SENATE DEMOCRATIC APPROPRIATIONS COMMITTEE FISCAL YEAR 2007-08 MID-YEAR BRIEFING REPORT

December 11, 2007

          Economic Outlook:  According to the Governor in his mid-year briefing the economy is at a delicate point.  The first half of this fiscal year has had growth consistent with a mature economic up-cycle.  There have been problems such as the housing market and the rapid increase in oil prices.  Global Insight, the econometric firm that the Commonwealth has a contract with to provide economic data, agrees with the concern.   Global Insight predicts that growth in nominal GDP will average 2.2% for the 2007-08 fiscal year.  Last fiscal year, GDP growth was 3.4%.  If that is the case then growth will slow by 1/3.  When the budget was passed in July Global Insight was predicting GDP growth to be 3.5% for the fiscal year.  It is important to note that they are not predicting a recession to occur.   

            Global Insight does not predict a steady decline in GDP.  Growth in the first quarter of the fiscal year was quite strong measuring 3.9%.  They expect it to plummet to .7% in the third quarter and improve to 1.6% in the last quarter.    

            So far all this doom and gloom is strictly in the future.  While oil prices began their rise in March and the housing market began to shudder in the fall of last year the economy has chugged along just fine.  Growth has not been spectacular but it has been solid.  Employment and productivity have been strong through October.  Global Insight thinks that will change.  They predict job growth will slow to .8% in 2008 compared to 1.7% in 2007.  Unemployment is low at 4.7% nationally.  That is expected to increase to 5.0% by the end of the fiscal year.  The other bright spot has been foreign trade.  Since the dollar is expected to continue to lose value compared to other currencies, foreign trade will continue to be a bright spot economically adding over 1% to real GDP per quarter for the foreseeable future. 

            The slowdown that Global Insight sees coming will hit hardest in the first 3 months of 2008.  While they expect the economy to dodge a recession, they have increased the probability that we might slip into one.  In October they considered a recession as a 30% probability.  By December they have increased the chance to a 35% probability. 

            One of the key predictions that Global Insight makes that keeps the economy out of a recession is a decline in oil prices.  While currently oil is flirting with a $100 a barrel price tag they see it slipping back down to $80 a barrel in early 2008 and then perhaps even further to $75 a barrel by the mid year. If it instead goes higher they foresee a recession as unavoidable. 

            As for the housing melt down, they see the amount of bank holdings that are in danger as between $60 to $120 billion.  So far only slightly over $50 billion have been written down by financial institutions so there is more pain to come.  

            The bottom line is that the economy is most likely just about to enter a dangerous low point where sluggish growth is the best that can be expected and a recession is indeed possible.  But the main effect will be this second half of this fiscal year and then the 2008-09 fiscal year will see better economic days.
 

          Revenues:  Much like the previous discussion on the economic outlook, the revenue picture looks very good at the moment but the worry is more difficult times are ahead.  As of the end of November, revenues were $135 million above the official estimates.  That is 1.5% higher than predicted.  The chart below shows the overages for each November and the final surplus at the end of the fiscal year.  The current November overage is consistent with the November overages that have preclude surpluses over $500 million by the end of the fiscal year.  The chart suggests that everything is fine; we will be spending a big surplus in June.  So why is the Governor sounding such a concerned note in his mid- year briefing? 

            In the mid-year briefing the administration suggested that hitting estimate will be a challenge.  If revenues maintain the current pace of 1.5% the surplus at the end of the year would be $300 million.  Of course there is little value to just projecting the November overage through the rest of the year.  The months of March and April are the key months that will decide the surplus.  That is when the bulk of the corporate taxes come in and final income tax payments are received. 

            Currently the revenue picture is looking quite good.  The table below shows the November year to date overages or deficits. 

                                                Tax                      Surplus or (Deficit)

            All of the major taxes are over estimates at this time.  It is only non-tax revenues that are below estimates by more than a million dollars.  Collections are coming in very well.  However, when the numbers are examined more closely there are some concerns that come to light.  The Department of Revenue insists that they received a two settlement payments to the corporate net income tax (CNI).  Those one time payments have created most of the overage in total corporate collections.  What seems more important, however, is the $38 million overage in September.  Five months account for 85% of the corporate tax collections.  September is one of those months.  So September collections were more meaningful than any other month so far this year, and September was good. 

