“We wanted to make sure we were fiscally prudent,” House Speaker Ron Mariano said at the time. “We’ll be here when and if the economy hits a downturn, we’ll talk about line item reductions, possible budget cuts.”
This is the financial reality facing governors and lawmakers across the country: States once hit hard by Covid shutdowns are now flush with cash from better-than-expected tax collections and one-time federal aid injections as they watch. down rising inflation and an economy teetering toward a recession.
After spending the first half of this year crafting budgets that struck a careful balance between spending big and bolstering reserves, the state of affairs in Massachusetts highlights the financial challenges lawmakers and governors will face when they return to their state capitals in 2023. under potentially more volatile fiscal conditions.
Some of those problems are already starting. After presenting an optimistic budget outlook that included a large surplus earlier this year, the office of Democratic New York Governor Kathy Hochul lowered their income estimates earlier this month and now anticipates bigger budget deficits in the coming years. In California, the nation’s largest state economy, tax revenues are starting to fall short of projections after running a surplus of nearly $100 billion earlier this year.
While not all states are seeing signs of trouble, record tax revenue in Texas, for example, give lawmakers an extra roughly $27 billion to launch in your next legislative session: Many legislators and governors are pouring billions of dollars into emergency funds just in case. They fear the economy will collapse, or Washington will become more hostile to handouts under Republican control of Congress, or both.
“States are at this crucial tipping point,” Justin Theal, an official with the Pew Charitable Trusts state fiscal health project, said in an interview. “They have experienced a lot of good fiscal and economic conditions. But that chapter in state budget policy may soon come to an end.”
The pandemic sent most states into panic mode. The stock market crash and the near collapse of tourism, hospitality and other key industries left many treasurers wondering how they would pay the bills. But the economy bounced back quickly, and Congress threw states a lifeline in the form of two covid-19 billionaires. help packs.
Those cash injections, plus better-than-expected tax collections, meant that states began to experience record revenue growth. After collectively experiencing a 0.6 percent decline in revenue in fiscal year 2020, states saw annual growth of 16.5 percent in fiscal year 2021, a record, according to the National Association of State Budget Officials.
States from California to Florida reported record budget surpluses, money that translated in election year income tax rate cuts, one-time rebates, new tax credits and gas tax temporary suspensions. Even as inflation began to hit consumers, it was a boon to state sales tax revenue in places like Texas and New York.
States also increased their rainy day funds by about 50 percent in fiscal year 2021, reaching $114.6 billion in reserves. By the end of fiscal year 2022, states were estimated to have set aside $121 billion. And 46 states expect to have larger reserve funds now than before the pandemic.
Officials are “in a better position than ever to handle budget gaps, like an upcoming recession,” said Theal, who tracks Pew’s rainy-day funding.
Even as they touted record spending plans and tax relief packages running into the billions dollars, governors approached their budget processes cautiously this year.
Take California, for example, where Democratic Gov. Gavin Newsom warned lawmakers in the spring that he opposed “massive ongoing spending” and wanted to funnel money into reserves and pay off debts. The record $308 billion spending plan that Newsom finally approved sent $9.5 billion back to taxpayers as part of a $17 billion “inflation relief” package.” He also grew California’s rainy-day fund to $23.3 billion, its constitutional limit.
“Given what we’ve seen in terms of having to cut programs even as recently as the Covid-19 recession two years ago, we don’t want to see that movie again,” said HD Palmer, spokesman for the California Department of Finance. .
That financial surveillance proved prophetic. California tax revenue fell $2.4 billion below projections in June. A month later, it fell another $1.3 billion below forecast. The state finance department attributed both shortfalls to lower state personal income tax revenue.
A early august report of the nonpartisan state Legislative Analyst’s Office, which advises lawmakers on tax issues, predicted that revenues from the state’s “big three” taxes (personal, sales and corporate income) “will likely fall short” of what was projected in budget .
Yet at the same time, California’s unemployment rate is the lowest in state history. And the number of jobs in high-income sectors has grown by 25,000 from its pre-pandemic level.
“We’re bracing for the ‘known unknowns,'” Somjita Mitra, chief economist at the California Department of Finance, said in an interview. “What is normally thought of as a recession and how people behave was upended during this early Covid recession. So one of the things that I think is a lesson for us since then is to expect the unexpected.”
California lawmakers will face another financial complication in the coming years: a constitutional requirement, approved by voters in the 1970s, that limits how much the state can spend on certain programs. With that spending limit in place, budget analysts predict California could struggle to pay for certain public services like health care and senior support for years to come, even if tax revenues remain strong.
planning for the worst
New York began its 2022-23 fiscal year on April 1 with a $2.3 billion surplus, allowing state leaders in an election year to approve record spending on education, expand child care subsidies, give bonuses to healthcare workers and institute a temporary gas tax cut
The state then lowered its revenue projections this month, citing the toll caused by inflation and a rocky fiscal outlook ahead. Now, after projecting surpluses, the state estimates deficits that could reach $6.2 billion for the 2027-28 fiscal year.
but hochul, who is seeking a full term in November, points to how the state used part of its windfall budget to build its rain fund to stave off an economic downturn. He has promised to put 15 percent of the state’s operating budget into reserves by 2025, which he said would be the most in New York history.
In neighboring Massachusetts, top House Democrats are taking no chances.
Baker and Senate President Karen Spilka, a Democrat, insist the state can pay for its $3.5 billion economic development bill, including delivering $1 billion to taxpayers through one-time rebates and tax code reforms, while meeting its obligations if the state triggers the 1986 law that would force Beacon Hill to put even more money back into people’s pockets.
But Mariano, the House speaker, insists it would be fiscally unwise for Massachusetts to pass a spending package of more than $3 billion and at the same time have to return nearly $3 billion to taxpayers. However, lawmakers won’t know if they hit the tax cap until state revenues are certified in September.
“If we continue to have strong revenue, we can go ahead and meet all the needs that have been identified,” Mariano said earlier this month at the state house. “But if the economy slows down, which it could, and we don’t get the revenue that we’ve been getting, it would be wise for us to refrain from some of these things.”
Joe Spector contributed reporting from New York. Lara Korte contributed reporting from California.