Presentation for Thomas Jefferson Institute’s 2007 Innovations in Government Conference

Presentation for

Thomas Jefferson Institute’s

2007 Innovations in Government Conference

Jody M. Wagner

Secretary of Finance

Commonwealth of VirginiaCommonwealth of Virginia

1111 E. Broad Street, 3rd Floor

Richmond, Virginia 23219

Phone: (804) 786-1148

Email: [email protected]

December 17, 2007

An Overview Of

Virginia’s Budget Issues

2

2008-2010 Budget:General Fund vs. Nongeneral Fund

Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget“Nongeneral Fund Revenues” do not include bond proceeds.

Appropriations – $76.4 Billion

NGF

52.7%

GF

47.3%

$36.1 billion General Fund

$40.3 billion Nongeneral Fund

3

Sales20%

Withholding55%

Corporate6%

Nonwithholding18%

Recordation4%

Withholding Sales Nonwithholding Corporate Recordation

FY 2007

o In FY07, individual nonwithholding, corporate income, and recordation tax payments accounted for $4.2 billion of GF Revenues, up significantly from FY02’s $2.0 billion.

o In FY02, 83% of GF Revenues were from withholding and sales tax collections. In FY07 75% were from those sources.

FY 2002

Components of General Fund Revenues

Sales23%

Withholding60%

Corporate3%

Nonwithholding14%

Recordation2%

Withholding Sales Nonwithholding Corporate Recordation

Note: The percentages below each source reflect the percent share of total general fund revenues. The sum of the components exceeds 100 due to the exclusion of individual refunds and other revenue sources.

4

-30

-20

-10

0

10

20

30

40

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Percent Change

Withholding Nonwithholding

Withholding and NonwithholdingFiscal Year Percent Change

5

o Net individual income taxes fell $111.8 million below forecast in Fiscal Year 2007.

o Both withholding and nonwithholding receipts grew, but much of the gains were given back in refunds.

o When the Fiscal Year 2007 shortfall was added to the reduced revenue forecast for Fiscal Year 2008, the total initial estimate of the shortfall grew to $641 million for the current biennium.

o Today we announced that as a result of administrative actions and a revised revenue forecast, the appropriation or budget shortfall is $522 million.

Virginia Completed Fiscal Year 2007 $234 Million Shy of the Forecast

6

The FY07 Forecast Variance was In Line With the Average Historical Forecast Variance…

The 20-year average forecast variance is 1.6 percent.

Annual Revenue Surplus/ShortageForecast Error on the Revenue Estimate

(millions of dollars)

Nominal RealFiscal Year Dollars ($) Percent (%) Dollars ($)

1988 115.3 2.3 159.51989 27.4 0.5 36.31990 (149.4) (2.6) (190.1)1991 51.5 0.9 62.71992 44.2 0.8 52.21993 112.1 1.9 129.01994 25.5 0.4 28.81995 51.6 0.8 56.91996 53.4 0.7 57.71997 198.3 2.6 209.91998 173.5 2.0 181.61999 155.3 1.6 160.72000 5.8 0.1 5.92001 (76.0) (0.7) (75.1)2002 (237.0) (2.2) (230.8)2003 60.5 0.6 57.82004 323.8 2.8 303.02005 544.6 4.1 496.02006 147.0 1.0 129.82007 (234.4) (1.5) (202.4)

7

Revenue Growth is Slowing Across the Nation & State

Numerous states are experiencing revenue problems

Florida is expected to face a $1.5 billion shortfall due to the weakening housing market. (Florida alone collected $2 billion in real estate taxes in 2004 – 30% of the total collected by all states.)

Maryland and Michigan each face $1.7 billion deficits for FY08. Both are cutting spending and raising various taxes.

Arizona is facing a $600 million shortfall in its current biennial budget.

California’s operating deficit is now expected to be more than $8.6 billion – 40% higher than the $6.1 billion gap projected as recently as August.

Virginia localities also are expected to face revenue challenges

Fairfax County receives more than 60% of general fund revenues from real estate taxes. Residential real estate assessments declined for the first time since 1998 by -0.33 percent.

Prince William County faces declining property tax revenues, resulting in a budget shortfall of $8.6 million in FY08 and $51 million in FY09.

Virginia Beach is facing a $30 million budget shortfall in FY09.

8

-40

-30

-20

-10

0

10

20

30

40

50

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Percent Change

Withholding Corporate

Withholding and CorporateFiscal Year Percent Change

9

Corporate Income Tax Receipts Were Slightly Weaker Than Expected in FY07, Finishing $21.8 Million Below Forecast…

Corporate income tax collections increased 1.4 percent in FY07, down substantially from the 32 percent annual increase averaged over the previous four fiscal years.

