disabled and
  elderly. Eats up about 25 percent of state
  general fund budgets.
• Rate of increase in Medicaid cost has been around
  10_at_yr and is projected to rise at 8_at_yr over the
  next 5 years.
• Rising employee and post-retirement health
  benefits GASB 45.

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Education Higher and Lower

• States are major financiers of public education.
  Big increase in state effort in the 1970s-1980s.
• Subsequently, other expenditures have pressed
  into educations share.
• Higher education took large hits in state budget
  cuts of early 2000s move to a user fee
  basis.
• Public schools and NCLB The Federal government
  de facto standards setter.

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Transportation

• Traditional state function, but highway spending
  has stagnated and state trust funds are waning.
• Federal Highway trust fund running down as
  maintenance takes most of funds. States borrowing
  against future.
• Opposition to gas tax increases.
• Privatization/tolling of roads appears to be
  coming fast. Passing off needed increases.

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Employee Pensions

• Funding public pensions is a continuing
  hangover from better times.
• Stock market downturn greatly reduced values of
  investments funds are only recovering some seven
  years later.
• Net result unfunded liabilities, which may
  lead to tax increases to pay.
• Employee pension benefits are usually legally
  protected cant be cut.
• Retiree Health Problem (OPEB Rule 45)

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Fiscal Meltdowns to Come?

• Built-in state deficits? Now, most states need
  good times to balance budget.
• States are stuck in the middle of the
  governmental system, with expensive programs
  health, education.
• Federal government in poor long-term condition.
  Its cure will reverberate.
• Over time, unavoidable large cuts in spending
  unless there is high growth.

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Remedies? No Easy Ones

• Federal payments represent about 32 of all state
  revenues and are now budgeted for only 1_at_yr
  growth in domestic spending over next decade.
• Pressure of entitlements on the Federal budget
  plus unknown defense needs.
• Volatile state revenues and decline in federal
  assistance spell continue shrinkage in spending
  for most states.

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And Where is Virginia?

• Great Advantage State economy is lightly
  burdened by taxes compared to the rest of the
  nation. Virginia ranks 48th in taxes as of
  personal income.
• State tax system is balanced among income,
  sales, charges, property taxes.
• Low reliance on Federal Aid, but
• Virginia has avoided damaging constitutional
  restrictions on taxes and spending. Flexibility
  remains.

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State and Local Revenues By Category as a
Percentage of Personal
Income Virginia and US State Average
25
20
15
10
5
0
Total State-Local
Federal Aid
Personal Income
Sales Tax
Corporate
Property Tax
Fees, Charges
Revenues (FY
Tax
Income Tax
2004)
Virginia
U.S.
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Virginias Challenge Diversify Economy ...
Integrate Regions

• States economy is a long-term challenge The
  overriding importance of Federal spending.
• Dependence on defense spending, especially No.
  Virginia and Tidewater.
• Problems of fast-growing outer suburbs and
  resuscitating older small cities.
• Extending growth along the states major
  transportation corridors.

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Motor Fuel Tax Mystery

• Virginia, despite growing transportation needs,
  has not increased its basic gas tax since 1986.
• At 17.5 cents/gal. gas tax ranks 40th in nation,
  below that of its neighbors.
• State allowed real motor tax receipts to erode.
  Total collections less in real terms than in
  1986, although miles traveled have gone up 80 per
  cent.

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Highway Revenues 1987 - 2007
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The Northern Virginia Problem

• High-income, urban area uncomfortably fitting
  with the rest of the state.
• New transportation authorities with taxing
  authority may lead to a de facto richer/poorer
  regional realignment.
• Foreshadowed by earlier actions and an
  intensified by political split. No tax belief
  versus service needs dilemma.

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Virginia Local Option Taxes

• Virginia does allow three regional authorities to
  levy an added local gas tax (2 of wholesale
  price).
• Transportation Act of 2007 extends the concept of
  regional taxes to regional transportation
  authorities.
• State is depending on surplus and higher fees and
  fines watch out!

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More Regional Government?

• Transportation Act State will spend surpluses
  and shift most program funding to local
  governments in Northern VA and Tidewater.
• Not a long term solution, state share will come
  apart at the next recession.
• Long-term More fiscal autonomy for growth areas
  and less redistribution through state taxes.

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Federal Role

• Federal governments fiscal posture is critical
  to Virginia, flowing out from NOVA and Tidewater
  to rest of state.
• Cutbacks in domestic spending hurt, but military
  procurement is the key.
• Long-term repairing of federal revenue/expenditure
  system will have large implications for all
  states.

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Federal Spending in Virginia, Northern Virginia
and US Average
(FY 2004) Dollars Per Capita
25000
Federal Defense Spending
19246
in Virginia is 4.5 times US
20000
per capita average . In
Northern Virginia, it is 9.2
times US average.
15000
12150
10594
10000
8651
7223
6985
6075
5166
5000
1148
0
Total
Defense
Non-Defense
Virginia
No. VA.
USA
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An Aging Virginia

• Demographics will be important.
• Virginia (like most America) is aging. State
  population will grow 38 between 2000 and 2030.
  But those over 65 grow by 134. Median age
  increases from 35.7 to 37.8 years.
• School age population will grow by 30 Most
  impact on outer suburbs in NOVA and Richmond
  area.

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Growing Senior-Related Spending 2007 2030
(state GF budget in billions)
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Senior-related Spending

• Because older population grows faster, as do
  prices for health care, this share of budget will
  rise the next 20 years.
• Under conservative assumptions, senior and
  disability costs will rise from 2.5 to about 12
  billion a year by 2030.
• This means increase from 15 now to about 25 of
  General Fund budget in 2030.

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Summing Up

• Virginia faces a host of challenges
• Regionalism and different needs/tastes
• Transportation Needs
• Reliance on Federal government
• Aging Population Needs
• Virginia, with strong and lean finances, has lots
  of running room. But state has been reluctant
  to use it.
• Need fiscal leadership (a difficult chore)

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End of Presentation

• Thanks for your interest
• John Petersen
• School of Pubic Policy
• George Mason University