KY Policy Blog

Is Another Budget Shortfall in the Works?

By Jason Bailey
November 10, 2014

One-third of the way through the budget calendar, the state is on track for a revenue shortfall if growth doesn’t pick up for the remainder of the year.

According to a state report released today, revenues grew only 1.9 percent in the period July through October compared to the year before. They need to grow by 3.6 percent on average for the whole year (and 4.4 percent for the last eight months) to meet the forecast that the budget is based on. However, a new forecast also released today in a separate report (forecast was made after the first quarter) says the state is expecting growth of only 2.1 percent for the year.

If that were to happen, the state would face a shortfall of $135 million.

The individual income tax, Kentucky’s largest source, performed well in the first four months with growth of 5.2 percent compared to the previous year. Sales taxes grew by a strong 4.1 percent. But gains in income and sales taxes were offset by weakness in other taxes, for which revenue fell by 2.8 percent in the first four months.

Among the weaker-performing taxes are the corporate income tax, which fell 24.1 percent, and the limited liability entity tax (another business tax), which fell 11.6 percent. Revenue from these taxes has been elevated in recent years because of strong corporate profits, setting the bar high for additional revenue growth. Corporate receipts have also been up because of the 2012 tax amnesty program and other measures that encouraged acceleration of tax payments. As the recovery continues and businesses begin to reinvest to replace aging equipment, that can reduce profit margins and therefore business’ taxable income.

Coal severance taxes, which fell 5.2 percent in the first four months, are dropping because of a decline in the market for eastern Kentucky coal that likely will continue. Cigarette taxes actually rose 0.2 percent for the first four months, which was unexpected and unlikely to persist. Property taxes are down by 5.5 percent because of timing issues with tax fillings, according to the state’s budget office, and have been weak in general in recent years because of the depressed housing market.

A bright point is that receipts for October grew much faster compared to the previous year than July through September’s receipts. However, revenues had declined in October 2013 by 0.4 percent compared to the year before that, meaning the hurdle for growth in October 2014 was easier to exceed.

Moving forward, the state’s economists note that “the national economic outlook remains filled with more questions than answers. In periods of great uncertainty, consumers and businesses exercise restraint and additional caution before making decisions that will affect current and future expectations. Until the fog of uncertainty is lifted, growth rates will remain muted.”

Indeed: while U. S. GDP grew at a higher rate than was expected this last quarter, many analysts don’t expect that to continue. Overall, the economy has been growing at steady but not fast rates.

And the economy is far from its full potential. Though jobs are expanding in Kentucky, the state is still over 70,000 jobs shy of getting back to the employment-to-population ratio it had before the recession hit. And wages have been stagnant for those with jobs.

The challenge of closing another shortfall

If the state ended up with another shortfall this year, that would be on top of the $91 million shortfall for the year that ended June 2014. To plug that budget hole, the governor took $50 million from various accounts across state government—ranging from the fund intended to clean up underground petroleum storage tanks to the Board of Nursing—withdrew $21 million from the already-eroding rainy day fund, made small cuts to some agencies and used $15 million that was budgeted but not spent.

Dealing with another shortfall would be tough because typical sources have been tapped so much already, including the rainy day fund and other reserves, transfers from various accounts in state government and budget cuts.

The additional withdrawal from the rainy day fund this summer reduces its balance to $77 million. Because of language put in the budget and because there was no surplus at the end of last year, the state will draw on the fund further if there are any unbudgeted expenses this year (known as necessary governmental expenses). And the rainy day fund is scheduled to have only $63 million by the end of 2016 because a portion is being used to balance next year’s budget. That puts it at just about half of the $122 million it had going into 2014, or only 0.6 percent of the 2016 budget—far less than the 10-15 percent experts say is needed to prepare for economic downturns.

The budget also assumes $81.7 million is carried-forward at the end of this year into 2016. Reducing that number further would create a hole in next year’s budget.

What’s more, the state is already using a lot of transfers from other accounts in state government to balance its current budget. The $50 million in additional transfers made this summer is on top of the $302 million in transfers included in the 2015-2016 budget. That’s much more than the $205 million in transfers used in the last two-year budget.

And many budget areas have already been slashed. The state has endured 14 rounds of budget cuts since 2008, and the most recent budget cuts many services by 5 percent, higher education by 1.5 percent and the state police by 2.5 percent.

A number of factors are contributing to slow revenue growth in the recovery, a situation made worse by the huge number of exemptions and loopholes in the state tax code that limit what revenue we can collect. While we all hope economic growth will pick up, we should be concerned that a sluggish economic recovery and eroding state tax system mean continuing budget woes.

 

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