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(2015) Major Issues: Budget Shortfall and Virginia's Economic Outlook

The 2015 General Assembly will continue to grapple with Virginia's large budget shortfall.  We are still struggling to fund essential programs and have not yet reached pre-recession funding levels for most state programs. Public expectations are high but our revenues are not keeping up.

Over the past few weeks I have attended four public hearings where over three hundred Virginians expressed their views on the needs facing our state. The needs are real, especially in education and human services.  The revenue stream is not sufficient to fund their real, often heartbreaking, requests.

I worked with the Senate Finance staff to prepare this paper and it is much longer than my usual reports.  But, the topic is critically important to understanding what is happening in Richmond and why it is so difficult to move the Commonwealth forward on essential programs.  I hope you take the time to read it.

As you probably know, Virginia has been contending with yet another budget shortfall over the last several months.  You may wonder why Virginia is back in a budget-cutting mode when the national economy appears stronger and many other states are returning to more predictable revenues and stable budgets.

At this time last year our state's economy did appear to be recovering.  We weren't flush by any means but we did appear to have sufficient resources to make additional investments in education, economic development, and our mental health services.

Last February we saw the first signs of weakening in fiscal year 2014.  We reduced revenues a bit and thought that would be the end of it.  In April we began to see further softening in revenues.  At that point, most of the weakness was in final and estimated payments -- these are taxes paid by those who may be retired or who have investment income.  It was assumed that this weakness was attributable to an anticipated change in federal income tax policy and not a systemic problem in our economy.

The fact is, we were wrong.  While we did see an impact of the federal tax policy change in FY 2014 -- as did a number of other states with an income tax-- the real culprit this year and next is the decline of federal expenditures and the ripple effect on Virginia's economy. We knew this shoe would drop at some point, but most economists believed we would not see meaningful impact until 2017.  We had already seen signs of softening in the growth of federal contractor jobs in Northern Virginia, but the decline had been gradual.

However, federal contractors and those businesses with whom they work had seen the handwriting on the wall and had already begun to downsize their workforce.  Additionally, the composition of jobs is changing dramatically.  Growth has halted or declined in the good-paying ($77k+/year) jobs in the "business and professional services" categories.  Instead, we are seeing more growth in lower-paying jobs, such as health, leisure and hospitality ($45k/year on average).

Unfortunately, no one believes this situation is a temporary one.

So, looking back to last year, we had anticipated economic growth in our revenues of around 4 percent for each year of the biennium. Now, we are assuming growth will be below 3 percent per year.  Just to put those numbers in context, Virginia's average growth rate in recent years had been about 5.5 percent.

The upshot is that the scope of the budget shortfall that we were attempting to address last year was about $2.4 billion. The General Fund base is about $16.8 billion a year, so this is a large percent. While most of the shortfall has been closed, we still have a remaining shortfall of $272 million.

Governor McAuliffe's budget, which we will be considering over the next few weeks, provides strategies to meet that remaining shortfall.  There are no cuts to K - 12 education, no additional cuts to higher education, and no additional cuts to aid to localities.  I am hopeful we will be able to sustain those positions as we go about our budget deliberations.

Most of the Governor's savings come from lower utilization in our Medicaid forecast, savings in debt service, and a reduction in state employee health care benefits.

I must note that, if we had adopted "Marketplace Virginia" and expanded Medicaid, we would have an additional $200 million in savings in this budget. We would also have a healthier workforce and a significant boost in healthcare jobs.

To close the remaining budget gap, and to cover required new spending, the Governor has proposed a modest package of tax policy changes that generate about $114 million over the biennium. This is an area that may require more scrutiny.  We have several tax credits and exemptions that were adopted when our economic growth rate was twice what it is currently.  I would suggest that we need to look at those programs and policies to determine if they still work well in tandem with our changing economy.

So where does that leave us?  Fortunately, as I have said, the Governor's budget closes the budget gap. His budget is balanced. What we do not have, however, is any real ability to make investments in public education, higher education, human services, or workforce development.

We know that we must diversify our economy to reduce our dependence on federal funds.  To do that, we need to attract and retain businesses and industries and grow the ones currently here.  And to do that requires a talented, well-educated, well-trained workforce.

Direct Aid to Public Education has been spared additional state cuts. However, unless we have a sudden, unexpected upswing in our economy, we will have to jettison a proposed and deserved salary increase.  For context, in terms of per pupil General Funds for public education, by FY 2016 we will be just back to FY 2008 levels on a statewide basis.  The temporary federal stimulus funds did help mitigate the state reductions during the recession, but even so total school spending from all sources did decline from 2009 to 2013.

Our General Fund appropriation for the instructional programs in higher education is below where it was in FY 2007, and about where it was in FY 2001.  As a result, tuition has risen significantly at all our colleges and universities.  And, our funding for financial aid has lagged as well.

So, our overall fiscal outlook is rather bleak. And this session we will continue to prioritize essential services in order to produce a balanced budget.