1. FISCAL ACCOUNTABILITY OF STATE GOVERNMENT Presentation Prepared for the Appropriation, Finance, Revenue, and Bonding Committees by the Office of Policy and Management November 29, 2005

2. 2 ECONOMIC AND DEMOGRAPHIC TRENDS “One of the greatest pieces of economic wisdom is to know what you do not know.” - John Kenneth Galbraith

3. 3 Economic Indicators Economic growth for the nation is expected to continue to expand at a slower pace over the forecast period Connecticut’s economy will nearly mirror the national trend The state’s personal income growth will slow Employment growth will continue The unemployment rate will remain relatively steady

4. 4 Significant Demographic Trends The state is projected to undergo major demographic changes, with significant impact on our economic and social infrastructures. While many of these trends also affect the nation in total, Connecticut will be impacted particularly hard by these trends –Connecticut’s population will grow only 8.3% between 2000 and 2030, while the nation will grow 29.2% –While the older population, which uses services, will grow significantly, the population between 18 and 64, who will be working and will be asked to pay for those services with their taxes, will shrink by 0.1% –The older population, those over 65, who are high users of various health and social services, will increase almost 70% between 2000 and 2030 –The very old and frail population, those over 85, who are very intense users of health and social services, will more than double in size from 2000 to 2030 –The school-aged population, those under 18, will decrease slightly –The median age of the state will increase to 41.1 years by 2030, while the nation’s median age will increase to only 39.0 years Projections of The Population in Connecticut (Mid-Year Resident Population In Thousands)

5. 5 BUDGET PROJECTIONS “Beware of little expenses; a small leak will sink a great ship.” - Benjamin Franklin

6. 6 Budget Projections Expenditures grew dramatically in fiscal 2006 and are projected to rise significantly in fiscal 2008 The general fund is projected to register ever-rising deficits beginning in FY 2008, if spending is left unchecked The income tax is projected to yield modest steady growth after a three fiscal year growth in estimates and final payments of over 65% Sales tax collections are forecasted to remain relatively stable

7. 7 Budget Growth Rates The adopted budget increases spending in fiscal 2006 by 9.0% That increase was due to the use of the 2005 surplus and the enactment of a provider tax That level of increase can not be sustained in the future General Fund

8. 8 Projected Balance of the General Fund The state ended fiscal year 2004 and 2005 in surplus We are currently projecting positive balances in the General Fund for fiscal year 2006 and 2007 However, beginning in fiscal year 2008, these surpluses disappear as the state is projected to register deficits, absent restraint on spending State of Connecticut General Fund Surplus/(Deficit) Note: Fiscal years 2008-2010 assume appropriations within the limits required by the Constitutional expenditure cap.

9. 9 CONNECTICUT REVENUES “In the end it's a revenue stream. And all revenue streams eventually reach the sea.” - Paul Schrader

10. 10 Personal Income Tax Over the past several years Connecticut’s income tax has fluctuated dramatically This was due to the stock market decline beginning in 2000 and the onset of the recession Although the tax has performed better in fiscal 2004 and 2005, the variability of this revenue source dictates caution when forecasting future revenues Economic Growth Rates of the Personal Income Tax

11. 11 Estimates & Final Payments P.I. Tax Growth Rates For Selected Months Fiscal Years 2004-2006 Final Payments OPM is forecasting continued strong growth in Estimates & Finals for the remaining IY 2005 payments OPM is forecasting 2.5% growth in the IY 2006 payments Estimated Payments

12. 12 Sales and Use Tax The sales tax recovered in fiscal 2004 and 2005 from the recessionary lows experienced earlier Fiscal 2006 collections have been weaker due to high fuel prices which robs consumers of discretionary spending Moving forward, rising internet sales is a cause for concern regarding this tax Economic Growth Rates of the Sales and Use Tax

13. 13 BUDGET RESERVE FUND “Balancing the budget is like going to heaven. Everybody wants to do it, but nobody wants to do what you have to do to get there.” - Phil Gramm, Senator, TX

14. 14 States With Budget Reserve Funds 37 states have a higher percentage than Connecticut At 2.4% of General Fund appropriations, CT’s reserves place our state 38 th in the nation for FY 04 The national average in FY 2004 was 8.8% Credit rating agencies view Connecticut’s inadequate reserves as a negative factor

15. 15 Depletion Of Reserves Prior to the 2000 recession, the state’s budget reserve fund was fully funded at the then 5% statutory level Even at 5% of General Fund appropriations, there were insufficient funds to carry the state through the recession In one year, the entire balance in the Fund was wiped-out Even with the Fiscal 2005 projected deposit of $300 million, the budget reserve fund will only attain a level of 4.3%, well below the national median of 5.3%, and not even 50% of the current statutory level Budget Reserve Fund

