THE 2009 AND 2010 MISSOURI BUDGET OUTLOOKJames R. Moody & Associates

September 3, 2008

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SPECIAL THANKS

Senate Appropriations Staff House Appropriations Staff Missouri Office of Budget and Planning Staff Missouri Department of Economic

Development Staff

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WHOSE VIEW IS CORRECT ON THE MISSOURI BUDGET?

Governor Blunt—Largest budget surplus ever Missouri Budget Project—We are about to fall

off of the cliff The View of Many Legislators—Expenditures

above revenues on a consistent basis, Do we have a structural deficit?

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THE ANSWER

A little bit of all three

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THE SURPLUS Missouri ends each year with a balance that

is a combination of planned cash balances and lapsed appropriations (authority to spend that is not spent)

The cash balance is similar to an individual’s bank account—it does not represent ongoing revenue

Similar to your bank account, the cash balance should not be put into ongoing programs, because it is not supported by ongoing revenue

We will show you how the “surplus” fits into the overall budget picture

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COMPONENTS OF MISSOURI GENERAL FUND

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BASIC BUDGETING 101

What goes up can also come down With our limited revenue stream, it is easy to

define which components could trigger a downturn

Because we rely so heavily on individual income tax and sales tax, there is a direct relationship between general revenue growth and personal income growth

Income tax growth (and decrease) over the past decade has also been driven by taxation of capital gains

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HOW MISSOURI HANDLES CASH FLOW AND BUDGET EMERGENCIES

Missouri has a constitutional “Budget Reserve Fund” equal to 7 ½% of general fund revenues

This fund can be used for cash flow requirements, or as a Rainy Day Fund

If used as a Rainy Day Fund, it must be repaid within three years

Since this fund is available for cash flow and emergencies, budgeting all revenues and beginning balances makes more sense

The Budget Reserve Fund is not a general revenue fund. The general revenue balance referenced here does not include the Budget Reserve Fund

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INTRO TO STATE BUDGETING

Historically Missouri has had nominal balances carried forward, and has budgeted beginning balance and prior year’s lapse

The next year’s beginning balance and lapse are created by expenditure management and the statutory 3% reserve

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THE FISCAL YEAR 1998 BUDGET—A GOOD EXAMPLE OF TRADITIONAL

STATE BUDGETING OF THE GENERAL FUND

(in millions)

Beginning balance

$132.8

Lapse $86.9

Revenue Collections

$5,906.6

Other Resources

$374.5

Total Resources

$6,500.8

(in millions)

Operating Appropriations

$4,612.7

Tax Refunds $536.9

Capital Impr., Deseg, Other Expenditures

$1,351.2

Total Obligations

$6,500.8

Ending Balance

$0

Beginning balance and lapse are completely budgeted

All funds are appropriated and ending balance is zero

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CURRENT CASH BALANCES ARE MUCH HIGHER THAN HISTORIC

AVERAGES

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WHAT SHOULD WE KNOW ABOUT THE TRADITIONAL BUDGETING METHOD

It probably does not work when the beginning balance and lapse are very large

In current circumstances, it could have the effect of putting one-time moneys into ongoing programs

If budgeted, one-time funds should be put into one-time expenditures, such as capital improvements

Many people, including many elected officials, do not understand that the “surplus” is one-time money

Therefore, they suggest putting the one-time money into ongoing programs 12

THE IMPORTANCE OF PERSONAL INCOME TO

THE MISSOURI BUDGET

Missouri derives most of its general fund income from the individual income tax and the sales tax

Growth in these factors is derived primarily from growth in personal income

Personal income does include all earned income and most unearned income, including dividends, interest and rents

Personal income does not include capital gains, and so what is happening with capital gains must be viewed independently from personal income growth 13

MOODY’S RATING SERVICE OUTLOOK FOR MISSOURI

PERSONAL INCOME

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THE RELATIONSHIP OF PERSONAL INCOME AND GENERAL FUND

GROWTH

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INCOME TAX WITHHOLDING COMPARED TO PERSONAL INCOME

GROWTH

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IS THE GR BUDGET GETTING OUT OF BALANCE?

