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Commonwealth of Massachusetts

The Governor's Budget Recommendation

Fiscal Health and Prospects




Over the last five years, the financial condition of the Commonwealth of Massachusetts has improved dramatically. At the close of Fiscal Year 1990, the State was in deficit by over $1.1 billion. At the close of Fiscal Year 1995, according to the Commonwealth's recently released audited financial statements, Massachusetts had an accumulated surplus of $726 million, an improvement in the Commonwealth's financial condition of over $1.8 billion in just five years. In Fiscal Year 1990, the Commonwealth's "rainy day" (Stabilization) fund was empty; it now has a balance of over $425 million, and is earning interest of more than $20 million a year. The improvement as measured by private sector accounting rules (Generally Accepted Accounting Principles, or GAAP) is even more dramatic: almost $2.2 billion over five years, resulting in the Commonwealth's first GAAP surplus since the State Comptroller began calculating GAAP balances ten years ago.

This turnaround in the State's finances has been achieved through cooperation between the Administration and Legislature. The Commonwealth has used conservative revenue estimates and held down the growth of state spending through the restructuring, reinvention, and privatization of state programs. These changes have occurred as the Administration and Legislature have made and kept a long-term commitment to increase local aid to the Commonwealth's cities and towns by enacting education reform and phasing out the cap on Lottery local aid distributions.

Much progress has been made in controlling spending and improving the administration of state government since the early 1990's. However, changes now occurring in the national economy and in the relationship between the federal government and the states make it imperative that the Commonwealth build on its achievements and even more thoroughly examine the purpose, scope, and operations of state government.

Over the last several years, the national and state economies have grown steadily, resulting in increasing revenues available to fund state programs and tax cuts. But as the national economic expansion enters its fifth year, it would be unwise for policymakers to assume that the business cycle has been abolished. Most economists believe that while the economy will continue to grow over the next few years, it will do so at a slower rate. Sound fiscal practice dictates that the Commonwealth anticipate this slowdown by reducing government spending wherever possible, so that Massachusetts does not again find itself in a position where its commitments exceed its resources.

Changes at the federal level will also have a far-reaching impact on state finances and operations. The full implications of the budget debate in Washington will not be clear until later this year. At the very least, there will be a substantial shift in the relationship between the federal government and the states. Funding mechanisms for many federally-supported programs are sure to change, with states having more autonomy in shaping programs but also bearing more of the risk of rising program costs. At the same time states will be in a position to benefit from innovations that slow the growth of spending.

In response to these risks and opportunities, the Weld/Cellucci Administration proposed in November 1995 to restructure and downsize State government. When fully implemented, this plan will reduce the number of cabinet secretariats by almost half and cut State spending enough to fund a personal income tax cut of more than $500 million. It will also enable the Commonwealth to keep its commitments on local aid, public safety, and welfare reform. The Weld/Cellucci Administration's Fiscal Year 1997 budget recommendation represents the first step in the two year process of implementing the reforms proposed last November.

THE ECONOMIC CONTEXT

The condition of the economy is an important determinant of both the resources available to state government and the demands upon it. Employment, income growth, and inflation have a significant impact on tax and non-tax revenue collections. These variables also affect spending requirements for Medicaid, public assistance, job training, and many other state programs.

The U.S. and the Commonwealth experienced continued economic growth in Calendar Year 1995, albeit at a slower rate than in 1994. Through the first three quarters of 1995, the nation's economy, as measured by the gross domestic product, grew at a rate of 2.7%. At the end of 1995, the recovery was in its nineteenth quarter.

Growth in Real Gross Domestic Product -- Chart


The growth in the national economy has been mirrored in Massachusetts where, since the trough of the recession, more than 180,000 jobs were created. As can be seen from the chart on the following page, unemployment in the Commonwealth has been falling steadily over the last five years, faster than in the nation as a whole. In March of 1991, Massachusetts's unemployment rate had risen to 9.5%, versus a national rate of 6.8%. By November 1995, the Commonwealth's unemployment rate had fallen to 5.1%, compared to a national rate of 5.6%.

Unemployment Rate: US and MA -- graph


Improvements in the employment picture have been reflected in the growth of Massachusetts residents' personal incomes. As the chart below indicates, during Fiscal Year 1995 personal income in Massachusetts grew at an annual rate of 5.0%.

