State Budget Update: March 2006

State budgets currently are solid, with nearly every state reporting stable or good fiscal conditions two-thirds of the way into fiscal year (FY) 2006. State officials attribute the improving situation to robust revenue performance. Collections continue to outpace original projections for most states and are surpassing revised estimates in many.

Although lawmakers have longer-term concerns about spending growth--especially as it pertains to education and health care costs--demands are stable through the first eight months of the fiscal year. The same number of states are reporting budget overruns today as did four months ago. Still, most overages appear to be modest and within the states’ ability to manage them with current resources.

Because of unexpectedly strong revenue collections and stable spending needs to date, most states expect to end the fiscal year with unobligated balances--revenues above amounts originally budgeted. States anticipate using these unallocated revenues for targeted program expenditures, tax relief or rainy day funds deposits.

At the same time that states are enjoying current budget stability, officials in many continue to be concerned about longer-term structural imbalance--ongoing revenue growth that does not keep pace with ongoing expenditure growth. Some states project structural gaps as soon as FY 2007. More see potential problems in FY 2008 and beyond.

This report is based on information collected from legislative fiscal directors in March 2006. It covers the revenue and expenditure situation for the first eight months of FY 2006 for most states. It includes information about revenue performance, spending overruns, unobligated balances and proposals for allocating excess revenues. It also includes a special focus on longer-term structural deficits.

FY 2006 Revenue Performance

Virtually all state revenue sources were performing well as states wrapped up the first eight months of the fiscal year. Overall revenues were above original estimates for nearly every state and were above revised forecasts in many.

FY 2006 revenues were above original targets in 44 states. In six of these, the amount was 10 percent or more. The largest unexpected increase was in Alaska, where robust energy taxes boosted collections $1.3 billion (50 percent) above original estimates. Energy taxes also contributed to large unexpected collections in New Mexico, Texas and Wyoming.
Revenues were on target with original forecasts in five states. Only Rhode Island reported that collections were below projected levels, with both sales and personal income taxes showing sub-par performance.
Forty-one states have revised their revenue forecasts since the fiscal year began, with a few states revising them multiple times. In most states, the change has been upward, with the revisions in Alaska, Alabama and Utah higher than 10 percent.
Three states have reduced their forecasts. In both Indiana and Wisconsin, the revisions were less than 1 percent. Despite strong performance early in the fiscal year, New Mexico has reduced its forecast twice--in December and January--largely because of fluctuations in oil and gas prices.
Of the 41 states with revised forecasts, 18 reported that collections were exceeding the new expectations. Collections were on target in another 18. Only South Dakota reported that revenues were below the revised level, down 1 percent overall because of weak performance in bank franchise and insurance company taxes. Officials expect the bank franchise tax will recover by the end of the fiscal year.
Eight states reported that all major tax categories were performing strongly or above expected levels. Another eight reported collections on or slightly above target. Most other states reported mixed performance among the various taxes they impose.
Business tax collections have been especially strong, with corporate income, franchise and other business-related taxes far exceeding expectations in many states. Nationally, these levies account for about 5 percent of total state tax collections. In Kentucky, corporate income tax collections were 98 percent above the estimate. In Nebraska they were up 56 percent. Oklahoma's corporate income taxes are up nearly 38 percent. Oregon officials expect corporate income tax levies to increase nearly 32 percent in the current fiscal year. Only three states--Alabama, Mississippi and Tennessee--reported business tax collections below forecast.
Personal income taxes also were performing well in most states. Collections in Arkansas were 5 percent above the forecast, and above estimate by 8 percent in Oklahoma. In North Carolina, withholding taxes have grown at an annual rate of 8 percent since 2005 and show no signs of slowing. On the other hand, three states--Minnesota, Ohio and Rhode Island--reported that personal income tax collections were below forecast, although in Ohio the decline was less than 1 percent.
Although sales taxes were above expectations in most states, collections were lagging forecasts in at least five--Connecticut, Massachusetts, New Jersey, Ohio and Rhode Island. Connecticut officials expect a $48 million decrease in collections. In Ohio, the auto sales tax was below estimate by 2.4 percent and the non-auto sales tax was below by 1.3 percent.
As already noted, energy-related taxes have performed strongly and, in some cases, significantly above estimate. In Alabama, oil and gas severance taxes were 137 percent ahead of the revised estimate. The coal severance tax was up 25 percent in Kentucky. Oil company taxes were up $75 million in Connecticut. In Oklahoma, gross production taxes on gas were 6.5 percent above the estimate.
Gaming or lottery collections were strong in Maryland, Nevada and Rhode Island. Gaming revenues were below forecast in Mississippi.
Three states--Maine, Mississippi and South Dakota--reported that insurance premium taxes were down. In Maine, they have declined 20.4 percent from FY 2005 levels.

FY 2006 Spending Overruns

Spending demands stayed relatively stable through the first eight months of the fiscal year. The same number of states reported budget overruns in March as did in November. Most overages appeared to be modest and within the states' ability to manage them with current resources.

