Fiscal Outlook


1. Fiscal Year 2008 Budget Summary

The Patrick-Murray Administration fiscal year 2008 budget is a balanced approach to closing a $1.3 billion gap that confronted the Commonwealth. It also establishes three important foundations for long-term fiscal discipline:

The fiscal year 2008 blueprint calls for budgeting revenue of $26.727 billion. The revenue forecast represents a consensus tax estimate of 3% growth over fiscal year 2007, or $19.879 billion. After accounting for the almost $2.8 billion transferred to off-budget items, the consensus forecast represents new revenue to the budget of only $415 million, or approximately 2.3%. Legislation being filed concurrently with the budget provides for an additional $295 million of revenue through the closing of various corporate tax loopholes. After accounting for the value of the loopholes, tax revenue is expected to grow by 4.5%.

The fiscal year 2008 budget authorizes spending of $26.714 billion, a 4% increase over the fiscal year 2007 budget. There are three factors that should be considered in evaluating this spending recommendation:

Bar chart showing budgetary and off budget spending d

2. Fiscal Year 2007 Update

The fiscal year 2007 budget enacted in July of 2006 was based on projected tax revenues of $18.93 billion. To supplement spending beyond that level, the budget also drew a net total of $450 million from the Stabilization Fund. This draw from the Stabilization Fund was vetoed by the prior Administration and was not overridden - leaving what appeared to be a $450 million budget gap for fiscal year 2007. In late 2006, the prior Administration made unilateral "9C" spending cuts to close this gap.

Bar chart showing tools for FY07 balance d

On January 5, 2007, Governor Patrick restored these "9C" cuts. He believed that a combination of higher-than-expected revenues and administrative spending controls would close the budget gap for fiscal year 2007 without the need for "9C" cuts.

Indeed, the latest estimates anticipate $19.3 billion in tax revenues for fiscal year 2007 - an increase of $370 million over the earlier estimate of $18.93 billion. Thus, to date, all but $80 million of the $450 million budget gap for fiscal year 2007 has been offset by increased tax revenues. The Patrick-Murray Administration also took steps to reduce the budget gap by implementing a variety of agency spending controls immediately upon taking office.

On account of higher-than-expected revenues and these administrative spending controls, the Patrick-Murray Administration expects that there will be sufficient revenue to support budgetary spending for fiscal year 2007. Indeed, it anticipates even being able to make a small deposit to the Stabilization Fund for that fiscal year.

Nonetheless, fiscal year 2007 does present problems for developing the fiscal year 2008 budget. Fiscal year 2007 includes $935 million of spending from excess revenue carried over from fiscal year 2006. While much of this $935 million spending was one-time in nature, some of it represents recurring programmatic spending. This creates an approximately $300 million structural deficit to start the fiscal year 2008 budget.

3. Fiscal Year 2008 Budget

$1.3 Billion Budget Gap

Fiscal year 2008 budget planning started with a $1.3 billion gap:

Bar chart showing FY08 fiscal outlook d

Budget Solutions

The Patrick-Murray Administration's fiscal year 2008 budget employs a balanced approach to closing the $1.3 billion budget gap. The path to closing this budget gap includes the following elements:

a. Revised Revenue Projections

In October 2006, tax revenues for fiscal year 2008 were projected to be $19.705 billion. However, after receiving testimony at a consensus revenue hearing, the Secretary of Administration and Finance and the Chairs of the House and Senate Ways and Means Committees reached agreement in January 2007 on a consensus revenue estimate of $19.879 billion for fiscal year 2008. This estimate was $174 million higher than the October revenue projection for fiscal year 2008, reflecting the belief that fiscal year 2008 revenues would grow off of a slightly larger fiscal year 2007 base than previously anticipated.

Bar chart showing revenue projections d

Additional Revenues: $174 million

b. Spending Restraint

The Patrick-Murray Administration has restrained overall growth in spending for fiscal year 2008 to a responsible, sustainable amount. Budgeted spending would increase by only 4 percent compared to that contained in the fiscal year 2007 General Appropriations Act. Compared to total estimated fiscal year 2007 spending (which includes funds appropriated in fiscal year 2006 but available for expenditure in fiscal year 2007), spending in House 1 would grow only by 0.9 percent.

