Close Read of Early OLS Projections Suggests Worst May Be Over

Mark J. Magyar | July 26, 2010
Next year's state budget is still in the hole, but the situation isn't as grim as it was this year.

Last week, July’s political rite arrived right on cue in Trenton: the end of the hangover from the prior state budget and the beginning of the debate over the next one.

Early predictions of future deficits came first, with the governor’s office playing them down and the opposition party running around like Chicken Little.

Ultimately, such predictions remain in large part a guessing game. But one thing appears clear from the annual forecasts of the nonpartisan Office of Legislative Services: the worst for the state budget appears to be over — at least for this recession.

budget deficit test

The state’s revenue decline has bottomed out. As OLS shows, most of the past year’s mega-billion-dollar revenue problems that stemmed from “one-shot” boosts have already been covered.

And while OLS forecasts a larger deficit next year, Gov. Chris Christie said publicly last week what legislators admit behind closed doors: Spending increases, even when “required” by statutory formulas, are not always funded.

Predictable Partisanship

OLS touched off the predictable partisanship last week when it estimated that the structural deficit for the next budget will be $10.472 billion — almost $2.5 billion higher than the $8 billion that OLS forecast the summer before.

Assembly Budget Committee Chairman Lou Greenwald (D-Camden), whose staff had requested the OLS deficit estimate, promptly scheduled an August 5 hearing.

“We cannot continue to rely on moves such as failing to make pension payments and slashing property tax relief,” he declared. “We cannot continue to do the same old things.”

It’s a familiar chorus that Christie himself repeated during the 2009 campaign, when he excoriated Democratic Governor Jon Corzine for the looming $8 billion deficit, only to see the actual problem ballooned to $11 billion.

While Corzine insisted it was “too soon” to forecast the size of the upcoming budget deficit, Christie went one step further now that he is governor and denounced the OLS study outright.

“The number is completely fake, and doesn’t understand the new reality,” Christie said at a press conference Wednesday.

Governor YouTube

Christie has emerged as the darling of the national Republican media for his no-nonsense Jersey guy persona and no-new-taxes, cut-spending-instead attitude. He had just released a “How Do You Like New Jersey Now?” YouTube video taking credit for signing an FY2011 budget that “closes [an] $11 billion deficit without raising taxes.” That $11 billion deficit figure, of course, is based on the same methodology the OLS used in calculating the budget deficit forecasts both years.

David J. Rosen, the respected longtime director of the OLS Legislative Budget and Finance Office, is used to controversy. He prefaced his forecast with his usual caveat: “the estimation of the State’s structural deficit is essentially an academic undertaking, dependent upon definitional assumptions and open to a range of defensible alternative conclusions.”

Caveats aside, a comparison of the OLS study clearly shows that the budget challenges that Christie and Democratic legislative leaders will face next spring year’s are very different than those they faced in balancing the budget last month.

The OLS budget deficit projection is based on a forecast of whether tax revenues will rise or fall, on how much non-recurring revenue needs to be made up and on what it would take to meet both the statutory and the programmatic needs for increased spending on major programs. Because it uses the same methodology every year, the projection provides a valid comparison in all three areas.

Slow Revenue Growth Forecast

The OLS study this summer forecasts a $1.01 billion increase in tax revenue that is higher than the $800 million increase anticipated last year. Both OLS and Corzine’s Treasury Department proved to be wildly off in their revenue estimates, as a $2.4 billion drop in income tax revenue forced drastic midyear budget cuts by Christie. While the Federal Reserve noted Friday that the pace of New Jersey’s economic recovery lags behind the rest of the region and most of the nation, the Fed’s analysis that the state’s economy has hit a “plateau at the bottom” indicates that the state budget should at least be immune to another dramatic revenue drop.

The OLS’s $1.01 billion increase represents a 3 percent bounce back in revenues. “It’s not rosy,” Rosen acknowledged. “Traditionally, we’ve gotten a rate of growth of 5 percent in the years following a recession, and with a 5 percent growth rate, you would get back to prerecession revenue levels by FY2014.” With economists forecasting a slower recovery than usual in New Jersey, it looks more like it will be FY2015 or later before state revenue, which is forecast to grow from $28.3 billion this budget year to $29.3 billion in the next budget year, FY2012, returns to its $33 billion high.

The Christie administration dismisses even that projection as optimistic. “There’s no accurate way to forecast that revenues will come back to what they once were,” said Andy Pratt, spokesman for Christie’s Treasury Department, said “We should plan for the worst and hope for the best, not do what Democrats have been doing for the past eight years, which is to hope for a miracle and not plan for the reality.”

Rosen agreed on the hazards of making any revenue forecasts several years in the future. “You can analyze past history, but we can’t make a statement about what’s likely,” he said, saying long-range economic forecasting is “more like a conversation you have in an undergraduate philosophy course — which angels are you going to put on the head of a pin?”

