The financial condition of the Commonwealth of Massachusetts continues to reflect the dynamic fiscal recovery that began six years ago. Instead of the debt and the deficit spending characteristic of the late 1980's, the Commonwealth, according to its recently released audited financial statements, ended Fiscal Year 1996 with a balance of $1.172 billion in its budgeted funds. This marks the sixth consecutive year in which revenues exceeded expenditures. Because of the successive budget surpluses, the Commonwealth's Stabilization (or "rainy day") Fund in Fiscal Year 1996 reached and then exceeded its statutory limit for the first time, triggering a deposit of $232 million into the Tax Reduction Fund. As a result, the Legislature approved a one-time $150 million income tax cut for Tax Year 1996 and legislation has been filed to authorize an $84 million tax cut for Tax Year 1997. Symbolic of the turnaround made in the last few years, the last of the Fiscal Recovery Bonds, issued to finance the overspending of several years ago, will be retired in Fiscal Year 1998.

The Commonwealth's robust financial health stems from six years of prudent fiscal management, continued cooperation between the Legislature and the Weld/Cellucci Administration, as well as an expanding economy. On-going efforts to streamline government, such as the recent reduction of secretariats from eleven to six, have stemmed growth in government spending. Efforts to consolidate overlapping or related government functions will continue through Fiscal Year 1998 with the Administration's proposals to integrate probation and parole services, abolish county government, and institute several administrative reorganizations within secretariats.

Simultaneously, the Legislature and the Weld/Cellucci Administration remain committed to increased support for the Commonwealth's cities and towns and to tax relief for its citizens and businesses. The phase-out of the cap on Lottery local aid distributions continues apace, and distributions for education and water/sewer rate relief will again increase in Fiscal Year 1998. These three commitments alone will increase aid to cities and towns by $317.7 million in Fiscal Year 1998. To further ease tax burdens, seven tax cuts are included in this budget proposal.

However, changes in federal reimbursements and the prospect of modest near-term economic growth dictate that the Commonwealth remain persistent in its efforts to hold down spending. With the passage of the federal Personal Responsibility and Reconciliation Act early in Fiscal Year 1997, the Commonwealth henceforth will be allocated fixed-sum block grants instead of receiving federal reimbursement for state welfare spending. The federal welfare reform legislation grants the state broad latitude in implementing innovative welfare programs; however, the Commonwealth simultaneously assumes more responsibility and risk associated with unforeseen increases in welfare costs.

Although most market analysts are optimistic that the economy in Calendar Year 1997 will experience moderate growth, a few are bearish. The prospect of economic stagnation or perhaps contraction is realistic: over the last fifty years, expansions in business cycles have averaged fifty months and the current recovery is in its seventieth. The unpredictability of the market and the possibility of an unsettled economy require a cautious and conservative approach to budgetary considerations and long-term planning.

The Weld/Cellucci Administration's Fiscal Year 1998 budget recommendation reflects not only the Administration's commitments to local aid, tax relief, welfare reform, and public safety, but also its responsibility to the citizens of Massachusetts not to repeat the overconfidence and excesses of the late 1980's.

THE ECONOMIC CONTEXT

The condition of the economy determines, to a great extent, both the resources available to state government and the demands upon it. Employment, income growth, and inflation are important determinants of tax and non-tax revenue collections. These variables also affect spending requirements for Medicaid, public assistance, job training, and many other programs supported with state revenues. Therefore, it is important to gauge the economy realistically when projecting budgetary revenues and spending.

Recent Economic Performance

The United States and Massachusetts experienced continued economic growth in Calendar Year 1996, albeit at a slower rate than in 1995. Through the first three quarters of Calendar Year 1996, the nation's economy, as measured by the gross domestic product, grew at a rate of 2.9%.

Economic growth at the national level has been mirrored in Massachusetts where, between December 1991, the low point of the last recession, and October 1996, more than 250,000 jobs were created.

As shown in the chart below, the unemployment rate has fallen in Massachusetts through each of the last five years. By November 1996, the rate in Massachusetts had dropped to 3.9%, compared to a national rate of 5.4%, and is now the lowest of any large industrial state.

