The fiscal condition of the Commonwealth of Massachusetts remains excellent. According to the Comprehensive Annual Financial Report recently released by the Comptroller, Fiscal Year 1999 closed with a $1.705 billion balance on a Generally Accepted Accounting Principles (GAAP) basis. The balance calculated on the less rigorous statutory basis of accounting is a resounding $2.112 billion. This is the ninth consecutive fiscal year that ended with a budgetary surplus.
The Cellucci-Swift Administration's focus for the future is to ensure that the economy continues to grow at a robust rate by keeping unemployment low and expanding economic opportunities for all Commonwealth residents. To this end, the Administration's primary budget priority is to maintain fiscal discipline and to preserve the reserves that have been built up over the past decade to safeguard against a slow down or recession in the national economy. Also of vital importance is to continue to reduce the costs of doing business and working in the Commonwealth so that Massachusetts can remain competitive with the rest of the nation. Finally, the Administration is seeking to alleviate potential barriers to further growth by encouraging the development of moderately priced housing and ensuring a first-class education system.
PREPARING FOR THE FUTURE
The fiscal well-being of the Commonwealth stems not simply from the long national economic expansion. The cooperation of the Legislature and the Administration in responsibly managing Massachusetts's finances has allowed the Commonwealth to recover from the budget deficits of the late 1980s as well as to prepare for the future. Legislation was approved in Fiscal Year 1998 to again raise the statutory ceiling on the Stabilization Fund, the Commonwealth's "rainy day" hedge against the fiscal pressures of an economic downturn. The fund's cap is now 7.5% of total budgetary revenue and the balance in the fund, including the Fiscal Year 1999 surplus deposit of $166 million, stands at almost $1.4 billion. As illustrated in the chart below, the fund's balance now stands approximately $123 million below its new statutory ceiling. The fund balance also ranks among the five largest in the nation, a stark contrast to the fund's zero balance in Fiscal Year 1990. The importance of this reserve was recognized recently when Massachusetts ranked in a national survey as one of only eight states with reserves sufficient to withstand a recession analogous in severity to that of the early 1990s.
To ensure that the hard-earned balance in the Stabilization Fund will not be expended frivolously, the Administration recommends a two-thirds vote of the Legislature to appropriate from the fund. At least seven other states require a super-majority vote to expend "rainy day" proceeds.
The Commonwealth has built up other protections against the possibility of a deteriorating economy. The State retains $131 million in the Welfare Caseload Increase Mitigation Fund, which originated with one-time revenue that resulted from federal welfare reform in Fiscal Year 1997. Massachusetts is among only 13 states to maintain a buffer against the rise in welfare caseloads that typically accompany an economic decline. The Unemployment Insurance Fund, depleted in the early 1990s, now carries a balance in excess of $1.8 billion. In addition, the first two tobacco settlement payments into the Health Care Security Trust were received in December 1999. By the beginning of Fiscal Year 2001, the Health Care Security Trust is expected to have a balance of nearly $270 million to support health care programs for our neediest citizens and to provide a reserve for future needs.
For the third consecutive year, surplus revenues were appropriated in Fiscal Year 1999 for one-time capital expenditures as part of the ongoing effort to address the demand for capital projects that built up as the Commonwealth recovered from the excesses of the late 1980s. Approximately $527 million was appropriated at the close of Fiscal Year 1999 for this purpose. The Commonwealth also has a balance of $139 million in the Capital Project Reserve Fund, which the Secretary of Administration and Finance can direct to fund previously authorized capital projects without having to authorize additional debt.
The Commonwealth's sound fiscal management has not gone unrecognized on Wall Street. Financial rating agencies have consistently cited the State's strong fiscal discipline and capital planning and management practices among the reasons for the Commonwealth's credit enhancements. Because ratings are indicators of the investment quality of a security, including the relative risk of default, bonds become increasingly difficult and hence more expensive to market as ratings fall. The rating upgrades since December 1989, when the Commonwealth's bonds were rated only one level above "junk," have saved the taxpayers of Massachusetts tens of millions of dollars in interest expenses.
Wall Street has consistently demonstrated its confidence in the Commonwealth by raising the State's bond rating nine times since 1991. In January 2000, Moody's Investor Services raised the State's rating to Aa2, moving Massachusetts's credit standing from 26th to 16th among the 50 states.
