State Revenue Deteriorating

By Charles M. Arlinghaus

March 2008

In each of the last four months, state revenues have fallen further and further behind the amount needed for the state budget. Revenues will end the year at least $91 million behind the budget – and even higher if business taxes also deteriorate. The two year budget shortfall will be between $205 and $258 million.

State tax revenues continue to come in well below the amount budgeted and have created the worst revenue shortfall since the deep recession of 20 years ago. Through the first eight months of the fiscal year, revenues are on a pace to end the year $91 million short of the budgeted amount. If the current economic slowdown also impacts business tax revenues as seems likely, the hole could get significantly worse.

The Deepening Hole

Non-business taxes are remarkably predictable. Each year the total through a given month is a consistent percentage of the final revenue within a very small range. For example, the five month total has been an average of 38.5% of the final total within a two point range. Therefore, each month we can look at the total and make a projection for where we will end the year. At the end of November, we were able to project that this category was on a pace to end the year $48.5 million short of the budgeted estimate.

That amount served as the basis for a state estimate of a revenue shortfall. In January of this year, state department heads testified before the legislature that we would end 2008 about $43 million behind revenue projections. The second year would build on that and end up another $104 – $157 million behind, depending on the economic situation, for a total range of $147 – $200 million.^[1]

It is worth noting that this estimate by state officials was considered too high by the Democratic majority on the House Ways and Means committee and too low by the Republicans on the same committee. As something of a middle ground, it is a useful starting point for determining the impact of the revenue deterioration of the last few months.

Their estimate of a $200 million budget shortfall is based on a revenue shortfall of $43 million in the fiscal year that ends in June. According to their estimates, business taxes (more volatile) would be even with the budget but other taxes would be $43 million behind.

On the basis of those estimates, the governor proposed cutting $50 million from the budget immediately and waiting to do anything else.

Revenue Deterioration

Based on current revenue trends, the estimate of $200 million shortfall is optimistic. Over the last three months, state tax revenues have continued to deteriorate making the goal of holding revenue losses to $43 million in the first year of the budget almost impossible.

In the broad category of non-business tax revenues, total receipts for the year are budgeted to be $1,213.2, fifty-six percent of the total budgeted revenue.^[2]In November, the shortfall could be projected at $48 million but in each succeeding month the situation has deteriorated.

Other revenues	November	December	January	February
Ave % of total	38.5%	46.3%	55.8%	62.1%
Actual revenue	$448.4m	$537m	$631.7m	$696.7m
Projected Total	$1164.7m	$1159.8m	$1132.1m	$1121.9m
Shortfall	$48.5 million	$53.4	$81.1	$91.2

Revenues keep falling further behind. Through November, revenues average 38.5% of their final total and were on track to be $48.5 million behind budget. Using precisely the same methodology, the expected annual total has deteriorated. After the first eight months of the fiscal year, non-business tax revenues are now on a pace to be $91 million behind. The shortfall comes not from one source but from almost every major tax in the state.

Of the seven largest revenue sources other than the business tax for the first eight months, only the communication services tax is performing as budgeted. The Meals & Rooms Tax, Tobacco Tax, Interest & Dividends Tax, Real Estate Transfer Tax as well as liquor sales and lottery revenue are all coming in below budget.

Impact on the Biennial Budget

In January, the state department heads estimated a two-year shortfall of $200 million if the economy worsened. Most observers would agree that the current problems with the economy, whether we call them a recession or not, are likely to continue for some time before recovery.

That $200 million was predicated on a shortfall in the current fiscal year of only $43 million. A shortfall of $91 million would increase the first-year estimated shortfall by another $48 million. In addition, it would affect the base from which the second year will grow. Therefore the $200 million estimate would increase to $296 million.

Business Taxes

Because business taxes are historically volatile, they are very hard to predict. As part of their estimated $43 million total shortfall for the first year of the two-year budget, state officials projected that business taxes would come in neither higher nor lower than the budgeted amount.

However, through eight months, business taxes are still $17.2 million ahead of budget. Many observers think that number may exaggerate business tax strength partly because of the audit revenues included in the total. For example, February business tax revenue was $5.8 million ahead of budget but included $7.0 million in audit revenues. Nonetheless, if we project business taxes forward without making any adjustment for audits, business taxes would end the fiscal year $25.3 million over budget.

However, business tax revenues for March and April are 35.5% of the final total, a disproportionately high amount. Even with just the March quarterly filings, we will have a much better idea if the current numbers are affected by audit or represent business strength in a weak economy.

It seems likely that the current economic situation will affect the net business filing and that business taxes will show some weakness. Expecting business taxes to come in on budget seems optimistic even with apparently strong audit revenues.

Mitigating Factors

• Insurance taxes represent about 5% of the total budget, about $99.5 million. Beginning this year, 90% of those taxes are collected in a lump sum in March. Rising health care premiums should ensure that insurance taxes don’t produce any shortfall. Unexpectedly high premium increases cause other problems but create the hope that premium may be slightly above budget.

• Medicaid Enhancement Revenues are about 95% collected and are one million dollars ahead of budget.

The Size of the Budget Hole

Using the estimates of state officials as a starting point, we can create a new estimate of the budget hole based on the deterioration of state revenues. The estimate varies considerably based on whether business taxes come in a little ahead of budget projections or a little behind.

If the current business trend is not based on audit revenues and New Hampshire businesses are less affected by the economy, the $25.3 million extra business tax revenue would offset some of the $91 million shortfall in other categories. Coupled with slightly higher Medicaid enhancement revenue and slightly higher insurance revenue, this best case scenario would produce a shortfall of $63 million instead of the $43 million state officials project. Using their estimates for 2009 would produce a revenue shortfall for the budget in a range of $187 – 240 million.

On the other hand, if business tax revenues are down in March and April because of an economic slowdown, perhaps $10 million would have to be added to the $91 million deficit in other revenue. This more realistic scenario would mean a shortfall of $101 million in the first year of the budget instead of $43 million and a total budget shortfall of $205 – 258 million. If business taxes do start to fall, the result will almost certainly be at the higher end of the range.