            Sales tax collections are $27 million over estimates but the growth of collections over last year is only 3.6%.  So sales tax collections may add to the surplus but they will not be huge.  Likewise, cigarette tax collections are showing slow growth.  They are only .4% higher than last year. 

            Personal income tax (PIT) collections are showing the most growth from the previous year at 11%, but the official estimate has already accounted for most of this growth.  So while there will be some additional revenue from PIT to add to the surplus it should be around a hundred million not the $300 million that went into the surplus last year. 

Inheritance tax collections are much like PIT collections.  The growth is large from last year at 15% but most of that growth is already accounted for in the official estimate. 

Realty transfer tax (RTT) collections are $26 million or 11% above estimates but those numbers in reality only show that the administration was too pessimistic in their estimate.  RTT collections are 10.7% below last years.  As the housing crash worsens the Governor’s more pessimistic number may prove correct.   

While the Governor’s somewhat dire mid-year briefing numbers may prove to be correct it is more likely that if the economy does indeed navigate around a recession there will probably be a surplus come June.

Having a year ending surplus is very good but the remainder of this report offers some perspective as to what the other risks and problems await the Commonwealth for the rest of this fiscal year.

          Department of Community and Economic Development:  Economic Stimulus programs, community and business incentive spending, and other investments in education and training initiatives continue to produce an expanding state economy.  Total state non-farm employment has increased more than 32,000 jobs over the past year, and 200,000 jobs over the past 5 years, while our 4.5% unemployment rate continues to trend below the national average. 

            A troubled housing market and lower projected GDP growth provide a cautionary note for the 2008 state economy, making commonwealth investments for new jobs and expanded commerce even more important this year.  The Governor had proposed an alternative energy investment program that could have provided additional stimulus for this sector of the state economy.  Unfortunately, Senate Republican opposition to this plan will delay enactment of the program until next year.  

          Education:  During the past 5 years the commonwealth has increased support to basic education programs by more than $2.4 billion.  These increases have included $600 million in target investments in early learning programs, tutoring assistance, science and math instruction, classroom technology, and high school restructuring.  The investments have provided results.  Pennsylvania is now one of only nine states continuing to demonstrate significant improvement in assessment results for math and reading instruction, with 90 percent of the commonwealth’s school districts meeting national proficiency standards. 

            Last year Act 114 of 2006, required the State Board of Education to complete a study of the adequacy and equity of school funding and to determine what educational resources and related expenditures are necessary to provide a quality primary and secondary education for each student in the commonwealth’s public schools.  

            That report was completed last month and presented to the State Board on Nov. 14. The following day, the board approved a resolution to accept the report and formally transmit the study to the Governor and General Assembly.  The report determined the need to increase state and local support by an estimated $4.6 billion to insure all school districts within the commonwealth provide an adequate education to their students. 

            The study will provide momentum for efforts to dramatically increase state support for basic education programs.  The recommendations could also be used as a blueprint to guide future education subsidy allocations to local school districts.

          Higher Education:  Overall state spending on higher education in the 2007-2008 budget increased by $41.2 million, or 2.6 percent, less than half of the increase of the prior year.  Support rose by 3.5 percent for the State System of Higher Education, 3.0 percent for the community colleges, and about 2.0 percent at the state related universities – Penn State, University of Pittsburgh, Temple and Lincoln University.   

            As pointed out by the Chronicle of Higher Education, in years past, such budgets typically led to big tuition increases, particularly at the state-owned institutions, making them the most expensive public universities in the country.  In the past three years, however, the state system’s Board of Governors has made a concentrated effort to keep tuition increases to roughly the rate of inflation, and as a result, tuition at Pennsylvania’s public four-year colleges now ranks fifth highest in the country.  In 2007-2008, full time in-state students pay $5,177, an increase of $139, or 2.8 percent.  Penn State raised its tuition by 4.5 percent for both resident and non-resident students on its 19 branch campuses.  The increase was 5.5 percent for in-state freshman and sophomores at the University Park campus, bringing the total there to $12, 284. 

