Our Broken Budget

November 16, 2016

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Our Broken Budget

Charleston - State Capitol BuildingBy Jennifer Jett Prezkop

Some could see the $381 million revenue shortfall coming. Others were blindsided by it, recognizing a problem only after the regular legislative session ended without a budget bill. A steady flow of complaints with an undercurrent of urgency became the conversational norm among outraged citizens. If the budget bill wasn’t passed in time, state government would face a shutdown.

West Virginia’s financial situation is a precarious one at best. While not wounded by the national recession to the extent other states have been, West Virginia in no way escaped unscathed. With a crippled coal economy and resulting plummet of severance tax revenue; a natural gas industry that boomed too quickly due to infrastructure constraints, causing prices to bottom out; an aging population with rising health care costs and a structured, annual decrease in federal Medicaid funding on top of a revenue gap that has been growing for four years, it’s no wonder the state budget is in the shape it’s in.

After a lengthy special session this past summer that cost taxpayers nearly $600,000, Governor Earl Ray Tomblin signed Senate Bill (SB) 1013 on June 17, approving the 2016-2017 budget for $4.19 billion. The budget bill increased tobacco-related taxes to create revenue, decreased funding to state agencies and used a one-time withdrawal from the Rainy Day Fund to bridge the financial gap between the cost of services West Virginians need and what the state’s purse could afford.

It was just shy of a week later when historic flooding devastated parts of the Mountain State, leaving homes, businesses and lives destroyed in its wake. An already strained people, struggling to pay their bills and keep their homes, lost much of what they were fighting to protect. They sat in the July heat, wringing out their lives, forging through mud and debris in search of some sense of normalcy, wondering how their state government, experiencing its own financial struggles, would be able to help them through the crisis.

As resilient as West Virginians are, it will take more than Mountaineer grit for the state to regain solid financial footing. Prudent planning for West Virginia’s business climate, including the exploration of new and as of yet undeveloped industries and a commitment to building a first-class work force through education, will be vital to West Virginia’s success. One of the most urgent needs is to address the state’s revenue gap, and in order to determine the direction in which we need to move, we must first consider how we got into this situation in the first place.

Where We Went Wrong

There is no short list of factors to blame for the state’s current economic situation, and without question, the challenges faced by the state’s coal industry have been some of the most impactful. “The drop we have seen in coal production has been far worse than most any analyst would have imagined,” says John Deskins, Ph.D., director of the Bureau of Business and Economic Research at West Virginia University. “We produced around 158 million short tons of coal in 2008. That number has been falling steadily since then, especially after the implementation of the EPA’s Mercury and Air Toxics Standards last year and in conjunction with the continuing low natural gas prices. In 2015, it was approximately 95 million short tons, and this year, we anticipate it to come in at about 75 million, which is expected to be the lowest level of production in around a century. This dynamic, combined with our heavy reliance on coal severance tax revenue, is our biggest short-term problem.”

The sharp decline in severance tax revenue created a snag in the state’s financial plans for Fiscal Year (FY) 2016, which ran from July 1, 2015 to June 30, 2016, causing additional challenges. According to Mark Muchow, the deputy secretary of the West Virginia Department of Revenue, the revenue estimates for FY 2016 were

based on the economic outlook released in November 2014, prior to when oil and natural gas energy prices began to fall. The declining prices, which continued in 2016, led to a 62 percent decline in severance tax revenue for FY 2016. This sudden decline in revenue equaled approximately 10 percent of the General Revenue Fund, creating a budget gap Muchow says was difficult to close.

Other culprits contributing to the state’s financial challenges include low natural gas prices, increases in the state’s Medicaid costs, the national recession and a lack of revenue from a failure to diversify industry. According to Ted Boettner, the executive director of the West Virginia Center on Budget and Policy, the state’s structural deficit has also been a key player in the budget gap. “For decades, West Virginia has had a structural deficit, which is a long-term, chronic problem where revenues fail to meet the costs of providing important government services,” he says. “This is caused by several factors, including a declining population and work force, growth in our elderly population, above-average rates of disability and poverty and an overdependence on volatile severance tax revenue. All of these factors combined reduce fiscal stability where tax revenue can’t keep up with the normal growth of expenditures.”

Boettner is also quick to point to the large tax cuts made by the state between 2007-2015, including the phase-out of the business franchise tax and the lowering of the corporate income tax rate from 9 percent to 6.5 percent, which he says not only failed to boost economic growth but also led to a significantly lower amount of tax revenue to pay for other vital services. “The results of these tax changes have led to substantial budget cuts that are impacting our state’s future prosperity,” he says. “For example, investments at our two- and four-year colleges have plummeted by $124 million since 2008, after adjusting for inflation, while tuition at West Virginia’s public colleges has grown by more than one-third during this time. This not only compromises the quality of education students receive but makes it harder for students to afford a college education. West Virginia already has one of the least-educated work forces in the country, where nearly three out of four workers do not have a college degree.”

Balancing the Budget

Many West Virginians were vocal about their disdain over the governor and Legislature’s inability to balance the budget in a timely manner this year, and as the special session dragged on, rumors of a government shutdown began to circulate, fueling the fear and fury of those living in the Mountain State.

