1. T HE 2009 AND 2010 M ISSOURI B UDGET O UTLOOK James R. Moody & Associates September 3, 2008 1

2. S PECIAL T HANKS Senate Appropriations Staff House Appropriations Staff Missouri Office of Budget and Planning Staff Missouri Department of Economic Development Staff 2

3. W HOSE V IEW I S C ORRECT ON THE M ISSOURI B UDGET ? Governor Blunt—Largest budget surplus ever Missouri Budget Project—We are about to fall off of the cliff The View of Many Legislators—Expenditures above revenues on a consistent basis, Do we have a structural deficit? 3

4. T HE A NSWER A little bit of all three 4

5. T HE S URPLUS Missouri ends each year with a balance that is a combination of planned cash balances and lapsed appropriations (authority to spend that is not spent) The cash balance is similar to an individual’s bank account—it does not represent ongoing revenue Similar to your bank account, the cash balance should not be put into ongoing programs, because it is not supported by ongoing revenue We will show you how the “surplus” fits into the overall budget picture 5

6. C OMPONENTS OF M ISSOURI G ENERAL F UND 6

7. B ASIC B UDGETING 101 What goes up can also come down With our limited revenue stream, it is easy to define which components could trigger a downturn Because we rely so heavily on individual income tax and sales tax, there is a direct relationship between general revenue growth and personal income growth Income tax growth (and decrease) over the past decade has also been driven by taxation of capital gains 7

8. H OW M ISSOURI H ANDLES C ASH F LOW AND B UDGET E MERGENCIES Missouri has a constitutional “ Budget Reserve Fund” equal to 7 ½% of general fund revenues This fund can be used for cash flow requirements, or as a Rainy Day Fund If used as a Rainy Day Fund, it must be repaid within three years Since this fund is available for cash flow and emergencies, budgeting all revenues and beginning balances makes more sense The Budget Reserve Fund is not a general revenue fund. The general revenue balance referenced here does not include the Budget Reserve Fund 8

9. I NTRO T O S TATE B UDGETING Historically Missouri has had nominal balances carried forward, and has budgeted beginning balance and prior year’s lapse The next year’s beginning balance and lapse are created by expenditure management and the statutory 3% reserve 9

10. T HE F ISCAL Y EAR 1998 B UDGET —A G OOD E XAMPLE OF T RADITIONAL S TATE B UDGETING O F T HE G ENERAL F UND (in millions) Beginning balance $132.8 Lapse$86.9 Revenue Collections $5,906.6 Other Resources $374.5 Total Resources $6,500.8 (in millions) Operating Appropriations $4,612.7 Tax Refunds$536.9 Capital Impr., Deseg, Other Expenditures $1,351.2 Total Obligations $6,500.8 Ending Balance $0 Beginning balance and lapse are completely budgeted All funds are appropriated and ending balance is zero 10

11. C URRENT C ASH B ALANCES A RE M UCH H IGHER T HAN H ISTORIC A VERAGES 11

12. W HAT S HOULD W E K NOW A BOUT T HE T RADITIONAL B UDGETING M ETHOD It probably does not work when the beginning balance and lapse are very large In current circumstances, it could have the effect of putting one-time moneys into ongoing programs If budgeted, one-time funds should be put into one-time expenditures, such as capital improvements Many people, including many elected officials, do not understand that the “surplus” is one-time money Therefore, they suggest putting the one-time money into ongoing programs 12

13. T HE I MPORTANCE OF P ERSONAL I NCOME T O T HE M ISSOURI B UDGET Missouri derives most of its general fund income from the individual income tax and the sales tax Growth in these factors is derived primarily from growth in personal income Personal income does include all earned income and most unearned income, including dividends, interest and rents Personal income does not include capital gains, and so what is happening with capital gains must be viewed independently from personal income growth 13

14. M OODY ’ S R ATING S ERVICE O UTLOOK FOR M ISSOURI P ERSONAL I NCOME 14

15. T HE R ELATIONSHIP OF P ERSONAL I NCOME AND G ENERAL F UND G ROWTH 15

16. I NCOME T AX W ITHHOLDING C OMPARED T O P ERSONAL I NCOME G ROWTH 16

17. I S T HE GR B UDGET G ETTING O UT O F B ALANCE ? Fiscal Year RevenuesExpendDifference 2006$7,635.0$7,219.9$145.1 2007$8,015.4$8,018.2($2.8) 2008$8,312.1$8,364.9($52.8) 2009$8,618.8$8,754.9($136.1) 2010$8,754.9$9,204.4 ($399.5) Fiscal Year 2010 assumes a 3.4% revenue growth in FY 2009 and FY 2010, and $350 million growth in obligations in Fiscal Year 2010 17

