Kentucky ended its 2014 budget year on June 30, and we will soon hear a final tally on the size of the state’s revenue shortfall. This spring, officials had predicted a shortfall of $27.7 million. But worse-than-expected receipts in April and May led the state budget director to announce last month that a “significantly larger shortfall” is likely. If the revenue growth rate for the year equals the 1.1 percent rate for the first 11 months, the shortfall would be closer to $100 million.
What that ultimately means for Kentucky’s budget also depends on how the spending side of the budget turns out, including the impact of any cost overruns that are allowed but not budgeted as well as what amount, if any, agencies spent under what was budgeted.
But if a deficit does result, Kentucky will find it especially difficult to craft an easy solution because of past budget decisions. Inadequate revenues and an unwillingness to address tax reform have meant a lean budget whose holes are plugged using a variety of extraordinary measures. Among the challenges are the following:
New budget depends on $80 million carrying forward
The original 2014 state budget as enacted assumed no budget balance at the end of 2014. When the General Assembly met in the 2014 session to craft a new budget for the next two years, it revised the 2014 budget to assume an $80 million balance at the end of the year (in part because of expected revenues higher than originally estimated and reductions in appropriations). The new budget then spends that money so that 2016 ends with a balance of $0. A revenue shortfall this year could threaten that $80 million, meaning the General Assembly would have to make up those funds through faster revenue growth or additional cuts in the next two years.
Kentucky’s rainy day fund has already been tapped, and is small
One option for the state to deal with the revenue shortfall would be to tap the state’s Budget Reserve Trust Fund (known as the “rainy day fund”), which is intended to help bridge the gap in hard times, particularly recessions. However, the budget already substantially draws from the rainy day fund even though Kentucky’s economy is in recovery. The rainy day fund had a balance of $122 million going into 2014, but will stand at only $85 million at the end of 2016, a decline of $37 million or 30 percent in just three years. At less than 1 percent of the state budget, it has far less than experts say is needed to help states prepare for economic downturns. While now is not the time to prioritize replenishing the fund given the state’s ongoing revenue challenges, continuing to deplete the fund creates future vulnerabilities.
The budget has been cut dramatically
State services have endured 14 rounds of budget cuts since 2008, and many areas have been cut 15 to 40 percent or more. The most recent budget cuts many services by 5 percent, higher education by 1.5 percent and state police by 2.5 percent. Even most of those areas that got additional monies, like K-12 education and raises for state workers and teachers, received just enough to keep up with inflation the next two years but not enough to gain back ground that was lost from the recession.
Fund transfers are already substantial
The new budget is balanced with $302 million over two years in transfers to the General Fund from restricted funds—monies intended for other purposes in state government. That’s more than the $201 million in transfers used in the last two-year budget. Among the transfers are $93 million from the public employees’ health insurance fund and $11 million out of the lottery as well as money from licensing boards, land conservation and petroleum storage tank clean-up. It’s unclear what—if any—other restricted funds are available to address the new budget shortfall, but if utilized they will impact those funds’ intended uses.
Revenue growth for new budget will need to be stronger than expected
A revenue shortfall in 2014 would hit the 2015 and 2016 budgets in another way—it would mean the state needs stronger revenue growth for the next two years than was expected when the forecast was created. That’s because the base upon which those forecasts were made is lower than originally estimated. For example, if General Fund revenue growth for 2014 is 1.1 percent for the year rather than the 2.2 percent that was projected, that means growth for 2015 would need to be 3.7 percent rather than the 2.6 percent that was projected in order to catch up. If that growth didn’t happen, more budget cuts would need to be made or resources would have to be found.