How did West Virginia’s Budget Weather the Great Recession? (Wonkish)

Last week, the Center on Budget and Policy Priorities updated their list of states with budget shortfalls in FY 2012. As you can tell from the chart below – or from reading the paper last week – the Mountain State is one of 6 states that does not have a budget shortfall in the upcoming fiscal year. In fact, our base-budget (General Revenue + Lottery Funds) is about $250 million more than last year’s budget.

 
Why is West Virginia one of the few states without a budge shortfall? While lean fiscal management is part of the answer, it is certainly not the biggest reason.  The central reason West Virginia has weathered the recession fairly well is the make-up of its economy, its aging population, and especially the Recovery Act

Let me explain in more detail. 

While the Great Recession officially began in December 2007 and ended June 2009, the economic recovery has been anemic for most part of the country. For West Virginia, we’ve seen a large drop in labor force employment over the last 3 years, but a steady rise in non-farm jobs.  West Virginia has lost 1.5% of its job base, compared to the US average of 5.6% (Dec-07–Jan-11). All together, West Virginia has lost fewer jobs than 45 states. This is the single largest reason why the state has been able to weather the recession better than most states. And a lot of it has to do with West Virginia being an energy state.

However, West Virginia has preformed better economically than most states for several other important reasons:

Housing bubble had smaller impact on state’s economy

Unlike many states, West Virginia did not see rapid growth nor a rapid drop in housing prices. The chart below shows the five-year change in home prices, from 2005 to 2010. As you can tell, the states that suffered the worst from the housing bubble – Nevada, Florida, California, and Arizona – have seen rapid declines in home values. West Virginia, on the other hand, has seen home values increase by 6.3 percent over this period.

 
While the national run up in housing prices did not dramatically impact West Virginia (except in the eastern panhandle and a few other areas), when the housing bubble collapsed it reduced household wealth by about $8 trillion and plunged the nation into a recession. This zapped about $3 trillion dollars in U.S. economic output in 2009 and 2010, which ultimately lowered demand for West Virginia goods and services, but it didn’t zap the wealth of our residents as much as it did in other states. 

Financial Industry small part of state’s economy.

The financial industry makes up a smaller share of total employment in West Virginia, 3.8%, than any other state in the nation (aside from DC). According the BEA, finance and insurance makes up about 4.8% of our state’s GDP compared to a national average of 8.3%. From 2007-2009, employment in the financial industry declined by 7% on average and only by 5% in West Virginia.

 
By being less reliant on the financial sector for jobs and revenue, the Mountain State was able to avoid some of the revenue problems that have plagued other states.

While West Virginia’s under reliance on the financial sector helped it avoid a lot of pain, its over reliance on transfers proved helpful.

Over reliance on income transfers (mostly demographic)

As Sean pointed out here, West Virginia relies for more of its income from transfer payments (mostly Social Security) than any other state in the country. This mostly due to the fact that West Virginia has the second oldest population in the nation. Therefore, the state receives a higher share of Social Security payments.   Unlike wage income that fell during the recession, transfer payments (including one-time Social Security payments) actually increased due to the Recovery Act  – the bulk of which rose when the state was sliding deep into the recession (2nd Quarter 2010).

West Virginia was also well positioned (due to being a low-income state) to benefit disproportionally from other parts of the Recovery Act, including tax credits (e.g. Making Work Pay, Child Tax Credit, EITC, etc.) and increased eligibility in food stamps (SNAP).

In short, we are poor and we are old.

Recovery Act Fiscal Relief

The Recovery Act provided about $728 million in state aid, including about $462 million in enhanced Medicaid funding, $218 for K-12 and higher education, and $48 million for general government services. (The reason the Recovery Act provided aid for public education and Medicaid is that they represent over half of all state expenditures.) So far, the state has spent about almost all of these funds and has received an additional $136 million when Congress appropriated additional state aid in August 2010.

Without the state fiscal relief included in the Recovery Act, West Virginia would have had to cut an additional $250-$350 million from both its FY 2010 and FY2011 budgets to stay at the previous year’s level.

