In the Red

Early Warnings About Virginias Fiscal Outlook

By Sara Okos, Laura Goren, and Michael Cassidy

The Commonwealth Institute

July 2011

Executive Summary
Virginia faces an estimated budget shortfall of more than $800 million in the upcoming 2012-2014 biennium, even with years of core service cuts and slowly rebounding state revenues. Sounding an early warning, this report provides a look at the impact of lagging revenues, increasing costs and the disappearance of vital federal funds. Virginia tax collections remain well below pre-recession levels despite recent modest improvements. For example, the state would require revenue growth of nearly 9.5 percent to return to 2007 pre-recession levels. State revenues also lag far behind the growing costs of maintaining existing services in Virginia. As Virginia families continue struggling to make ends meet in the face of declining incomes, reduced hours, and continuing job losses, the need for public programs such as food stamps, Temporary Assistance to Needy Families (TANF), and Medicaid, which grew substantially during the recession, remains at high levels despite two years of recovery. Complicating the budget situation are the loss of federal funds from the American Recovery and Reinvestment Act and a series of new fiscal obligations paying back the Virginia Retirement System (VRS), rebuilding the Rainy Day Fund, and making interest payments to the federal government on unemployment insurance borrowings. This presents serious risks to critical state investment in key areas like education, health care, and economic development.

Virginia faces a future budget shortfall of over $800 million.

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Because Virginia faces these tremendous budget gaps, the states best strategy will remain a balanced combination of modest spending cuts and new revenue measures to strengthen the revenue recovery. If Virginia chooses to close this budget shortfall with a cuts-only approach, it will likely impede our economic recovery and cost both public and private sector jobs. When the state slashes funding for services, it leads not only to job losses among state and local employees, but also to reduced payments and canceled contracts to private sector vendors, companies, and organizations that provide many of the services funded by the state budget. The estimated $800 million budget shortfall comes on top of large shortfalls Virginia faced in recent years due to the recession.

publicly available data on expected revenues and expenditures from the states six-year financial plan and adjusts those expected amounts based on both updated revenue projections from the state and on the actual expenditure levels included in the state budget enacted by the General Assembly and the Governor in April 2011. Assuming a continuation of the funding levels passed in this years budget, adjusted for the states own projections of any spending changes in 2013 and 2014, current revenue forecasts leave the state falling short by about $800 million. This gap between the need for public services and the resources available to pay for them only grows when you factor in the costs of restoring cuts to K-12 education or provider rates to doctors and hospitals in the states public health insurance program, Medicaid, and the interest due to the federal government on Virginias recent unemployment insurance borrowings. Like the rest of the country, Virginia was battered by the recession. For the first time in the recorded history of the state, revenues declined for two years in a row in 2009 and 2010 and revenue remains down by historic amounts. On top of this trend, the sizes of recent revenue declines dwarf those of prior recessions.

In 2009 alone, the 9.6 percent decline was more than double the declines of the last recession. In addition, Virginia remains near the bottom of a very deep jobs hole. Over two years into the recovery, unemployment still hovers around 6 percent statewide -- and the announcement of over 14,600 jobs lost this past June illustrates continuing challenges in getting Virginians back to work. Virginias anemic economic recovery and lingering high unemployment mean that revenue growth has been inadequate to get the state back on track. Despite the heavily touted surplus of 2010, revenues were still lower in 2010 than in 2009 and the surplus only occurred because the decline in revenue ended up smaller than expected (-0.7 percent actual decline instead of -2.3 percent forecasted decline). Based on recent revenue collections, the 2011 fiscal year will close with another surplus. Annual revenue growth is tracking at around 5.8 percent, which is ahead of the 3.5 percent projection on which legislators built the current budget. While any returning revenue comes as welcome news, Virginia is not out of the woods. It would take revenue growth of nearly 9.5 percent just to get fiscal 2011 revenue collections back to their 2007 pre-recession level. The real problem is that in order to keep up with the states growing population and increasing costs for delivering services in the future, revenue growth needs to be and stay in the 6 to 8 percent range, year after year.

Budget Outlook
Despite signs of a fragile economic recovery in Virginia, state revenues are not rebounding to the levels needed to meet either current or future demand for public services. This report compiles

The Needs Are Still Great

Just as revenues dropped, public demand for essential services spiked. As Virginia families began struggling to make ends meet in the face of declining incomes, reduced hours, and continuing job losses, the need for public programs such as food stamps, Temporary Assistance to Needy Families (TANF), and Medicaid, grew substantially. More importantly, as shown in Figure 3, the needs of Virginians