Improvements in the employment picture are reflected in increased personal incomes for Massachusetts residents. During Fiscal Year 1996, personal income in Massachusetts grew at an annual rate of 5.0%.

An expanding economy translates directly into a broader tax revenue base. Increased employment, incomes, housing starts, and business activity directly impact sales, personal income, corporate, deeds, and other tax collections. Compared to Fiscal Year 1995, Fiscal Year 1996 income tax collections grew 12.3%, and sales tax collections grew 5.2%. Overall, tax revenue available for the budget totaled almost $12 billion in Fiscal Year 1996, a 7.9% increase from Fiscal Year 1995.

The Economic Outlook

Halfway through Fiscal Year 1997, the national economy continues to expand at a moderate pace with little inflation. Most economic forecasters believe that the economic outlook for the second half of Fiscal Year 1997 and for Fiscal Year 1998 is one of continuing, albeit slow, economic growth. Gross domestic product is expected to grow between 2.1% and 2.2% annually throughout the next eighteen months. Employment in the Commonwealth is expected to increase at a rate between 1.1% and 1.6%, and personal income is expected to grow at a rate from 4.4% to 5.6% over the same period. On the inflation front, growth in consumer prices is expected to remain low, between 2.4% and 3.4% over the next eighteen months.

REVENUES

Tax and non-tax revenue assumptions for the Fiscal Year 1998 budget are organized by fund and revenue type in the following table. Fiscal Year 1998 total revenues are projected to be $17.998 billion. Tax revenues are projected to be $12.667 billion, which reflects a reduction of $82 million for tax cuts proposed in this budget recommendation (see the Proposed Tax Cuts table) and a reduction of $84 million from the recently filed Tax Reduction Fund income tax cut. This represents a raw increase of 2.9% over Fiscal Year 1997 projected tax revenues. Non-tax revenues are projected to be $5.331 billion, a 3.5% increase over Fiscal Year 1997.

Fiscal Year 1998 Revenue by Source and Budgeted Fund (in millions of dollars)
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	146.0	146.0	0.0	0.0	0.0
Savings Institutions	71.0	71.0	0.0	0.0	0.0
Cigarette	305.0	88.7	0.0	0.0	216.3
Corporations	872.0	523.2	348.8	0.0	0.0
Deeds	40.0	3.1	36.9	0.0	0.0
Income Tax	7,011.0	4,126.3	2,750.8	0.0	133.9
Estate/Inheritance	78.0	78.0	0.0	0.0	0.0
Insurance	304.0	304.0	0.0	0.0	0.0
Motor Fuels	612.0	82.5	0.0	521.8	7.7
Utilities	146.0	146.0	0.0	0.0	0.0
Racing	11.5	11.5	0.0	0.0	0.0
Room Occupancy	75.1	48.8	0.0	0.0	26.3
Sales: Regular	2,136.0	1,281.6	854.4	0.0	0.0
Sales: Meals	397.0	238.2	158.8	0.0	0.0
Sales: Motor Vehicles	399.0	239.4	159.6	0.0	0.0
Miscellaneous	5.5	5.5	0.0	0.0	0.0
Total Tax Revenue	12,667.0	7,451.7	4,309.3	521.8	384.1
Non-Tax Revenue
Federal Reimbursements	3,302.8	2635.9	0.0	3.4	663.5
Departmental Revenue	1,072.1	604.5	2.0	322.9	142.7
Consolidated Transfers	956.1	392.1	635.4	0.0	(71.4)
Total Non-Tax Revenue	5,331.1	3,632.5	637.4	326.3	734.9
Total Budgeted Fund	17,998.1	11,084.2	4,946.7	848.2	1,119.0

Revenue Shifts To and From Budgeted Funds

The above revenue estimates reflect several revenue (and associated spending) shifts between budgeted and non-budgeted funds. These shifts have no net effect on budgeted fund balances or the Commonwealth's financial condition since both spending and revenue change in equal amounts. However, they do affect gross spending and revenue totals, changing the overall size of the state budget, and thus should be noted. This budget incorporates the following revenue and spending shifts between budgeted and non-budgeted accounts:

• To enable public higher education campuses to manage their fiscal affairs more effectively, the Administration will permit these institutions to retain and spend all revenues they generate. As a result, $134.3 million in revenue and spending has been shifted to three trust funds. This shift will provide institutions with a revenue source that is directly related to enrollment, and with an incentive to adjust to enrollment changes more efficiently.