Quarterly Growth - MA personal income -- graph


A growing economy translates directly into a growing tax revenue base. Increased employment, incomes, housing starts, and business activity directly increase personal income, sales, corporate, deeds, and other taxes. Compared to Fiscal Year 1994, Fiscal Year 1995 income tax collections grew 5.0%, sales tax collections grew 7.8%, and corporate excise tax collections grew 16.4%. Overall, tax revenue available for the budget totaled more than $11.1 billion in Fiscal Year 1995, a 5.3% increase from Fiscal Year 1994.

The Economic Outlook

In an effort to prevent the economy from overheating, the Federal Reserve Bank raised interest rates in 1994. This, combined with the tendency for economic expansions to slow as they mature, has led to a moderation in both economic growth and inflation, just the "soft landing" the Fed intended. While this type of balanced recovery is good for the economy in the long run, it means that in the short-term economic growth is unlikely to be as robust as it has been over the last few years. Most economists believe that the moderating trend in both economic growth and inflation will continue into the second half of Fiscal Year 1996 and through Fiscal Year 1997. Gross domestic product is expected to grow at an annualized real rate of between 2.4% and 2.7% over the next 18 months. The Massachusetts economy is projected to grow somewhat more slowly, with job growth of between 1.2% and 1.5% and real personal income growth of between 1.7% and 2.3%. Inflation is expected to remain low, with consumer prices in both the U.S. and Massachusetts rising between 2.7% and 3.0%. As a result, the growth in tax revenue collections over the next fiscal year is likely to moderate.

REVENUES

The table below sets out tax and non-tax revenue projections for the Fiscal Year 1997 budget, organized by fund and revenue type. Fiscal Year 1997 budgeted fund revenues are projected to total $16.807 billion. Factoring out $37 million in additional deeds excise tax revenue that the Commonwealth will retain as part of the plan proposed in this budget to eliminate county government, Fiscal Year 1997 tax revenues are projected to increase by 2.8%. Adjusted for Fiscal Year 1997 shifts to and from non-budgeted accounts below, non-tax revenues are projected to increase by 6.6% over Fiscal Year 1996.


Revenue by Source and Budgeted Fund (in millions)
SOURCE All Budgeted Funds General Fund Local Aid Fund Highway Fund Other Budgeted Funds
Tax Revenue




Alcoholic Beverages 58.0 58.0 0.0 0.0 0.0
Commercial Banks 168.0 168.0 0.0 0.0 0.0
Savings Institutions 51.0 51.0 0.0 0.0 0.0
Cigarette 233.0 103.8 0.0 0.0 129.2
Corporations 896.0 537.6 358.4 0.0 0.0
Deeds 76.9 40.0 36.9 0.0 0.0
Income Tax Base 6,669.9 3,841.3 2,560.8 0.0 267.8
Income Tax Reduction (132.5) (79.5) (53.0) 0.0 0.0
Estate/Inheritance 117.0 117.0 0.0 0.0 0.0
Insurance 328.5 328.5 0.0 0.0 0.0
Motor Fuels 607.0 81.8 0.0 517.6 7.6
Utilities 90.0 90.0 0.0 0.0 0.0
Racing 13.5 13.5 0.0 0.0 0.0
Room Occupancy 71.1 46.2 0.0 0.0 24.9
Sales: Regular 1,973.0 1,183.8 789.2 0.0 0.0
Sales: Meals 377.0 226.2 150.8 0.0 0.0
Sales: Motor Vehicles 365.0 219.0 146.0 0.0 0.0
Miscellaneous 6.0 6.0 0.0 0.0 0.0
TOTAL TAX REVENUE 11,968.4 7,032.2 3,989.1 517.6 429.5






Non-Tax Revenue




Federal Reimbursements 2,840.3 2,727.1 5.3 4.0 103.9
Departmental Revenue 1,025.2 557.5 5.5 332.6 129.6
Consolidated Transfers 973.5 382.1 613.1 0.0 (21.7)
TOTAL NON-TAX REVENUE 4,839.0 3,666.7 623.9 336.6 211.8






TOTAL BUDEGETED FUND REVENUE 16,807.4 10,698.9 4,613.0 854.2 641.3

Revenue Shifts To and From Budgeted Funds

Due primarily to changes in the way federal funds are expected to be accounted for in Fiscal Year 1997, the above revenue estimates reflect several revenue (and associated spending) shifts between budgeted and non-budgeted funds. These shifts have no effect on budgeted fund balances or the State's financial condition, since both spending and revenue change in equal amounts. However, they do affect spending and revenue totals, and thus should be noted. This budget incorporates the following revenue and spending shifts between budgeted and non-budgeted accounts:

