Stabilization Fund Policy

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Governor Patrick    FY09 House 2 Budget Recommendation:
    Issues in Brief

    Deval L. Patrick, Governor
    Timothy P. Murray, Lt. Governor

 

Overview

As a part of the balanced approach to solving the fiscal year 2009 budget challenge, the Governor's budget proposal includes a $369 million transfer from the Stabilization Fund. The amount of the transfer is based on a fiscally responsible and innovative approach to the use of the Stabilization Fund to support budgeted spending. The following is a general description of the Stabilization Fund and of the Administration's policy for determining the appropriate amount of the budgeted transfer from the fund.

General Information regarding the Stabilization Fund

The Stabilization Fund is established in Chapter 29, section 2H of the General Laws as a reserve of surplus revenues to be used for the purposes of: (1) covering revenue shortfalls, (2) covering state or local losses of federal funds, or (3) for any event which threatens the health, safety or welfare of the people or the fiscal stability of the Commonwealth or any of its political subdivisions. The fund is sometimes referred to as the state's "rainy day fund," serving as a source of financial support for the state budget in times of slow or declining revenue growth and as the primary source of protection against having to make drastic cuts in state services in periods of economic downturns.

The following table shows the amount on deposit in the Stabilization Fund at the end of each of the last 16 fiscal years and the projected balance for fiscal years 2008 and 2009.

The following table shows the amount on deposit in the Stabilization Fund at the end of each of the last 16 fiscal years and the projected balance for fiscal years 2008 and 2009. amounts in the Stabilization Fund provided critical support in maintaining state services in fiscal years 2002 and 2003 when the Commonwealth experienced declining tax revenues in the face of an economic downturn.  Since then, surplus revenues have built the fund back up to a healthy balance of $2.335 billion at the end of fiscal year 2007.

In recent years, budgeted state spending has exceeded projected revenues and has relied to some extent on the use of Stabilization funds. However, in fiscal years 2004 through 2007, actual state tax revenues exceeded the consensus revenue estimates upon which the budget was developed, ultimately avoiding the need to transfer amounts from the Stabilization Fund to support budgeted spending.

This chart shows the consensus revenue vs. actual revenues for FY2004 to FY2008 by consensus revenue estimate and the amount over the estimate.  FY2004 shows by millions $14,687 consensus estimate with $1,266 over consensus; FY2005 shows $15,801 with $1,287 over estimate; FY2006 shows $17,100 with $1,387 over estimate; FY2007 shows $18,930 with $806 over estimate; FY2008 shows $19,825 with $400 over estimate.

The Governor's budget proposal for fiscal year 2008 relied on $175 million from the Stabilization Fund ($100 million from suspending the deposit and $75 million from interest earnings on the fund), but the final approved fiscal year 2008 budget enacted by the Legislature calls for a $415 million transfer ($100 million from suspending a required deposit to the fund, $75 million from the interest earnings, and a $240 million draw from the balance of the fund). The Commonwealth has already transferred $240 million from the fund to support fiscal year 2008 spending, and it remains to be seen whether state tax revenues will exceed the revised projections for the remainder of fiscal year 2008 to the extent necessary to eliminate the need for further Stabilization Fund transfers or even to reimburse the Stabilization Fund for the amount already transferred. So far, the fiscal year 2008 consensus revenue estimate has been revised upward by the Secretary of Administration and Finance and is currently performing slightly above benchmark as of December.

Policy for Stabilization Fund Use in the Fiscal Year 2009 Budget

The Stabilization Fund should be used judiciously and responsibly to sustain critical state services and programs in the face of changing economic conditions and fluctuating tax revenues. The Commonwealth's prudent funding and use of the Stabilization Fund allowed the Commonwealth to weather the economic downturn in the early years of this decade much more easily than most of the other states in the nation. It is in the long-term financial interest of the Commonwealth to preserve and build a healthy rainy day fund balance in years of strong revenue growth to assist the Commonwealth in weathering future economic storms.

The state's consensus revenue process projects the underlying revenues that support nearly 2/3 of the budget. The accuracy of the consensus tax revenue estimate upon which the budget is based is a key factor influencing whether there will be a surplus contributing to the balance of the Stabilization Fund or a need to draw on the fund. Although this estimate is based on economic models and advice from various experts, it is made 6 to 18 months before the related fiscal year and is consequently unlikely to predict actual tax revenues with precision. As indicated above, consensus tax revenue estimates have been well below actual revenues in recent years. As a result, budgets have been enacted that rely on the use of Stabilization Fund transfers which have ultimately not been needed. In addition, large year-end surpluses have been generated and a large portion of these surpluses have been expended outside of the context of the budget-making process through which all state funding priorities are taken into account and weighed against each other. This recent trend in under-estimating tax revenues and ad hoc spending of large year-end surpluses contributes to public skepticism about the budgeting process. It also raises questions about the circumstances under which it is appropriate to rely on amounts in the Stabilization Fund for budgetary purposes.