            To help students pay for college, the budget provided $386 million, the same as the previous year, for undergraduate grants awarded by the Pennsylvania Higher Education Assistance Agency (PHEAA), which gives scholarships to residents who attend colleges in the state.  In addition, PHEAA provided an additional $75 million from its earnings to the grant program. 

Education is increasingly important to getting a high-paying job.  Half of the 20 fastest growing occupations require a bachelor’s or associate degree, according to the Bureau of Labor Statistics.  The Center for Economic and Policy Research says that nationwide nearly two-thirds of students at four-year public colleges or universities take out loans.  Eighty percent of these kids hold jobs to help pay their bills.  Still, their average debt graduation is $17,000.  Credit card debt among Americans aged 18-24 has doubled since 1992.  Fear of loan debt may discourage millions from even trying college.  On July 1, 2008, the rate on new federally guaranteed student loans will hit a fixed 6.8 percent, the highest rate since 2001.

Given all this, and the importance of college educated workers to Pennsylvania’s economy, we must address the cost of rising college tuition.  And while Pennsylvania enjoys a generously state funded grant program, the cost of loans may increase as federal budget proposals include deep cuts to its student loan program.   At a time when record numbers of applicants are seeking admission to our institutions, we must assure students affordability and access to higher education. 

          Property Tax Relief:  Expansion of the Property Tax Rent Rebate (PTRR) program began this summer providing an estimated $200 million, eventually funded through gaming revenues, to raise eligibility limits for the program from $15,000 to $35,000, and increasing maximum payments from $500 to $650.  The expansion will more than double the eligible number of claimants to more than 750,000 commonwealth families. 

            In April of 2008 the Budget Secretary is expected to certify the first distribution of gaming funded tax relief to all qualified Pennsylvania homeowners.  This minimum distribution of at least $400 million annually will be credited against school district tax bills during the 2008-09 fiscal year.  Distribution of this statewide tax relief will trigger additional expansion of tax rebates through the PTRR program, including supplemental grants for Pittsburgh, Scranton, and Philadelphia residents, and eligible residents throughout the state whose property taxes exceed 15% of their household income.  Gaming Revenues will also begin providing reimbursements to suburban Philadelphia school districts impacted by Philadelphia’s wage tax.   

          Gaming Control Board

             As shown in the chart above, all of the operating gaming facilities in the Commonwealth are on track with the original projected gross terminal revenues estimates.  These projections were based on 365 days of operation with only track based venues operating.  Some of the actual GTR’s that are lower than the original projection is due to the fact that these facilities did not begin operating on the date originally given.  For example, the Meadows was to begin operating in May of 2007, and although they opened only a month later you are able to see the difference in the projected and actual gross terminal revenues.   

            However, many of the projections have been in excess of those original projections.  This can be seen when comparing the gross terminal revenue numbers for Mohegan Sun.  The total gross terminal revenue for all of these venues totals $977,989,379 .   

          Property Tax Relief: The total amount collected to date for property tax relief is $632,516,451.  This amount includes $300 million collected in licensing fees from the six operating venues.  At the time additional venues begin operating this base of licensing fees will increase in addition to the relief funds that each site contributes.   

          Projected Opening Schedule for 2008-09 

            Including the venues listed above, the Pennsylvania Gaming Control Board is anticipating that by the end of 2009 the total number of operating venues will be thirteen throughout the Commonwealth. The breakdown of those facilities will be seven category 1, four category 2 and two category 3. 

          Total Gambling Collections FY 2007-08 to Date : 

w  Local Share Assessment (4%)                                $21,721,368                                                             

w  Economic Development & Tourism Fund (5%)         $27,151,710   

w  PA Race Horse Development Fund (12%)                 $65,164,104   

w  State Tax (34%)                                                        $184,631,627

           Lottery Fund:  Lottery ticket sales are higher than expected according to the Governor in his mid-year budget briefing.  Ticket sales were expected to grow by 2% from last year.  Ticket sales through October are 3% higher than they were last year through October. 

Expenditures are also lower than anticipated so the lottery fund’s balance should be healthier than the $472 million ending balance projected for the end of the 2007-08 fiscal year.  While the Governor didn’t offer a new ending balance in the briefing he is optimistic about the finance of the fund. 

