Tuesday, October 20, 2009

Maryland’s New Structural Deficit

Remember when the state’s leaders fixed the “structural deficit” during the 2007 special session? Well, that deficit is baaa-aaack, and it’s bigger than ever.

The original structural deficit dates back to income tax cuts in 1997 and 1998 and the 2002 Thornton education spending bill. The big increases in school spending under the Thornton bill helped make Maryland’s schools the best in the nation, but they combined with the tax cuts to produce a projected $1.7 billion deficit by 2007. Governor O’Malley was determined to abolish the deficit early in his term and worked hard to pass a tax package and a constitutional amendment allowing slots to close it.

But the poor economy has robbed the ability of the special session tax rate increases to generate new revenue. The state’s new Spending Affordability Briefing shows general fund revenue falling from $13.5 billion in FY 2008 to an estimated $12.3 billion in FY 2010. The biggest culprit: the personal income tax, which raised $6.9 billion in FY 2008 and is now projected to yield $6.1 billion in FY 2010. And the state’s formula-driven spending keeps rising.

How bad will it get? In FY 2009 and FY 2010, the state received federal stimulus funds and executed a series of fund transfers that together brought in more than $1.7 billion over those two fiscal years. That money will largely run out starting in FY 2011, leaving the state with $12.9 billion in revenues and $14.9 billion in spending that year. Both revenues and spending are projected to grow at a 4.7-4.8% rate thereafter, but because revenues are not projected to catch up, the resulting deficits will total $2.0-2.5 billion every single year. And that includes over $600 million of annual slots revenues from FY 2013 thereafter.

The general fund is devilishly hard to cut because it is comprised primarily of three items: education (which accounts for 51% of spending in FY 2010), health care (21%) and public safety (9%). That’s four out of every five state dollars going to priorities that are extremely important to the public.

But the state is running out of options other than a fundamental restructuring of spending. Various groups are now pushing for combined reporting, sending teacher pensions down to the counties or extending the millionaire tax. The truth is that even if all were done together, they would come nowhere close to resolving a $2 billion deficit. The state’s current dink-and-dunk strategy is working about as well for the budget as it is for the Redskins’ offense.

At some point, the state’s leaders will have to divide spending line items into two groups: “absolutely-must-do” and “would-be-nice-to-do.” The latter group will have to comprise at least 10-15% of the former group, which is the approximate size of the future deficits relative to general fund spending. The “would-be-nice-to-do” group will have to be postponed until times are better. And then any remaining gap would be fair game for a tax hike.