The primary purpose of the Stabilization Fund is to preserve the fiscal stability of the Commonwealth. In the context of less than certain consensus tax revenue estimates, the Administration believes that the use of the Stabilization Fund as a resource to support the budget can be justified as a means of providing overall budgetary stability. However, the amount of any such budgeted transfer from the Stabilization Fund should be linked to the consensus tax revenue estimate and viewed in the context of historic tax revenue trends to ensure that the planned use of the fund is not excessive.

The following describes the methodology used by the Administration for purposes of determining the appropriate Stabilization Fund amount to support the fiscal year 2009 budget:

Historic Tax Growth
Fiscal Year Total Collections
($ in millions)
Growth (%) Growth
($ in millions)
2002 14,287    
2003 14,964 4.7% 677
2004 15,953 6.6% 989
2005 17,088 7.1% 1,135
2006 18,488 8.2% 1,400
2007 19,736 6.8% 1,249
5 year Average   6.7% 1,131

The proposed calculation for determining the maximum amount from the Stabilization Fund that may responsibly be used:

1. Reach agreement on Consensus Revenue Forecast:  
  FY2008 $20,225
  FY2009 - 3.8% Growth $20,987
  New Tax Revenues for FY2009: $762
2. Determine the actual growth in tax revenue over the past 5 years and develop the average (as shown in chart above) $1,131
3. Subtract the new tax revenue growth from the 5 year average of actual tax revenue growth $369
4. This is the maximum amount of Stabilization Funds that may responsibly be used: $369

Benefits of the Stabilization Fund Policy in the Fiscal Year 2009 Budget

This approach to budgeting for a Stabilization Fund transfer is fiscally responsible. It provides for budget stability by taking into account the inherent uncertainty of the consensus tax revenue estimate and historic revenue growth trends, and it provides for budget stability in both an increasing and decreasing revenue environment. If tax revenue estimates are too conservative and revenues come in higher than projected, as has been the case in recent years, the need to transfer from the Stabilization Fund to support the budget will be reduced or eliminated. If the consensus tax revenue estimates are correct and revenues are less than the five-year historic average, we will need to use Stabilization funds to support base spending and budget stability for critical programs and services.

This approach also ensures that the budget is not based on an excessive use of amounts in the Stabilization Fund. By linking the budgeted transfer to the consensus tax revenue estimate and the five-year historic average annual growth in tax collections, this policy ensures that we are not using the Stabilization Fund to support spending beyond what historic trends suggest can be supported by revenues.

In recent years, there has been no rationale behind the amount of Stabilization Fund transfers supporting the budget. This approach provides a fiscally responsible and transparent rationale for the use of the fund.

Status of the Stabilization Fund

Based on the Governor's Fiscal Year 2009 budget proposal, and depending on what other states do this fiscal year, the Commonwealth's Stabilization Fund balance is one of the highest in the nation based on FY07 data from other states.

This chart shows that the Commonwealth's Stabilization Fund balance is one of the highest in the nation based on FY07 data from other states.  According to the data California leads the nation with a fund balance (in millions) of $10,071, Alaska in second and Massachusetts in third with its FY2008 projected figure and in fourth place with its FY2009 projected amount.

Reforming the Statutorily Required Deposit into the Stabilization Fund

M.G.L. Chapter 29 s5C subparagraph (a) provides that 1/2 of 1 percent of the total revenues from taxes in the preceding fiscal year be deposited in to the Stabilization Fund. It is important to build up the Commonwealth Stabilization Fund to help cushion the impact of an economic downturn. At the same time, our contributions to growing the fund must be made strategically and weighed against other targeted investments for which those funds could be used to help grow our economy. In this budget, the Governor proposes to amend this provision by allowing investment earnings on the balance of the fund to count toward the statutorily required deposit. This policy ensures that when the fund is at its highest levels, as it has been in recent years, the interest earnings, along with a more modest deposit, should be enough to support continued growth in the fund. Conversely, when the fund balance is at its lowest levels and we cannot rely on investment earnings to help grow our savings a larger deposit would be required. Overall, this policy ensures that limited resources are invested wisely. For fiscal year 2009 the scheduled deposit is estimated to be $107 million and interest earnings are projected to be approximately $100 million. That would mean that a deposit of approximately $7 million will be made for fiscal year 2009.


Prepared by the Executive Office for Administration and Finance • Rooms 373 & 272 • State House
For more information contact:
Rob.Dolan@massmail.state.ma.us
www.mass.gov/budget/governor