Friday, February 13, 2009

How Broke is the State? Does Our Slice of the Stimulus Pie Help? Notes From An Interview With Senate Finance Chair John Arthur Smith

Few people know the overall financial picture of the state as well as Sen. John Arthur Smith, Chair of the Senate Finance Committee. Deficit spending is forbidden by the Constitution, so the state keeps track year-round of the flow of money into and out of state coffers to make sure a deficit does not occur. Each year the Department of Finance and Administration (DFA) estimates (projects) the revenues for the coming year as best they can. The Senate Finance Committee is where the buck stops in balancing the next budget against projected revenues, which makes it arguably the most powerful committee in the legislature.

This year the state is in a fiscal crisis, since oil and gas revenues are down (we depend heavily on these) and the recession has cut other revenues such as sales taxes and investment income earnings. Smith warned last summer of the coming storm, but was dubbed "Dr. No" by Governor Richardson, who held a special session to give taxpayers a rebate, ignoring the warnings. It turned out Smith's predictions were on target. I asked him to give me some of the major findings from a briefing he got this afternoon from the DFA about the latest estimates of the crisis and what we might expect from the state's share of the Stimulus Package, passed in Congress this evening. Note: In New Mexico the Fiscal Year begins on July 1. So when I write "FY10" below I mean the year beginning on July 1, 2009.

Budget and Revenues Dissected: The Statistics of the Bad News

DFA is now estimating that the projected tax revenues to get us to July 1, 2009 will fall $438 million (not $300 million, as previously thought) short of current expenditures for a FY09 budget of about $6 billion. So the state either has to find the money or cut spending by that much. The situation for next year is even worse. Assuming a $6 billion budget in FY10, the best estimates place the shortfall of revenues at $582 billion. In the next 16 months the state will have to find $1.02 billion (438 plus 582), and, possibly, if things get worse, up to $1.2 billion in order to maintain the same level (a little over $6 billion) of expenditures. After that the picture is still bleak. For FY11 the estimate is the state will have revenues of about $5.7 billion, still short of the $6 billion budget for FY08. DFA believes the state's revenues, given the current tax rates, will not get back up to the level they were in FY08 until FY2013.

Dealing With the Bad News This Year

In dealing with the shortfall the state is counting on two sources to make up the difference and prevent a big spending cut: state reserves and the Stimulus. First, the state is digging into its reserves. The state's Tobacco Settlement Endowment Fund is one example. Each year the tobacco industry gives a certain amount to the state as part of a national settlement for the health costs caused by tobacco-induced diseases. The state leaves half of the money in the fund for a rainy day, and this year it has dipped into the principal of that fund to cover the shortfall. Likewise, the College Endowment Fund, set up by the legislature for a rainy day, had about $100 million built up. However, because it was invested in equities, which crashed last fall, it lost about a quarter of its value. This year the state grabbed $15 million from it to help cover the shortfall.

The state has set a goal of maintaining enough in reserves to cover 10% of the budget, but this year, due to dipping heavily into reserves, Smith indicated to me we are currently only at 8%, or about $100 million short of 10%. The governor, he asserts, was "highly optimistic" when in his state of the state address last month said the state's reserves were at 13%. Remember, we may well have to dip into reserves again for the next few years.

The second source of revenue this year is the famous Stimulus Package of $790 billion, which passed through Congress this evening. The state of New Mexico's share of that package is $1.582 billion, which must be spent over the next 27 months. Prorated by month, this should add up to about $937 million over the next 16 months. As seen above, the shortfall to July 1, 2010 is up to $1.2 billion, so it goes a long way, but doesn't quite cover it by about $300 million. So assuming the state is able to spend the $937 million of Stimulus money (see below) in timely projects the state will still either have to cut spending, raise taxes or dig deeper into the reserves, unless the price of oil starts going up very quickly, increasing the state's revenues. If the state decided to increase taxes, the entire $300 million shortfall would be covered if every taxpayer who files a return in NM paid an average extra tax of $375, or about $23 per month for the 16 months in question. The situation is serious, but not as bad as it is in some other states.

Where Does the Stimulus Go in New Mexico? (Do I get a piece?)