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remain high. And even though Virginia is well into its recovery, food stamp participation and Medicaid enrollment are currently at their highest levels since the recession began. Unemployment is still up 81 percent since the start of the recession, food stamp recipiency is up 61 percent, TANF recipiency is up 16 percent, Medicaid enrollment is up 18 percent, and enrollment in Virginia community colleges and universities is up 10 percent. Until Virginia can make substantial progress in reducing the unemployment rate, the needs of Virginians will remain high. So far, Virginia has dealt with the persistent gap between available resources and the need for services through a mix of strategies. Roughly 40 percent (about $4.4 billion) of the total shortfall was closed through spending cuts to programs. Another 7 percent (about $783 million) was closed through use of the states Rainy Day Fund, which held its highest balance on record going into the recession. While the Rainy Day Fund served its purpose in helping stabilize spending at a time of decreased resources and increased need, the Recovery Act played an even more critical role in preventing even deeper cuts to core programs: 27 percent of the states shortfall during the downturn was closed with $3.1 billion in Recovery Act funds. As shown in Figure 5, the bulk of these dollars supported health care and education, two areas of the budget that serve vulnerable populations -- and which would have faced even more crippling levels of cuts without this federal assistance. In addition to cutting programs and bolstering the general fund with Rainy Day Fund and Recovery Act dollars, the state used a variety of other one-time tactics to balance expenses with revenues. These tactics included shifting money out of special funds into operating accounts, delaying some capital projects, and selling bonds to fund others capital projects, deferring maintenance, and knowingly underfunding the states pension system.

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What Lies Ahead

Looking forward, the short and longterm fiscal outlook in Virginia remains challenging. Many of the tools used to close the budget shortfalls and sustain critical services are no longer available. While federal Recovery Act funding is coming to an end, public service demands continue. Virginia would need revenue growth of nearly 9 percent in 2012 just to make up for the expiring Recovery Act funds that supported education and health care. While use of the Rainy Day Fund to cope with the massive revenue declines of the recession was entirely appropriate, the fund is now mostly depleted. Furthermore, Virginia was already bumping up against its debt capacity ceiling whereby debt service cant be more than 5 percent of certain tax revenue. The state has already tweaked the formula by which it calculates debt capacity to accommodate greater borrowing. The unavailability of these tools going forward, coupled with meager revenue growth, means that the prospects for restoring recent cuts made to services like education, health care, and public safety are bleak. In addition, our use of these tools and accounting gimmicks has placed new demands on returning revenue that will lessen Virginias ability to adequately fund priorities like education and health care. Specifically: Virginia Retirement System. Virginia must repay the states retirement fund to make up for deliberate underfunding. Rainy Day Fund. The Rainy Day Fund must be replenished. As revenues pick up, Virginia is on the hook for deposits

into the fund in coming years so that the state can prepare for the next downturn. Unemployment Insurance Loan. Our unemployment insurance loan must be repaid. Like many states, Virginias unemployment insurance trust fund is insolvent, and weve had to borrow from the federal trust fund during the recession in order to pay benefits. Congress enacted a moratorium on interest payments for that borrowing, but that moratorium is coming to an end. This means Virginia will soon have to pay that interest out of the states general fund. The first interest payment of $11 million is due this September, and the Virginia Employment Commission estimates that Virginia likely will owe another $9.2 million in fiscal year 2013. Transportation Funding. Transportation is first in line for funding. A provision of the transportation funding bill enacted under Governor Kaine says two-thirds of all undesignated surpluses go to transportation. In addition, Virginia cuts imposed since the recession began have impeded our economic recovery and cost both public and private sector jobs. State and local governments have cut 6,000 jobs in education and other areas since 2008 and are likely to cut even more. If Virginia chooses to close this budget shortfall with a cuts-only approach, it would likely impede our economic recovery and cost public and private sector jobs. This is because when the state slashes funding for services, it leads not only to job losses among state and local employees, but also to reduced payments and canceled contracts to private sector vendors, companies, and organizations that provide many of the services funded by the state budget.

Conclusion
The fiscal challenges facing Virginia are substantial. Though revenues show a slight uptick, the increase will still fall over $800 million short of what is required to support even current state spending assumptions for the coming biennium. Inadequate revenue growth, coupled with the loss of Recovery Act funds, and increasing other demands on state resources will likely place Virginia on red alert unless action is taken. This could hinder much-needed investments and innovation in public education, health care, public safety, and economic and workforce development.

Appendix: Notes on Methodology

The estimate of the budgetary shortfall in the 2012-2014 biennium was derived by: 1) estimating the 2011 year-end total general fund revenues number using the year-end fiscal 2010 total general fund revenues figure and adjusting by the 5.8 percent growth rate reported in the May revenue report, and then inflating that figure for fiscal 2012-14 using the GACRE December forecast growth rates of 5.9 percent in fiscal 12, 4.2 percent in fiscal 13, and 4.7 percent in fiscal 14. 2) updating the spending projections from Department of Planning and Budgets Six Year Financial Plan 2011-2016 with the 2012 spending levels included in Chapter 890, and then assuming the Six Year Plans growth rates to calculate the 2013 and 2014 spending levels.

The Commonwealth Institute for Fiscal Analysis provides credible, independent and accessible information and analyses of state fiscal issues with particular attention to the impacts on low and moderate-income persons. Our products inform state fiscal and budget policy debates and contribute to sound decisions that improve the well-being of individuals, communities and Virginia as a whole. For more information, go to www.thecommonwealthinstitute.org. This research was partially funded by the Annie E. Casey Foundation. We thank them for their support but acknowledge that the findings and conclusions presented in this report are those of the authors alone and do not necessarily reflect the opinions of the Foundation. 1329 East Cary St, Suite 202 Richmond, VA 23219 | 804-396-2051 | www.thecommonwealthinstitute.org

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