16. 16 Cost Of Deficit Financing The failure to have adequate reserves meant the budget deficits from FY 02 and FY 03 both required financing In the near-term these costs remain significant Total price tag for taxpayers – roughly $345 million over 6 years Cost of Financing Budget Deficits (In Millions)

17. 17 Shortfall In The Budget Reserve Fund Responding to the financial crisis, the state's legislature passed 2 public acts, first raising the 5% budget reserve level to 7.5%, then to 10% Even assuming the projected FY 05, FY 06, and FY 07 budget reserve fund deposits, the state will not reach its 10% goal and will be short by $635.6 million The lack of resources places the state in a precarious financial position in the event of another recession Unfunded Budget Reserve Fund

18. 18 Projected Balance of the Budget Reserve Fund

19. 19 THE EXPENDITURE CAP “Always do right. This will gratify some and astonish the rest.” -Mark Twain

20. 20 Origin Of The Expenditure Cap Part of income tax compromise in 1991 Taxes were raised by over $1 billion after just having been raised by $860 million in the late 1980’s Assurance that the state would not engage in runaway spending Avoid future budgetary crisis, such as necessitated the income tax Budget would only grow at the same rate as the state’s ability as measured by personal income Ratified by the state electorate by a 4 to 1 margin Average Nominal Growth In State Spending Fiscal Year

21. 21 The Expenditure Cap Has Been An Effective Tool The expenditure cap has not prevented the state from paying down debt From fiscal 1995 to fiscal 2005, 33.7% of registered surpluses was used for the early retirement of debt or debt avoidance State of Connecticut Use of Surplus Fiscal 1995 to Fiscal 2005

22. 22 EXPANDING COMMITMENTS “A billion here, a billion there, pretty soon it adds up to real money.” - Senator Everett Dirksen

23. 23 Department Of Children & Families Since 1991 DCF has been operating under the provisions of a federal court ordered Consent Decree in the Juan F. case. Since that time DCF’s budget has quadrupled In the fall of 2003, DCF entered into an Exit Plan for the Consent Decree The Plan requires DCF to maintain a minimum level of staffing in addition to employing sufficient numbers of social workers to achieve caseload ratios The Exit Plan also requires significant additional funds to implement specific provisions of the Plan. The FY 06 budget includes over $56.8 million in new funding for the department DCF Expenditures (In Millions)

24. 24 Department Of Education The Education Cost Sharing Grant (ECS) is the state’s major education grant, designed to equalize the ability of towns to finance local education costs The expenditure for the current fiscal year is $1.62 billion, which is a growth of 3.6% over FY 05. Average growth in ECS since 2001 has been 3.1% The recently passed legislative budget for FY 2006 & FY 2007 includes $57M in surplus funds divided over the biennium Even with this increase, the grant will not be fully funded. An additional $40 million would be required for full funding Education Cost Sharing Grant (In Millions) Note: Figures provided for FY 2001 to 2005 are revenue based (not entitlement based) in that they include prior year adjustments. The estimates provided for FY 2006 & 2007 are at the entitlement level based on the recently passed legislative budget.

25. 25 Department Of Mental Retardation New funding over FY 05 levels of $65M in FY 06 and $94M in FY 07 has been appropriated for DMR to continue to meet the service requirements of the most at risk clients. These funds are targeted to serve clients on the waiting list as well as those "aging out" of current placements. There is an ongoing commitment to maintain services to individuals with future funding for this effort With additional and ongoing funding commitments the state has been able to reach a settlement in the Association for Retarded Citizens (ARC) vs. CT suit. As part of the settlement, funding of $8.1M in FY 06 and $16.6M in FY 07 is provided to serve 300 individuals on the waiting list Additional funding is provided to add 20 new case management staff in order to reduce client caseload ratios DMR Expenditures (In Millions)

26. 26 Long-Term Care Alternatives Homecare Connecticut has significantly improved its long-term care system by continuing to develop home and community based services for individuals and families and allowing DSS clients to remain in their communities as long as possible Due to Connecticut’s strong support for home care options, enrollment in the CHC program has more than tripled, increasing from approximately 6,000 cases in Fiscal 1997 to a forecasted 19,000 cases in fiscal 2007

27. 27 Medicare Part D

28. 28 Summary Of Local Aid Estimated Formula Grants To Municipalities (In Millions) Municipal aid has been predominately flat-funded for the past several years The use of the fiscal year 2005 surplus permitted the first significant increase in these grants in several years The budget would still require an infusion of $61M to meet statutory requirements and fully fund these grants

29. 29 DEBT LEVELS “A balanced budget takes us in the right direction. Clearly, adding billions and trillions of dollars to our debt takes us in the wrong direction.” - Tim Johnson, Representative, IL

30. 30 Impact Of Debt Expenses The percentage of the budget devoted to debt service has grown dramatically over the past decade It will have grown from 6.7% of the budget in fiscal 1995 to 9.9% by fiscal 2007 The dramatic increase in debt service expenditures crowds out discretionary spending General Fund Debt Service Expenditures