 

America, We Have A Revenue Problem

The federal deficit has been a hot topic for awhile now, with an overwhelming chorus reciting that the federal government has a spending problem, and that drastic cuts are needed to close the deficit. But is spending the whole problem? Without a doubt, federal spending has increased a great deal the past few years in response to the recession, not to mention a decade’s worth of wartime spending. But we’ve also seen major tax reductions, the “Bush tax cuts” of 2001 and 2003, and their subsequent extension this past winter. Don’t tax cuts contribute to the deficit too?

Not according to their proponents. The tax cuts of the early 2000s were promised to actually raise revenue. It’s a familiar refrain that is repeated by politicians and pundits; tax cuts help grow the economy and increase jobs, which then allows the tax cuts to pay for themselves. Unfortunately, this is rarely true, and as it turns out, the federal government has a serious revenue problem.
 
 
 
Across the board, federal revenue was significantly lower in 2010 than it was in 2000. Total individual income taxes were down 30% in real terms, while corporate income taxes fell by 27%, despite corporate profits increasing 60%. Payroll taxes increased slightly, but fell per capita, as the population grew five times as fast as the workforce. Clearly, lower tax rates did not result in increased revenues.
 
In fact, if individual and corporate income taxes had just remained flat (adjusting for inflation) from 2000 to 2010, the 2010 federal deficit would have been $449 billion lower, a reduction of nearly 40%.
 
Now certainly, the recession played a role in lowering revenue, but even with the recession, real GDP grew 16% from 2000 to 2010, but as shown above the growth did not translate into tax revenue. The growth also did not translate into the taxpayer’s wallet, as average wages continued to stagnate in real terms, with a decline from $39,194 in 2000 to $39,055 in 2009.
 
The promise of tax cuts turned out to be an empty one. Economic growth was anemic, wages went nowhere, job growth was scarce, and the federal deficit exploded. All of which makes recovering from this recession that much more difficult.
 
So as we begin to tackle the federal deficit, let’s make sure we look at the whole picture.

State Workforce Training Spending Lowest in History

 

The most important asset to a firm is the presence of a well-trained and productive workforce.  One effective way the state achieves this goal is through the Governor’s Guaranteed Workforce Training Program, which provides businesses and workers with customized job training. 

Customized, state-funded job training funding is a vital piece in providing the resources needed to spur economic development and to make the state an attractive place to do business. They also provide a good bang for the buck. Economist Tim Bartik has shown that investments in customized workforce training are 17 times more effective at creating jobs than tax incentives like these and these.

Nevertheless,  as the chart below shows, the state has reduced its investment in customized job training at the worst possible time, as the state’s unemployment rate has soared due to the Great Recession.  (Today, the unemployment rate stands at  a 17-year high of 9.6%.)        

Figure 1:  State Workforce Training Spending Lowest in History

 In fact, funding for the Governor’s Guaranteed Workforce Training Program is at its lowest point since the program was created in 1994 by Governor Wise.  The Governor’s FY 2012 budget cuts the program by over $1 million from its FY2010 levels of $2.2 million. 

As Lawmakers take up the budget this week, they should consider restoring funding to the Governor’s Guaranteed Workforce Training Program back to its FY 2010 level.  Increased investments in customized workforce training will help the state attract and retain new and existing firms relative to our surrounding states.

Deleware Governor ‘Gets it’ on Taxes and Economic Growth

The Washington Post has a fantastic editorial by Delaware Governor Jack Markell. Markell explains why the “economic war between the states” is a lost cause and why states should focus on public investment to boost economic growth. This is something we’ve been trying to get the media and legislators to understand for quite some time.

Taxes are the wrong focus for economic growth

  By Jack Markell

Friday, March 11, 2011

Two months ago, Wisconsin Gov. Scott Walker invited businesses in Illinois to “escape to Wisconsin” as a result of the recently enacted tax increases in Illinois.

Admittedly, I don’t know whether Walker’s offer has been effective. My own experience, though, as a business executive and as a governor, tells me that businesses are interested in a lot more than a low tax rate when they decide where to locate.

The debate in Wisconsin over whether workers should be allowed to collectively bargain has garnered most of the attention, yet Walker’s attempt to woo Illinois businesses while cutting funding for Wisconsin’s schools raises a fundamental question: What will drive economic growth?