• To accommodate the fact that spending by the State Reclamation Board on mosquito control actually is municipal spending, the Administration proposes to shift $4.2 million in estimated spending and revenue off-budget. The State Reclamation Board provides technical assistance and administrative support to the Commonwealth's various mosquito control districts. This fund shift will enable the Board and mosquito control districts to fulfill their mission more effectively.

• As part of the proposal recently filed by the Administration to take over the functions and associated revenues of county Registries of Deeds in Fiscal Year 1998, $26.0 million in revenue and spending will be moved into the Commonwealth's budgeted funds. The $26.0 million in revenue is generated by Registry fees. A portion of this revenue will be set aside in a reserve account to assist local communities and/or the Secretary of the Commonwealth with unanticipated fiscal burdens that might arise from this transfer. As part of the Administration's proposal to abolish county government, the Commonwealth would assume responsibility for remaining county functions, including county corrections, effective July 1, 1998.

• Federal grants for MassJOBS and child care programs have been replaced by the Temporary Assistance to Needy Families (TANF) and Child Care Development Fund block grants. The $17.9 million MassJOBS grant, $14.2 million Child Care Development Block Grant (CCDBG) and $6.2 million At-Risk child care grants, which previously were "off-budget" as federal grant appropriations, are now counted as state spending. In Fiscal Year 1998, the spending for these employment assistance and child care programs will be divided among the General Fund and the new TANF and Child Care Fund minor funds.
  

Tax Revenue

Moderate economic growth with low inflation is the basic assumption underlying the Fiscal Year 1998 tax revenue forecast. Overall, the Department of Revenue projects a slowing in the growth rate of the tax revenue base (the tax estimate before the Fiscal Year 1998 impact of any tax law changes are incorporated), from the 6.5% rate in Fiscal Year 1996 to 5.8% in Fiscal Year 1997 and 4.6% in Fiscal Year 1998. Total Fiscal Year 1998 tax receipts (the projected tax base with the Fiscal Year 1998 impact of any tax law changes included) are estimated to increase by 2.9% over Fiscal Year 1997 tax receipts. These estimates are consistent with the forecasts of private economic forecasters and the Massachusetts Taxpayers Foundation.

Continuing Tax Relief for Massachusetts Citizens

Over the past six years, the Commonwealth has made significant advances in easing its citizens's tax burden. The Fiscal Year 1998 budget proposal continues the Weld/Cellucci Administration's commitment to tax relief with seven new tax cuts that will benefit individuals and encourage business investment and expansion in Massachusetts. The proposals, all of which would become effective January 1, 1998, are described below. The revenue impact for each proposal is outlined in the table at the end of this section.

1. Reduce Part A ("unearned income"; i.e., interest from non-Massachusetts banks, dividends, and short-term capital gains) tax rate from 12% to 5.95% over five years.

   Under current tax law, Massachusetts residents pay a 12% tax on interest from non-Massachusetts banks, dividends, and short-term capital gains. Under the recently enacted capital gains reform, the 12% tax on long-term capital gains is being phased out. However, the 12% tax on other forms of investment, or Part A "unearned", income penalizes Massachusetts investors and discourages productive investment. Under this proposal, the Part A tax rate would be reduced by 1.2 % a year until the tax rate is 5.95%, the prevailing rate on "earned income"; i.e., wages, salaries, pensions, and business income.

   Approximately 770,000 taxpayers would qualify for a tax cut under this proposal.

2. Increase the child dependent deduction from $600 to $1,600 to adjust for inflation.

   Since 1976, eligible personal income taxpayers have been allowed a deduction of $600 for dependents under age 12. (Only one deduction can be claimed regardless of the number of dependents.) The Administration proposes that the deduction be increased to $1,600 to adjust for Boston-area inflation since 1976, which has been approximately 260%. This would be the first adjustment to the deduction since it was enacted.