Projected SpendingFY07 FY08
House 1
Variance Growth
GAA25,677 26,714 1,037 4.0%
FY07 Spending/FY06 Revenue935
FY07 Supplemental Spending 27
Surpluses/Deficiencies (157)
Total Projected Spending 26,482 26,714 232 0.9%

This spending restraint also results in about $500 million of savings towards closing the budget gap, as it yields lower overall spending than what would otherwise be required to maintain state programs at the fiscal year 2007 level.

The Patrick-Murray Administration achieved this spending restraint by setting priorities, eliminating underperforming programs, maximizing efficiencies, and otherwise making targeted spending reductions in a manner that minimizes impacts on services. It achieved savings in the following categories:

Savings Initiatives(millions)
Medicaid Cost Control & Savings (net)$179
Earmarks (net)$86
Chapter 70 Funding at $200 million $55
Other Reductions in Maintenance in over 200 Areas$195
Total of Savings Initiative$515

Total savings: $515 million

c. Enhanced Revenues

The Patrick-Murray Administration's fiscal year 2008 budget takes a number of steps that will increase revenues and thus help to close the budget gap. The budget contains $43 million in increased revenue collections through a variety of initiatives - including enhancing audit enforcement at the Department of Revenue, increasing Appellate Tax Board staff to expedite tax appeals, providing increased funding for enforcement of our state's wage and hour laws by the Attorney General's Office and converting the Inland Fish and Game Fund into a budgeted major fund.

The budget also includes $295 million in additional revenues for fiscal year 2008 from eliminating inequitable, unintended corporate tax benefits. The value of these initiatives annualizes to more than $500 million in fiscal year 2009, helping not only to pay for direct property tax relief for homeowners (through the expansion of the existing senior "circuit breaker") but also to reduce our long-term structural deficit.

Unintended Corporate Tax BenefitsFY08 Value
Combined Reporting 135.6
Conform Entity Classification Rules to Federal Laws; Tax Business Trusts as Corporations99.2
Insurance Companies Operating Non-Insurance Businesses 13.5
Deeds excise avoidance through dispositions of interests in LLCs, etc. 11.7
Room Occupancy Tax; Internet Resellers (Total) 5.6
Sales Tax: Captive Leasing Companies 27.5
Income Tax: Earned Income Credit for Non-Residents 2.0
Total 295.0

Total additional revenues: $338 million

d. Cash Management and Debt Initiatives

The Patrick-Murray Administration's fiscal year 2008 budget includes over $120 million in increased revenues from strategies proposed by the State Treasurer to improve the state's cash and debt management practices and from a more realistic forecast of fiscal year 2008 Lottery receipts. These revenues primarily result from increased interest earning performance through better cash and debt management.

Total additional revenues: $123 million

e. Stabilization Fund

According to the National Association of State Budget Officers (NASBO), Massachusetts has the third largest Stabilization Fund in the country at almost $2.2 billion.

Bar chart showing stabilization fund balances d

Despite the relatively robust balance, the Stabilization Fund contains 8.2% of fiscal year 2008 expenditures. This compares to a 50-state average of approximately 6.8% for fiscal year 2007. When Massachusetts experienced its dramatic fiscal downturn in fiscal year 2002, it went through about half of the Fund in one year alone.

Bar chart showing stabilization fund balance since 1992 d

In fiscal year 2002, the Commonwealth used nearly $1 billion in reserves to cushion the impact of a severe, unexpected decline in tax revenues. The sharp tax revenue drop, almost 15% in one year alone, was the result of a major downturn in corporate tax revenues and capital gains taxes. Subsequently, over the past several years of robust tax revenue collections, the Commonwealth has replenished the Stabilization Fund to its highest level in history. Replenishing the Stabilization Fund was an important and wise investment of public resources, as a significant portion of recent tax revenue growth is attributable to growth in volatile capital gains and corporate revenues.

Bar chart showing proportion of tax revenues and growth d

Maintaining a healthy reserve is vital to protecting state programs and services that the people of Massachusetts rely on. When we do not have sufficient reserves to weather an economic downturn, these programs and services are susceptible to reductions that compromise core functions of government and hurt vulnerable citizens.