Tax Revenue

The prospect of slower economic growth in Fiscal Year 1997 argues for caution in the tax revenue forecast. The Department of Revenue projects a slowing in the growth of the tax revenue base from 5.3% in Fiscal Year 1995 to 4.4% in Fiscal Year 1996 to 4.3% in Fiscal Year 1997. These estimates are consistent with the projections of most private economic forecasters. Factoring in the recently enacted corporate tax cut and the income tax cut proposed in this budget (see below), as well as deeds excise taxes that will be retained by the state as part of the abolition of county government, Fiscal Year 1997 tax revenues as reflected in this budget proposal are projected to grow by $328 million, or 2.8% over Fiscal Year 1996 tax collections.

The Weld/Cellucci Administration is committed to continued tax relief for Massachusetts's citizens and businesses. The Fiscal Year 1997 budget proposal recommends cutting the personal income tax rate by 0.50%, from its current level of 5.95% to 5.45%. This tax cut will be phased in over two calendar years: on January 1, 1997 the income tax rate will be reduced to 5.70%; on January 1, 1998 the rate will be further reduced to 5.45%.

The Fiscal Year 1997 tax forecast also reflects a new formula for calculating the corporate excise tax liability of manufacturing firms. The so-called "single sales factor" formula calculates taxable income as a function of where a company sells its products, not where it produces them. Legislation effecting this change was signed into law by Governor Weld in November 1995. The new formula applies in full to defense firms as of January 1, 1996, and will be phased in over five years for all other manufacturers. The annual impacts of both the change to the single sales formula and the proposed personal income tax cut are set out in the table below.

Fiscal Year Incremental Value of Tax Cut (in millions)
DESCRIPTION OF TAX CUT Fiscal Year 1996 Fiscal Year 1997 Fiscal Year 1998 Fiscal Year 1999 Total






Personal Income Tax Cut of 0.5% 0 133 265 132 530






Single Sales Factor Tax Cut 44 46 25 5 120






TOTAL 44 179 290 137 650


Non-Tax Revenue

Three classes of non-tax revenue are shown in the Commonwealth's financial statements: federal reimbursements (primarily for health and human services programs, spending for which is reimbursed by the federal government); departmental revenue (licensing and user fees, fines, and miscellaneous revenue collected by the state); and consolidated transfers (mainly State Lottery profits deposited in the Local Aid Fund and fringe benefit charges to off-budget funds). The Weld/Cellucci Fiscal Year 1997 budget recommendation is based on non-tax revenues of $4.839 billion, or $5.497 billion when adjusted for the shifts to and from off-budget accounts mentioned above. This represents an increase of $339 million from Fiscal Year 1996. The major changes in non-tax revenue are explained below.

Federal Reimbursements and Block Grants

Federal reimbursements, including anticipated revenue from block grants for Medicaid and TAFDC-related programs, are projected to total $2.840 billion in Fiscal Year 1997, or $3.347 billion when adjusted for the $507 million in shifts to and from non-budgeted fund accounts explained above. This represents an increase of approximately $379 million from Fiscal Year 1996 federal reimbursements. This increase is primarily the result of changes in the way federal funds will be distributed under the new federal block grant formulas.

The details of how federal funds will be allocated to states in Fiscal Year 1997 have yet to be finalized. The best information now available indicates that block grants will replace many of the formulas that calculate federal reimbursements based on how much a state spends. The new block grant distribution rules will primarily affect federal Medicaid and TAFDC payments to the Commonwealth. Currently, the federal government reimburses the Commonwealth at a rate of approximately 50% of state expenditures for these programs. Under a block grant system, federal payments to Massachusetts will be guaranteed at a certain level as long as the State meets certain maintenance-of-effort spending.

The new federal 'Medigrant' program will reimburse the Commonwealth at 60% of Medicaid state spending, until payments reach a cap set by federal statute. As a result, the Commonwealth anticipates receiving additional federal reimbursements, $100 million of which will be deposited in a dedicated fund that will be established to provide a cushion against future unanticipated Medicaid expenses or to implement health care reform.

