Budget Task Force Finds $2.33 Billion Deficit

January 16, 2015 by Wolf Transition Press

York, PA - Governor-elect Tom Wolf's Transition Budget Deficit and Fiscal Stabilization Task Force today released the key findings from their review of the depth of Pennsylvania's budget deficit.

"After analyzing the budget documents and meeting with both the Independent Fiscal Office and the Office of the Budget, the Task Force projects that the budget shortfall will be $2.33 billion in 2015-16 and could grow to as much as $2.8 billion in 2016-17."

Below is a copy of the full key findings memo.

Budget Deficit and Fiscal Stabilization Task Force

Governor-elect Tom Wolf asked a team of Pennsylvania leaders to serve on a Budget Deficit and Fiscal Stabilization Task Force. He asked Task Force members to use their expertise to determine the scope of the fiscal challenges facing Pennsylvania and begin discussions about how to get Pennsylvania's fiscal house in order. The first task was to review revenues and expenditures to determine the size of the projected budget deficit.

Structural Budget Deficit

The Current Fiscal Situation

The Commonwealth faces a major budget challenge in 2015 and going forward. The state budget is deeply out of balance. Recurring revenues are growing at a slower rate than expenditures, and this trend has been further exacerbated by the use of one-time revenues and accounting measures.

Under existing law and policy and current economic conditions, the state's base revenue growth is lower than its base spending growth. Yet there is a critical need for increased state investment in key service areas like education, environmental protection, and economic development.

The budget situation has also created cash flow concerns. Earlier this fall, Treasury provided a $1.5 billion line of credit to meet the cash flow needs for General Fund expenditures. The last time the General Fund needed a transfer of this amount, this early, was in 1991.

Meanwhile, there is only $231,000 in the Rainy Day Fund. Moody's, the credit rating agency, took note of this in their recent downgrade of Pennsylvania's credit rating. While some have misleadingly suggested that the downgrade is the result of excessive debt issuance by the Commonwealth to support state capital projects, in reality Moody's cited a structural imbalance in the General Fund and the lack of reserves. Moody's also cited:

  • The lack of reserves, like a Rainy Day Fund.
  • Growing unfunded pension liabilities. Act 120 has put into place a gradual increase in employer contributions. Pennsylvania will return to its full actuarially required payment to its two state pensions systems in roughly two more years.
  • Demographic trends that limit long-term prospects given the age and slow growth of the state's population.

Pennsylvania's relative debt burden is roughly in the middle of the pack compared with the other forty-nine states when measured by debt per capita, or as a portion of personal income or a portion of Gross State Domestic Product (GSP). However, its credit rating has declined and continued failure to address the underlying structural budget issues cited by the ratings agencies may lead to increased borrowing costs compared to many other states. According to a recent Wall Street Journal article, our credit rating is 47th when compared to other states.

The business tax cuts of the last four years have been one of the reasons Pennsylvania's underlying state tax base has been painfully slow to return to normal pre-recession levels. In 1994, taxes levied directly on businesses accounted for more than 25 percent of total state General Fund tax collections. Soon that percentage will drop below 15 percent. The resumed phase-out of the Capital Stock and Franchise Tax has greatly exacerbated the Commonwealth's structural deficit. Other contributing tax cuts include: the single sales factor apportionment, increases in Net Operating Loss caps, and growth in tax credit and tax exemption. In 2013-14, taxes levied directly on businesses actually declined for the first time in a recovering economy, an extraordinary event.

Rather than addressing the structural deficit realistically, and even though deep and unprecedented cuts were made in many appropriations, the Corbett administration still increased reliance on unsustainable revenue sources and temporary expenditure deferrals as a means to balance the 2014-15 budget. It appears that no potential source was spared, to the point where even Special Funds are facing future deficits that will need to be made up from the General Fund.

At the same time, many of the services the Commonwealth supports are related to health care, where annual cost escalation is always much higher than the general rate of inflation. Even in other major expenditure areas, like education, inflationary pressures typically require higher annual spending levels to support the same level of service delivery. Therefore, declines in state spending, or even zero growth in state spending, almost necessarily mean reductions in services and in the number of service recipients supported by state-funded governments, agencies, and institutions.

The 2015-16 Budget and the Structural Deficit

A structural deficit is the share of Pennsylvania's budget deficit that is not the result of changes in the economy (natural revenue growth or contraction, for example). It is a shortfall that will exist even if the economy returns to its peak cycle. And, ongoing mandated annual expenditures, under current law and policy, exceed ongoing sustainable levels of annual income.

More than a year ago, the Independent Fiscal Office (IFO) first projected a structural budget deficit of $1.2 billion in 2014-15 growing to $2 billion annually by 2018-19.

This past November, the Independent Fiscal Office (IFO) increased its deficit projection to $1.85 billion in 2015-16, growing to $2.5 billion annually by 2018-19. Their analysis was based on preliminary budget information and assumed only $1.55 billion in one-time measures budget balancing measures were used in 2014-15. According to the IFO, a return to normal growth will not solve the problem - even if we had positive job grow for each of the next five years we would still have a deficit.

In December 2014, the Task Force met with both the Independent Fiscal Office and the staff of the Office of the Budget and learned from the Budget Office that the unsustainable measures used to balance the 2014-15 budget totaled $2 billion, not $1.55 billion. They also learned from the Budget Office that in 2015-16 mandated costs are expected to increase by $1.8 billion and that a number of one-time revenues assumed in balancing the 2014-15 budget are not expected to materialize. In addition, they learned that several agencies will require supplemental appropriations to cover unanticipated costs. All of these factors have an impact on the projected deficit.

