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State Budget Update: November 2005

State budget conditions continue to improve, showing strong signs of recovery in nearly every state. Buoyed by robust revenue performance, states are collecting more revenue than they projected for nearly every major tax. In some cases, collections are significantly above forecasts.

The positive news about revenue performance is tempered by soaring spending demands—both in the short and long term. In the current fiscal year, Medicaid and corrections are leading the charge for more mid-year funding. A host of other categories, especially energy assistance programs, are needing additional funds, too. In the longer term, even more spending areas will stress state budgets. In addition to Medicaid and other health care programs, states expect growing demands from elementary-secondary (K-12) education, transportation, infrastructure and employee compensation, among others. These issues will dominate legislative discussions in 2006. 

This report is based on information collected from legislative fiscal directors in November 2005. It covers the revenue and expenditure situation for the first four months of fiscal year (FY) 2006 for most states. It includes information on revenue performance, spending overruns, and the top fiscal issues anticipated for 2006 legislative sessions. It also includes a special focus on high energy costs and their effects on state budgets.

FY 2006 Revenue Performance

Virtually all state revenue sources were performing well as states entered the second quarter of FY 2006.

• Personal and corporate income tax collections were especially strong in most states, with various other taxes (e.g., severance, real estate, utility) also performing well.
• Five states also noted particularly high estate tax collections, a revenue source that can be especially difficult to predict.
• One notable area of concern is the sales tax. Seven states—Connecticut, Indiana, Massachusetts, Missouri, New Jersey, Ohio and Rhode Island—reported that sales tax collections were below forecast through the first quarter of the fiscal year. Some officials surmise that high motor fuel and home heating costs have dampened consumer spending on other goods and products, thereby reducing sales tax revenues. It is too early to know if this development is the beginning of a trend or if collections will recover in the coming months. Certainly, December sales tax collections will be watched closely in many states. In the meantime, it appears that strong collections from other taxes are covering the lower-than-expected sales tax collections.
• Of the 49 states reporting revenue performance information (Texas did not have information available), 42 reported that overall revenue collections were above forecasts. Six reported they were on target. Only Rhode Island reported that collections were below estimates. This continues the trend that began in 2003 and is a dramatic turnaround from three years ago when states were in a revenue trough. At that time, collections were above forecast in eight states and below in 33.
• Revenues are performing so well in most states that officials have started to boost their collection expectations. So far, 25 state have revised their forecasts, and in 24 the revision has been upward. Rhode Island is the only exception. Officials there recently reduced the forecast by 1.9 percent.
• Robust revenue collections and expectations that they will continue are leading officials to be positive about revenue performance for the remainder of the fiscal year. More than half the states expect revenues to be stable while 22 are optimistic.
• Officials in Rhode Island are concerned about the revenue outlook. In Louisiana, officials are pessimistic, not knowing the full brunt of recent hurricanes on longer-term revenue collections. Again, this is a marked turnaround from the low point in 2002, when 29 states were concerned about revenue performance and nine were pessimistic.

Table 1. Revenue Outlook for the Remainder of the Fiscal Year
Outlook as of	November 2002 (FY 2003)	November 2003 (FY 2004)	November 2004 (FY 2005)	November 2005 (FY 2006)
Optimistic	2	8	17	22
Stable	8	24	31	26
Concerned	29	15	2	1
Pessimistic	9	2	0	1

FY 2006 Spending Overruns

Spending overruns do not seem to be as widespread or significant as they were in recent years. By the end of the first quarter of FY 2006, 19 states reported overruns. At this time one year ago, 23 states reported overages.

• As in past years, Medicaid is the program most often over budget and was cited by 12 states.
• Corrections spending is outpacing appropriations in seven states.
• So far, six states report that energy costs and funding for home heating assistance are over budget. Many states expect that supplemental funding will be needed (see below).
• Three states report that education spending is over budget. Arizona and Washington are looking at overages in K-12 education generally, while Hawaii’s funding concerns focus on special education.
• A variety of other programs are over budget and include mental health services (Hawaii and Montana), child welfare (Maine), juvenile justice (Maryland) and natural resource programs (Vermont).

Top Fiscal Issues for 2006 Legislative Sessions

Legislative fiscal directors are well informed about the budget pressures facing state government. This year’s survey again asked these fiscal experts to identify the key budget issues their legislatures will address in the 2006 sessions.

