By Grant Bosse
The Regional Greenhouse Gas Initiative is an agreement among ten Northeastern and Mid-Atlantic states to limit carbon dioxide emissions through a mandatory cap-and-trade scheme applying to fossil-fueled power plants. It is administered through a non-profit corporation, RGGI Inc., which contracts with private companies to administer and monitor quarterly auctions.
Which states are participating?
Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont.
Who is covered in New Hampshire?
RGGI applies to electric power plants generating more than 25 megawatts that are fueled by coal, oil, or natural gas. In New Hampshire, five power plants meet these requirements:
Newington Station in Newington, Oil
Merrimack Station in Bow,Coal
Schiller Station in Portsmouth, Coal*
*One of the three units at Schiller Station has been converted to run on biomass, and is not regulated under RGGI.
Granite Ridge in Londonderry, Natural Gas
Newington Energy in Newington, Natural Gas
How does cap-and-trade work?
For the next three years, RGGI will cap total CO2 from covered sources at 188 million tons per year. That total will drop by 2.5% in each proceeding three-year period until it is 10% lower than current levels. In March 2012, each of the five power producers in New Hampshire will have to produce carbon allowances for every ton of CO2 they’ve released from 2009 to 2011. These allowances may be purchased at quarterly auctions, or on the secondary market. Each allowance permits a ton of CO2 in any of the ten states, and at any time during the three-year compliance period. Power producers will be covered under RGGI beginning January 1, 2009, but will not have to show compliance with the restrictions until March 2012.
Why only coal, oil, and natural gas?
RGGI is designed to reduce carbon dioxide emissions. Nuclear power does not produce CO2. Biofuels such as wood do produce CO2 but as considered carbon-neutral under the law, since trees being grown the replace the biomass fuel theoretically absorb as much CO2 as the burning fuel produces.
What about other greenhouse gasses?
No other greenhouse gasses are covered under RGGI.
How would a federal cap-and-trade law affect RGGI?
Congress has considered several alternative cap-and-trade proposals for years. Most include provisions for state and regional greenhouse gas regulations. Any federal law would likely protect RGGI and other regional agreements from federal pre-emption, and count the established baseline of carbon emissions as the relevant federal baseline, rather than asking states to cut emissions from an already reduced baseline.
How do we know how much CO2 each plant produces?
Each of these power plants is already regulated under the federal acid rain program, which requires constant measurements of smokestack emissions. Since CO2 output is already being measured, electric power generation is considered the low-hanging fruit for CO2 reduction. Other sources such as transportation and agriculture would require extensive measuring and monitoring systems to be developed before a cap-and-trade program could be implemented.
What percentage of New Hampshire emissions come from these power plants?
It’s difficult to determine, since other CO2 sources such as cars, livestock, and even people are much more difficult to measure. Policy-makers estimate that electric power generation accounts for one-third of CO2 emissions nationally.
How are New Hampshire’s annual CO2 emissions calculated?
For most states, RGGI calculates the three-year average emissions from 2000 to 2002. Since two natural gas power plants went on line in New Hampshire in 2002, this figure would be artificially low. New Hampshire uses the two-year average of 2003 to 2004, which comes out to 8.62 million tons of CO2 annually. New Hampshire has 8.62 million carbon allowances to distribute, of which 5.95 million will be auctioned off each year.
Why isn’t New Hampshire selling off all of its CO2 allowances?
PSNH is New Hampshire’s largest electricity provider, and its largest CO2 source under RGGI. Prior to RGGI, PSNH was subject to regulation under the state Clean Power Act. As part of the transition from the Clean Power Act to RGGI, PSNH will be allocated 2.5 million allowances each year at no cost for three years, and 1.5 million allowances annually for the following three years.
New Hampshire lawmakers set aside two percent of the state’s allowances for other purposes. One percent has been reserved for residential homeowners who install renewable electricity to request state allowances to be retired. If unclaimed, these allowances will be added back to a future auction.
Additionally, if power companies are forced to exceed the allowances they’ve purchased in order to meet peak demand during a power emergency, they may receive additional allowances at no cost. One percent of the state’s total has been reserved for this purpose, and would go back into a future auction if not needed.
How much revenue will New Hampshire receive, and where does it go?