Massachusetts Bond Ratings History
While the improvement in the Commonwealth's credit rating is an indication of the State's fiscal progress, it is also a reminder of how sharply its fiscal condition deteriorated during the last recession. In fact, the Commonwealth has fared worse than the nation as a whole during three of the last four national recessions. To avoid such desperate circumstances in the future, the Cellucci-Swift Administration has advanced an economic strategy for preserving our prevailing prosperity.
Fiscal discipline remains the cornerstone of this strategy. To this end, the Governor's budget recommendation continues the policies of the past nine years: save for future contingencies, commit to one-time projects instead of new initiatives for which funding could prove untenable over time, and return budgetary surpluses to the Commonwealth's taxpayers. Of the Fiscal Year 1999 surplus, $166 million was transferred to the Stabilization Fund, $527 million was appropriated for one-time capital projects, and $110 million was transferred to the Capital Project Reserve Fund.
The second element of the Administration's economic strategy is to continue bringing the costs of doing business in Massachusetts in line with those of the rest of the nation. Since 1991, 38 tax cuts, Worker's Compensation Reform, Unemployment Insurance Reform, and Electricity Deregulation have reduced the costs of living, working, and doing business in the Commonwealth, and comprehensive regulation reform has helped streamline business interaction with state government. However, much remains to be done. Unemployment insurance costs per employee still rank eighth in the nation. Most significantly, Massachusetts has the highest income tax rate of the 15 states without a multiple rate structure and the second highest effective rate of all 50 states.
Reduced income taxes will draw more workers and businesses to the Commonwealth. Moody's Investor Services reported in its announcement of the Commonwealth's recent credit rating upgrade that "the current economic outlook and spending controls could enable the Commonwealth to accommodate further multi-year tax cuts, if approved by the voters in November 2000, within a balanced budget." Moody's comments are powerful evidence that the tax cut is not only timely, but affordable.
The Cellucci-Swift Administration's economic policies aim to proactively mitigate impediments to the Commonwealth's sustained economic success. Most threatening are tight labor and housing markets, and the Fiscal Year 2001 budget includes several proposals to ameliorate these issues.
The Fiscal Year 2001 budget recommends an additional $132 million to maintain the State's commitment to Education Reform, thereby ensuring a skilled future workforce. Finally, the budget directs $47 million in local aid to communities that develop affordable single- and multi-family housing. Further proposals to promote housing affordability are being evaluated by a multi-agency task force formed by the Administration last November.
Most importantly, the Cellucci-Swift Administration's Fiscal Year 2001 budget recommendation continues the fiscally prudent policies that have been the hallmark of the Commonwealth since 1991. It incorporates revenue projections that have been forecast conservatively but realistically. Proposed spending reflects a modest increase of 2.8%, primarily for increased Local Aid, education, and expanded health care coverage. Targeted investments such as these provide a sound foundation for enduring prosperity in succeeding generations.
THE ECONOMIC CONTEXT
Tax and non-tax revenue collections are dependent on employment levels, personal income, and inflation. During economic downturns, spending in support of many publicly funded programs, including budget-busting entitlement programs such as Medicaid and public assistance, may rise in inverse relation to revenues. Responsible fiscal management dictates that the economy be assessed realistically on an ongoing basis.
Recent Economic Performance
Overall, Calendar Year 1999 was another economically healthy year for both Massachusetts and the nation. The national economy grew at a surprisingly strong rate with few signs of inflation. Through the third quarter of 1999 (the latest data available), growth as measured by real Gross Domestic Product was up 4.3% from a year earlier. Inflation through November 1999, as measured by the consumer price index, rose 2.7% over November 1998.
The Commonwealth's economy again outpaced that of the nation as a whole in Calendar Year 1999. As shown in the following graph, the unemployment rate in Massachusetts has fallen almost consistently since the peak of 9.6% in mid-Calendar Year 1991, and has remained at or below that of the nation for nearly five years. Monthly unemployment in Massachusetts in Fiscal Year 1999 averaged a low 3.1% as compared to the national rate of 4.2%. In November 1999, the rate in Massachusetts stood at 3.2%. The national rate during the same period was 4.1%.