On June 17, SB 1013 was signed into law, a compromise of revenue-generating tax increases, funding cuts and the one-time use of Rainy Day Fund money to help fill the gap. A 65-cent tax increase on cigarettes, e-cigarettes and other tobacco products added $98 million to the state’s purse for FY 2017.

The tobacco tax hike was met with mixed reviews, but Deskins says it wasn’t a bad move to make. “Generally, taxing items that create negative external costs, such as poor health outcomes that come from cigarette smoking, is a better way to raise revenue,” he says. “This approach is not without costs—it is true that retailers in places such as Martinsburg and Bluefield that border Virginia, which has a lower cigarette excise tax rate, will lose some business. But overall, the balance the Legislature struck will help in an important way.”

According to the West Virginia Center on Budget and Policy, a sizeable list of state agencies and programs were impacted by budget cuts, the largest of which include:

  • $1.6 million from the Department of Education and the Arts,
  • $2.5 million from the Development Office,
  • $2.9 million from the Department of Education and
  • $5 million from the Division of General Services.

 

In making budget cuts, one challenge lies in the fact that some line items are simply off limits. “About two-thirds of the $4 billion general revenue fund budget is statutorily or constitutionally protected, so that means it is more difficult to make significant cuts to some of these programs, like K-12 education, Medicaid and the Supreme Court,” says Boettner. “However, higher education funding is discretionary, and it always receives the brunt of budget cuts because our colleges and universities can just raise tuition, which they have extensively.”

In addition to limitations on which programs can be cut, Deskins says funding decreases are difficult to make because it’s hard to choose which agencies and programs should be affected. “All of these services play a part in establishing a strong economic base,” he says. “Rather than cutting budgets with large strokes, any budget cutting should be done in a more precise manner with an in-depth look at each department. There is an old saying: ‘Use a scalpel rather than a hatchet.’ Overall, we are limited in how much we can cut and still be able to maintain the public services that are important in creating a strong economic base.”

Resetting Our Course

On December 5, 2012, President Barack Obama, in remarks made at a quarterly meeting of the Business Roundtable in Washington, D.C., said, “We can’t cut our way to prosperity… there’s got to be a balanced approach in which we also are bringing in new revenues—partly because our revenue levels are as low as they’ve been in most of our lifetimes.” It’s clear that the same obstacles facing the Mountain State are those facing our nation, and much like the nation, West Virginia is in dire need of a fix—not a bandage, but a long-term, revenue-generating, job-creating solution.

Alternative—and creative—solutions must be identified in order to alter West Virginia’s current financial course. In addition to looking at broadening the state’s tax base and lowering the marginal tax rate, Deskins believes West Virginia needs to find a way to do more with less. “In looking at Monongalia County, do we really need separate governments for Star City, Westover, Morgantown, Granville and Monongalia County? Are the citizens really getting better service for their tax dollars with these five governments covering what is really a small area and one economic system? Nashville, Tennessee and its home county, Davidson County, have one consolidated government, and the same is true for Louisville and Jefferson County in Kentucky and Charlotte and Mecklenburg County in North Carolina. If these very large and prosperous metropolitan areas can get by with one government, do we really need five governments for a county of 100,000? We have to have more creative, outside-of-the-box solutions for the challenges we face rather than small tweaks on the margin.”

According to Boettner, the state’s policymakers will need to address the revenue problems in order to improve the state’s fiscal health and make much needed investments that will help the state’s economy. “Policymakers need to take a more balanced approach by exploring more progressive options, including raising the personal income tax on those making more than $250,000 per year, adequately taxing natural gas that is mostly used out of state, expanding the sales tax to include additional personal services and digital downloads, taxing large—mostly out-of-state—land and mineral owners adequately and exploring additional funding streams to help pay for the state’s match to Medicaid, such as a tax on managed care organizations and an increase in the soda tax and/or the health care provider tax,” he says.

Other areas to consider are K-12 education and corrections. “As our K-12 population declines, the state will need to look at consolidating some school boards and taking a hard look at Regional Education Service Agencies across the state for cost savings,” Boettner explains. He also believes the state incarcerates too many people, especially youth, which is another area he has identified for savings potential. “According to the Division of Justice and Community Services, West Virginia could save approximately $100 million annually if our supervision mix—including adults on probation or parole or in community-based programs or prison—matched the supervision mix in the average U.S. state. We have far too many youths between the ages of 10-18 in confinement. On average, those kids cost more than $120,000 each per year compared to less than $30,000 for evidence-based community services. If we could keep half of these kids closer to home with community-based alternatives and sanctions, we could easily save another $20 million per year.”

Looking Toward the Future

With planning for the FY 2018 budget in the works and a projected budget gap of $300 million for next year, Muchow says legislators and the administration will be looking at revenue options and government restructuring in order to address the state’s financial crisis. At the end of the day, though, it is vital that the state find new sources of revenue in order to address its long list of challenges.

“The biggest economic challenges we face in West Virginia are an undereducated and unhealthy population, lack of economic diversity, subpar infrastructure and a rugged and scarred landscape that make it difficult to attract investment,” says Boettner. “By generating new revenue to invest in the building blocks of our state, we can begin to build an economy where more people have an opportunity to thrive and improve our quality of life. By neglecting to focus on raising revenue, we risk not making the important investments in our state’s physical and human capital that provide a foundation for economic growth and shared prosperity. These investments can create jobs in the short run and improve economic growth and job quality in the long run.”

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