The Good News On ‘One-Shot’ Revenues

Christie had to make up for the loss of $3.1 billion in “one-shot” revenues from Corzine’s previous budget, which would not be recurring in FY2011. But the worst is over. Next spring, the governor will only have to make up for $1.305 billion in nonrecurring revenue, and if he is able to get through the FY2012 budget the way he did this year, the figure for the following year will be no more than $200 million or so.

The biggest chunk of “one-shot” revenue in both years is federal stimulus money from the Obama administration that was doled out over three years. The program helps state governments maintain vital health, education and capital programs during the recession in the face of declining state tax revenues. Federal stimulus funding dropped by $1.6 billion last year; the lion’s share of the cut was in school aid, and Christie passed along most of that cut to school districts by slicing state aid to education by $828 million.

The last $1.03 billion in federal stimulus money is scheduled to go away in the FY2012 budget. But because that was an increased federal share of annual state Medicaid spending that is extremely difficult to cut and essentially amounted to a direct state budget subsidy, Christie will have to find the money to make up for that cut elsewhere in the budget. (Like other states, New Jersey has a hole in this year’s budget — $600 million — if Congress fails to extend Medicaid funding for the second half of FY2011, but Congress is expected to do so.)

Christie already covered the “one-shot” loss of $1.1 billion from the “millionaire’s tax” state income tax surcharge on those earning more than $400,000 a year. He refused to allow the Democratic Legislature to extend it, and the $272 million in miscellaneous “one-shot” revenues that Christie relied upon last year were less than the $400 million in Corzine’s last budget.

From a structural standpoint, the state is more than halfway through dealing with its reliance on “one-shot” revenues from federal stimulus funds and state income tax surcharges that were needed to get through the recession. It is that fact, coupled with the sense that the decline in state revenues has bottomed out, that Christie was referring to when he declared, “We’re going to have a budget situation to deal with if the economy doesn’t pick up more, of course we are. But it’s not going to be as severe as the one we had to deal with last year.”

Pensions, Transportation and State Spending Needs

Almost $6 billion of the OLS structural deficit projection for the next fiscal year is based upon assumptions about how much the state will need to fully fund school aid, municipal aid, property tax rebate programs, the senior citizen property tax freeze and other programs at the level authorized under state statutes, to restore the higher education cut, and to fund the usual increase in state salaries and health benefits.

Christie points out that he has no intention to do so. “This is a mindset that says, ‘We’re going to build back all the cuts the governor made this year, and we’re going to then give it the hands-off-the-wheel enhancement,” Christie noted in his Wednesday press conference. “The new bar is set. The place to reduce from is where we are now.”

What that means is that in Christie’s eyes, the additional $2.3 billion needed to fully fund the school aid formula is largely a mythical number, unless the state Supreme Court rules otherwise. The $330 million to fully fund the municipal aid formula or the $272 million to restore cuts to higher education funding fall into the same category.

Christie is developing a plan for direct property tax credits to replace the $2.242 billion OLS is projecting to fully fund the old Homestead Rebate program and the Senior Citizen Freeze for all those eligible under the law. He did, however, put aside less than $300 million for a fourth-quarter credit in this year’s budget and had made no commitment on how much he will spend next year.

Similarly, OLS projects $400 million for salary increases and benefit increases for state workers in the new contracts Christie will be negotiating to take effect July 1, 2011. But Christie has been campaigning publicly against the unions and certainly does not anticipate such a first-year cost increase.

There are two categories of new spending Christie will most likely have to deal with in next year’s budget that are identified in the OLS forecast. First, the $300 million in increased Medicaid spending because of health care cost inflation will be difficult to cut, unless Christie can get the legislature to go along with a cut in some of the optional benefits offered by the state, which is unlikely. Second, Christie has already said he plans to cover the cost of funding transportation capital programs within the existing budget, although he may not be willing to go as high as the $800 million figure projected by OLS.

That leaves the cost of fully funding the state’s pension obligation, which OLS projects at $3.530 billion for the next 20 years, up from $2.5 billion in OLS’s forecast the year before. For two decades, that figure has been growing, as governor after governor failed to put the needed funding into the budget to cover the state’s future pension obligations. Christie followed Corzine’s lead from the year before in not putting anything into the budget for pensions, asserting that the pension reforms he is planning could markedly reduce the state’s obligation.

But that’s not what OLS projections show. “Our projection of the state’s pension obligation is based on what it would take to fully fund pensions over a 20-year period,” Rosen said. “Pension income is based on a five-year rolling estimate, so adding another subpar year on pension investment income to three earlier down years pushes up your number. But much of the increase from year to year is based on the failure of the state to make payments the year before. Every year you put off the problem, the eventual cost of the solution grows.”

To put that $3.530 billion a year pension figure in perspective, the state would have to raise the income tax by 35 percent or hike the sales tax from 8 percent to 11 percent to generate that kind of revenue this year, and the magnitude of the problem gets worse every year.

When the Assembly Budget Committee takes up the issue next week, expect chairman Greenberg to make that point in the first five minutes.

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