State Fiscal Forum: Assessing the Fiscal Environment

in the Midwest and the NationFederal Reserve Bank of Chicago and the National Tax Association

November 12, 2003

By Randy BauerBudget Director

State of Iowa

“Before you go any further, let me reiterate that I, for one, see nothing wrong with killing the messenger.”

Source: Business Law Today, March/April 1998

Is There Something Different About the Current Budget Cycle?

• More rapid change in revenue performance

• Deeper descent

• Less bounce in the revenue rebound

Rapid Change, Bigger Drop

State Tax Rev enue Has Fallen Far More Sharply Relativ e to Ec onomyThan in 1980-82 and 1990-91 Rec es s ions

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

State F is cal Y ear

Sources : U .S. Bureau of Ec onom ic Analy s is , U .S. Bureau of the C ens us , Signif ic ant Features of Fis cal Federalism -1984 (AC IR ), Fis c al Survey of the States (N GA), R oc kef eller Ins t itute of Gov ernm ent

-8

-6

-4

-2

0

2

4

6

% C

hang

e

R eal GD P per capita, c alendar y ear in whic h f is c al y ear began R eal s tate tax rev enue per capita, adjus ted f or legis lat ion

-7.4

-2.0

-3.0-3.5

-1.8

-0.7

Source: Rockefeller Institute of Government, SUNY

Iowa: No Revenue ReboundIowa General Fund Revenue Growth

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

Fiscal Year

Perc

en

tag

e C

han

ge

Red – Recession

Green – Expansion

Dark Green – Expansion & Tax Increase

Yellow – Expansion and Tax Cut

Mean +5.6%

Source: Iowa Department of Management

Is Revenue Sufficient to Meet Program Needs?

• Not according to previous history

• Eight successive quarters of no growth (adjusted for tax changes)

• States are enacting tax increases, but Iowa has not

State and Local Taxes: Out of Sync With GDP

(Percent change)

Source: Global Insight, Inc.

Eight Successive Quarters of Negative Revenue Growth

State Tax Revenue Adjusted for Legislation and InflationFour-Quarter Moving Average, Indexed to 1994

100

105

110

115

120

125

1994

=100

Source: Rockefeller Institute on Government, SUNY

Iowa’s Price of Government is Falling

Source: Iowa Department of Management

FY03 state taxes: 6.1% of income - lowest in 33 yearsFY02 state and local taxes: 10.5% - lowest in 17 years

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

FY

72

FY

74

FY

76

FY

78

FY

80

FY

82

FY

84

FY

86

FY

88

FY

90

FY

92

FY

94

FY

96

FY

98

FY

00

FY

02

Iowa tax price ofgovernment: taxes,licenses & permitsas % of personalincome State taxes andfees only

Local taxes andfees only

States are Raising Taxes

Source: NASBO, NCSL

Enacted State Revenue Changes

-10

-5

0

5

10

15

20

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Fiscal Year

Bill

ion

s o

f D

olla

rs

Deficits – Structural or Cyclical?

• Magnitude of budget gaps suggests it’s structural

• Problems persist two years after end of recession ………..

• Tax law changes reduce the size of the -----normal bounce back• Demographics may be more of a factor

A Remarkable Change

• 2000: “How long can the good times roll?” (S&P)

• 2002: “State budgets are .under siege” (NASBO)

• “Nearly every state is in .fiscal crisis” (NCSL)

–$71 billion FY 03 deficit–$78 billion FY 04 shortfall–$200 billion 4-year gap

(Source: NCSL State Budget and Tax Actions 2003)

Midwest Slow to Recover?

Source: Standard and Poor’s

How to Protect Revenues and Programs from Volatility?

• Devise tax structures with more reliability, predictability, and sufficiency– Sales tax in an e-commerce and services

economy– Corporate income tax: a ‘voluntary’ tax?– Squeezing counter-cyclical taxes

• Nothing safe in budget firestorms – need reserves as insurance

Personal Income Outpacing Sales Tax Collections

Iowa Sales Tax per $1,000 Personal Income

$19$20

$21$22$23

$24$25

$26$27

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

Fiscal Year

Sal

es T

ax D

olla

rs P

er

$1,0

00 P

erso

nal I

ncom

e

Source: Iowa Department of Revenue

Corporate Income Taxes’ Declining Share

Corporate Income Tax Share of All State Taxes

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

1975 1980 1985 1990 1995 2000Fiscal Year

Source: Dr. Peter Fisher, University of Iowa 1975-2000; 2001-2002 data from Tax Policy Center

Estimated Loss of State Corporate Income Tax Attributable to Tax Sheltering, FY 2001

$0

$100

$200

$300

$400

$500

$600

$700

$800

IA MO WI MI MN IN OH IL

Mill

ions

of D

olla

rs

0%

10%

20%

30%

40%

50%

60%

70%

80%

Loss

as

a Pe

rcen

t of R

even

ue

National Average: -29.3%

Source: State Policy Reports, Multistate Tax Commission

Decline of Counter-cyclical Taxes

Source: Iowa Department of Management

Iowa Real Inheritance and Cigarette Tax Collections (in millions)

$20

$30

$40

$50

$60

$70

$80

$90

$100

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Fiscal Year

Tax

Co

llect

ion

s Cigarette Tax

Inheritance Tax

Additional Replacement of Property Taxes with General Fund Revenues

$0

$50

$100

$150

$200

$250

$300

1996 1997 1998 1999 2000 2001 2002 2003 2004

Fiscal Year

Am

ou

nt i

n M

illio

ns

0%

1%

2%

3%

4%

5%

6%

7%

Per

cen

t of G

ener

al F

un

d

Iowa Budget Cuts Reverse Course on Property Tax Replacement

Source: Iowa Department of Management

1990s Expenditure Growth in Key Areas

Nine of Ten New State Dollars Went to Education, Health, and Corrections

K-12 Education41%

Higher Education7%

Medicaid 32%

Corrections12%

All Other8%

Source: Center for Budget and Policy Priorities

States Put the Brakes on Budget Increases

Source: NASBO

Percent Nominal Budget Change

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

1996 1997 1998 1999 2000 2001 2002 2003 2004

Fiscal Year

Per

cent

Cha

nge IOWA

ALL STATES

Do the States Have the Tools to Manage their Budgets?

• State credit ratings would suggest they do

• Generally greater financial attention than 20 years ago

• Tax/expenditure limits can lessen flexibility

• The issue may have more to do with politics …than budgets

States Built, Rapidly Depleted Reserves

0%

2%

4%

6%

8%

10%

12%

Ba

lan

ce

Pe

rce

nt

of

Ex

pe

nd

itu

res

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Fiscal Year

Source: NASBO

Source: NCSL, 1999

Half of States Have Tax and/or Expenditure Limits

A Problem with TELs – Required State Costs Can Outstrip CPI

Several Factors Motivating Use of Debt

• 9.7% of state and local revenue in 2002– Borrowed $127 billion more than repaid– 3 ½ times the level of 1999

• Borrowed $224 billion during FY 2003

• “Perfect Storm” - Historic low interest rates- Historic late-FY shortfalls- Election year distaste for tax …increases- Keynesian approach to the recession

Political Will: Revenue Accelerations

• Six states utilizing revenue accelerations in their FY 2004 budget?

• Georgia, Illinois, Kansas, Maryland, Minnesota, Oklahoma

• .Six states with new Governors, party affiliation …switched hands, and ‘I won’t raise taxes’ …campaign promises.• Georgia, Illinois, Kansas, Maryland, Minnesota, …Oklahoma