18. C APITAL G AINS S UBJECT T O S TATE I NCOME T AX ( IN THOUSANDS ) 18

19. T HOUGHTS O N C APITAL G AINS They are not included in personal income, and budget decision-makers should track them separately The major downturns in state revenues in the early 2000’s were largely driven by a major downturn in capital gains, not by a drop in income tax withholdings Treatment of capital gains could change at the federal level, but have a direct impact on Missouri’s general fund 19

20. I NDIVIDUAL I NCOME T AX For Fiscal Year 2009, the consensus revenue estimate is that 66% of general fund revenues will come from the individual income tax Approximately 72% of all income tax revenues come from employee withholdings Non-withholding income tax comes in the form of declarations and remittances, and would include income from quarterly estimated payments and annual final payments by self-employed persons, as well as payments of taxes on unearned income such as interest, dividends, and capital gains 20

21. I NDIVIDUAL I NCOME T AX 21

22. Individual income tax withholding has been growing each year since 1999. The shortfalls in income tax in the early 2000were driven by reduced capital gains, not by reduced withholdings 22

23. T HOUGHTS R EGARDING I NDIVIDUAL I NCOME T AX W ITHHOLDING The last three years have been strong for income tax withholding (7.0%,5.1%,6.0%). The four years prior to FY 2006 only averaged 3.3% withholding growth. Income tax withholding tends to track personal income growth, and Moody’s projects moderate personal income growth in the next few years. That would tend more toward the four years of moderate growth 23

24. S ALES T AX G ROWTH 24

25. C AUTIONS R EGARDING S ALES T AX G ROWTH We generally do not tax the products where prices are rapidly rising (food, prescription drugs, utilities) Some products which we do tax are experiencing price declines (electronics, appliances) Motor fuel is not subject to the sales tax, and the motor fuel tax is earmarked for transportation. Motor vehicle sales tax also goes to transportation Continued erosion of the sales tax base due to internet sales It appears that nominal sales tax growth (or slightly negative growth) will continue Sales tax is over 23% of the general fund. If it is not growing, the other major component (individual income tax) must outperform for revenues to grow (Note consensus revenue estimate slide) 25

26. FY 2007 Credits Issued--$171 million FY 2008 Credits Issued--$161 million 26

27. O VERALL T AX C REDIT R EDEMPTION 27

28. O THER B UDGETARY P RESSURES Medicaid inflationary pressures Possible uninsured expansion of coverage Corrections Fully funding the school formula Higher education funding Deferred maintenance Capital improvements Unknown impact of Senate Bill 30 changes to sales tax laws Unknown impact of accelerated depreciation from the federal economic stimulus package Potential impact of Missouri Guaranty Fund covering pre-need policies for National Prearranged Services 28

29. The consensus revenue estimate for Fiscal Year 2009 illustrates the dependence on the individual income tax. To reach 3.4% growth overall, individual income tax must grow 4.5%, while sales tax is estimated to grow only.4%. ComponentConensus Revenue Growth Estimate Individual Income Tax4.5% Sales Tax.4% Corporate Tax5.0% County Foreign Insurance 6.6% All Other(2.8%) Net GR Collections3.4% 29

30. T HE “G UN AT THE H EAD ” Q UESTION If forced to predict whether actual receipts would exceed the revenue estimate or be below the revenue estimate in the next few fiscal years, what would your prediction be? Below However, because Missouri exceeded the revenue estimate in FY 2008, only 2.8% growth is need to make the FY 2009 estimate of 3.4% growth. Potential problems might not appear until FY 2010. 30

31. W HAT S HOULD M ISSOURI D O ? Relative to other states, we may actually be in an enviable position Budget Rule 1—Don’t put one-time funds into ongoing programs. Keep a very close eye on capital gains and personal income Consider putting one-time funds into capital improvements or deferred maintenance or other one-time investments Don’t allow the public to think that excess cash balances are ongoing revenue Manage the situation 31