   The proposal would benefit 350,000 to 425,000 Massachusetts families.
   

3. Phase out 5% telecommunications sales tax over five years.

   Because telecommunications is one of the fastest growing industries in the Commonwealth as well as in the nation, it is one of the most important to the Massachusetts economy. Under current law, purchases of telecommunications services are subject to the Commonwealth's 5% sales tax. The services include local and long distance telephone, internet access, paging, facsimile, and data transmission.

   Under our proposal, the tax rate would be reduced by 1% a year for each of five years beginning January 1, 1998, until the tax is eliminated effective January 1, 2002. The tax on on-line and internet services would be eliminated effective July 1, 1997.

   Almost all businesses in the Commonwealth would benefit from this phase-out, especially those with large telecommunications usage such as mutual fund companies, airlines, and banks. Most households also would benefit since long distance and internet access charges currently are fully taxable.
   

4. Exempt military retirement pay from income tax.

   Under current law, retirement payments made by the United States military to Massachusetts residents are taxable at a rate of 5.95%.

   Approximately 17,500 military retirees in Massachusetts would benefit from this proposal.

5. Eliminate net investment income tax on domestic life insurance companies.

   Under current law, life insurance companies domiciled in Massachusetts are subject to a 14% tax on net investment income, a tax life insurance companies located elsewhere do not pay. This tax puts Massachusetts life insurance companies at a competitive disadvantage vis-a-vis out-of-state insurers.

6. Set the investment tax credit rate permanently at 3%.

   The investment tax credit is an important incentive encouraging capital investment by businesses. Although the investment tax credit rate is currently 3%, it is scheduled to be reduced to 1% effective July 1, 1999. Under this proposal, the rate would be set permanently at 3%, benefiting the approximately 2,600 companies doing business in Massachusetts that claim the credit each year.

7. Create a Job Training Tax Credit.

   Job training is a key element in preparing Massachusetts workers for employment in a rapidly changing economy. This proposal would offer a tax credit, up to $3,500 per eligible trainee, to expanding Massachusetts businesses for the cost of training a new worker, or retraining an existing employee for a higher position.
   

Proposed Tax Cuts	Fiscal Year 1998 Revenue Impact ($ millions)
1. Tax all income at 5.95% rate	$27.0
2. Increase child dependent deduction to $1,600	12.0
3. Eliminate telecommunications services sales tax	16.0
4. Exempt military retirement pay from income tax	7.0
5. Eliminate life insurance net investment tax	15.0
6. Make 3% ITC permanent	0
7. Create a Job training tax credit	5.0
Total	$82.0

Non-Tax Revenue

Three classes of non-tax revenue are shown in the Commonwealth's financial statements: federal reimbursements and block grants (spending for which the federal government reimburses the state, or provides matching funds); departmental revenue (licensing and user fees, fines, and miscellaneous revenue collected by state agencies); and consolidated transfers (primarily state Lottery profits deposited in the Local Aid Fund for distribution to the cities and towns, and fringe benefit charges to off-budget funds).

The Weld/Cellucci Administration's Fiscal Year 1998 budget recommendation assumes non-tax revenues of $5.331 billion, or $5.405 billion when the shifts to and from off-budget accounts mentioned above is removed. This projection represents an increase of $318.4 million from Fiscal Year 1997. The major changes in non-tax revenue are described below.

Federal Reimbursements and Block Grants

Federal reimbursements, including anticipated revenue from block grants for TANF and Child Care programs, are projected to total $ 3.303 billion in Fiscal Year 1998, or $3.265 billion when the impact of shifts to and from off-budget accounts is removed. This level of reimbursement represents an increase of approximately $362 million over Fiscal Year 1997 federal revenues. This increase is primarily the result of the way federal funds will be distributed under the new block grant formulas.

