Budget cuts of up to $226 million could hit the state in coming months, needed to make up for a severe drop in the amount of money Montana expected to take in through taxes.
Over the last two weeks as agencies around the state have scrambled to put together proposals to reduce their budgets by up to 10 percent and Montanans heard that programs considered essential could be eliminated, many wondered how the state got into this situation.
It’s not that the state’s economy is tanking; in fact there are more Montanans working than ever before.
“We’re not talking about a decline in revenue, we’re not talking about the economy shrinking and contracting and revenues falling off. What we’re talking about is how fast the growth rate is,” Dan Villa, the governor’s budget director, said last week.
What happened is an error in predicting how much money the state would bring in through taxes, mainly by overestimating income tax receipts.
The amount the state expects to take in is set by what’s called House Joint Resolution 2. Lawmakers receive several revenue estimates through the four-month legislative session, which runs January to April, and vote on the estimate they think is best.
For the fiscal year that ended in June, the estimate was 3.4 percent higher than actual collections. Going forward, some predictions show the state could bring in $131.3 million less than expected in fiscal year 2018 and $144.8 million less than expected in fiscal year 2018, according to estimates from the governor's office.
If budget cuts aren’t made, the state will be $35 million in the hole by the end of this fiscal year, according to estimates from the governor's office. That’s why Gov. Steve Bullock has asked state agencies to propose 10 percent budget cuts that he’ll spend the coming weeks sifting through.
State law allows Bullock to make cuts of up to 10 percent when his budget director determines actual or projected collections from taxes will be insufficient to maintain enough cash in the bank, also called an ending fund balance. Having $143 million in the bank at the end of fiscal year 2019 is what the state is aiming for.
At the end of the last fiscal year, which ended in June, the ending fund balance was $47.5 million. That’s not enough to support state operations, putting Montana in a position where it will likely have to borrow money between agencies or the Board of Investments, which isn't common, to pay bills.
Bullock campaigned on a strong ending fund balance and said he's worked to shrink government. While there are about 175 fewer full-time equivalent employees across state government than in 2012, spending has increased across most state agencies.
In the Department of Public Health and Human Services, for example, the amount of general fund money they get has grown $115 million over the last five years, mostly attributable to growth in the number of people who get services. Other agency budgets have grown because of issues like managing sage grouse, increased funding the Legislature approved for schools and new programs such as drug courts.
“We’ve hit (the point) where we have to act,” Villa said.
Individual income taxes
What the state already knows is that for fiscal year 2017, which ended June 30, general fund revenues came in $75.5 million lower than expected. Of that, $70.3 million is individual income taxes, 5.7 percent lower than estimates the Legislature approved.
When income tax payments are off, that’s a big deal to the revenue picture. Income taxes paid by individuals make up 55 percent of the state’s seven largest general fund revenue streams. The next largest source is property taxes at 12 percent, then corporate taxes at 6 percent. Those sources were also down, property taxes just $800,000 less than expected but corporation taxes off by $6 million, also lower than projected.
The problem isn’t so much withholding on wage incomes. That actually was up 4.1 percent, or $37.3 million, over last year. But the other types of tax payments paid by individuals on non-wage income like capital gains are down significantly. Mineral royalties, another type of that income, are down 22.5 percent from last year.
Non-wage payments are down $21.9 million from last year.
“At this point we’re still trying to surmise what happened,” said Stephanie Morrison, lead fiscal analyst in the Legislative Fiscal Division that creates the revenue estimates lawmakers can adopt. “In looking at the payment data in this way, it gives me a clue maybe there’s something going on with non-wage income.”
Audit, penalty and interest and amended income also came in 21.2 percent lower than last year, for an $11 million drop.
Morrison cited an article from the Rockefeller Institute on Government that showed states across the nation also struggled to accurately predict revenues this year.
Morrison pointed to the election of Republican Donald Trump as president, who joined a Republican-dominated Congress, as one reason for why payments came in lower than expected. Taxpayers who think a conservative-dominated federal government could pass a tax plan that lowers the rate they pay on non-wage taxes could push back that income until action is taken.
“There is some indication taxpayers were, especially taxpayers with non-wage income, were looking to minimize their tax in calendar (year 2016) in hopes of lower federal tax rates in ‘17 or later years,” Morrison said. “The idea is maybe taxpayers are hoping for lower tax rates because of the all-Republican administration.”
