Revenue on Track for $75 Million Shortfall

By Charles M. Arlinghaus

 December 2007

New Hampshire State revenues are currently on a track to produce a shortfall of more than $75 million in the fiscal year ending June 2008. That shortfall could be reduced by a strong economic performance over the next months but will likely grow larger as corporate profits growth slows after the explosive growth of recent years.

A revenue shortfall is more damaging even than it seems because of the way the New Hampshire budget is put together. Revenue has always been estimated somewhat cautiously to provide a cushion in case spending is somewhat higher than expected or the economy doesn’t look as bright as once thought. That cautiousness has been necessary because annual spending has almost always significantly exceeded the budgeted amount.

On a monthly basis, the state government publishes updates on tax revenue. However we will have little information about the spending side of the budget until the end of the fiscal year. Monthly spending estimates are possible and have been planned for but have yet to be implemented.

We know for every tax how much was budgeted to come in and how much actually did come in. This level of detail and timely reporting is one of the most transparent parts of government. It helps serve as an early warning system so we can prepare for potential budget shortfalls.

On the spending side of the budget however, we have little or no idea where we stand compared to budget. In February, the governor announced a plan to place monthly spending updates online as well. At this date, ten months later, no progress has been made. That makes careful consideration of revenue projections all the more important.

 

Projecting year-end totals

Projecting the likely revenue total at the end of the fiscal year based on the first 5 months of data can’t be done with a simple straight-line extrapolation (the assumption that the 5 month total is simply 5/12 of the final total). Some revenue sources are received quarterly or in lump sums or are stronger in certain months than in others.

A modified straight-line extrapolation gives us a broad picture but is more accurate after some months and for some taxes than others. Revenues through the first five months may not be 5/12 of the final annual total but month by month trends are fairly consistent and historical averages can accurately predict final totals. For example, if total revenues through November are usually 38.5% of the final total, we can make a fairly good prediction by extrapolating the current total as 38.5% of the final.

 

Three Categories of Revenue

Total state general and education fund revenues can be divided into three broad categories: “Medicaid enhancement revenue,” (5% of the budgeted total of $2,055.8 Million), Business taxes (31% of the budget) and other sources (61%). The statewide property tax amount is dictated by statute at $363 million. Because that money never enters the treasury and doesn’t vary, it is eliminated from the tax analysis.

 

Medicaid Enhancement

Medicaid Enhancement revenue^[1] is that source of money derived through creative billing of the federal government to enhance their outlays to New Hampshire based on their Medicaid program. The amount received is not based on economic activity and 90% of it comes in one lump sum in October. For FY2008, the budget projects a total of $105.1 million. Through November, we’ve received $1.0 million less than budgeted, with about 90% of the total annual amount already collected^[2]. Some of that difference will likely be recovered in the last seven months of the fiscal year so for this analysis the difference from budget will be treated as more or less zero.

 

 General Taxes

The largest category of taxes is general tax revenue, the basic taxes of state government after setting aside the combined Business Profits and Business Enterprise tax and Medicaid enhancement. These general tax revenues account for 61% of the projected revenue for Fiscal Year 2008 or $1,312.7 million.

To compare revenues year over year it is necessary that no major changes have been made in revenue sources or their manner of collection. Using the last eight years of tax collections, revenue numbers are comparable with one significant exception. The insurance tax, like most other sources, was collected month by month. However, because of a change in law, for fiscal year 2008 the insurance tax will be collected with a lump sum in March accounting for 90% of the total tax collection. To make comparisons useful, the insurance tax totals have been removed from both historical data and the current fiscal year.

Insurance tax collections are budgeted at $99.5 million, about 5% of the total revenues. At this point there is no evidence that those collections will diverge from the budgeted amount by a significant number. So, for the current analysis, the difference from budget for the insurance tax will be projected at zero.

The remaining general revenues are projected to be $1,213.2, 56% of the budgeted total. Over the last eight years, these revenues have been remarkably consistent. Year to year there is some variation but the November total has been consistent within a small range.

Revenues Through November as a Percentage of Annual Total
Year	5 Month Total	Annual Total
2007	$419.7	$1123.6	37.4%
2006	$420.2	$1084.1	38.8%
2005	$390.7	$1000.6	39.0%
2004	$392.0	$986.0	39.8%
2003	$358.5	$954.7	37.6%
2002	$353.3	$900.1	39.3%
2001	$331.2	$865.2	38.3%
2000	$329.0	$869.7	37.8%
			Average: 38.5%

On average, the five-month total has been 38.5% of the final total for this category. The variation has been between 37.4% and 39.8%, a very small variation of only 2.4 percentage points.

Before using these totals as guidelines, we have to examine each month’s return for each tax and look for anomalies like a change in collection or a one time large windfall from a sale, federal grant or penalty that might distort the current total. Leaving out insurance taxes eliminates that distortion. No other tax has shown a significant distortion in any month’s return.

Through November, this general revenue category has produced $448.4 million. If this total is 38.5% of the final annual total, the total raised will be $1,164.7 million, or $48.5 million below budget. Because the historic number varies between 37.4% and 39.8%, we can project that the shortfall would be $14.3 million at the low end of that variation and as much as $86.6 million at the high end.

 

Business taxes

Business taxes, the combined total of the Business Profits and Business Enterprise taxes, are projected to be $638 million or 31% of the total for FY2008.  The bulk of business taxes are collected quarterly with large deposits made in September, December, March, and June with an additional large sum in April. In the last seven years (since the current rates were established), the revenues have been consistent overly quarterly intervals.

 

Audit Revenue

In the last few years, predictions are more difficult early in the year because of growing and less predictable audit revenues. Mixed into the business profits tax totals are audit collections that reflect not economic activity but enforcement collections. From 1996-2003, audit collections averaged $15.9M, a smaller percentage of the business tax total. In 2004-05, collections increased to $26.8M each year and were $62.8M and $50.9M in 2006-2007^[3], a significant portion of the total.

Through September, business tax collections had predicted an additional $44 million shortfall^[4]. However, in October, BPT revenues projected to be $5.8M came in at $36.5. That sort of anomaly is not predictive and was largely the result of audit collections. In November BPT collections were actually negative.

Making an accurate prediction will require a way to pull audit collections out of the total and compare non-audit business taxes to prior years. After the December end of the year business filings are reported, we can make a better prediction because audit revenue will be less of a distortion to a higher total.

FY 2006 saw a similarly large October filing. If 2008 tracks similarly to that year, the current $175.4 million in receipts would be $27 million less than budgeted^[5]. However, this year corporate profits nationally are down after the recent expansion and the Business Enterprise Tax is tracking 13% below budget. In all likelihood, the business tax shortfall will be closer to $50 million. At the upper end, if the striking anomaly in October represents economic activity and delayed returns from September rather than an unusually high audit number, business taxes will likely be $22 million higher than budgeted.

An accurate assessment of business tax liability will require data on audit collections on a semi-annual or quarterly basis. Currently, the Department of Revenue Administration is reluctant to release monthly audit collection totals for privacy reasons. Quarterly totals or at least semi-annual numbers will probably avoid those privacy concerns.

 

Current Range of a Projected $75.5 million Revenue Shortfall
	projected	high	low
Medicaid Enhancement	0	-1.0 million	0
Business taxes	-27 million	-50 million	+22 million
Insurance tax	0	0	0
Other general Revenue	-48.5 million	-86.6 million	-14.3 million
Total	-75.5 million	-137.6 million	+7.7 million