31. 31 Five Year Bond Projections

32. 32 Five Year Bond Projections Debt service continues to grow as a percentage of budget even with annual G.O. bond allocations fixed at $1.1 billion Projected higher education bonding will comprise 30% of all G.O. bond allocations over the next five years School Construction bonding will comprise more than half of all G.O. bond allocations over the next five years

33. 33 LONG TERM LIABILITIES "Zeroes are important.“ - Denis Hayes, author and contributor to Starbucks ‘the way I see it”

34. 34 Unfunded Pensions State Employees Retirement System State employees unfunded pension liabilities continue to grow State’s obligations at the end of fiscal 2004 totals $6.9 billion This obligation represents roughly $1,969 for every man, woman, and child in the state This obligation rose even with the large increase in equity valuations that took place over the 1990s State Employees Retirement System As Of 6/30

35. 35 State Employee Retirement System Contributions The State’s contributions to the State Employee Retirement System continues to grow The anticipated contribution in fiscal 2007 is $541 million. This is a $300 million increase since fiscal 2000 In fiscal 2010, the anticipated contribution is $645 million, an increase of more than $400 million over fiscal 2000 Contributions to the State Employee Retirement System

36. 36 State Employees Pension & Health Insurance - All Funds Fiscal 2005-07 pension costs are 30% higher than in prior biennium Fiscal 2007 total employer pension costs are 21.3% of payroll Fiscal 2005-07 health insurance costs for active employees are estimated to be 26.1% higher than in the prior biennium Fiscal 2005-07 health insurance costs for retirees are estimated to be 20.7% higher than in the prior biennium Fiscal 2005-06 estimated average health insurance cost to the state is $9,712 per active employee SERS & Health Insurance Expenditures As Of 6/30

37. 37 Unfunded Pensions Connecticut Teachers Retirement System Teachers’ unfunded pension liabilities continue to grow State’s obligations at the end of fiscal 2004 totals $5.2 billion Teachers Retirement System As Of 6/30

38. 38 Scarce Discretionary Spending Room The spending cap allowed capped growth of about $465 million in fiscal year 2006 Rising payroll and benefit costs for state employees and local teachers will consume 71% of all allowable capped growth This leaves just $135.8 million in growth for all other capped state programs Total personnel costs and fringe benefits amount to over $3.4 billion in the General Fund. That's nearly 25% of G.F. spending * Exclusive of salaries supported by block grants provided to the constituent units of higher education, or other current expense appropriations

39. 39 Other Post Employment Benefits The Governmental Accounting Standards Board (GASB) requires large employers, such as the State of Connecticut, to quantify the amount of non-pension retirement benefits offered to employees beginning in fiscal year 2008 Connecticut’s substantial health benefit package results in a significant unfunded liability. Preliminary estimates of this unfunded liability are most likely to exceed the liabilities of the unfunded liabilities of SERS and TERS combined Connecticut’s unfunded liability may place the state at a disadvantage relative to other states that have a much lower unfunded liability or have undertaken a plan to address such shortfalls Connecticut will also have to quantify the amount of non- pension retirement benefits offered for Teachers

40. 40 Rising Energy Costs

41. 41 Underfunded Items in the Fiscal Year 2007 Budget There are many underfunded areas that may need to be addressed in the fiscal year 2007 midterm adjustments. These include: 1. Unsettled Collective Bargaining Contracts 2. No Nursing Home Rate Increases 3. No Managed Care Organization Rate Increases 4. No Private Provider Increases 5. Escalating Energy Costs 6. Roll-out of FY 2006 additional costs

42. 42 SUMMARY

43. 43 Summary The state is projected to experience a surplus at the end of FY2005-06 and 2006-07 Projections indicate that spending will exceed available room under the expenditure cap in fiscal years 2007-08 and forward Beginning in fiscal year 2007-08 the state will experience significant deficits if spending remains unchecked The budget reserve fund fails to reach the statutorily required 10% over the projection period, putting the state at risk in the event of a recession

44. 44 Summary Even with the projected surpluses from both fiscal years 2005-06 and 2006-07 deposited into the budget reserve fund if spending remains unchecked current services spending will exceed current services revenue beginning in fiscal 2008 Debt service as a percent of budget expenditures will continue to grow despite maintaining general obligation allocations and issuances fixed at the current level In order to achieve a significant reduction in debt service as a percent of budget expenditures, significant reductions in bond issuances would be required The state faces significant long-term obligations including debt, unfunded pension liabilities and unfunded post- employment retirement benefits

45. 45 Summary Major issues and trends impacting the state’s fiscal situation include: –Significant cost drivers which include: pharmacy costs, expenditures related to the Department of Children and Families, the Department of Correction, Department of Education, and Department of Mental Retardation –State grants to local government have increased significantly over the biennium –Energy costs have increased dramatically due to natural disasters