First, a caveat: As a governor for two years in a state hit hard by the recession, I sympathize with all governors who are struggling to balance budgets. Flat revenue, soaring costs for Medicaid and increasing demand for other government services are a tough combination. So over the past two years, we in Delaware have implemented dozens of proposals to reduce spending. I’ve cut the state government workforce and endured mass protests, including impeachment signs, as a result of a pay cut I pushed through over huge opposition. Now I’m working with our state’s unions to develop a plan to reduce health-care and pension spending by taxpayers.

My focus on the budget, though, has played second fiddle to what I believe is even more important – creating jobs. I’ve visited hundreds of businesses the past two years and always ask the same question: What can I do to facilitate their success?

The number of business leaders who asked me to lower their taxes can be counted on one hand. Perhaps that’s because they recognize they get great value in Delaware already. But what I hear most from business leaders is that they want the government to continue to improve our schools, reduce the time it takes to issue permits and licenses, enhance our transportation infrastructure, protect our arts community, strengthen linkages between our institutions of higher education and local companies, and be responsive.

Don’t get me wrong. Business leaders want to be in places where the taxes they pay are spent wisely. But they’re more interested in things that will allow them to succeed in the marketplace.

That doesn’t happen on its own. And as much as I, an MBA graduate from the University of Chicago, respect the value of the free market, I believe there is a role for government to play here.

This precise argument is playing out in states across the country and is, in fact, probably the most important part of the budget debate in Washington.

Certainly, we must get control of our nation’s spending, deficits and debt. But doing so is not the ultimate job-creation strategy.

As one of the first employees at a small cellular phone start-up called Nextel, I gained firsthand experience in how a business grows from an idea to a company that, at its peak, employed many thousands. Taxes were the least of our concerns, but we did have a problem finding employees with the right skills.

President Obama has appropriately focused in recent months on the need to out-innovate other countries. But where will the innovation come from if we don’t make necessary investments in federally funded research? Who will take innovation to market if we don’t help millions of workers retool their skills with appropriate job training? How will we get these new goods to market cost-effectively if we don’t improve our infrastructure? These are precisely the investments other nations are making. We must, too.

These, then, represent the key competing visions for our country’s future. My money is on appropriate cutting coupled with investments in the factors that will lead to economic growth. We’ve never succeeded as a country by racing to the bottom, cutting the investments that matter the most. Now’s not the time to start.

The writer, a Democrat, is governor of Delaware.

 

Putting OPEB in Budget Context (Again)

The Daily Mail reported today on the fate of legislation to address the state’s OPEB liability and the future of public employee retiree health care. In doing so, they may have confused readers by not putting the OPEB issue in context for its readers.

For example, the lead paragraph states: “Ask West Virginia legislators if they want to pay down or reduce the budget-busting $8 billion the state owes retired public workers for health care over the next three decades, and many will say it’s one of the top issues they face.”

Is OPEB busting the budget? What percent of the budget is retiree health care? Readers need answers to these questions before they can conclude it is a “budget-buster.”

In FY2012, retiree health care (PayGo) will make up about 3.8% of General Revenue spending or about $145 million (About $20 million of this will come from local agencies, lowering amount to 3.3%).  In 1995, retiree health care (PayGo) was about 2% of General Revenue spending. So yes, it is growing – just as all health care related expenditures – but you’d be hard pressed to call this “budget-busting.” For example, this is nothing compared to Medicaid/Medicaid/CHIP at the federal level. These social insurance programs make up 21% of the federal budget. Or take corrections. In 1992, corrections made up 1.1% of direct state government expenditures, compared to 2.8% in 2009. This is a far larger growth than OPEB costs, but I haven’t read one article about “budget-busting” spending in jails and prison.  This is not to say that controlling retiree health care is not a serious
budget concern for the state, it clearly is and we should do everything we can to reign in those costs.

Another point of constant confusion in the article is the assertion that the “state owes” retired public workers $8 billion over the next 30 years. The state is under no contractual obligation to provide these benefits (we don’t have collective bargaining) and they can be taken away by the PEIA Finance Board (this already happened to new hires starting 2010). If the state does owe public employees this money, why not give every covered public employee (75,000) an average check of $107,000 and get rid of the subsidy. This because the $8 billion is not a “fixed” dollar amount like a pension and that we do not owe this money today. Nor is this a “debt” of the state. As Moody’s stated last month in an AP article:

“”While we do include OPEB liabilities in our analysis of states, we have not included them in the current report because they are less binding under state law,” the report explained. “Once accrued, public pension benefits are protected, contractual obligations, sometimes shielded by specific pension provisions in state constitutions.” West Virginia’s OPEB liability is considered a looming problem for the state. But for its analysis, Moody’s concluded that pension shortfalls “have an irrevocable, long-term nature that resembles bonded debt.