Based on current market prices, New Hampshire would receive approximately $18 million each year, those this could vary widely. All auction proceeds will be deposited into the state’s Greenhouse Gas Emissions Reduction Fund, which is administered by the Public Utilities Commission. State law requires that the fund support energy efficiency, conservation, and demand response programs, and that at least 10 percent be used to assist low income residential customers to reduce total energy use. The Legislature has already set aside $1.2 million in anticipated auction revenues towards the state’s weatherization program. The PUC has sole authority to determine how the rest of the Fund will be spent, barring further Legislative directives.
Can auction revenues be used to balance the state budget or for other spending priorities?
Under current law, the Greenhouse Gas Emissions Reduction Fund can not be used for other programs, or to balance the General Fund. However, like all dedicated revenue streams in New Hampshire, these revenues may be redirected at any time through legislation.
What is carbon capture and sequestration?
Rather than emitting CO2 through their smokestacks, power plants could capture the escaping gas, preventing it from increasing atmospheric CO2 levels. While technically possible, this technology is not yet commercially viable, and long-term storage of tons of lighter than air gas is challenging. One possibility is to use the underground space in depleted oil and natural gas deposits to sequester CO2 permanently. Carbon capture and sequestration would be allowed under RGGI, since the cap-and-trade regulations would not apply to CO2 that is never released into the atmosphere. Such an approach is unlikely to take off until the cost of capturing and storing a ton of CO2 is less than the cost of a carbon allowance.
What are carbon offsets?
Carbon offsets are an alternative way to comply with carbon caps. Rather than reduce their own carbon emissions, the source may choose to support programs that offset them. The most common is afforestation, planting trees that absorb CO2 as they grow. Under RGGI, power producers may offsets for up to 3.3% of their CO2 emissions. There are currently five project categories approved for offsets:
Landfill methane capture and destruction
Reduction in emissions of sulfur hexafluoride (SF6) in the electric power sector
Sequestration of carbon due to afforestation;
Reduction or avoidance of CO2 emissions from natural gas, oil, or propane end-use combustion due to end-use energy efficiency in the building sector
Avoided methane emissions from agricultural manure management operations
How will this affect electric rates?
The cost of carbon allowances will become part of the cost of producing electricity in the Northeast, and will ultimately be borne by ratepayers. How much is will cost depends not only on the price that producers pay for these allowances, but also on the fuels used. Coal is the most carbon-intensive fuel source, producing 2,000 pounds of CO2 per megawatt of power. Natural gas produces 800 pounds of CO2 per megawatt, and oil is somewhere in between depending on the type of oil used. At $3.00 per allowance, this would add $3.00 per megawatt of electricity made by burning coal, and about $1.20 per megawatt from natural gas, or $.003 per kilowatt hour for coal and $.0012 per kilowatt hour for natural gas.
Power producers may avoid the cost of carbon allowances by reducing their carbon emissions, either through upgrading their fossil-fuel facilities, switching to more expensive but carbon-neutral fuel sources, or purchasing offsets as a means of alternative compliance. These costs would also be passed on to ratepayers, but would not produce revenue for the ten RGGI states.
What happens if a power plant exceeds its carbon allowances?
Power producers who do not provide sufficient allowances to meet their emissions would face a three to one deduction penalty at the beginning of the next compliance period. For instance, if PSNH released 1,000 tons more CO2 than it purchased for 2009-2011, it would be forced to purchase 3,000 additional credits for 2012-2014. Since this would be an expensive penalty, New Hampshire Emissions Reductions Trading Program Manager Joe Fontaine expects nearly 100% compliance. It will almost certainly be cheaper for utilities to purchase additional allowances on the open market than to pay the penalties.
Who is buying carbon allowances?
The identities of auction winners are not being made public. RGGI has contracts with Potomac Economics to monitor its quarterly auctions. On October 16, 2008, Potomac issued its report on the September 28, 2008 auction, which included 59 entities submitting bids ranging from $1.86 to $12.00. 80% of the bidders were “compliance entities”, which are power producers covered under RGGI. 20% were “non-compliance entities” not covered under RGGI, but who may now sell their allowances in the secondary market.
Where are carbon allowances traded?
Once purchased through the quarterly auctions, RGGI allowances are traded on the Chicago Carbon Futures Exchange (CCFE), and futures contracts for RGGI allowances are available on the New York Mercantile Exchange (NYMEX). At the close of trading on December 18, 2008, RGGI was trading at $3.27 on the CCFE, and $3.30 on NYMEX.
