Wisconsin Taxpayer Magazine Unwrapping the Governor's Budget Proposal

March 2017  •  Vol. 85 No. 2
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  • Summary
  • Press Release
  • The governor's new 2017-19 state budget proposes increased spending for K-12 schools, the University of Wisconsin System, and local roads. The $76.1 billion spending package from all funds also includes income and property tax cuts, along with a sales tax holiday. But the governor pays for $371 million of spending by drawing down surpluses, raising deficit concerns should the economy slow.

  • Todd A. Berry or David Callender

    Proposed 2017-19 State Budget Leaves Lawmakers with Choice on Surplus

    Will They Spend Or Save?

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    “To every thing there is a season . . . a time to plant, and a time to pluck up that which is planted.”
    And so it is with Wisconsin’s economy and state finances. To paraphrase the Old Testament verse: there is a time for boom and a time for bust, a time to spend and a time to save.
    If Gov. Scott Walker’s (R) 2011-13 budget, his first, was an austerity budget in a time of economic uncertainty, the 2017-19 edition is different. It relies on an unplanned surplus and anticipated new revenues to fund noticeable spending increases, particularly in the areas of education and health.
    This is good news for program beneficiaries who stand to gain from the increases. There is an unanswered question, however: Will the economy and state tax collections continue to grow as forecast? If not, the proposed budget leaves little in reserve with which to stave off deficit and associated spending cuts or tax hikes.
    All-Funds Overview
    To understand the budget recently proposed by the governor, it helps to understand its basic structure and vocabulary. The term “state budget” can be used loosely to refer to one of two related, biennial tax-and-spending plans.
    The larger of the two, the “all-funds” budget, includes revenues and spending from all sources: federal, program revenues, segregated fees, and general purpose revenues.
    The 2017-19 budget proposes to spend a total of $76.1 billion beginning July 1, an increase of 1.0% in 2017-18 and 3.2% in 2018-19.
    At $22.0 billion, federal revenues account for nearly a third of the all-funds budget. Federal aid plays a significant role in medical assistance (Medicaid), transportation, and the U.W. System. (see Figure 1, page 2).
    Program revenues are primarily derived from user fees, such as state parks stickers, hunting and fishing licenses, and university tuition. Some may be deposited in the general fund, while others are reserved for specific purposes. They account for $11.9 billion, about 16% of the all-funds budget.
    Segregated revenues are deposited in specific accounts for a particular purpose, such as gas tax collections and vehicle registration fees deposited in the transportation fund that may be used only for related programs. At $7.6 billion, segregated revenues account for 10% of all-funds spending.
    General Fund Overview
    The remainder of the all-funds budget is comprised of general purpose revenue. When state officials or the media mention the state budget, they are usually referring to the general fund budget.
    Major budget debates almost always center on general fund revenues or programs, whether the issue is income tax policy, school aid payments, property tax relief, or prisons.
    GPR Revenues. General purpose revenues (GPR) include almost all state taxes, plus departmental revenues and tribal gaming payments. In 2017-19, they total a proposed $33.5 billion.
    From only GPR tax sources, total revenues are $32.5 billion over the next two years (see Figure 2, page 3). The individual income tax ($16.64 billion) dominates collections, accounting for over half the total; sales taxes ($10.96 billion) represent another third; and corporate income taxes ($1.93 billion) are nearly 6% of the total. Together, these three major taxes comprise almost 91% of collections.
    More than any other factor, estimating tax revenues makes state budgeting uncertain. Anticipated collections rise and fall with the economy. After proposed tax cuts, their annual growth for the biennium is expected to average about 3.4%, slightly higher than late-2016 forecast of about 3.0%.
    GPR Spending. The governor requests $34.5 billion in gross GPR expenditures for 2017-19. After lapses, or unspent appropriations, proposed net spending would be $16.6 billion next year and $17.3 billion the year after, compared to $15.9 billion this year. Year-to-year increases are 4.5% for 2017-18 and 3.7% for 2018-19. Total spending in 2019 would be 8.3% higher than in 2017.
    Putting It Together. The overall general fund budget is recapped in Table 1 (page 3). It shows GPR revenues and expenditures as estimated for 2016-17 and as requested in 2017-18 and 2018-19.
    The 2018 fiscal year begins with a projected surplus of $453 million. New revenues from various sources total $16.49 billion. Combined, the two make $16.95 billion available for potential expenditures.
    After various adjustments, the governor is requesting net spending of $16.65 billion, leaving a gross balance, or ending surplus, of $297.8 million.
    Similar figures for 2019 are shown in the column to the right. The carryover surplus is added to new revenues, yielding a total of $17.34 billion available for spending. Subtracting net appropriations of $17.26 billion leaves a gross ending balance of $81.7 million, an issue to be discussed later. In other words, the opening surplus would be spent down by $371 million.
    gpr budget detail
    Purpose vs. Programs
    There are two ways to look at state budget spending in greater detail: by purpose and by program. State government has certain functions that it carries out through specific programs.
    Spending by Purpose. Most taxpayers would be surprised to learn that, by category, Wisconsin state government’s leading purpose is providing financial assistance to local governments. About half the GPR budget is devoted to local assistance (see Figure 3), primarily school aids and shared revenues to municipalities and counties.