 
Let’s hope someday, somewhere, someone puts OPEB in context.

Education Matters for Prosperity

West Virginia lags behind much of the country in many areas, but one particular measure may explain many of the others; West Virginia’s workforce is poorly educated. 

West Virginia’s workforce is plagued by low wages. One explanation for the state’s low wages could be the low educational attainment of its workforce. Earnings increase with educational attainment. In West Virginia, workers with a college degree earn 63% more than workers with just a high school diploma.
 
 
However, in 2009, West Virginia ranked 46th in percent of its workforce with a college education, at 23.8%, compared to the national rate of 31.2%.
 
 
And, as it should be to no surprise, states with highly educated workforces tend to have higher wages.
 
 
This corresponds with the findings of a more rigorous study done at the Federal Reserve Bank of Cleveland which found that the knowledge base of a state’s population, particularly the relative proportion of workers with advanced degrees was the strongest determinant of higher income levels. The reasons? Highly educated workers tend to be more productive and innovative, making them more valuable to employers. A highly educated workforce is also more adaptable to downturns and changes in an economy, making a state’s economy more flexible overall.
 
Another finding from the report; taxes are not a significant factor in state income growth. Sounds familiar. In fact take a look at this chart, which is the same as the above chart, but swaps out educational attainment with business taxation levels
 
 
Not really a clear relationship. Remember that the next time someone argues that business tax cuts will translate into higher wages for workers.
 
So with the clear and hard to deny benefits of a highly educated workforce, is now the time to cut Pell Grants?

The $8 Billion OPEB Liability is Not Due Today

How many people understand this point? My guess, not many. An article in the Charleston Gazette this morning may help:

“The unfunded liabilities would be a problem if all state and local retirees went into retirement at once, but they won’t. Nor will state governments go out of business and hand underfunded pension plans over to a federal regulator, as happens in the private sector.  State and local governments are ongoing enterprises.”

The same could be said of West Virginia’s OPEB liability, which may be addressed this week. The $8 billion OPEB liability reflects the total projected cost of retiree health care benefits over the next 30 years. It is important to recognize that the growth of retiree health care costs is not happening in a vacuum; state and local budget will also grow over the next 30 years.

For example, the total shortfall in funding is $7.6 billion in FY 2011. In 2009, West Virginia’s GDP was $63.3 billion. Using a growth rate of 2.6% per year (which is modest given our 12-year annual state average of 4.3% from 1997-2009) and a 3.0% discount rate, our total output over the next 30 years would be about $1.8 trillion. Of this amount, the OPEB liability represents about 0.42% of future income. This implies that increased revenue equal to 42 cents of every $100 of future output would be enough to eliminate the shortfall. As I noted here, this does not imply that we should do nothing to control costs or that we should not find additional revenue.

Another clarifying point made in the above article is the crucial difference between state governments and the private sector. Since private sector employers cannot raise new revenue easily, it makes sense to worry if pensions and OPEBs are not fully prefunded. A state, on the other hand, does not “go out of business” and they can always raise revenue through taxation (although this can be difficult).

The Property Tax Shift

There has been plenty of attention lately about unfair property tax assessments for homeowners, where even without a rate increase, a homeowner’s property tax bill jumps due to an increase in the assess value of the home. However, there is another issue with property taxes that has been going unnoticed. 

Since 1994, when the first statewide reappraisal was completed, the property tax base has been slowly shifting away from business property and towards homeowners. From 1994 to 2010, the total assessed value of Class II properties (owner-occupied residencies) increased by 163%, while the total assessed value of Class III and IV properties (predominately business property, both real and personal) grew much slower, increasing only 103%.
 
The result of this disparity in assessments has been a shift of the tax burden onto homeowners. In 1994, Class II properties made up about 31% of the property tax base, in 2010, their share had grown to nearly 40% (Figure 1). 
 
 
 
And since effective tax rates have been relatively flat for all property in WV, the share of total tax revenue from Class II properties increased from 19.6% to nearly 25% (Figure 2).
 