Grant Bosse is an investigative reporter with The Josiah Bartlett Center for Public Policy
By Charles M. Arlinghaus
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.
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.
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.In November, the shortfall could be projected at $48 million but in each succeeding month the situation has deteriorated.
|Ave % of total||38.5%||46.3%||55.8%||62.1%|
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.
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.
- 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.
These numbers are based on published reports. There was not an official report produced by the government. The estimates included shortfalls only in the Tobacco tax, Interest & Dividends Tax, Real Estate Transfer Tax, and liquor and lottery revenues. Medicaid Enhancement revenues as well as board and care were projected to increase for a total shortfall of $42.6 million for 2008. The 2009 estimates included shortfalls also in the Meals & Rooms Tax and combined business taxes. The estimates for 2009 ranged from an additional $104.3 million if there was a mild economic slowdown to $157.3 if we were in recession. An additional $1.8 million shortfall for 2009 affects the highway fund and is not part of this analysis.
 This category includes revenues other than business taxes and Medicaid enhancement revenue. Because insurance taxes are now collected largely in one lump sum, they are also removed from the analysis. For a more detailed explanation see “State Revenues on Track for $75 million Shortfall,” at www.jbartlett.org.
By Charles M. Arlinghaus
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 revenue 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. 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.
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|
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, 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.
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, a significant portion of the total.
Through September, business tax collections had predicted an additional $44 million shortfall. 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. 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
|Medicaid Enhancement||0||-1.0 million||0|
|Business taxes||-27 million||-50 million||+22 million|
|Other general Revenue||-48.5 million||-86.6 million||-14.3 million|
|Total||-75.5 million||-137.6 million||+7.7 million|
 For the purposes of this analysis, Medicaid enhancement revenue is comprised of the line items for “Net Medicaid Enhancement Revenue” and “Recoveries” from the state revenue reports. The reports and estimates are available at http://admin.state.nh.us/accounting/reports.asp.
 Through November, the state had received $94.8 million. The budget had projected $95.8 million. For the remaining seven months of the year, we are budgeted to receive another $9.3 million, largely from the “recoveries” line-item which is slightly ahead of expectations.
 This data is based on a report provided to the author by the Dept. of Revenue Administration.
 First quarter collections have been an average 19.9% of the final total for the last seven years. Collections of $118.5M then predict a total of $594.8M, $44.2 less than budgeted.
 In FY2006, October receipts were $38.4 million, probably because of audit revenues, and the five-month total through November was 28.7% of the final total compared to a seven year average of 26.6%.
By Charles M. Arlinghaus
There is a growing hole in the New Hampshire state budget. Alone it would require tax increases that would cause undue economic damage. Coupled with a planned but undefined increase in education spending, the amount will be too large to close with small changes to our current tax structure.
New Hampshire’s state budget is required to be balanced in only the most technical of senses. Both the spending and revenue numbers in the budget are estimates. A budget that seems balanced at the time of passage will become a problem later if some spending had been left out of the budget estimates or agreed to outside the budget process. Similarly, optimistic revenue estimates can exaggerate the revenue that will realistically be available to spend and force emergency cuts later.
The New Hampshire House of Representatives has passed a proposed budget that has both problems. Revenue estimates are exaggerated and will have to be changed in the Senate. Spending increases are much higher than the recent average but don’t take into account a massive education funding increase that is purposely being left out of the current budget even though it will become effective immediately. Simply put, there is a hole in the budget that has passed the House and is being considered by the Senate.
By one calculation the hole will approach $200 million. But when the planned off-budget spending increases are added in, the total shortfall will be $800 Million.
The Effect of Exaggerated Revenues
The easiest way to create a budget problem is to exaggerate revenue. As a result of the exaggeration, spending is then set at a level to match the unrealistic revenue estimate and a crisis occurs when the revenue doesn’t materialize. The budget passed in June 2001 is a good example. Then-Governor Jeanne Shaheen considered vetoing the budget because revenue estimates were unrealistic. In the end she let the budget pass but its shortcomings occupied the remainder of her time in office.
