The Patrick-Murray Administration is the first Administration in Massachusetts to establish a long-term planning policy to ensure that the state budget is consistent with the principle of fiscal sustainability. The FY 2014 budget achieves fiscal sustainability based on an evaluation of structural balance as defined by the Commonwealth’s Long-Term Fiscal Policy Framework, which is posted on www.mass.gov/anf. Structural balance is achieved when budgetary spending is based on sustainable levels of revenue and does not include excess spending that would result in a structural deficit. When the economy is operating under capacity, the policy benchmark to evaluate structural balance compares the cyclical shortfall in tax revenue to the use of one-time resources included in the budget to offset this shortfall. When the economy is operating over capacity, the policy benchmark compares the cyclical surplus in tax revenue to the deposit of excess resources into the Stabilization Fund.
The Governor’s proposed FY 2014 budget is in structural balance because the proposed use of $393 M in one-time resources is significantly lower than the estimated $1.313 B cyclical shortfall. The $393 M in one-time resources is based on the $555 M figure identified in the budget development write-up, net of $162 M in projected stabilization fund deposits. The estimated cyclical deficit of $1.313 B is based on the long-term revenue forecast that was developed in concert with the consensus tax revenue process as described below.
Note that these forecasts do not include the impact on revenue and spending of the Governor’s revenue proposal. This revenue proposal would eventually increase the long-term tax revenue forecast by over $1.9B annually to fund new investments in transportation, education, and innovation, with a portion of the new revenue generated in FY 2014 used to support current budgetary spending. In future years, the entire amount of new revenue would be applied towards new investments as the fully annualized impact of the revenue proposal is realized and the projected economic recovery provides additional resources to support existing programs. As a result, while the proposed changes to tax policy would have a significant impact on the different components of the structural balance analysis in the future, the evaluation based on the forecast developed earlier this year still provides a reasonable basis to evaluate the benchmark.
The policy benchmark for structural balance is based on a framework for long-term tax revenue forecasting, developed by the Executive Office of Administration and Finance (A&F) and the state’s Office of Tax Policy Analysis, using revenue projections provided by outside economists. The revenue forecast is also used to evaluate other policy benchmarks, described in the Long-Term Fiscal Policy Framework, based on best practices recommended by the Government Finance Officers Association (GFOA).
The FY 2014 budget achieves structural balance based on an estimated $1.313 B cyclical shortfall and the use of $393M in one-time resources, net of deposits into the stabilization fund. The cyclical shortfall represents the difference between the FY 2014 consensus tax revenue estimate of $22.334 B and A&F’s estimate of $23.647 B in tax revenue that the Commonwealth would generate if the economy were at full capacity or “on trend.” The difference between actual/forecasted tax revenue and trend tax revenue is depicted in Figure 1. The development of these estimates is described in more detail in the “Long-Term Revenue Forecast Methodology” section that follows.
The use of $393 M in one-time resources provides a significant margin of safety in comparison to the cyclical shortfall. Further, the Governor’s proposed budget will maintain $1.035 B in stabilization fund balances at the end of FY 2014. The Commonwealth currently has the third highest stabilization fund balance in the country. The projected stabilization fund balance for year-end FY 2014 will ensure that there are sufficient resources to support the balance of the economic recovery and to provide protection in the event of another economic slowdown. For further discussion of the Stabilization Fund balance, see the Budget Challenges section.
The long-term tax revenue forecast used to estimate the cyclical shortfall is developed in three steps. The foundation for the analysis is the 10-year tax revenue forecast developed by outside economists for the FY 2013 - FY 2022 time period. Second, these forecasts include an estimate of the long-run “steady-state” tax revenue growth rate, which reflects the level of tax revenue growth that may be expected in the future when the economy is at full capacity. The third step is to develop an imputed revenue-trend line, which is based on the FY 2022 tax revenue estimate for each forecast, discounted for the steady-state rate of revenue growth.
A summary of the external forecasts, the Administration’s estimates for long-term tax revenue growth, key assumptions and calculations are included in Table 1 below. These results show strong revenue growth of 6.0% annually during a projected economic recovery between FY 2014 and FY 2017, a steady state growth estimate of 4.0% applied to the period between FY 2018 and FY 2022, and a resulting growth rate of 4.7% during the full forecast period. The cyclical shortfall reflects the difference between the FY 2014 consensus tax revenue estimate of $22.334 B and $23.647 B, which is the FY 2014 estimate associated with the revenue trend-line calculated using the formula described above and noted in Table 1.
The long-term tax revenue forecast also plays a central role in developing other policy benchmarks that are included in the Commonwealth’s Long-Term Fiscal Policy Framework. The projections for long-term growth in tax revenue and the Massachusetts economy are used to formulate policy benchmarks for the sustainable rate of growth in total spending and health care spending in the budget. The projected rate of growth for Massachusetts gross state product, which is inherent in the tax revenue forecast, is used to evaluate projected changes in the level of long-term liabilities as a percentage of the state economy over time.
In addition, M.G.L. Chapter 224, the Health Care Cost Containment law, requires the Secretary of A & F and the House and Senate Ways & Means Committees to develop an estimate of long-term growth in Massachusetts potential gross state product, to be used by the Health Policy Commission to set the state’s health care cost growth benchmark. Potential gross state product, a measure of the output of the Commonwealth’s economy excluding fluctuations due to the business cycle, is also an estimate of the long-term trend in gross state product.
The alignment of these policy benchmarks and the best practices for long-term planning prescribed by GFOA and GASB are described in more detail in the complete Long-Term Fiscal Policy Framework, which will be updated based on the FY 2014 budget proposal and posted on www.mass.gov/anf.
Beginning in FY 2012, the A & F budget staff has consulted the Long-Term Fiscal Policy Framework cited above to establish parameters for agency and program cost growth based on projected annual revenues over medium- and long-term periods. These parameters were used to inform decision-making related to allowable hiring and related program expenditures, as well as served to help A & F develop funding targets for FY 2014 to ensure that state spending ultimately could be sustained by available resources.