• Medicaid and other health care concerns will dominate legislative discussions, as they did last year. At least 23 states will address these issues.
• Medicaid accounted for 12 percent of general fund budgets in FY 1995, but grew to nearly 17 percent by FY 2005. As the fastest growing category of state spending, Medicaid inevitably consumes lawmakers’ attention. Issues to be addressed include enrollment and utilization growth, rising medical inflation, the reduction in the Federal Medical Assistance Percentage (FMAP) in many states, waivers and the effects on state Medicaid budgets of federal Medicare Part D (prescription drug coverage).
• Some of the cost drivers behind Medicaid, like medical cost inflation, also will affect other state-provided health care programs. Lawmakers will examine state employee health insurance and coverage for state retirees.
• Fifteen states expect education to be a top fiscal priority in 2006 sessions. Most states expect to address K-12 funding issues, although some also will deal with higher education concerns. Dominant issues will include class size reductions, changing aid formulas, teacher salaries and enrollment increases. In Georgia, officials anticipate 10,000 new students from the hurricane-ravaged Gulf area. Kansas and New York will address court-ordered financing issues. Officials in Louisiana, Mississippi and Wyoming also will examine higher education issues. In Wyoming, lawmakers will consider whether to fund a $400 million scholarship program.
• Taxes will top discussions in 14 states. At least seven states specifically will explore property tax relief or reform. As real estate values have increased, property tax burdens have risen as well, placing pressure on state lawmakers to work with local officials to confront the problem. Several other states will consider tax reform, either for businesses specifically (Michigan and New Hampshire) or reform more generally (New Mexico and Utah). Because revenue collections are robust and elections occur next year, some states will be pressured to consider tax cuts. Nebraska is one of those states.
• General budget issues will be a high priority in 11 states. Several—like Alabama and Utah—remain concerned about the use of one-time revenues in past budgets and the lack of those resources for future budgets. Maryland will explore its structural deficit in light of scheduled payments for education funding enhancements. Some states, like Colorado, will consider restoring funding to a wide range of programs. A few states will consider the appropriate size of their reserves (Nebraska and Washington) or what to do with surplus revenues (Virginia and Wyoming).
• Ten states will consider funding for transportation and other infrastructure projects. Some states—such as Delaware and Florida—face deficits in their transportation funds that they need to address. California and Minnesota will deliberate bond issues to fund capital projects. In New Mexico, an oil and gas revenue windfall will mean that many more projects can be funded. 
• Tax and expenditure limits will top discussions in six states. Two of the six—Colorado and Connecticut—already have limits in place. Colorado lawmakers will address the implementation of Referendum C, which altered some of the restrictions imposed by the Taxpayer Bill of Rights (TABOR). Connecticut policymakers will consider whether to relax the spending cap imposed there. At least four states will discuss new TABOR-like measures.
• Corrections funding will top agendas in five states. Issues include prison overcrowding, salaries for prison personnel and medical contracts for prisoner health care.
• Other topics that will dominate legislative agendas include pensions and retirement issues (Alaska, Washington and West Virginia), gambling expansion (Indiana and Rhode Island), hurricane recovery (Louisiana and Mississippi), a new gas pipeline (Alaska), housing (Hawaii) and new sports stadiums (Minnesota).

Special Focus on Energy Costs on State Budgets

Higher energy costs have made front page news for consumers, but many of the same expenses affect state and local governments as they pay to operate motor fleets, heat government buildings and provide energy assistance programs to low-income families. This year’s survey included a special focus on the effects of higher energy costs on state budgets. While the information does not lend itself easily to summarization, it is detailed in a table at the end of this report. Some highlights include:

• As many as 17 states expect to consider or make supplemental appropriations to address higher fuel and heating costs. Many states already note that state funds to augment the federal Low Income Heating and Energy Assistance Program (LIHEAP) have been diminished and will be insufficient to aid homeowners throughout the winter.
• At least six states expect agencies will need to absorb extra energy costs in their existing budgets.
• At least three states are focusing on conservation measures, although other states likely will consider them as well. Georgia’s governor has implemented a variety of programs including alternative work schedules and telecommuting for state employees. He has encouraged similar measures for local governments and businesses across the state. He also asked schools to take two "early snow days" in September to save more than 225,000 gallons of diesel fuel per day. Minnesota’s governor has directed state agencies to reduce fuel consumption wherever possible. Montana also is looking into conservation measures.
• Two states—Ohio and South Carolina—specifically noted that they will allow school districts the flexibility to use school bus acquisition funds for fuel expenses.
• Some states noted that higher energy costs will affect the budgets for transportation projects as the cost for certain oil-based products (like asphalt) rise.