She was right about revenues. Business tax revenues had been exaggerated by $97.6 million. Despite the beginning of the short lived Real Estate Transfer Tax boom, the business shortfall led to a budgeted revenue hole of $98.2 million when the biennium ended.For the last 18 months of her time in office Gov. Shaheen was forced to issue executive orders to restrain spending. Her successor, Craig Benson, did the same during the final six months of the budget he inherited. In all the two of them were forced to issue six different executive ordersto decrease spending outside normal planning process of the budget. At the end of fiscal year, however, the budget required a one-time $25 million grant from the federal government and a transfer of $69.6 million from the state’s reserve funds to achieve balance.
The consequences of this budget imbalance were significant. It put great pressure on the next budget to increase taxes to keep up with a level of spending that was obviously beyond the tax structure’s ability to pay. That temptation was resisted only because then-Governor Craig Benson was insistent that he would veto any increase in any tax.
More serious, national bond rating agencies lowered the state’s bond rating. According to State Treasurer, our credit rating was lowered because “the state produced current year operating deficits for state fiscal years 2000 through 2003.” The result is higher interest rates and a greater cost of debt. It is the equivalent of paying a higher mortgage rate.
So the June 2001 budget produced a huge deficit because of exaggerated revenue estimates. The June 2003 budget was just the opposite. According to our bond statements, the state’s official representation to the nation’s financial community, then-Governor Craig Benson vetoed the budget because it relied on one-time revenues and didn’t increase the state’s reserves. As a result, a negotiated compromise passed in September that relied on very conservative revenue estimates. Good economic performance if it came would rebuild the state’s depleted reserves.
In contrast with 2002-03, revenues exceeded the budgeted amount and the state produced a surplus of $82 million. A huge surplus made everyone’s life easier and the next legislature borrowed $30 million as a one-time infusion to the next budget. They kept the other $50 million aside but finally released it to the rainy day fund after the next year’s revenues came in ahead of schedule as well.
The budget that was passed in June of 2005 also included conservative revenue estimates. In addition, it included $100 million in tax increases and the one-time infusion of $30 million from the previous surplus. It will produce a revenue surplus of about $104 million. Projections in the Governor’s budget call for operating surpluses of only $20 million. That means spending was $84 million higher than the budget – possible only because of the flexibility gained through cautious budgeting.
The budget that has passed the House and is currently being considered by the Senate is much closer to the June 2001 budget than the June 2003 budget. The immediate source of difficulty is revenue estimates.
The Recent History of Estimating Revenue
The most difficult part of any budget is projecting into the future how much revenue will be available. Some taxes are easy to estimate and others are much more volatile. In New Hampshire, business taxes are volatile and extremely difficult to estimate accurately. For the most part, the rest of our state taxes have been estimated within very small margins. The Real Estate Transfer Tax has been an exception recently because of the volatility caused by the housing boom and the end of that boom.
Business Taxes: Since the new tax rates were set eight years ago, business taxes have been as
much as 13.6% below budget and as much as 19.2% above budget. In six of the eight years, the budget projection was wrong by at least 8%. For comparison purposes, that range of 33 percentage points represents a $179 Million margin of error on the 2006 business tax total of $546 Million. So far this year, business tax revenue is $64 Million ahead of projections.
Real Estate Tax: The other significantly volatile tax in recent years has been the Real Estate Transfer Tax. A housing boom and escalating property values followed by the rapid end of the boom has caused this tax to be unpredictable. Over the last five years, the RETT has been as much as 36% above budget and 32% below budget but always at least 13% off from the budget one way or another. Predicting this tax has been very difficult. Its 68 point range of variation represents a $108 million margin of error off its 2006 base of $158 million.
Other Taxes: As volatile as business and real estate taxes are, other taxes are relatively predictable. After taking out the two volatile taxes, the total remaining taxes have not deviated from budget by even one percentage point over the last eight years. The range has been from 0.87 above to 0.92 below. That range leaves a margin for error of only $24 Million off the 2006 base of $1370 Million.
The two most volatile taxes comprise about 34% of unrestricted tax revenue. The margin for error based on their recent history is $287 million in 2006 or about $300 Million per year in 2008 and 2009. Conservative critics of the current revenue estimates suggest they are about $100 million too high over 2 years. That analysis is based largely on a claim that the volatile taxes, business and real estate transfer taxes, were inflated in recent years by record corporate profit levels and the housing boom.