Welfare Reform. On October 1, 1996, Massachusetts became eligible to receive federal block grants for welfare and child care programs. The TANF and Child Care Development Fund block grants replace certain federal grants, as well as federal reimbursements that provided the Commonwealth with approximately 50% of state expenditures for eligible programs in prior years. Under the terms of the federal law, the Commonwealth is entitled to a fixed block grant for state programs related to needy families, including Transitional Aid for Families with Dependent Children (TAFDC), emergency assistance, employment services, child care, and administrative expenses in support of these programs, provided that maintenance-of-effort spending requirements are met.

The TANF block grant will total $459.4 million annually for six federal fiscal years, or Massachusetts Fiscal Years 1997 through 2002.

The federal Child Care Development Fund block grant combines former TAFDC-related child care reimbursements with the Child Care Development Block Grant (CCDBG) and the At-Risk federal grant. The Child Care block grant amount will be $76.1 million in Massachusetts Fiscal Year 1998, which is $5.4 million more than Fiscal Year 1997 federal grants and reimbursements. The Child Care block grant will increase by 15% over the next six federal fiscal years to approximately $87.9 million in federal Fiscal Year 2002.

In Fiscal Year 1998, three minor funds accounts were established for the TANF, Child Care and Social Services block grants. The creation of these funds provides specific accounting to ensure that federal funds are spent on eligible programs and that maintenance-of-effort spending requirements are met. The amount needed to support Transitional Assistance for Families with Dependent Children (TAFDC) programs in Fiscal Year 1998 is $325.6 million; the balance of the TANF grant will be transferred to the Child Care and Social Services minor fund accounts. In Fiscal Year 1998, $102.3 million will be transferred from the TANF Fund to the Child Care Fund to support child care programs, and $31.5 million will be transferred to the Social Services Fund for programs at the Department of Social Services.

• $325.6 million in federal revenue from the Temporary Assistance to Needy Families (TANF) block grant will be deposited into the Transitional Aid to Needy Families Fund for TAFDC, child care, and social service programs.

• $178.4 million in federal block grant revenue will be deposited into the Child Care Fund, of which $76.1 million will be from the Child Care Development Fund and $102.2 million will be from the Transitional Aid to Needy Families Fund.

• $85.9 million in federal block grant revenue will be deposited into the Social Services Fund, of which $54.3 million will come from the Social Service Block Grant and $31.5 million will be from the Transitional Aid to Needy Families Fund.

Medicaid. In Fiscal Year 1998, federal reimbursement at the Division of Medical Assistance (DMA) is projected to increase $145.5 million to $2.027 billion, or a 7.7% increase from $1.882 billion in Fiscal Year 1997. Of this increase, approximately $81.7 million is due to federally reimbursable increases in spending in the traditional Medicaid program, primarily due to medical inflation, increased utilization of services, and changes in case mix.

In addition to the $81.7 million, the Commonwealth anticipates receipt of approximately $72.7 million in federal reimbursements as a result of DMA's federally approved health care waiver extending Medicaid eligibility to individuals and families up to 133% of the federal poverty level instead of the previous 100% cap, and the implementation of Chapter 203 of the Acts of 1996 (the Health Care Access Improvement Act). This $72.7 million in new federal reimbursement will be credited to the Children's and Seniors' Health Care Assistance Fund. Of the $72.7 million, approximately $51.5 million will result from reimbursement due to Medicaid expansion and other expanded DMA services, and $21.2 million will derive from new federal revenues for Commonwealth medical programs previously not reimbursed: the "CommonHealth" program, which provides primary and supplemental medical care and assistance to disabled working adults and children, and the Medical Security Plan, which provides medical benefits to the unemployed. (The Medical Security Plan is administered through the Division of Employment and Training where its estimated $9 million in federal reimbursements, which is included in the $72.7 million in new reimbursements, will be deposited.)

Departmental Revenues

In Fiscal Year 1998, departmental revenues are projected to total $1.072 billion, or $1.185 billion when the impact of shifts to and from off-budget accounts is removed. This projection is approximately $70 million lower than the Fiscal Year 1997 departmental revenue estimate. The most significant changes in projected departmental revenues for Fiscal Year 1998 are from Registry of Motor Vehicle registrations and licenses and the Revenue Optimization Program.