-40

-30

-20

-10

0

10

20

30

40

50

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Growth in Net Corporate Income Tax Receipts, FY82-07Percent Growth Over the Prior Year

10

The Share of Corporate Income Tax Receipts Attributable to Housing Declined Significantly Between FY06 and FY07…

The top 200 corporate payers represent about 53% of total gross payments.

Housing is defined as mortgage companies, home builders, and real estate-related companies.

9%

16%

10%65%

Fiscal Year 2006

20%

8%

17%

55%

Fiscal Year 2007

Defense

Housing

Trade

Other

Corporate Income Tax Receipts From Large Companies Final and Estimated Payments in April-June

By Industry Percent Share of Total

$232 million

$191 million

11

-30

-20

-10

0

10

20

30

40

50

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Percent Change

Withholding Recordation

Note: Recordation growth rate is adjusted to remove the rate increase.

Withholding and RecordationFiscal Year Percent Change

12

Total General Fund Revenues Have Become Increasingly Volatile…

The increased significance of individual nonwithholding, corporate income, and recordation tax have introduced additional variability into collections.

Taken together, the three most volatile revenue sources represented 28 percent of total revenues in FY07 compared with the historical average of 21 percent.

-20

-10

0

10

20

30

40

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Total Revenue

Three Volatile

Volatility in Total Revenues, FY91-07Percent Growth Over the Prior Year

December Revenue Forecast

14

The December Forecast Is Essentially Unchanged From The August Interim Revenue Forecast…

Summary of the December 2007 Revenue Forecast(millions of dollars)

Major Source

Withholding 56.2 % $ 9,042.3 $ (49.1) $ 9,601.8 $ (35.1) $ 10,177.8 $ (56.6)

Nonwithholding 19.0 3,059.4 33.0 3,279.5 10.6 3,545.8 43.9

Refunds (10.4) (1,680.6) (43.4) (1,795.3) (43.8) (1,833.2) (44.1)

Net Individual 64.8 % $ 10,421.1 $ 27.4 $ 11,086.0 $ 19.3 $ 11,890.4 $ 31.4

Sales 19.5 % $ 3,136.0 $ 0.0 $ 3,300.9 $ (1.2) $ 3,488.7 $ 4.9

Corporate 4.6 747.9 21.7 743.7 (21.7) 783.9 (12.1)

Wills (Recordation) 3.2 520.3 (10.2) 449.4 3.2 489.8 3.5

Insurance 2.5 403.4 7.3 284.2 (0.0) 305.9 8.9

All Other Revenue 5.3 858.6 15.3 746.5 (12.6) 766.0 (11.8)

Total 100.0 % $ 16,087.3 $ 61.6 $ 16,610.8 $ (13.0) $ 17,724.7 $ 24.8

As a % of Total

Revenues

Fiscal Year 2008

$ Amount $ Change

Fiscal Year 2010Fiscal Year 2009

$ Amount $ Amount$ Change $ Change

15

The December Forecast Is Essentially Unchanged From The August Interim Revenue Forecast (continued)…

Summary of the December 2007 Revenue Forecast(millions of dollars)

Notes:a) Adjusted for the Estate Tax repeal, underlying growth is 3.6% for fiscal year 2008. b) Adjusted for the Estate Tax repeal and HB 3202 (Transportation Plan), underlying growth is 5.2% for fiscal year 2009.

Major Source

Withholding 56.2 % $ 9,042.3 5.6 % $ 9,601.8 6.2 % $ 10,177.8 6.0 %

Nonwithholding 19.0 3,059.4 10.0 3,279.5 7.2 3,545.8 8.1

Refunds (10.4) (1,680.6) 7.7 (1,795.3) 6.8 (1,833.2) 2.1

Net Individual 64.8 % $ 10,421.1 6.5 % $ 11,086.0 6.4 % $ 11,890.4 7.3 %

Sales 19.5 % $ 3,136.0 2.8 % $ 3,300.9 5.3 % $ 3,488.7 5.7 %

Corporate 4.6 747.9 (15.0) 743.7 (0.6) 783.9 5.4

Wills (Recordation) 3.2 520.3 (10.7) 449.4 (13.6) 489.8 9.0

Insurance 2.5 403.4 4.8 284.2 (29.5) 305.9 7.6

All Other Revenue 5.3 858.6 (2.6) 746.5 (13.1) 766.0 2.6

Total 100.0 % $ 16,087.3 3.3 % $ 16,610.8 3.3 % $ 17,724.7 6.7 %

Fiscal Year 2010Fiscal Year 2009 (b)

$ Amount $ Amount% Growth % Growth

As a % of Total

Revenues

Fiscal Year 2008 (a)

$ Amount % Growth

16

The December Revenue Forecast Reflects An Economy That Continues To Expand Over The Forecast Horizon…

Economic-based revenue growth is expected to improve over the next biennium.