The Hole in the Budget
The hole in the budget that will lead to tax hikes has been created by both a spending side problem and a revenue side problem. As we’ve seen, projecting the two most volatile taxes is risky and difficult. Because of that uncertainty, it is both sensible and necessary to forecast those two taxes conservatively. With a more cautious revenue projection, revenues at the lower end of the projected range will not create a crisis like the optimistic estimates that wreaked havoc with the 2002-2003 budget. If revenues do exceed expectations, the windfall can be used for the inevitable claims on the budget that occur. After all, in the current budget just ending, the legislature did manage to spend almost all of the extra $104 million of revenue.
The Revenue Problem
The revenue side problem is approximately $200 million but in a range from $151-$236 million:
The former Republican chairman of the Ways and Means committee, Norm Major, claims the House budget estimates are $100.4 million too rosy.
- Business taxes: Most of the remaining total comes from the volatile business and real estate taxes that should slow down as the record housing market cools and corporate profits come off their 2006 record levels. Prudence suggests using a more cautious number. In additional, business revenues have been enhanced by a significant collections campaign that began as a campaign pledge of Craig Benson’s in 2002. Those additional revenues artificially inflate the rate of increase. In that light, Rep. Major’s assertions seem prudent. Even if Major is only partially right, the shortfall in business taxes is likely to be between $37 and $53.1 million.
- The Real Estate Transfer Tax is much more problematic. From 2002-2005, the RETT increased by a ridiculously high 60.1%. Revenues leveled off for a year and then collapsed. They have been more than 20% below estimate for nine straight months and counting. Revenues for 2007 will represent a decline of about 12% over 2006. Revenues will likely continue to decline before leveling off. A small 6% decline and then level for the second year would make the House numbers off by $47.7 million. Even if the 2007 level were sustained for two years and didn’t decline, revenues would still be $34.5 million below the House budgeted estimates.
- The Interests and Dividends Tax is also somewhat responsive to corporate profits levels. Basic levels of savings are more likely to be part of the individual exemption on the first $4800 of a couple’s return. However, tax returns so far this year have been surprisingly strong. In fact, over the last three years revenues have increased more than 90% after a 30% decline in 2002-2003. In that light, the House estimates are probably fairly conservative in the first year and a moderate estimate in the second.
- Insurance Premium Tax revenues have been very strong and a change in the insurance tax is unlikely to have a significant impact on revenues in the very short term. In addition, the tax change will not affect premiums paid on health insurance policies which seem to be rising in New Hampshire at a strikingly high rate. While that is bad news for consumers, it helps with tax collections. In that light, the House estimates on Insurance Premium Taxes are fairly modest increases over the current fiscal year and at the low end of historical averages.
Tobacco Taxes: While the Governor had proposed a 35% increase in tobacco taxes, the House budget increased that to 56%. The larger increase will decrease total tobacco and other collateral sales to certain business by more than $200 million. Those same small businesses have suffered through a reduction of about 21 million packs and the collateral sales as a result of the tax increase two years ago.
Each time the tobacco tax is raised, sales drop significantly. Each time a neighboring state raises its rates, our sales climb. When Massachusetts raised its tax 71 cents to $1.51 in 2002, we saw a 20 percent jump in sales over the next two years. When we raised our tax from 52 to 80 cents two years ago, we saw an 11 percent decline.
Following our 2005 tax hike, sales declined by about 7 million packs. In Massachusetts, sales increased by 8.5 million. Our decline wasn’t as severe because Maine raised its tax and we increased cross-border sales with the smaller Maine market. This year, sales have declines by an additional 14 million packs.
Over the last two years we lost 11 percent based on a 28-cent increase. A 45-cent increase should be much worse. We lost 11 percent of sales because the price advantage on a carton was only $7. A 45-cent increase would reduce the price difference to less than the price of one gallon of gas. The 45 cent increase will likely have a greater impact on sales than the 11% loss from the last increase. If the annual reductions are 5 and 10 percent instead of the 3.4% and 7.5% we just experienced, the House budget estimate is too high by $41 million.
If the Senate takes into account the devastating impact to small business and goes back to the tax increase proposed by the governor, decreased sales of 4% and 8% and he lower rate will make the House budget estimate off by $87 million.
Collateral damage: New Hampshire sells significantly more cigarettes than its residents consume. Because each neighboring state has a higher tax rate, as many as 40 percent of our cigarettes are sold to residents of neighboring states crossing over to buy by the carton and save themselves some money.