The departmental revenue estimate reflects the implementation of lifetime driver licensing and vehicle registration. Beginning in Fiscal Year 1998, licenses and registrations for non-commercial passenger vehicles will be renewed automatically and free of charge. The Commonwealth will continue to require that all parking tickets, moving violation citations, excise taxes, and insurance premiums be paid before license and registration renewals are processed. The Commonwealth's cities and towns thus will be guaranteed not to lose revenue from the change to lifetime licenses and registrations.

Free renewals of licenses will not result in a revenue loss until Fiscal Year 2001. The savings to Commonwealth citizens in Fiscal Year 1998 for free registration renewals will be $13.75 million. When all vehicle owners become potentially eligible for free registration in Fiscal Year 1999, revenues are projected to decline by about $55 million. Revenue reductions due to lifetime licenses will total approximately $11.25 million in Fiscal Year 2001. In Fiscal Year 2002, when all drivers become potentially eligible for free license renewals, the revenue reduction is expected to total approximately $45 million.

In Fiscal Year 1998, the Revenue Optimization program, which provides incentives for departments to generate additional revenues through new initiatives, will be in transition. Enacted as part of the Fiscal Year 1996 budget, the program first implemented numerous revenue initiatives identified in a feasibility study conducted during Fiscal Year 1995. Those projects generated a year-end General Fund balance of $39.29 million in Fiscal Year 1996, and $57.5 million is projected for Fiscal Year 1997.

By the close of Fiscal Year 1997, the revenue optimization opportunities identified in Fiscal Year 1995 will be exhausted. In addition, changes in federal reimbursement policies since Fiscal Year 1996, such as the institution of block grants, have further reduced potential revenue flows into the program. As a result, the Fiscal Year 1998 estimate reflects a reduction in revenue from the program. After spending obligations, the General Fund will contain a year-end balance of $10 million, which reflects a reduction of $47.5 million from Fiscal Year 1997.

Fiscal Year 1998 activities include the implementation of two new statewide revenue optimization projects in Fiscal Year 1998. One of the new projects proposes licensing and marketing official Commonwealth merchandise. The other project anticipates generating revenue from leasing space on state-owned property to private enterprises for the placement of communications antennae. These activities, together with those which will be identified as the result of new project feasibility studies, may enable the program to move toward its historically higher revenue levels in Fiscal Year 1999.

Consolidated Transfers

Transfers from the Commonwealth's non-budgeted funds to its budgeted funds are projected to increase by $26.1 million in Fiscal Year 1998. Lottery profits, the largest component of consolidated transfers, are expected to rise by $17.1 million in Fiscal Year 1998. The additional revenue will be distributed to the Commonwealth's cities and towns as increased local aid.

SPENDING

The Weld/Cellucci Administration's Fiscal Year 1998 budget recommendation projects spending of $18.150 billion, or $18.224 billion when the impact of shifts to and from off-budget accounts is removed. This represents a 2.9% increase over projected Fiscal Year 1997 expenditures. Several areas in which spending has changed, either because of their importance to the Commonwealth's citizenry or because they are non-discretionary in nature, are highlighted below.

Education Local Aid. The Weld/Cellucci Administration's Fiscal Year 1998 budget proposal sustains the State's commitment to full funding of the 1993 Education Reform Act. Education Local Aid will increase by $259 million in Fiscal 1998 for a cumulative increase of $1.32 billion in Education Local Aid over the last five years.

Welfare Reform. The Weld/Cellucci Administration, in continuing its commitment to welfare reform programs, recommends total welfare spending of $1.01 billion for Fiscal Year 1998. This includes $46 million to extend EAEDC income benefits to legal immigrants who have lost their federal benefits. Also proposed is $7.5 million for Adult Education and Job Search programs to afford welfare recipients the opportunity to develop the skills necessary to secure employment.

The Administration also proposes an additional $25.0 million for day care for TAFDC recipients who are actively seeking employment, and for low income working families. In addition, spending for Food Bank programs is increased by $7.0 million to provide food assistance for needy families who have lost federal Food Stamp benefits.