What he is not happy about is the main reason that expenditures are down.  The expansion of the property tax rent rebate program has not reached as many seniors as should be eligible.  These benefits are not being claimed.  It is estimated in the mid-year briefing that as many as 200,000 seniors may be failing to sign up for the extended benefits. 

          Pensions:  The two main pension systems, the school employee’s retirement system (PSERS) and the state employee’s retirement system (SERS), are currently healthy.  Their return on investment has been great as they finished the last fiscal year earning 22.9% and 22% respectively.  But there is a crisis on the horizon.  The mid-year briefing outlined the problem in detail.  The amount that the state and school districts have been contributing to the pensions, while at the level required by the current law, has not covered the true retirement costs.  Act 40 changed the actuarial assumptions to cushion the effect of the losses accrued in 2001 and 2002.  In 2013 those losses will be fully calculated into the contribution rate.  The contribution rate is expected to increase from 4.71% to 12.2% for PSERS.  The rate increase will be less dramatic for SERS going from 4% to 7.8%.   

            The Administration has put together a plan that essentially does two things.  It increases the contribution rate now to spread out the huge increase that would otherwise arrive in 2013 and it places boundaries on how much the contribution rate can change.  This is designed to prevent the contribution rate from dropping below the true retirement cost. 

            The Governor also discussed the directive from the Department of Education to the school districts advising them that in December PSERS would set the contribution rate below 4% based on current law, but the school districts should budget for the contribution rate to be 7.13%.  Such a rate would be consistent with the Governor’s pension rescue plan. 

          Motor License Fund:

The revenue estimates in the Motor License Fund compared to the actual revenue was -1.4% from July until September.  However, in the month of October, the Motor License Fund received an infusion of $150 million.  This raised the growth rate of the Motor License Fund by 8.7%.  This extra revenue that the Fund received was expected pursuant to Act 44.  According to this Act, the $150 million is part of a total of $450 million that is to be allocated to PennDot by the Turnpike Commission over the 07-08 fiscal year.  The $150 million that PennDot received will be used to improve Pennsylvania’s highways and bridges that are in serious need of repair.  

          Public Welfare:  The Department of Public Welfare is requesting supplemental appropriations in a net amount of $10 million.  The $10 million represents 25% of all supplemental funding being requested by the Governor for this fiscal year ($40 million).  Based on current information, the $10 million is largely related to additional costs in the Medical Assistance program.

          Medical Assistance: The Medical Assistance supplemental requests total $10 million.  Despite the request for supplemental funding, the Budget Secretary and the Department are still projecting slower growth (1.5%) in MA enrollment than in past years (3%).

          Child Welfare: The Department of Public Welfare (DPW) and the Federal government are currently negotiating a resolution of the federal audits of the Commonwealth’s Title IVE child welfare payments.  DPW’s objective is to resolve any audit findings in a way that limits, if not eliminates, any financial impact on the Commonwealth.

          TANF: The 2006 federal budget contained a provision to reauthorize the TANF program, including a mandate that states meet a 50% work participation rate by October 1, 2006 in order to avoid federal penalties.  In January 2006, Pennsylvania needed 64,733 families participating in some kind of work activity to meet the Federal mandate.  This number was almost 5 times higher than the actual number of families who met the requirement at that time.  As of July 2007, the Commonwealth has 51.6% of families meeting the Federal work participation.   

          2008 Outlook

          Loss of Federal Funds:  The loss in federal support forces the Commonwealth to make up the difference with general fund money.  The most significant loss in Federal support is due to the IGT phase-out.  Since FY 03/04, Pennsylvania’s IGT funding has been cut by $513.3 million.  In FY 07/08, an additional $108.7 million will be lost in IGT funding, with a further reduction scheduled for FY 08/09.  The IGT is expected to terminate by FY 08/09. 

          Healthcare:  Increases in healthcare costs are a growing national trend.    While it has been a policy position of this Administration to sustain all those currently receiving health and social services, the escalating healthcare costs will require the Administration to find new funding sources to maintain the status quo and to accommodate those who will need the services in the future.  In addition, the Administration is striving to put in place a new healthcare program, Cover All Pennsylvanians.  While the Legislature agrees with the policy of “covering all of the uninsured,” it is how we pay for such a policy that has divided the Legislature from the Administration.