But the economic impact doesn’t stop there. A cost-conscious shopper driving across the border brings more than just cigarettes to the cash register. According to the New Hampshire Grocers Association, for each dollar of cigarettes purchased, the out-of-state consumer will buy more than $3 worth of other sundry items. Many of them, such as beer and lottery tickets, also contribute to our tax revenues. The Grocers Association has estimated that a 28-cent increase will lead to a loss of $93 million in total sales to the grocery and convenience stores. Even worse, the 45-cent increase that is included in the House budget will cause a loss of about $200 million in sales. That number is based on a conservative estimate of sales loss at 7%. We’ve already seen a reduction of 11%.
Not all of the lost additional purchases will affect tax collections but many of them do. Cost-conscious border shoppers tax advantage of our price advantages on beer and our different lottery games. About 25% of the cost of cigarettes is New Hampshire Tax. If 8% of the collateral sales revenue is made up of lottery tickets or beer taxes, then a $1 loss of cigarette sales will generate an additional $1 loss of other state revenue, a good rule of thumb. Therefore additional losses to other state revenue should range between $37 and $44 million.
In addition, the federal government is considering a change to the federal tobacco excise tax that is projected to reduce New Hampshire revenue under current assumptions by $13 or $15 million depending on the elasticity assumption used. It is beyond the scope of this paper to project the likelihood of its passage so the number is not included in estimates of the total size of the budget shortfall.
Registration Charges: The budget was balanced with a hike in the car registration charge (a fee or tax depending on your perspective) of $6 million. The $6 new charge per motorist is calculated to create no great outcry but the fee of as much as $200 per truck hurts the important trucking industry disproportionately. Because of that economic impact, the new charge will likely change and reduce the total by $2-4 million.
Summary of Estimated Revenue Shortfalls
|Low range||High range|
|Business Taxes||$37 million||$53.1 million|
|Real Estate Transfer Tax||$34.5 million||$47.7 million|
|Interest and Dividends, Insurance||0||0|
|Tobacco Taxes||$41 million||$87 million|
|Other Tobacco Related Sales||$37 million||$44 million|
|Registration Charges||$2 million||$4 million|
|Total||$151.5 million||$235.8 million|
The Spending Problem
On the spending side, budgets are made to be broken. The House made admirable efforts to make their spending estimates more open. They avoided the past practice of leaving out some spending only to have it authorized later by the elite super-legislature called the “Legislative Fiscal Committee.” This is a substantial improvement. However, supplemental spending occurs in every biennium, even in the face of fiscal crisis.
For example, in the 2002-2003 budget, even after six executive orders reduced spending, the final net appropriations for the biennium were higher than the budget anticipated. The initial budget used revenue of $4.04 billion. A year later, halfway through the budget cycle, the treasury estimated $4.21 billion. The final number was $4.238 billion, about $198 million higher than the original estimated revenue. A similar situation occurs every year.
One of the most important reforms is the governor’s announcement that he will require monthly spending updates to be posted on the internet just as monthly revenue comparisons currently are.
Supplemental Appropriations: Because the revenue estimates used to balance the budget don’t allow for a later readjustment, it is sensible that the budget either forbid supplemental spending or specifically budget an amount that can not be exceeded without cutting other spending to make room. Capping the amount of supplemental spending at 1% of the general fund would allow for a contingency of approximately $45 million. That number should be specifically budgeted to admit the reality of what will almost certainly occur and provide at least some budget structure to currently off -budget decision making.
However, all other changes to revenues or spending pale in comparison to a potential increase in education spending that would require a complete restructuring of the budget. In response to the latest in the Claremont series of lawsuits, the “Londonderry decision,” the House has passed a “definition of an adequate education.” This is not an education directive but a list of the things the state government must cost out and send a check to local communities for.
The bill has already passed the House, is almost certain to pass the Senate, and has the support of the Governor. Its proponents have suggested that we can wait to total the exact cost until sometime next year even though we’ll start paying for the cost before we know how much it is. They argue that worrying about how much it will cost will hinder decision making and focus the debate on dollars not students. The other school of thought argues that all bills require a fiscal note because no decision that affects the budget can be made independent of cost. To vote a financial obligation without knowing an amount is irresponsible.
The price tag will not be included in the current budget but the undefined obligation begins immediately. It’s not that we don’t owe the money until the legislature votes to define the actual cost, the bill takes effect “upon passage” and is a definition of what the state will pay. The obligation will be incurred but we are waiting for an accountant to add up the amount. It is a little like going on a shopping spree and waiting for the credit card bill to come. You owe the money, you’re just waiting for the shock of opening the envelope in the mail.