Although most states are concerned about the effect of higher energy costs on their budgets, a few mentioned that additional revenues are accruing to state coffers from sales taxes on motor fuels or higher utility taxes. States that derive portions of their revenues from oil and gas severance taxes also are reporting revenue benefits from higher energy prices.

Tables

• FY 2006 General Fund Revenue Collections
• Performance of Major State Tax Categories, FY 2006
• Revised Revenue Estimates for FY 2006
• Outlook for FY 2006 General Fund Revenues
• FY 2006 Spending Overruns
• Summary of Top Fiscal Issues to be Addressed in 2006 Legislative Sessions
• Top Three Fiscal Issues to Be Addressed in 2006 Legislative Session
• Special Focus on Higher Energy Costs in FY 2006  

 

Table 6. FY 2006 Spending Overruns
State	Over		Comments
	No	Yes
Alabama	x
Alaska	x
Arizona		x	K-12 education and Medicaid.
Arkansas	x
California		x	Department of Corrections.
Colorado	x		None currently. There is the potential for Medicaid to be over budget.
Connecticut		x	The state reports that $15.5 million of $38.8 million in total deficiencies is attributable to additional energy needs for state facilities and operations. Other deficiencies are relatively minor.
Delaware		x	Medicaid, but only slightly.
Florida	x
Georgia	x
Hawaii		x	Officials anticipate additional funding requests for electricity from all state agencies in the current fiscal year and possible requests in adult mental health and special education.
Idaho		x	Medicaid and corrections.
Illinois (N/R)
Indiana	x
Iowa		x	Medicaid. Officials anticipate a supplemental need of $39 million to $54 million.
Kansas	x
Kentucky		x	Medicaid, corrections and personnel health care costs.
Louisiana	x		There is no information yet on spending overruns; however, the Legislature reduced spending by $606 million from the FY 2006 budget during a special session in November.
Maine		x	The governor is reviewing supplemental budget requests. Most of the requests center on estimated shortfalls related to higher energy prices, but others are related to higher caseloads in such programs as general assistance and child welfare services. Maine will also need to address some adverse federal audit findings. The Medicaid program with its claims processing problems may be facing shortfalls, but sufficient data are not available at this time.
Maryland		x	The Department of Legislative Services projects general fund spending for FY 2006 to be over budget by $184 million. The largest area is Medicaid ($110 million) to pay previous years’ bills and to address unrealized cost containment, an underfunded base, and higher managed care organization rates. A $23 million deficiency for the Department of Human Resources may be needed to cover claims against federal grants that were denied. A new inmate medical contract will cost $22 million more than budgeted. Another $18 million is needed to address prior and current year per diem costs for juvenile services programs. A number of miscellaneous items make up the remaining projected shortfall.
Massachusetts	x
Michigan	x
Minnesota	x
Mississippi	x
Missouri		x	Medicaid.
Montana		x	Corrections populations are higher than anticipated and will likely result in a supplemental appropriation. The Montana State Hospital, which cares for the mentally ill, is experiencing a significant increase in population and will also likely require a supplemental appropriation.
Nebraska	x		It is too early to say. Likely candidates are motor fuels costs, natural gas and employee health insurance, but amounts are not likely to be disruptive, budget-wise.
Nevada	x
New Hampshire		x	Higher energy costs throughout the entire state government.
New Jersey	x
New Mexico		x	Corrections.
New York		x	Medicare Part D ($72 million), Medicaid ($117 million), and energy costs ($86 million).
North Carolina	x
North Dakota	x
Ohio	x
Oklahoma	x
Oregon		x	Department of Human Services—Medicaid. Although the agency has not yet submitted a formal budget rebalance to the Legislative Emergency Board, it appears that substantial cost increases over the adopted budget are due to caseload changes and other factors.
Pennsylvania	x
Rhode Island	x
South Carolina	x
South Dakota	x
Tennessee	x
Texas	x
Utah		x	Medicaid is expected to require $11 million in supplemental funding for FY 2006.
Vermont		x	Vermont’s fuel assistance program is usually funded primarily with federal dollars, but the program is requiring a significant infusion of state funds to meet its need. Currently, Medicaid and corrections are running higher than expected. The special funds that support natural resource programs (forest and parks, and fish and wildlife) are not performing well and are likely to require general fund help.
Virginia	x
Washington		x	Public school spending is up due to migration and higher inflation. State medical assistance costs are rising as the federal government further tightens its requirements.
West Virginia	x
Wisconsin	x
Wyoming	x
Totals	30	19
Source: National Conference of State Legislatures survey of legislative fiscal offices, November 2005.