Massachusetts state budget reaches “point of reckoning”
Volatility and uncertainty threaten state's fiscal future in face of looming recession, according to new MassINC policy brief
[MassInc news release - Mar 19, 2008]

The Massachusetts state budget has reached a point of reckoning, as the nation's looming recession threatens to shatter Beacon Hill's ability to juggle the budget's structural imbalance and skyrocketing health care costs, according to Point of Reckoning: Two Decades of State Budget Trends, a new policy brief released today by MassINC, a nonpartisan think tank in Boston.

This brief, which analyzes two decades of state fiscal policy, reveals the volatile capital gains tax as the largest source of revenue growth in recent years. Pegged to the whims of Wall Street, capital gains tax revenues plummet during recessions, endangering the state's ability to cope with the impact of a struggling economy on revenue collections and the demand for state services.

"Given these multi-year trends on both the revenue side and the spending side, the Commonwealth now finds itself in an extremely precarious position," said Greg Torres, MassINC president. "We have gradually introduced an unsustainable level of risk and volatility to both sides of the ledger. As the current economic slowdown turns into a recession, we are moving into uncharted financial waters," he continued.

According to the policy brief, state revenues are expected to increase by $750 million to $1 billion based on the long-term performance of the economy, far short of the $1.3 billion to $1.6 billion needed to match likely spending growth. Between 2002 and 2006, capital gains tax generated most of the revenue growth that helped make up the gap between overall revenues and spending, hitting a high of $1.7 billion in 2006. However, those receipts could easily evaporate: During the last two recessions, capital gains taxes dropped by two-thirds (post-September 11th) and 75 percent (1987-1991).

"Relying on capital gains for budget growth introduces enormous risk into the policymaking process," explained Cameron Huff, author of the policy brief. "The state is already struggling with health care and other costs that exceed its ongoing revenue capacity. A major, sustained decline in capital gains receipts clearly would plunge the state's finances into crisis," he continued.

Health care spending dominates the state's on-going programs, according to the policy brief, almost doubling from 16 percent of the state's budget in 1987 to 30 percent in 2006. Practically all of this spending (90 percent) is dedicated to Medicaid, an entitlement that provides health care to the poor. The program's requirements - those who meet the income threshold are served - mean that its annual cost increases are not only large, but also unpredictable and outside the control of state administrators. The state's new universal health care law adds additional fiscal uncertainty.

While Massachusetts is similar to other states in facing these pressures, successfully dealing with them is made more challenging by the Bay State's demographic trends.

"New workers and new businesses provide revenue that insulates the effects of a budget out of balance," noted Torres. "Massachusetts will have a tougher time growing out of this problem because our cost of living and anemic job growth continue to cause out-migration from the state."

The policy brief also details a history of budget winners and losers over the past 20 years. In addition to health care programs, K-12 education has seen dramatic increases in spending in response to the state's reform movement. On the other hand, state support for higher education and local aid has been significantly cut back.

The brief outlines six points of possible reform, including considering a broadening of the state's tax structure to move away from its dependency on capital gains; developing specific criteria for withdrawals from the state's rainy-day reserve fund; and creating greater transparency of all government spending in the face of increased off-budget spending.

Key Facts:

On the spending side, health care has become the state's predominant spending priority, growing from 16 percent of the state's budget in 1987 to 30 percent in 2006. Medicaid accounts for nearly 90 percent of the state's health care spending. As an entitlement, the state is required to fund the state share in any given year or change the laws. The Massachusetts program offers more benefits than is federally mandated and also covers a broader population. Approximately half of the cost of Medicaid is paid by the federal government. Because many components of the program are not directly under the control of the state administrators (e.g. who and how many enroll and the health status of enrollees), spending can fluctuate unpredictably. Medicaid accounted for almost two-thirds of all spending growth since 1987. The state's new universal health care law adds further to the fiscal uncertainty.

About MassINC: The Massachusetts Institute for a New Commonwealth (MassINC) MassINC (The Massachusetts Institute for a New Commonwealth) is a nonpartisan, evidence-based organization. Its mission is to develop a public agenda for Massachusetts that promotes the growth and vitality of the middle class. Its governing philosophy is rooted in the ideals embodied in the American Dream: equality of opportunity, personal responsibility, and a strong commonwealth.

[News release - March 19, 2008. Contact: Emily Wood, MassINC Office: 617-224-1709, Cell: 617-869-4528, Email: ewood@massinc.org]