Most impressively, the unemployment rate in 1999 averaged below 5% in all ten of the state's major labor markets. Even western and southeastern Massachusetts have achieved close to full employment levels, down from double-digit rates of unemployment in 1991. In fact, the regions with the fastest growing employment over the last year were among the hardest hit during the last recession: Barnstable - Yarmouth (3.7%), New Bedford (2.3%), Lowell (2.1%), Pittsfield (1.9%), Lawrence (1.8%), and Brockton (1.8%). The strong regional employment growth is further evidence of the strength of the economy statewide.
Growth in the rate of employment has a positive impact on personal incomes for Massachusetts's residents. Personal income in Massachusetts has outpaced the rate of growth in the national economy in most quarters since the depths of the recession in Calendar Year 1991. As indicated on the following chart, Massachusetts personal income in the second quarter of Calendar Year 1999 (the latest information available) grew 5.4% from the corresponding period in the previous year.
The levels of employment, income, and general business activity directly affect the income, sales, corporate, and other tax revenues available to the Commonwealth. In Fiscal Year 1999, sales tax collections were up by more than $307 million, or 6.9%, after adjusting for tax law changes in the timing of sales tax collections. Income tax revenues were strong, with baseline growth of 12.9% over Fiscal Year 1998. In all, baseline tax growth increased by a solid 8.5% in Fiscal Year 1999.
In part because Massachusetts has changed the business climate by substantially reducing taxes, the Commonwealth is much better positioned to withstand economic shocks than it was eight years ago. The economic base has also diversified as reliance on traditional manufacturing and defense contracting has transitioned to emerging technologies, high tech manufacturing, financial services, and health care industries. As indicated on the chart below, Massachusetts has shifted to a more service-oriented economy faster than the nation as a whole in the last ten years.
Massachusetts's economy has also become decreasingly reliant on large employers. The workforce is more concentrated in small- and medium-sized establishments than it was ten years ago, as demonstrated on the chart below. Disruptions in the businesses of the Commonwealth's large employers should have a diminished impact on the overall economy.
Another aspect of the Massachusetts economy that bodes well for the future is the broadening of the Massachusetts export base. As the chart below shows, Massachusetts's exports have grown steadily in the 1990s, which is consistent with the growth in the national economy. Massachusetts has also expanded the number of markets to which it exports, from 23 receiving $50 million or more in exports in 1989 to 33 in 1998. The new markets have helped Massachusetts to weather shocks such as the 1997 Asian Crisis, when declines in exports to Japan and South Korea were offset by increases to Central America, Europe, and mainland China.
THE ECONOMIC OUTLOOK
Halfway through Fiscal Year 2000, the U.S. economy continues to expand with an inflation rate that, given the tight job market, remains low. However, most economic forecasters believe that the outlook for the second half of Fiscal Year 2000 and for Fiscal Year 2001 is one of more moderate growth. The tax revenue forecast for Fiscal Year 2000 is based on an annualized rate of growth in real GDP of about 3.1%. This rate of growth reflects the maturing of the current economic expansion, which as of January 2000 is the longest in U.S. history. Inflation as measured by consumer prices should range near 2.4%. The U.S. unemployment rate is not expected to change significantly in the next year or two; the jobless rate in Fiscal Year 2000 is projected to average approximately 4.3%, increasing by 0.1% in Fiscal Year 2001.
Growth in the Massachusetts economy over the next 18 months is expected to roughly mirror that of the nation. Unemployment is projected to average approximately 3% for Fiscal Year 2000 and to remain near that level in Fiscal Year 2001. Growth in personal income is expected to decline from the Fiscal Year 1999 average rate of about 6.0% to approximately 5.3% in Fiscal Year 2000. It is expected to decline slightly in Fiscal Year 2001. The rate of inflation, as measured by consumer prices, should approximate that of the nation. The economic risks for Massachusetts remain unchanged from those of the past few years-a shortage of skilled labor that, coupled with low net population growth, could constrain job creation, and a tight housing market.
Tax and non-tax revenue assumptions for the Fiscal Year 2001 budget are organized by fund and revenue type in the following table. Total Fiscal Year 2001 revenues are projected to be $21.315 billion. Tax revenues are projected to total $14.903 billion, which reflects a reduction of $135 million for tax cuts incorporated in this budget recommendation. It also reflects $645 million in sales tax revenue that, along with the associated spending, will move off budget as a dedicated revenue stream to forward fund the MBTA.