Under the block grant program for transitional assistance programs, the Commonwealth will be entitled to a fixed amount for TAFDC and daycare, emergency assistance, and employment services, as well as administrative spending for these programs. Fiscal Year 1997 block grants for transitional assistance are projected to be $448 million, an increase of $59 million above Fiscal Year 1996 reimbursements.

Departmental Revenues

In Fiscal Year 1997, departmental revenues are projected to total $1.025 billion, or $1.176 billion after adjusting for transfers to and from off-budget funds. This projection is virtually identical to the Fiscal Year 1996 departmental revenue estimate. The only significant change in projected departmental revenues for Fiscal Year 1997 is an estimated $20 million increase in motor vehicle licensing and registration fees. This increase is due mainly to the pattern of drivers' license renewals established several years ago when the Commonwealth made licenses valid for five years instead of four. Smaller revenue decreases in other agencies offset this increase.

The departmental revenue estimate also reflects the proposed changes in passenger car and motorcycle licensing and registration that will be implemented in Fiscal Year 1996. Starting this spring, licenses and registrations for non-commercial passenger vehicles will be valid for two years and five years respectively, with free mail-in renewals. The Commonwealth will maintain the requirement that all parking tickets, moving violation citations, excise taxes, and insurance premiums be paid before license and registration renewals are processed. This will guarantee that cities and towns do not lose revenue from the change to lifetime licenses and registrations.

Since free renewals will not begin until two years (for registrations) and five years (for licenses) after the Spring 1996 implementation of these changes, there will be no revenue loss to the Commonwealth in either Fiscal Year 1996 or Fiscal Year 1997. The total projected reduction in registration fees in Fiscal Year 1998 is $13.75 million. When all drivers become eligible for free registration renewals in Fiscal Year 1999, revenues are projected to decline by about $55 million. Revenue reductions due to lifetime licenses will not begin until Fiscal Year 2001, when they will total approximately $11.25 million. In Fiscal Year 2002, when all drivers become eligible for free license renewals, the revenue reduction will total approximately $45 million.

Consolidated Transfers

Transfers from the Commonwealth's non-budgeted funds to its budgeted funds are projected to decrease by $36.9 million in Fiscal Year 1997. This decrease is primarily the result of a Fiscal Year 1996 transfer of $40 million from inactive trust funds to the Commonwealth's budgeted funds, which will not recur in Fiscal Year 1997. Lottery profits, the largest component of consolidated transfers, are expected to rise by $5 million in Fiscal Year 1997, with the new revenue being distributed to cities and towns as increased local aid.

SPENDING

The Weld/Cellucci Fiscal Year 1997 budget recommendation projects spending of $16.739 billion, or $17.360 billion after adjusting for transfers to and from off-budget accounts. This represents a 2.5% increase over projected Fiscal Year 1996 expenditures. In most cases year-to-year comparisons of spending for specific programs are not meaningful, since most agencies have been restructured and/or consolidated, and their budgets built from the ground up (that is, "zero-based"). However, there are several areas where changes in spending should be noted, either because they are of paramount importance to the Commonwealth or are nondiscretionary in nature.

Education Local Aid. The Weld/Cellucci Fiscal Year 1997 budget proposal keeps the State's commitment to full funding of the 1993 Education Reform Act. Education local aid will increase by $243 million in Fiscal Year 1997, for a cumulative increase of $1.06 billion in education local aid over the last four years.

Lottery Local Aid. In accordance with the Administration's commitment to phase out the cap on State Lottery distributions to the Commonwealth's cities and towns, this budget recommends an additional $41.2 million in Lottery local aid distributions. This will bring the cumulative increase in Lottery distributions to more than $155 million over the last three fiscal years.

Criminal Justice. This budget proposes a $20 million increase for the Courts and District Attorneys, and $15 million for the Department of Criminal Justice, thus continuing the Weld/Cellucci Administration's commitment to public safety.

Welfare Reform. This budget proposal includes $50 million for additional day care services, to fulfill the Administration's commitment to the recently enacted welfare reform program.

Medicaid. Under the Weld/Cellucci budget recommendation, Fiscal Year 1997 spending for the Medicaid program will grow by $66.0 million, or 2.0% over Fiscal Year 1996. This continued low rate of growth in spending will be achieved by enhancing Medicaid's successful managed care program, maximizing third party health insurance coverage, and continuing to control provider rate increases.