If the difference between the proposed cost and what we spend today were an insignificant amount, it would not matter. However, the increase is huge. The vice chairman of the committee that worked on the bill said a very rough estimate of the cost is probably about $1.2 billion compared to the $890 million we are projected to spend without the bill. That additional $310 million dollars is not part of a budget that calls for revenue of $2,317 million in the second fiscal year of the budget.
The additional cost will be obligated for both fiscal years although determined well after the first fiscal year begins. Without a change to the effective date of the bill, the budget is out of balance by at least $620 billion if the Dunn estimate is correct. If his very rough estimate is low by just 10%, the budget is $860 million out of balance on this item alone.
Estimated Range of Budget Imbalance
|Low estimate||High estimate|
|Revenue Estimates||$151 million||$236 million|
|Supplemental Appropriations||$45 million||$45 million|
|Education Funding Problem||$620 million||$840 million|
|Total Hole in the Budget||$816 million||$1121 million|
Tax Hikes on the Horizon
A huge spending obligation of $620 – $840 million will push the size of the hole in the budget over a billion dollars. Given the size of the developing hole in the budget, there are a limited number of solutions available to policymakers.
Other than the education funding issue, the problem is close to $250 million. Therefore, the education funding problem should be treated separately to make a solution manageable.
- The $620 – $840 million education funding obligation cannot be solved within the state’s current revenue structure. The only feasible solution is to delay the effective date of the act until the measure’s actual cost can be identified. Without knowing the size of the problem, a solution can’t even be discussed. If the state decides to incur this huge cost, the impact of tax increases, a completely changed revenue structure, and reductions to other government programs will have to be debated within the context of the next budget. Anything else will require reopening the budget at a later date to add an item that represents more than 25% of annual spending. To do so would require significant tax increases and spending reductions. The turmoil would require a discussion of spending priorities and economic incentives that can’t be done in just a few weeks.
The rest of the spending hole may seem small in comparison to the larger problem but it too puts an impossible strain on our state’s admirable tax structure.
- Business Taxes are already too high and can’t be raised any further. The last time education funding was increased, businesses bore the brunt of the burden. The Business profits tax saw a 21% increase (from 7 to 8.5) and the Business Enterprise tax was increased 300 percent (from 25 to 75 basis points). Our corporate tax rates are now 38th best in the country, not quite as good as Massachusetts at 36th. New Hampshire economist Lisa Shapiro’s influential study of the economic consequences of state business taxation found “even a small additional increase in business taxation … creates a significant drag on the state’s economy.”
- The Statewide Property Tax will raise $363 million but that entire amount is retained locally, never enters the state treasury, and is a tax only on paper. The level was set to eliminate the donor town problem that had created enormous divisions between communities in New Hampshire. To increase the tax to a level high enough to create cash flow to the state treasury would reduce real grants to many towns and create dozens of new donor towns. In addition, there is a bipartisan consensus that the state to eliminate the statewide property tax while it is still an accounting gimmick.
- The only other current state tax that raises a significant amount of money is the Meals and Rooms Tax borne in large measure by the state’s precarious tourist economy. However, at 8% the tax is already too high for a state so reliant on tourism. To raise even $50 million would require a 25% increase and send tourists away from out hotels and restaurants. Given the precarious nature of a tourist economy, any increase is intolerable.
Raising any tax will impact some sector of the economy and cause economic losses. Raising a broad basket of taxes merely spreads that pain around so that everyone is equally miserable. Alternatively, the spending that causes a $250 million hole is about four percent of a $5 billion budget.
 The Department of Administrative Services publishes monthly comparisons of actual revenue v. budgeted revenue at http://admin.state.nh.us/accounting/Prior%20years.asp. This data is taken from the last report of each fiscal year. FY2002 (ending June 2002) showed business tax revenues $61.5 million below estimate and total general revenues $62.6 million below. The shortfalls for FY2003 were $36.1 and $10.6. The non-business tax revenue for FY2003 is inflated with the addition of the unanticipated $25 million federal grant so the real shortfall compared to budgeted estimates is $35.6 million. In each year, Medicaid enhancement revenues were slightly higher than expected so the total two- year shortfall in all monies available for the general fund was$62.4 Million. There are some small variations once audited data is compiled many months later but not this purpose I used the monthly reports because they represent the information available each month to legislators during the process.