Fiscal Year 2001 Revenue by Source and Budgeted Fund
Revenue Transfers Among Funds
The Fiscal Year 2001 revenue estimates reflect several proposed transfers between budgeted and non-budgeted funds. These movements have no net impact on the Commonwealth's statutory balance or financial condition. However, they do affect gross spending and revenue totals, changing the overall size of the state budget, and should be noted.
Moderate economic growth with low inflation is the basic assumption underlying the Fiscal Year 2001 tax revenue forecast. Overall, the Department of Revenue projects a slowing in the growth rate of the tax revenue base (that is, the tax estimate before the Fiscal Year 2001 impact of any tax law changes). In Fiscal Year 2001, the tax revenue base is expected to increase by 4.4% from that in Fiscal Year 2000, as compared to (fiscal) year-over-year increases of 7.3% anticipated for Fiscal Year 2000 and 8.5% for Fiscal Year 1999. These projections are fiscally conservative and fall below the forecasts of most private economic forecasters.
Continuing Tax Relief for Massachusetts Citizens
The Fiscal Year 2001 budget recommendation reflects the Cellucci-Swift Administration's commitment to tax relief. Increasing the disposable income of the Commonwealth's taxpayers serves as an economic stimulant and enhances the State's ability to attract new businesses and workers. Therefore, the Fiscal Year 2001 budget recommends a reduction in the tax rate on Part B ("earned" income) and on the interest and dividend components of Part A ("unearned" income) to 5.0% over three tax years. In the Fiscal Year 2000 budget, the Governor signed into law a reduction of the income tax rate from 5.95% to 5.75% over three tax years. This was a small step toward keeping the promise made in 1990 to return the tax rate to 5.0% once the Commonwealth's fiscal recovery was complete. The Administration's recommendation to reduce the rate to 5.0% mirrors the initiative petition scheduled for the November 2000 statewide ballot. The tax cut would be phased in over three tax years, beginning in Tax Year 2001. The rate would decrease to 5.6% on January 1, 2001 (from the 5.8% rate prescribed in current tax law), to 5.3% on January 1, 2002, and to 5.0% on January 1, 2003. If approved, more than 2.5 million taxpayers would qualify for a tax cut under the terms of this proposal. The revenue impact of the tax cut is estimated at $135 million in Fiscal Year 2001.
Three classes of non-tax revenue are shown in the Commonwealth's financial statements: federal reimbursements, or revenue associated with spending for which the federal government reimburses the State or provides matching funds, including block grants; departmental revenue, or licensing and user fees, fines, and miscellaneous revenue collected by state agencies; and consolidated transfers, primarily Lottery profits deposited in the Local Aid Fund for distribution to cities and towns, and fringe benefit charges to off-budget funds.
The Cellucci-Swift Administration's Fiscal Year 2001 budget recommendation assumes budgetary non-tax revenues of $6.412 billion. The major changes in non-tax revenue are described below.
Federal Reimbursements and Block Grants
Federal reimbursements are projected to total $3.808 billion in Fiscal Year 2001. This level of reimbursement represents an increase of approximately 5.6% from estimated Fiscal Year 2000 federal revenues.
Medicaid. Division of Medical Assistance (DMA) revenue in Fiscal Year 2001 is projected to total $2.429 billion, an increase of $146.1 million over Fiscal Year 2000 that is attributable mainly to increased Medicaid program expenditures. Expenditures from the Tobacco Settlement Trust will produce $47.3 million of federal reimbursements for the trust.
Welfare. In Fiscal Year 2000, the Commonwealth will meet maintenance-of-effort requirements enabling it to collect its annual share of the federal Temporary Assistance for Needy Families (TANF) block grant, or $459.4 million. The Commonwealth will also collect $5.7 million in unspent funds from prior years' block grants, raising its total TANF revenue for Fiscal Year 2000 to $465.1 million.
In Fiscal Year 2001, the Commonwealth will collect $507.5 million in TANF block grant funds: its full $459.4 million Fiscal Year 2001 grant, $30.6 million in TANF high-performance bonus awards, and $17.5 million in unspent funds from prior years' block grants. The majority of the TANF funds, $368.9 million, will be deposited into the Transitional Aid to Needy Families Fund at the state level, and the balance will be transferred at the federal level to the Child Care Development Fund (CCDF) and the Social Services Block Grant (SSBG). Several departments will collect this revenue:
In Fiscal Year 2001, departmental revenues are projected to total $1.309 billion. This projection is approximately $11 million, or 0.8%, higher than the Fiscal Year 2000 departmental revenue estimate.