 

The shift of the property tax burden away from businesses and on to homeowners has been brought about, in part because of the preferential valuation of business property. Legislation like Senate Bill 465 and House Bill 3099 increase the number of facilities that qualify for salvage valuation treatment, which lowers the assessed value of their property and reduces their tax burden. Previous examples of this special treatment since 1994 include Coal Waste,Disposal Power Projects, Wind Power Projects, tools/dies/jigs/molds used in manufacturing, Qualified Capital Additions to Manufacturing Facilities, Special Aircraft Properties, and certain High-Technology Properties.

 Rather than encouraging economic development that allows the tax reductions to pay for themselves, the property tax burden has instead shifted to homeowners, through higher assessments for Class II property. 

 Proposals to eliminate the tax on personal property (which would primarily benefit large manufacturers) will likely have the same effect.
 
Eroding away at the tax base is a poor model for economic development, particularly when the attacks are focused on property taxes. In West Virginia, over 75% of property tax collected funds local schools. Attracting businesses and economic growth requires more than cutting taxes. Communities need a quality education system, an educated workforce, and an infrastructure that is capable of supporting businesses. Giving away our tax base to attract businesses only increases the burden on the people of West Virginia and makes it nearly impossible to make the investments necessary for real, sustained economic prosperity.

OPEB Bill Would Have Drastically Lowered Public Employee Compensation

The issue of other post employment benefits for West Virginia’s public employees has been discussed at length, here, here, and here. The growing cost of health care presents a real and substantial problem for our state budget. In 1973, PEIA medical expenses made up two percent of general revenue funds. This number increased to 10 percent in 1990, and 16 percent in 2009. This growth has “crowded out” funding for other priorities like higher education and is a serious concern for a state that has the lowest number of college graduates in the country. 

Last week, the State Senate introduced Senate Bill 566, which would have reduced the retiree health care subsidy for public employees. It now appears that the bill has died in Senate Finance.

As we highlighted in January, the best way to address the growing cost of retiree health care is not to get caught up in the enormity of the OPEB liability. Rather, the focus should be on paying for retiree health care while finding constructive ways to lower health care costs. Unfortunately, SB 566 seems to focus solely on fully prefunding the OPEB liability and, in effect, ended the benefit for early retirees in about 10-20 years (see raw data here).

The first chart below shows that SB 566 would shift nearly the entire funding of retiree health care to retirees. Retirees currently pay for about 32 percent of their health care premium – under the proposed legislation, that share would grow to a whopping 82 percent by 2030.

The second chart shows that in 2030 a retiree would pay over $18,000 a year in health insurance premiums, while pension income stayed fairly constant. For a retiree with a final salary of $50,000 in 2030, this would be about 53 percent of his or her pension income. Thus, most state workers would forgo retiring before age 65 even though they were “promised” this benefit in their compensation package when they were hired.

The last chart demonstrates that SB 566 would have drastically lowered the retiree health care subsidy, especially for early retirees. The red line shows the current PayGo – how much employers [state and local governments] and employees pay toward the retiree health care subsidy. The blue line shows how SB 566 reduced the PayGo subsidy from the current projection, while the green line includes these changes but adds in the $50 million included in SB566 from an increased tobacco tax. As you can see, by 2030 SB 566 would reduce the subsidy by a projected $675 million, leaving retirees to foot almost the entire bill. SB 566 does little to tame
the underlying problem of the rapidly growing cost of health care and, in our opinion, focuses on eliminating the
retiree health care subsidy for the state’s public employees.

 
The focus should not be on ending the retiree health care subsidy, but rather on bringing it more in line with the natural growth of government services. According to Census data, West Virginia’s state and local governments grew at an annual average rate of 5.4 percent from 1990 to 2008. This is about the same as the national rate.

The purple line in the chart above caps the PayGo subsidy at this rate. As you can see, even if you capped the subsidy at 5.4 percent, it would provide a greater benefit for retirees than SB 566. In 2030, retirees would receive an additional $200 million toward their premiums. (If lawmakers decided to cap the PayGo subsidy at 5.4 percent, they should also look for ways to further compensate public employees since the subsidy is part of their benefits package)

If the Legislature decides to tackle this issue again in the near future, we hope that the focus will be placed on controlling health care costs rather than on drawing arbitrary lines in the sand to lower or eliminate public employees’ deferred compensation.