Medicaid. Under the Weld/Cellucci Administration's budget proposal, Fiscal Year 1998 spending for the current Medicaid program will total $3.511 billion, an increase of $123.5 million, or 3.5%, over Fiscal Year 1997. The budget recommendation also includes an additional $102.5 million for the expansion of the Medicaid program to include approximately 55,000 adults and children not previously eligible for Medicaid benefits, as well as for the creation of a new state benefit plan enabling 31,000 adults to qualify for health care coverage (of whom 18,000 previously had received benefits under the EAEDC health program). The proposed Fiscal Year 1998 expansion in Medicaid coverage conforms to the terms of the Commonwealth's federal waiver and was authorized by the Legislature in July 1996.

Lottery Local Aid. In accordance with the Administration's commitment to phase out (over five years) the cap on State Lottery distributions to the Commonwealth's cities and towns, this budget recommends an additional $55.4 million in Lottery Local Aid distributions. This will bring the cumulative increase in Lottery distributions to more than $210 million over the last four fiscal years.

Criminal Justice. This budget proposes the transfer of post-sentencing probation services from the Judiciary to the Executive branch, effective July 1, 1998. During Fiscal Year 1998, the affected agencies will map out the fiscal and operational details of the transfer. There will be no spending or revenue shifts during Fiscal Year 1998. However, an estimated $50 million will be transferred in Fiscal Year 1999.

The Weld/Cellucci Administration's budget proposal also includes a $21.8 million increase for the Courts and District Attorneys, and a $1.5 million increase for the Attorney General, thus continuing the Administration's commitment to public safety.

Employee Pensions and Health Insurance. Under the Administration's Fiscal Year 1998 budget recommendation, spending on employee pensions will decrease by $54 million, based on the Administration's proposed new funding schedule. The savings is possible as the result of a successful investment strategy and careful management. As a further indication of the Commonwealth's dramatically improved fiscal situation over the past six years, the revised pension schedule recommends paying off the Commonwealth's unfunded pension liability in just twenty years, a full ten years sooner than the current schedule projects.

The budget recommendation for state employee health insurance reflects a net savings of over $21 million attributable to a proposal that state workers pay a 25% share of their health insurance premiums in Fiscal Year 1998, versus the 15% share they currently pay.

Water and Sewer Rate Relief. In Fiscal Year 1998, the Sewer Rate Relief Program is projected to distribute $50.3 million, or an increase of $3.3 million over Fiscal Year 1997, to more than 100 communities statewide, including the forty-three members of the Massachusetts Water Resources Authority. This aid has helped hold the average MWRA household rate increase to only slightly more than 3% annually for the four years since the program's inception in Fiscal Year 1994.

Debt Service. The over-extended budgets of the late 1980's and an aging infrastructure forced the Commonwealth to increase its long- and short-term borrowing to fund operating shortfalls and capital improvements. The Weld/Cellucci Administration has successfully implemented a debt management policy such that the percentage growth in general obligation debt outstanding has dropped from 29% in Fiscal Year 1991 to 2% in Fiscal Year 1997, and has averaged 1.5% in the last five fiscal years. In Fiscal Year 1998, the year the Commonwealth retires its last Fiscal Recovery Bond, long-term debt service appropriations are projected to decrease by 2%, or $26.24 million, from Fiscal Year 1997. Short-term debt service obligations are expected to increase to approximately $15 million in Fiscal Year 1998, as Central Artery/Tunnel Project cash flow requirements begin to outpace the inflow of federal revenues. The Commonwealth will fund this planned-for interim cash shortfall with Grant Anticipation Notes to be paid back as federal reimbursements are received.