Most of the Stimulus goes to the following items:

1. The Highway Department: $271 million. The feds want "shovel-ready" projects out to bid within 30 days starting the minute the President signs the bill. At the present time, according to Smith, the Highway Department is about $400 million short, so the stimulus doesn't take care of all of it, and the funds will be used for projects that have been approved but delayed for lack of funds.
2. Education: $266 million. Plus a "General Purpose Flex Fund" of $58 million, for a total of $324 million. Given the fiscal crisis this year the Senate zeroed out capital expenditures for school construction; the House had asked for $165 million. So some of the Stimulus money may well be spent for construction, since this will immediately create jobs, a major goal of the Stimulus package. It is still not worked out whether Higher Education will get a piece of the education pie, but universities will gobble up as much as they can.
3. Medicaid: $563 million. This should prevent the crisis in health care in New Mexico from becoming catastrophic.
4. Programs for the elderly, nutrition, Head Start, and Special Education: $90 million
5. Public housing capital funds, homelessness prevention: $27 million
6. Law enforcement: $28 million
7. Transit capital grants: $35 million
8. Title I Education funds: $6 million

Problems, Issues

The state has little experience in spending large injections of earmarked funds as quickly as Congress would like, which raises questions about how well the state can absorb this money in truly worthy projects. Although Smith did not mention this, in Third World countries it is commonplace for quick injections of money from, say, the International Monetary Fund or World Bank, to be wasted in corruption or foolish, politically motivated, expenditures that do not contribute to economic development. The technical phrase for this is "absorptive capacity." Unless a legal and bureaucratic infrastructure is in place for spending unexpected money, absorptive capacity is limited and the chances are high the money will be wasted. In New Mexico, as we have learned from painful experience, there is still a lot of politically motivated spending stemming from the state's government spending infrastructure, such as the capital outlay process. This suggests the legislature and public should be watching carefully to make sure we don't get scandals coming out of this.

The good news is that Congress, in its wisdom, prevents the Stimulus money from being used to "supplant" the General Fund. In other words, state legislators cannot get their grubby fingers on this money and carve it up in the usual porkish way. Moreover, Smith pointed out, a good deal of it--Highways, Education, Medicaid--is earmarked into agencies subject to pretty strong mechanisms to keep pork projects at a minimum. It is the other expenditures that most need to be watched.

Another note of caution that Smith stressed is that the Stimulus bill makes no recommendations or distinctions between "recurring" expenses and "one-time-only" expenses. Should the Stimulus money be used to pay for recurring expenses, say, to increase the size of the bureaucracy, or create new jobs for teachers, then in some ways the employment problem will simply be postponed for the next 27 months. Those hired under the stimulus would have to be laid off in 27 months when the money runs dry, because state revenues are not projected to reach the FY08 level until 2013. Unless the economy has created a lot of new jobs in New Mexico, it might be difficult for these people to find employment. Likewise, if the funds are used to increase the operating budgets of bureaucracies, this will create a serious problem down the line when the funds end but the bureaucracies will resist being cut down to non-Stimulus size. Smith hopes, therefore, that as much of the Stimulus money as possible should be spent on capital projects, with one-time-only expenditures, such as buildings, bridges, culverts, levees, and other projects that would have long-term benefits while providing short-term employment.

Smith said it was important to keep the above in mind because over half the Stimulus money (well over $800 million) goes to education and medicaid, where the bulk of the expenditures (85% for education, 78% for medicaid) is for salaries.

In other words, the Stimulus was designed to have an effect on the entire U.S. economy by putting people to work. But to the extent that the funds stimulate employment in New Mexico, helping solve the national problem, the way the funds are earmarked and the way New Mexico's government is organized makes it very tempting and easy to simply increase the budgets of bureaucracies hire more teachers. If this happens it could easily cause another crisis down the line 27 months from now when the Stimulus money runs out and budgets need to be cut.

So while there are still serious issues to be dealt with, it seems unlikely New Mexico will be forced, as some states have been, to slash their funding drastically. In Arizona, for example, Arizona State University was asked to slash 40% of its budget this year, and ended up last week slashing only 18%. By comparison, New Mexico State University is preparing to cut by only 2.5% in FY 2010.


Anonymous said...

Great story! Did Sen Smith mention cutting some of those high paid Gov Richardson appointed jobs. Over 300 k per year for one state employee that is a waste..

Jose Z. Garcia said...

I should have asked him about this. Top levels of the bureaucracy have in recent years been using their political clout to raise their own salaries far above the salaries and salary increases of the rest of the bureaucracy. We don't need an entitled class of bureaucrats living far beyond the level of ordinary citizens, especially when a lot of these are recruited from out of state, as is the case with many university administrators who have been stuffing their pockets in recent years. You are right. The legislature should show leadership here and make clear through their actions they intend to hold the line.

Anonymous said...

Dr Garcia,

Another fine article and thank goodness for your BLOG. I live and work in Santa Fe and we are left in the dark on many issues that Gov Richardson has done to our state. Just recently he hired his brother n Law for a high paid state gov job and we should be cutting our state costs. The northern NM media is scared of Richardson.