Fiscal Year

Revenues Expend Difference

2006 $7,635.0 $7,219.9 $145.1

2007 $8,015.4 $8,018.2 ($2.8)

2008 $8,312.1 $8,364.9 ($52.8)

2009 $8,618.8 $8,754.9 ($136.1)

2010 $8,754.9 $9,204.4 ($399.5)

Fiscal Year 2010 assumes a 3.4%

revenue growth in FY 2009 and FY 2010, and $350 million

growth in obligations in Fiscal Year 2010

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CAPITAL GAINS SUBJECT TO STATE INCOME TAX

(IN THOUSANDS)

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THOUGHTS ON CAPITAL GAINS

They are not included in personal income, and budget decision-makers should track them separately

The major downturns in state revenues in the early 2000’s were largely driven by a major downturn in capital gains, not by a drop in income tax withholdings

Treatment of capital gains could change at the federal level, but have a direct impact on Missouri’s general fund

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INDIVIDUAL INCOME TAX For Fiscal Year 2009, the consensus revenue

estimate is that 66% of general fund revenues will come from the individual income tax

Approximately 72% of all income tax revenues come from employee withholdings

Non-withholding income tax comes in the form of declarations and remittances, and would include income from quarterly estimated payments and annual final payments by self-employed persons, as well as payments of taxes on unearned income such as interest, dividends, and capital gains

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INDIVIDUAL INCOME TAX

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Individual income tax withholding has been growing each year since 1999. The shortfalls in income tax in the early 2000were driven by reduced capital gains, not by reduced withholdings

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THOUGHTS REGARDING INDIVIDUAL INCOME TAX

WITHHOLDING

The last three years have been strong for income tax withholding (7.0%,5.1%,6.0%).

The four years prior to FY 2006 only averaged 3.3% withholding growth.

Income tax withholding tends to track personal income growth, and Moody’s projects moderate personal income growth in the next few years. That would tend more toward the four years of moderate growth

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SALES TAX GROWTH

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CAUTIONS REGARDING SALES TAX GROWTH

We generally do not tax the products where prices are rapidly rising (food, prescription drugs, utilities)

Some products which we do tax are experiencing price declines (electronics, appliances)

Motor fuel is not subject to the sales tax, and the motor fuel tax is earmarked for transportation. Motor vehicle sales tax also goes to transportation

Continued erosion of the sales tax base due to internet sales

It appears that nominal sales tax growth (or slightly negative growth) will continue

Sales tax is over 23% of the general fund. If it is not growing, the other major component (individual income tax) must outperform for revenues to grow (Note consensus revenue estimate slide)

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FY 2007 Credits Issued--$171 million

FY 2008 Credits Issued--$161 million

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OVERALL TAX CREDIT REDEMPTION

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OTHER BUDGETARY PRESSURES Medicaid inflationary pressures Possible uninsured expansion of coverage Corrections Fully funding the school formula Higher education funding Deferred maintenance Capital improvements Unknown impact of Senate Bill 30 changes to

sales tax laws Unknown impact of accelerated depreciation from

the federal economic stimulus package Potential impact of Missouri Guaranty Fund

covering pre-need policies for National Prearranged Services

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The consensus revenue estimate for Fiscal Year 2009 illustrates the dependence on the individual income tax. To reach 3.4% growth overall, individual income tax must grow 4.5%, while sales tax is estimated to grow only .4%.

Component Conensus Revenue Growth Estimate

Individual Income Tax 4.5%

Sales Tax .4%

Corporate Tax 5.0%

County Foreign Insurance

6.6%

All Other (2.8%)

Net GR Collections 3.4%

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THE “GUN AT THE HEAD” QUESTION

If forced to predict whether actual receipts would exceed the revenue estimate or be below the revenue estimate in the next few fiscal years, what would your prediction be?

Below

However, because Missouri exceeded the revenue estimate in FY 2008, only 2.8% growth is need to make the FY 2009 estimate of 3.4% growth. Potential problems might not appear until FY 2010.

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WHAT SHOULD MISSOURI DO?

Relative to other states, we may actually be in an enviable position

Budget Rule 1—Don’t put one-time funds into ongoing programs.

Keep a very close eye on capital gains and personal income

Consider putting one-time funds into capital improvements or deferred maintenance or other one-time investments

Don’t allow the public to think that excess cash balances are ongoing revenue

Manage the situation31