The Patrick-Murray Administration's fiscal year 2008 budget does not tap the balance of the Stabilization Fund. It does, however, use $75 million of the projected $89 million in Fund interest earnings expected during the fiscal year. It also suspends the annual deposit to the Fund. This approach strikes the right balance between using the Fund to address current budget needs - particularly in a challenging fiscal environment - and continuing to maintain a healthy balance to address future budget contingencies. Notably, even without an annual deposit included in the fiscal year 2008 budget, the Fund should still grow slightly due to its interest earnings that were not used for the fiscal year 2008 budget.

Bar and line chart showing tax growth and stabilization fund use

Total revenues: $175 million

f. Health Care Security Trust Funds

The fiscal year 2008 budget recommends using $50 million from the Health Care Security Trust Fund towards closing the $1.3 billion gap. The $50 million supports increased funding in fiscal year 2008 for public health programs such as universal immunization, substance abuse and disease prevention.

Total: $50 million

4. Tax Forecasting

Conservative Tax Forecasts

Since fiscal year 1992, there have been only three years that the Commonwealth failed to collect revenues that were estimated for the budget (see chart below). In fact, the Commonwealth surpassed initial revenue projections in most years due to the fact that these projections were based on conservative estimates.

This year's 3.0% consensus tax revenue growth estimate is based upon leading economic indicators and testimony provided during hearings that took place in January 2007. It reflects a modest decrease in capital gains collections and is generally in line with independent forecaster estimates.

Bar chart showing actual vs. budgeted revenue since 1992 d

5. Other Post-Employment Benefits

Background

In August 2004, the Government Accounting Standards Board (GASB) issued Statement 45, which directs government entities to identify future costs of providing post-employment benefits other than pensions to their workers (commonly known as OPEB's). The accounting change reflects increasing recognition of the rising costs to provide these benefits, primarily health care insurance, and the need for adequate reserves to meet this expense.

This year, the Commonwealth, like other government entities with budgets greater than $100 million, is required to report its liability for these benefits in its annual financial statements. This liability is similar in nature to the Commonwealth's liability for paying retiree pensions, for which the Commonwealth has already adopted a funding schedule to eliminate the pension liability by 2023.

The Liability

The Commonwealth has already taken the first step and produced an actuarial calculation of its unfunded liability to provide these benefits. The current liability exceeds $13 billion assuming the Commonwealth takes no action. This liability was determined by using assumptions about health care cost inflation, average life span, and rate of return on investments.

However, by establishing an irrevocable trust and depositing funds in the trust, the Commonwealth can greatly reduce its liability due to favorable accounting treatment that allows it to assume a greater return on its investments. By doing so, the Commonwealth will reduce its liability by nearly half.

Bar chart showing liability d

The Patrick-Murray Administration's Proposal

The Patrick-Murray Administration recognize that it is prudent to address this liability and plan to work with the Legislature to devise a fiscally responsible funding plan. The budget proposes the establishment of an irrevocable trust, the State Retiree Benefits Trust Fund, with a governance structure similar to the pension trust, but with the addition of the Executive Director of the Group Insurance Commission and Secretary of Administration and Finance. The trust will be responsible for investments and act as a custodian of the funds, but will not make retiree benefit decisions. Those decisions will remain with the Legislature and the Group Insurance Commission. Annual contributions for current retiree health costs will be transferred from the General Fund to the trust fund each year to be expended without further appropriation at the request of the Group Insurance Commissioner.

The Patrick-Murray Administration's budget also recommends a two-tiered funding strategy. First, by repealing the Health Care Security Trust Fund and transferring the assets to the newly created State Retiree Benefits Trust Fund, $423 million in investments and earnings will be used to reduce the Commonwealth's liability. Second, the proposed legislation dedicates a portion of future Master Settlement Agreement payments from tobacco companies towards reducing our liability. Under the Administration's plan, 10% of all future payments are first set aside to support smoking cessation programs. Beginning in fiscal year 2009, one quarter of the remaining 90% received would be deposited in the new trust fund. By 2012, and all subsequent years, 90% of the annual tobacco payment would be deposited in the fund.

Further Collaboration Needed

The Administration recommends the establishment of a study committee charged with making recommendations on a funding schedule and identifying potential additional funding sources to eliminate the Commonwealth's liability. The study commission will be comprised of the Chairs of the Joint Committee on Public Service, the Chairs of the House and Senate Committees on Ways and Means, the Secretary of Administration and Finance, the State Treasurer, the Comptroller, the Executive Director of the Pension Reserves Investment Management Board (PRIM), and the Executive Director of the Group Insurance Commission.