FISCAL YEAR 1997 MID-YEAR UPDATE

Through December 31, 1996, Fiscal Year 1997 tax revenue collections totaled $5.81 billion, up 7.8% or $420 million from the same period in Fiscal Year 1996 and well within the benchmark range forecast by the Department of Revenue (DOR). While DOR estimates that the tax base will grow by 5.8% in Fiscal Year 1997, they project total tax receipts of $12.31 billion in Fiscal Year 1997, a raw increase of 2.1% over Fiscal Year 1996. Two factors make this raw increase much lower than the growth of the base: 1) DOR has estimated that approximately $250 million of the Fiscal Year 1996 tax receipts were one-time in nature, directly related to the outstanding performance of the stock market in Calendar Year 1995; and 2) the Fiscal Year 1997 tax estimate incorporates the Tax Year 1996 $150 million personal income tax refund resulting from the Commonwealth's Fiscal Year 1996 deposit to the Tax Reduction Fund. The Administration will continue to watch Fiscal Year 1997 tax receipts closely to monitor any changes associated with the dynamic performance of the stock market in Calendar Year 1996.

Total revenues in Fiscal Year 1997 are projected to equal $17.393 billion. Using conservative assumptions for the total amount of authorizations that will remain unspent by the end of Fiscal Year 1997, spending is projected at $17.703 billion. In Fiscal Year 1997, the Commonwealth's Stabilization ("rainy day") Fund is expected to earn $20 million in interest, increasing the Fund's balance to $563 million.

FISCAL YEAR 1996 AUDITED RESULTS

In December 1996, the Office of the Comptroller released its annual audited financial report on the Commonwealth's Fiscal Year 1996 operations (the Comprehensive Annual Financial Report, or CAFR). As the Comptroller noted in his introduction to the CAFR, the financial condition of the Commonwealth is excellent. For the sixth consecutive year, revenues exceeded expenditures by a significant amount and the Commonwealth improved its financial position as measured according to generally accepted accounting principles (GAAP). (See below: GAAP vs. Statutory Basis Accounting). For the second year in a row, the Commonwealth achieved a budgeted funds's GAAP surplus. By the end of Fiscal Year 1996, the GAAP balance in these funds was a resounding $709.2 million, a marked change from the Fiscal Year 1990 GAAP deficit balance of $1.9 billion.

In Fiscal Year 1996, the Commonwealth's Stabilization Fund was funded to its statutory limit of $543.3 million. An additional $232 million was available for deposit into the Fund but, because it had reached its statutory ceiling, these funds flowed into the Tax Reduction Fund, triggering a $150 million income tax cut for Tax Year 1996 (as authorized by Legislative act during Fiscal Year 1997); the Legislature and the Weld/Cellucci Administration have recently agreed to authorize an additional tax cut of $84 million for Tax Year 1997. These one-time bonuses (increases in the personal income tax deduction) are the first the citizens of Massachusetts have been afforded since the Stabilization Fund was established in 1986.

The Administration recently has filed legislation proposing to increase the Stabilization Fund's statutory cap to 5% of total revenues instead of the current ceiling of 5% of tax revenues. This will ensure that the fund can reach and maintain a balance of 3 to 5% of budgeted expenditures, as recommended by Wall Street analysts.

GAAP vs. Statutory Basis Accounting

The chart below compares the financial performance of the Commonwealth's budgeted funds under generally accepted accounting principles (GAAP) and under the statutory basis of accounting for the last seven fiscal years.

Under the statutory basis of accounting, which is used to develop the Commonwealth's budget and to control its daily activities, 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 year but recorded in the next fiscal year. Accordingly, the Commonwealth's overall financial condition at fiscal-year end might appear healthier than it actually is. Under this method, the budgeted funds's ending balances for each year shown progressed from a negative balance of $1.104 billion in Fiscal Year 1990 to a positive year-end balance of $1.172 billion in Fiscal Year 1996. The cumulative improvement, then, is $2.277 billion.

In contrast, GAAP, the more stringent accounting system used in the private sector, matches inflows pertaining to a fiscal year to 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 a GAAP basis, the Commonwealth's budgeted funds's balance in Fiscal Years 1990 through 1996 grew from a deficit $1.896 billion to a positive $709.2 million, a cumulative improvement of $2.605 billion.

Thus, the Weld/Cellucci Administration's lauded efforts to achieve fiscal balance are even more impressive when viewed on a GAAP basis.