Total General Fund Revenues(annual percent change)

FY08 FY09 FY10 Revenue Base 3.3% 3.3% 6.7% Economic Base 3.6% 5.2% 6.7%

17

Tax Policy Changes That Reduce Or Reallocate General Fund Revenues Are Affecting Revenue Resources…

Tax policy changes remove $724.3 million from General Fund Revenue in the 2008-2010 biennial budget.

December Forecast FY08 FY09 FY10Increase Filing Threshold/Personal Exemption -13.5 -27.1 -26.9Sales Tax Holiday -- Hurricane/Energy Efficient -1.6 -1.7 -1.8Estate Tax Repeal -42.2 -140.0 -140.01/3 Insurance Premiums to Transportation 0.0 -134.5 -139.6$0.03 Recordation Tax to Transportation 0.0 -53.9 -58.8Total -57.3 -357.2 -367.1

Tax Policy Changes Affecting General Fund Revenues

(millions of dollars)

18

Year-to-date Revenue Collections Through November Are Running Very Close To The December Forecast…

Summary of Fiscal Year 2008 Revenue CollectionsJuly through November

As a %of Total YTD December 2007

Major Source Revenues Actual Estimate Variance

Withholding 56.2 % 5.0 % 5.6 % (0.6) %Nonwithholding 19.0 13.4 10.0 3.4Refunds (10.4) (7.5) 7.7 (15.2) Net Individual 64.8 6.8 6.5 0.3

Sales 19.5 2.8 2.8 0.0Corporate 4.6 (26.7) (15.0) (11.7)Wills (Recordation) 3.2 (15.3) (10.7) (4.6)Insurance 2.5 5.8 4.8 1.0All Other Revenue (a) 5.3 5.1 (2.6) 7.7

Total (a) 100.0 % 3.2 % 3.3 % (0.1) %

Percent Growth over Prior Year

(a) Adjusted for nongeneral funds interest earnings for October and November that will be transferred in January. Not adjusted for the transfer, all other revenue growth is 11.7 percent and total general fund revenue growth is 3.6 percent.

Key Risks to the Outlook

20

The National And Virginia Economies Face Significant Risks…

There are downside risks that members of the Governor’s Advisory Board of Economists (GABE) and Governor’s Advisory Council on Revenue Estimates (GACRE) highlighted:

Housing Market – not expected to recover until early calendar year 2009

Energy Prices – oil prices over $90 per barrel could stall the economy

Federal Government Spending – future spending priorities unknown

10

20

30

40

50

60

70

80

90

100

Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec

Dollars Per Barrel

Price of West Texas Intermediate CrudeSeasonally-adjusted 3-month moving average

2000 2001 2002 2003 2004 2005 2006 2007

21

One Key Risk To Economic Growth Is From The Slowdown In The Housing Market…

Recent data reveal a significant slowdown in housing-related economic activity.

The seasonally-adjusted, three-month moving average of home sales fell 22% in October. Pending home sales in Northern Virginia were down 18%.

Sales volume in Northern Virginia is 56% below the October 2004 level.

The average sale price declined 2.8% in October, the third consecutive monthly year-over-year decline.

The average sale price has declined in 4 out of the last 6 months. Over the last 10 years, it has declined in only 8 months.

22

Pending Home Sales, A Leading Indicator Of Future Closings, Illustrate The Weakness In Housing…

Pending Home Sales in Northern Virginia, Hampton Roads, and RichmondLevels

Seasonally-adjusted 3-month moving average

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

Northern Virginia Hampton Roads Richmond30% 24% 14%

Northern VirginiaHampton Roads

Richmond

(% share of total home sales in Virginia)

Average Sale PriceOct-06 Oct-07 % Growth

Northern Virginia $493,615 $480,748 -3%Hampton Roads 271,893 289,315 6%Richmond 266,402 299,816 13%

23

The Risk From The Slowdown In The Housing Market Is That It Could Spread To The Overall Economy…

The general slowdown in housing and the subprime mortgage meltdown broaden risks to overall economic growth.

Tighter credit requirements for consumers and businesses.

Negatively impacts consumer spending.

Weakens related sectors of the economy.

24

Other Key Risks For The Fiscal Year 2008-10 Forecast…

Other factors will influence economic and revenue growth:

Stock market volatility

Defense and federal procurement spending International instability

1,300

1,350

1,400

1,450

1,500

1,550

1,600

1/3 1/24 2/14 3/7 3/28 4/18 5/9 5/30 6/20 7/11 8/1 8/22 9/12 10/3 10/24 11/14 12/5

S&P 500 Index – Calendar Year 2007

25

The December Global Insight National Economic Outlook Is Signaling Caution…

The latest monthly forecast put probability of recession at 40%.