Unsustainable Budget Gap Closers in the 2014-15 General Fund Budget

According to the Budget Office, the 2014-15 General Fund budget is built on more than $2 billion in unsustainable and unrealistic revenues or spending offsets, most of which will not recur in 2015-16. The $2 billion number is $450 million more than the Independent Fiscal Office had assumed in one-time measures in their November projection.

An example of a one-time measure is the use of Special Funds to supplement programs normally funded out of the General Fund. For example, the budget transferred significant Department of Human Services spending to the Lottery Fund and the Tobacco Settlement Fund. Using Special Funds like these to balance the General Fund Budget puts at risk the programs that have traditionally been supported by these Special Funds and calls into question whether the funding demands put on these Special Funds are sustainable.

2014-15 One-Time Gap Closers

General Fund Projection – Fiscal Years 2014-15 to 2016-17

After analyzing the budget documents and meeting with both the Independent Fiscal Office and the Office of the Budget, the Task Force projects that the budget shortfall will be $2.33 billion in 2015-16 and could grow to as much as $2.8 billion in 2016-17. This projection is based on a “cost-to-carry” budget that only takes into consideration mandatory cost increases and assumes current law.

Consistent with the IFO, the projection assumes that recurring base tax and fee revenues grow by 3 percent, but total revenue growth is only 1 percent as a result of the loss of one-time revenues used to balance the budget in 2014-15.

This projection assumes that the cost of expenditures grows by only 2.4 percent, but again the General Fund has to make up for the impact of the one-time transfers and spending delays used in 2014-15. The General Fund expenditures have to grow by 5.4 percent over the current year to make up for the one-time measures used to reduce spending in 2014-15.

The only assumptions for increased spending are for major mandatory programs including Debt Service, Corrections, School Pensions, and Human Services. These mandated General Fund expenses are projected to grow by $1.8 billion according to the Office of the Budget Projections:

  • Debt Service - $112 million
  • Corrections - $215 million
  • School Pension Appropriation - $592 million
  • Human Services - $910 million

Once again, if not for the one-time measures used to reduce General Fund expenditures in 2014-15 for pensions and Human Services, the increase for mandated costs would have been $897 million less than the projected $1.8 billion.

The General Fund cost-to-carry projection does not account for increases in expenditures for other services and grant programs that, in many cases, are in desperate need of increased funding, like K-12 education or general government operations that will have to absorb benefit cost increases, and it does not include funding for any new state programs or initiatives.

Key Differences between Task Force projection and the IFO Cost-to-Carry Five Year Forecast

Fiscal Year 2014-15

  • $26 million – consistent with updated Budget Office projections, an increase over the IFO in the amount allocated for refund reserves.
  • $191 million – net downward revenue adjustment compared with the IFO to account for both one-time revenues that are not expected to be received and for increased revenues.
  • No lapses of current or prior year funds are assumed, IFO had assumed $75 million.
  • $213 million -- assumed "supplemental appropriations/adjustment" to correct for potential inadequate funding levels for some mandated services in the enacted 2014-15 budget listed below:
  • $55 million (Corrections) - projected mid-year increase to provide contractual salary increase not factored into the 2014-15 budget.
  • $11.6 million (State Police) - projected mid-year budget increase to pay for the Frein manhunt.
  • $12 million for school district formula grants.
  • $134.8 million (DHS) - funding shortfall projected in the DHS re-budget request.

Fiscal Year 2015-16

  • $56 million increase in refund reserves based on projections in the 2013-14 Comprehensive Annual Financial Report.
  • No lapses of current or prior year funds are assumed; IFO had assumed $75 million.

Fiscal Year 2016-17

Pennsylvania currently levies a Gross Receipts Tax (GRT) on Medicaid Managed Care Organizations that saves the state approximately $600 million on an annualized basis. This tax is used to draw down federal funds and to reduce the need to spend state General Fund dollars for the Medical Assistance managed care program (Health Choices). The Centers for Medicare and Medicaid Services (CMS) has issued a letter to states regarding taxes similar to Pennsylvania's GRT stating that such taxes are inconsistent with applicable federal statutory and regulatory requirements. States have until the end of "their next regular legislative session" to make the necessary changes. That means that the GRT tax needs to be replaced before November 30, 2016. Unless an alternative funding source is found to replace the existing GRT, there will be a need for additional state General Funds to support the Medical Assistance Managed Care program beginning with 2016-17 in order to avoid significant program cuts.

Next Steps

It's clear that we need significant action to get Pennsylvania back on track. The decisions made in constructing the 2015-16 General Fund Budget will "set the stage" for balanced budgets for the years that follow.

It is important for Governor-elect Wolf to immediately identify any possible cost savings in the current year and proposed budget. Unfortunately, given the depth of cuts that have been made over the last few years, there are no easy solutions. The Task Force urges the Governor-elect to direct his Budget Secretary to work with the others in his cabinet to take immediate actions to find cost savings.

Governor-elect Wolf is developing policy proposals to tackle these long-term problems and transform operations to be more effective and productive. The Task Force believes all policymakers must send a clear message that everyone needs to work together to fix a system that is stretched to the breaking point. This fiscal crisis presents significant challenges, but it is an opportunity to transform the way the Commonwealth operates with a comprehensive plan that will endure and stabilize the Commonwealth's finances for the long term.