Medicaid or other health care programs continued to be the category most often over budget. Nine states reported such overages. In Maryland, more than half the total deficiency appropriation ($237 million) was for Medicaid. On the other hand, Colorado reported lower than anticipated caseload growth for Medicaid.
Corrections spending was outpacing appropriations in at least seven states. Four states reported that expenses for public defenders or the courts were over budget.
Five states reported that energy costs and funding for low-income energy assistance were exceeding budgeted levels.
Three states reported that education spending was over budget. Arizona and Hawaii reported overages in K-12 education. In Ohio, higher education spending was exceeding the estimate by $30 million because of higher than expected enrollment in the Ohio Instructional Grant Program.
A variety of other programs are over budget, including children's services (Alaska, Nevada and New Mexico), Temporary Assistance to Needy Families (Pennsylvania and Washington), juvenile justice (Maryland), and snow and ice removal (Massachusetts).
Although not a budget overrun, the costs associated with flooding in the western part of New Hampshire last fall created a need for the state to help affected towns.

Preliminary Unobligated Balance Estimates

Because of unexpectedly strong revenue collections and stable spending needs to date, most states expect to end the fiscal year with unobligated balances. These balances represent revenues above the amounts originally budgeted. States anticipate using these unallocated revenues for FY 2006 supplemental appropriations or for targeted program expenditures, tax relief, as carry-forward funds in FY 2007 or as deposits to state rainy day funds.

Forty-two states expect to end FY 2006 with unobligated balances. As a percentage of general fund budgets, the amounts range from 1 percent or less in five states to 10 percent or more in nine. Some of these balances include rainy day funds.
Currently, revenues are exceeding budget obligations by $28.9 billion, or about 5 percent of general fund budgets. This amount will decline as some of the funds are used for supplemental appropriations in FY 2006.
At least 21 states anticipate using some of the unexpected revenue for targeted expenditures, either in FY 2006, FY 2007 or both. Likely recipients include higher education (14 states), capital expenditures (11 states) and transportation programs (seven states). Some will target funds to state employee salary and benefits (five states) or retiree health benefits (three states). Seven states expect to direct some of the extra revenue to reducing unfunded pension liabilities. Several states also noted that they would direct some of the extra revenues to K-12 education.
Thirteen states have provided or expect to provide tax relief. A variety of proposals affecting a multitude of taxes are under consideration in Hawaii, Maryland, Nebraska, New York and Oklahoma. Income tax reductions are being considered in Alabama, Hawaii, Oklahoma and South Carolina. Maine, South Carolina and Texas are looking at property tax relief. Wyoming already eliminated the sales tax on food for home consumption for FY 2007 and FY 2008. Oregon will return about $666 million of its $785 million projected ending balance to personal and corporate income tax payers as required by law.
Many other actions have been taken or are under consideration. At least 10 states expect to carry forward any unexpected revenues for the FY 2007 budget or subsequent budget periods. Maryland plans to use the extra revenue to help address its projected shortfall in FY 2008.
At least nine states plan to deposit all or portions of the unexpected revenue into their rainy day funds. Idaho expects to transfer $70 million into its budget stabilization fund to reach the 5 percent cap. Pennsylvania will deposit $68 million (25 percent of total excess revenues) into its rainy day fund as required by statute. Utah made a $25 million deposit into its rainy day fund. South Carolina plans to repay “other fund” accounts that were tapped between FY 2002 and FY 2005 to offset revenue shortfalls in those years.

Special Focus on Longer-Term Structural Deficits

Although most states are solid or stable in FY 2006, officials in many states remain concerned about structural deficits--ongoing revenue growth that does not keep pace with ongoing expenditure growth (absent law changes). Some states project structural gaps as soon as FY 2007. More see problems in FY 2008 and beyond.

Most state officials expect FY 2007 budgets to be stable, with 37 reporting that they will not confront structural deficits next year. Ten states, however, project structural gaps in FY 2007.
The number of states expecting structural imbalances nearly doubles for FY 2008. At least 19 states project gaps in FY 2008 and the years beyond. Eleven states did not respond for the outlying period, noting that they did not have sufficient information to make such a prediction.
Twenty states do not foresee structural gaps in FY 2007, FY 2008 or beyond. Seven predict them for all three periods.
Some states have calculated the differences between anticipated revenue and spending growth. Vermont places spending trends at 6 percent, with forecasted revenues at 4 percent. In Maryland, general fund spending is growing at 11 percent, while revenue growth is projected at less than 6 percent. Officials anticipate a structural deficit of $200 million in FY 2007, increasing to nearly $1 billion by FY 2011. Maine's gap represents 5.5 percent and 7.7 percent of projected spending levels in FY 2008 and FY 2009, respectively. New Jersey's structural gap ranges from 14 percent to 18 percent of appropriations.
Officials tend to identiFY the same programs to explain their long-term budget concerns. Many states expect spending growth in four areas--Medicaid, other health care programs, K-12 education and corrections--to outpace revenue growth, directly leading to structural imbalances.
A sizeable year-end balance does not mean that a state's finances are stable. California notes that it currently shows a large reserve because it borrowed more than $25 billion to balance its budget in prior years. These large balances actually mask an underlying operating shortfall that has not been resolved.
Colorado reports that the passage of Referendum C, which allows the state to retain excess revenues beyond the state's fiscal limit for five years, has eliminated its structural deficit. Utah reports that lawmakers have been particularly cautious in budget plans, using one-time revenues for one-time purposes, thereby avoiding structural imbalance.

Many unknowns exist about future state budget stability. The health of the economy is the most important factor influencing state fiscal conditions. Even with a strong national economy, however, states are faced with numerous fiscal challenges--from growing spending demands to antiquated tax systems. They also are vulnerable to federal tax and spending decisions. Separately or in combination, these factors could initiate longer-term structural problems for states.

Tables

Posted April 2006.
Email State Budget Update: March 2006 for more information.
Visitor counts for this page.

Featured Links