The October probability was 30%.

A recession would delay the recovery well into fiscal year 2009.

Moody’s Economy.com puts the probability of recession at 48%.

How the General Fund Revenue is Appropriated in the 2008-2010 Biennium

27

Where the Money Goes 2008-2010 (General Fund Operating) = $35.1 Billion

K 12$12,884.8

76.4%

Higher Education$3,642.421.6%

Other$347.12.1%

80.8% of state general fund revenues are for education, public safety, and health programs.

“Other” includes legislative and judicial branches, technology, natural resources, commerce and trade, independent agencies, and non-state agencies. “General Government” category includes administration, finance, executive offices, and central appropriations. “Other Education” includes Education Secretariat and Museums. Excludes Capital Outlay.Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget

Health & Human Resources$8,672.6

24.0%

Public Safety$3,659.910.1%

Transportation$262.00.7%

Debt Service$1,040.4

3.0%

Car Tax$1,900.0

5.4%

General Government$2,120.5

6.0%Other

$1,590.54.4%

Education$16,874.4

46.7%

28

Car Tax$1,900.010.7%

Public Education$12,744.7

71.5%

Local Sheriffs $1,006.2

5.6%

Other Aid to Localities$2,173.412.2%

Almost One-half of the General Fund Operating Budget Goes to Localities

State Programs $10,034.7

28%

Debt Service $1,017.8

3%

Aid to Individuals $7,243.5

20%

Aid to Localities$17,824.3

49%

Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget

Proposed Budget Actions

30

Steps Taken To Close The Fiscal Year 2008 Budget Shortfall…

Agency-based budget reductions contained in the Governor’s Budget Reduction Plan released October 1, 2007.

Carryforward of unexpended appropriations from fiscal year 2007.

Transfer funds from the Revenue Stabilization Fund.

31

What Are the Permitted Uses of the Revenue Stabilization Fund?

1. A shortfall in current enacted budget YES

2. A projected severe downturn in economy

in next biennium NO

3. An emergency spending event

(i.e. natural disaster or terrorist attack) NO

32

How Much Can Be Withdrawn From The Revenue Stabilization Fund?

Rule #1 – The General Assembly may appropriate a withdrawal from the Revenue Stabilization Fund if there is a revenue shortfall of 2 percent or greater in certified tax revenue ($278.8 million for FY2007).

FY2008 calculation – uses data from FY2007

Individual Income + Corporate Income + Sales Tax = Total x 2% Shortfall

$9,787.8 $879.6 $3,274.3 $13,941.6 $278.8

Rule #2 – The withdrawal cannot exceed ½ of the revenue shortfall ($522.3 million).

Shortfall Potential Withdrawal $522.3 2 = $261.1

A Withdrawal From The Revenue Stabilization Fund May Be Possible In The Event Of A Revenue Shortfall

($ in millions)

33

The Governor Is Proposing A $261.1 Million Withdrawal From The Revenue Stabilization Fund In Fiscal Year 2008…

80 85

157

224

361

575

472

247

340

482

1,065

1,190

1,098

1,1651,215

716

0

200

400

600

800

1,000

1,200

1,400

FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

History Forecast

Millions of Dollars

Revenue Stabilization Fund -- June 30 BalanceFY 1995-07 Actual and FY 2008-10 Forecast

(millions of dollars)

The Governor is Proposing a General Obligation Bond to Address Construction of Higher Education Buildings

35

Virginia’s Fiscal Health And Financial Management Practices Are Reflected In Our “AAA” Bond Rating…

260284

249220

243

445

531

671698

628

482

662691

886

946

0

100

200

300

400

500

600

700

800

900

1,000

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Year of Recommendation

Historic Debt Capacity(millions of dollars)

36

The Governor’s Proposal For Higher Education Improvements Will Still Leave Virginia With Debt Capacity…

Historic Debt Capacity Plus New and Potential Authorization

(millions of dollars)

260284

249220

243

445

531

671698

628

482

662691

886

946

798

615

0

100

200

300

400

500

600

700

800

900

1,000

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Year of Recommendation

Notes:(1) Represents 2006 Base Capacity plus debt authorized during 2007 Session.(2) Represents 2006 Base Capacity plus 2007 authorization plus potential 2008 Proposed Authorization

($1.5 Billion of General Obligation Bonds and $700 Million of VCBA/VPBA Bonds)

(1) (2)

37

Construction costs have historically outpaced inflation.

Breakout of type of building: $728.3 million is related to the sciences/technology $896.2 million to classroom and administrative space $27.5 million is infrastructure

Constructing The Higher Education Buildings Now Will Save Money Over The Long Term…

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07

Commercial Construction Hospitals & Health Facilities CPI

Percent Historical Increase in Construction Cost For Buildings