Employee Pensions and Health Insurance. Under the Administration's Fiscal Year 1997 budget recommendation, spending on employee pensions will grow by $52.8 million, based on the Commonwealth's obligations to current retirees and to those employees expected to retire during the next year-and-a-half. The recommendation for state employee health insurance reflects $28.5 million in savings attributable to a proposal that state workers pay a 25% share of their health insurance premiums in Fiscal Year 1997, versus the 15% share they currently pay. This change will bring state employee health insurance premiums more closely in line with those in the private sector.

Debt Service. The Weld/Cellucci budget recommendation projects an increase in debt service appropriations of $106 million, based upon previous borrowing and projected debt requirements under the current capital spending plan.

To fulfill these commitments to local aid, public safety, and welfare reform, and to fund a personal income tax cut, the Weld/Cellucci Fiscal Year 1997 budget proposes cutting state spending through the reorganization and streamlining of state government. These reorganization proposals will reduce Fiscal Year 1997 expenditures by more than $300 million. The initiatives include streamlining the education bureaucracy, eliminating duplicative administrative structures for licensing, and consolidating human resources programs, just to name a few. They are described in the secretariat narratives that follow this section.

FISCAL YEAR 1996 -- MID-YEAR UPDATE

Through December 31, 1995, Fiscal Year 1996 tax revenue collections totaled $5.378 billion, 4.7% higher than tax collections for the same period in Fiscal Year 1995. This was well within the benchmark range established by the Department of Revenue (DOR). DOR projects that tax revenues in Fiscal Year 1996 will total $11.604 billion, approximately 3.95% higher than in Fiscal Year 1995. This forecast incorporates an estimated $44 million reduction in corporate excise taxes due to the "single sales factor" tax cut signed into law by Governor Weld in November 1995. Adjusting for this reduction, tax revenues are projected to grow by 4.4% in Fiscal Year 1996. This growth rate is consistent with the estimates of most independent forecasters.

Fiscal Year 1996 revenues are projected at $16.762 billion. Using conservative assumptions for the total amount of authorizations that will go unspent by the end of the Fiscal Year 1996, spending is projected to total $16.935 billion. In Fiscal Year 1996 the Commonwealth's Stabilization ("rainy day") Fund is expected to earn $21 million in interest, increasing the Fund's balance to $446 million.

It should be noted that through December 1995 there has been a total of just $13.1 million in Fiscal Year 1996 supplemental appropriations. The Administration estimates that total Fiscal Year 1996 supplemental appropriations will be substantially below the Fiscal Year 1995 level, which itself represented a dramatic reduction from previous years' deficiency spending. These reductions in mid-year revisions to the budget are primarily the result of the Commonwealth's control over what the Massachusetts Taxpayers Foundation has recently labeled the "former budget buster" accounts, as well as more realistic budgeting at the start of the fiscal year.

FISCAL YEAR 1995 AUDITED RESULTS

In December 1995 the Office of the State Comptroller released its audited financial report on the Commonwealth's Fiscal Year 1995 operations (the Comprehensive Annual Financial Report, or CAFR). For the fourth consecutive year, the Commonwealth spent less than it collected in revenue and for the fifth consecutive year it significantly improved its financial condition measured according to Generally Accepted Accounting Principles (GAAP). As the Comptroller writes in his introduction to the CAFR, Fiscal Year 1995 was a watershed in that it marked the first time the Commonwealth achieved a budgeted fund GAAP surplus.

In Fiscal Year 1995, the Commonwealth's GAAP balance improved by $268 million. bringing the cumulative improvement during the Weld/Cellucci Administration to almost $2.2 billion. It should also be noted that the difference between the "GAAP" and "statutory" balances (the latter being the budget balance according to Massachusetts law) has narrowed by more than $550 million over the last four years. This is a reflection of the Administration's and Legislature's successful efforts to eliminate many of the non-standard accounting practices on which the Commonwealth had relied for too long.

As a result of the Fiscal Year 1995 budget surplus, the Commonwealth increased its budgeted fund balances to $726 million and deposited $27.9 million in the Stabilization Fund, bringing the Fund's balance to almost $425 million, the highest since it was established in 1986. The Stabilization Fund is now earning interest at a rate of over $20 million a year, providing the Commonwealth with an additional reserve against contingencies.

Click here to view Fiscal Year 97 Projected Financial Statement
Click here to view Fiscal Year 96 Projected Financial Statement
Click here to view Fiscal Year 95 Financial Statement



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