Drivers become eligible for the "lifetime license program" beginning May 1, 2000, resulting in a revenue loss of $11.25 million in Fiscal Year 2000. In Fiscal Year 2001, the first full year of the program's new license renewal charge of $2, the revenue reduction is expected to total approximately $43 million.
The Revenue Optimization program continues to be a successful mechanism by which departments identify and generate new sources of non-tax revenue. Largely due to new initiatives pertaining to federal reimbursements of state expenditures, the program is expected to generate net revenue for the General Fund of $9.5 million in Fiscal Year 2000 and $9.4 million in Fiscal Year 2001.
Transfers from the Commonwealth's non-budgeted funds to its budgeted funds are projected to increase by $126.3 million from Fiscal Year 2000 levels, including an increase of $41 million in the Uncompensated Care Pool transfer to the Children's and Seniors' Health Care Assistance Fund, and an increase of $48.7 million from proceeds of the national settlement with the tobacco industry. Lottery proceeds, the largest component of consolidated transfers, are expected to increase by $14 million in Fiscal Year 2001.
FISCAL YEAR 2000 MID-YEAR UPDATE
On October 15, 1999, the Executive Office for Administration and Finance established the Fiscal Year 2000 tax revenue estimate at $14.85 billion. Tax law changes enacted in the Fiscal Year 2000 budget reduced the October estimate by $145 million. Through December 31, 1999, tax revenue collections totaled $7.03 billion, up 4.9% or $330 million, from the same period in Fiscal Year 1999. After adjusting for tax law changes in the first six months of the year, baseline tax growth was 9.5% through December. Collections were approximately $290 million over the midpoint of the benchmark range established by the Department of Revenue (DOR) for the October 15, 1999 estimate.
Based on tax revenue collections through December 1999, the Executive Office for Administration and Finance now projects that Fiscal Year 2000 tax receipts will total $15.288 billion, $583 million higher than the October 15, 1999 estimate. The new estimate represents an increase of 6.9% over Fiscal Year 1999 actual tax collections, and a baseline increase (which factors out revenue impacts caused by tax law changes) of 7.3% above Fiscal Year 1999. Since baseline tax growth for the first six months of the year increased by 9.5%, the $15.288 billion estimate will require baseline growth of 5.6% for the remaining six months of Fiscal Year 2000 over the same period last year.
FISCAL YEAR 1999 AUDITED RESULTS - GAAP vs. Statutory Basis Accounting
The State Comptroller issued the Comprehensive Annual Financial Report (CAFR), the Fiscal Year 1999 audited financial report on the Commonwealth's operations, in December 1999. The CAFR reports the Commonwealth's financial position as measured according to Generally Accepted Accounting Principles (GAAP), the stringent accounting system used in the private sector. GAAP contrasts to the statutory basis of accounting, which is defined in Massachusetts law and is used to develop the Commonwealth's budget and to control its daily fiscal activities.
With the statutory basis of accounting, expenditures and revenues are, for the most part, equivalent to cash disbursements and receipts. If, for example, Medicaid bills incurred in a fiscal year remain unpaid at year-end, the expense or liability is not accounted for in that fiscal year, but recorded in the next fiscal year. Accordingly, the Commonwealth's statutory-basis financial condition may appear better than it actually is. As indicated on the following chart, according to the statutory basis of accounting, the budgeted funds' year-end balances progressed from a negative balance of $1.104 billion in Fiscal Year 1990 to a positive balance of $2.112 billion at the close of Fiscal Year 1999.
In contrast, GAAP matches inflows pertaining to a fiscal year with outflows for the same period using a modified accrual basis of accounting to recognize certain assets and liabilities (or, in state finance parlance, revenues and expenditures). Under GAAP, the unpaid Medicaid bills are accounted for in the year in which they were incurred despite no cash having been disbursed for payment. GAAP, therefore, provides a more realistic picture of the Commonwealth's financial condition. On the GAAP basis of accounting, the Commonwealth's budgeted funds' balance for Fiscal Years 1990 through 1999 grew from a deficit $1.896 billion to a positive $1.705 billion, a cumulative improvement of an astounding $3.6 billion. Implementation of MBTA Forward Funding in Fiscal Year 2001 will remove the last large variance between the statutory and GAAP balances.
FISCAL YEAR 2001 RESOURCE SUMMARY ($000)