 The executive orders are discussed in the state’s bond information supplement found here: http://www.nh.gov/treasury/Divisions/DM/NHState2-OS.pdf
 At that time the state had multiple reserve funds. A transfer of $33.9 million closed out the former health care transition fund and an additional $35.7 million significantly lowered the revenue stabilization account commonly known as the rainy day fund.
 The State Treasurer in his 2004 annual report wrote that a strong local economy and reasonable levels of debt were overshadowed by “the fact that the state produced current year operating deficits in state fiscal years 2000 through 2003. As a result of that poor financial performance the state’s credit rating was downgraded” in December 2003. See page 6 of http://www.nh.gov/treasury/Divisions/DocsForms/AnnualReport2004.pdf
 Buried deep inside the trailer bill for the 2005 budget was a brief paragraph suspending the law that automatically placed any surplus in a rainy day fund. The size of the surplus led some legislators to announce plans for spending the surplus until public pressure forced them to keep only $30 million and put the rest back in the rainy day fund.
 The state’s tobacco tax went up 54% and will produce an estimated $101.4M more at the new rate than the same number sales at the old rate would produce.
 The budgeted number is derived from the end of the year “Actual v. Plan” page of the monthly revenue report published by Administrative Services and compared to the audited actual revenue numbers published long after the fiscal year ends. The 19.2% is a ten-month total for the current year based on the monthly revenue report.
 See “House Budget in the Red,” New Hampshire House of Representatives Republican Office Press Release, April 11, 2007( http://www.nhhousegop.com/index.htm). Major claims the business tax estimate is $53.1 million too high, Interest and Dividends $15.7M, Real Estate Transfer $14.3M, Tobacco $9M, and Insurance Taxes $8.2M.
 An accurate estimate of the number of packs sold can be derived by dividing tobacco tax revenues by the tax rate. Since about 99% of tobacco tax revenues are from cigarettes not other products, this pack equivalent is very accurate. The total loss for 2007 assumes the last two months follow the same trend of the previous 10 producing estimated sales of 174.3 million packs. By comparison, sales in 2005 were about 195.2 million.
The two year total of sales would be 314.6 million packs at the higher rate.
 At the 28 cent increase, the two year total of packs sold would be 321.3 million.
 Based on a trade analysis done for Altria, a cigarette manufacturer, “61 Cent Cigarette Increase Could Cost New Hampshire $16 million annually.” The paper projects lost sales that would affect both the tobacco lawsuit settlement payments and tobacco taxes. The Treasury model produces a loss of $13.97 million and the CBO model $15.72 million. Both are based on older models of demand elasticity. I suspect the impact is somewhat lower with the current higher prices.
 The House-passed budget estimates unrestricted revenue exclusive of “Medicaid enhancement” of $4.56 billion.
 See for example the story in the 15 May 2007 Concord Monitor, “Seantors Grill Reps on Costless Approach.” The figure $610 million is an approximation based on Rep. Dunn’s estimate compared to total nominal state aid of approximately $890.36 million budgeted for each of the next 2 years. That number includes the statewide property tax “aid” that is not actually sent but retained locally. On the other hand, if his very rough estimate were off by 10%, it would add another $240 million to the state budget.
 The bill takes effect “upon its passage” which will likely occur at the end of this fiscal year. The bill assumes that it is defining what the state must pay to towns for education aid. That fiscal obligation begins when the bill is signed. To avoid a financial obligation for both FY2008 and FY2009, the effective date would have to be moved forward two years.
 See Curtis Dubay and Christ Atkins, “State Business Tax Climate Index,” The Tax Foundation, October, 2006 at http://www.taxfoundation.org/publications/show/78.html
 The Shapiro study was a response to increased tax rates and the concern that the legislature might look to further squeeze taxes out of businesses a few years ago. See Lisa Shapiro, “Budget Deficits and Business Taxes in New Hampshire,” May 2002 at http://www.gcglaw.com/resources/economic/businesstaxes.html
 Current state aid is a function between what the state property tax would nominally raise in a town and the amount of aid the formula theoretically produces. As one rises the other falls.
 For a discussion of the problems with state taxation of property, see my paper “The Opportunity to Eliminate the Statewide Property Tax,” http://www.jbartlett.org/files/pdf/policy_matters_web.pdf