That’s something wage-income earners can’t do. “You get your paycheck when you get your paycheck and you pay your taxes,” Morrison said.
Rep. Becky Beard, R-Elliston, asked Thursday what Morrison called “the multi-million dollar question” — if these non-wage tax payments were delayed, is it possible they’ll flood in in coming years?
Morrison said it’s “certainly possible.”
“Taxpayers aren’t going to delay forever, but they may still be waiting to see what kind of action the federal government is going to take. If change does not happen at the federal level, taxpayers may just get tired. They may not be able to hold off forever. We may see a real bump if there is some sort of change at the federal level.”
Morrison said her theory can’t be proven until she gets the full details about 2016 tax returns in November. “We’re still waiting for taxpayer data. We’ll know more in November. We’ll understand to what extent … taxpayers are trying to delay movable types of income in hopes of lower federal rates.”
But Villa disagrees with her assumptions.
“This phenomenon started before the election,” he said, tracing it back to 2015. “We can’t say people are waiting for a tax policy change that may or may not be realized.”
Villa said instead what's happening is the economy in Montana is fundamentally different than it was over the last two decades. Years ago when he started working for the governor’s office, timber was one of the largest sectors of state's economy. Now the largest growth sector is health care.
“Timber mills paid property taxes, hospitals do not,” Villa said. “That is a fundamental shift in what our economy looks like.”
He also said substantial changes in federal tax policy from 2005 to 2017, such as the PATH Act, had real impacts on state revenues. He also pointed to lower business equipment taxes approved by the Legislature.
“What we’re facing now is something we will have to wrestle with over the long term,” he said.
Whatever the cause, lower-than-expected tax revenue collection couldn’t have hit at a worse time for Montana — a summer when more than a million acres had burned before rain and snow started falling last week.
Most recent estimates put the cost of fighting fires, including funding from the Federal Emergency Management Agency, at $56.7 million to the state. Amy Carlson, legislative fiscal analyst and director of the Legislative Fiscal Division, estimated total costs could run $70.3 million to $90.3 million for this summer alone.
Already enacted cuts that reduced the state fire fund to $32.3 million leave the state about $25 million to $45 million short of being able to pay the bill for fighting fires, after tapping the governor’s emergency fund of $13 million. Estimating a normal year for fires next summer and costs of $22.5 million, that leaves the state in a hole of from $47.5 million to $67.5 million over the two-year budget period.
Villa said the state should “basically hope for no natural disasters.”
“We have absolutely no ability to respond to any of those natural disasters,” he said.
What happens next?
Carlson presented lawmakers last week with a range of scenarios for what could happen with the revenue, ranging from reality rebounding to match estimates over the next two years to predicting money coming into the state more in line with what governor’s office originally proposed at the start of the year, an amount lower than what the Legislature adopted as their estimate.
To make up for existing losses, individual income tax growth would have to be 13.1 percent in the next year.
“It’s not impossible, certainly not, but it’s probably not something you want to bank on,” Carlson said.
Carlson said that even though the revenue estimates created by her division and adopted by the Legislature are off, they shouldn’t be tossed aside entirely.
“While I’m not advocating (House Joint Resolution 2) is the number anybody should use right now, what I’m also advocating is you may not want to dismiss it entirely,” she said, noting that estimates two years ago were low and actual revenue came in much higher. “I’m just saying it’s the world we live in and it does have a lot of variability associated with it.”
Villa said that while the state has had growth years of 10 percent before, he’s not sure that’s possible now.
“The conditions that correlate to 10 percent revenue growth are not present right now,” he said.
Oil isn’t booming like it was a few years ago and employment numbers are already high and don’t have much room to improve, so Villa can’t see where the growth would come from.
“The conditions that correlate to 10 percent revenue growth are not present right now."
Another hypothesis Morrison floated, which gels more with Villa’s assumptions, is that national economic data were just wrong.
“They’re always revised backward, up to sometimes five years backward, and one of the possibilities outlined in the Rockefeller report was that perhaps the underlying national economy was not as strong as the current estimate of the economic indicators would have suggested.”
What Villa and Carlson agree on is the state is not in a good position.
“I don’t think the gravity of the situation can be dismissed,” Villa said.
“One million people are waiting on us. There are 250,000 people right now who need answers on Medicaid services, there are 147,000 kids wanting to know what’s going to happen to their schools, there’s 40,000 in our university systems who need to know what’s going to happen to their tuition. And we need to figure it out, and we need to figure it out sooner rather than later."