    Aid to individuals accounts for about another fourth of GPR spending. Included in this category are various human service programs, such as food stamps (now called Food Share), Medicaid, and W-2 (or Wisconsin Works).
    State operations, such as the legislature, governor’s office, courts, and administration, comprise almost 11% of GPR spending by purpose.
    Finally, the Department of Corrections, which operates state prisons and probation and parole programs, and the University of Wisconsin System, which provides higher education statewide, each represent more than 6% of GPR spending.
    Spending by Program. While spending by purpose broadly explains how the state spends its money, examining individual programs better describes where expenditures actually go.
    Six programs comprise nearly 80% of general fund spending: K-12 school aids, 35%; Medicaid, 18%; state property tax credits, 7%; corrections, 6%, the U.W. System, 6%, and shared revenue, 5%.
    These programs, plus the segregated transportation fund, will figure prominently in the 2017 budget debate and are examined in greater detail through the remainder of this report.
    K-12 Education
    The state spends more money on K-12 education than any other program, consistently making school funding a subject of major debate during budget deliberations. Total K-12 spending from all revenue sources tops $11 billion and is the largest state-local “program.”
    In 2017, the state will spend $5.4 billion on school aid. Most aid is distributed through the no-strings-attached general aid formula. A variety of activity-specific programs are lumped under categorical aid.
    The governor is proposing aid increases of $200 million (3.7%) in 2018 and an additional $249 million (4.4%) in 2019. Most of the new money would be added to per pupil aid, a categorical program that helps fund schools outside state-imposed revenue limits. In the past, increases came mainly in general aid that, along with property taxes, were limited by state-imposed revenue caps.
    Per Student Increases
    Specifically, the governor is requesting increases of $200 and $204 per student, respectively, over the next two years. Though categorical, these amounts can be spent on general programs. This is a departure from past actions in two important ways.
    First, the $200 per student bump next year would be the largest since similar increases in 2010 and 2011. The $204 per student increase in 2019 would be the largest since 2009 (See Figure 4).
    Second, per student increases have traditionally come through revenue limits, that have been in place since 1994 (blue bars in chart). Revenue limits restrict the combination of state general aid and school property taxes and affect more than 80% of school revenues.
    That began to change in 2013 when lawmakers allowed a $50 per student increase in revenue limits and another $50 per student in a new per pupil categorical aid (orange bars in chart) that, again, were outside revenue limits. In 2014 and 2015, lawmakers continued this dual approach, allowing revenue limits to rise by $75 per student in each year, and adding another $25 per student in 2014 and $75 per student in 2015 to per pupil aid.
    Since revenue limits link school property taxes and general school aid, small increases in the revenue limits allowed the state to keep school levy increases low. Because the increases in per pupil aid, though modest, are not covered by revenue limits, they give schools more spending authority.
    The 2015-17 budget made the shift complete. It allowed no increase in K-12 revenue limits, but provided for a $100 increase in per pupil aid in 2017. Per pupil aids were unchanged in 2016.
    The governor’s proposal continues the 2015-17 approach, but with more money. There is no increase in revenue limits. But, as noted, per pupil aid outside the limits would rise $200 in 2018 to $450 per student and increase another $204 per student in 2019 to $654 per student.
    General Aids
    The governor is proposing no increase in general school aids in 2017-18 and a $72.8 million increase in 2018-19. However, revenue limits are unchanged since increased school spending would be funded with additional per pupil aids. Thus, changes (or lack thereof) to general aids would not generally benefit school districts. Rather, the governor notes that the 2019 increase is designed to lower property taxes.
    Categorical Aids
    Much of the remainder of the increased K-12 spending is in categorical aids targeted primarily to rural schools. Districts eligible for sparsity aid (fewer than 745 students total and 10 students per square mile) would see their payments double to $400 per student. A new $100 per student payment would be paid to sparse districts with 746 to 1,000 students.
    Districts eligible for high-cost transportation aid would receive 100% reimbursement for costs, rather than partial reimbursement. This would cost $25.4 million over the two years.
    The University of Wisconsin System receives more than $1 billion annually in state GPR as part of its $6.1 billion all-funds budget. Its two main sources of state-derived revenue—GPR and in-state tuition—have been constrained in recent budgets. The state froze in-state, undergraduate tuition for the past five years and cut $250 million GPR from the System’s 2015-17 budget.
    In 2017-19, the governor would increase U.W. all-funds spending by $236 million. Included in that figure is an additional $77.2 million GPR and $52.4 million in nonresident and graduate tuition increases.
    The governor’s budget also would provide $35 million to offset a 5% in-state undergraduate tuition cut in 2018-19, plus another $42.5 million over the next two years to be allocated according to several performance measures, such as affordability and attainability, work readiness, student success in the state workforce, efficiency, and other criteria set by the U.W. Board of Regents.
    The governor also proposes requiring the U.W. to:
    Increase the number of programs offered under the Flexible Option expanded-hours program by at least 50% over the next two years;
    “Establish pathways” to a three-year degree for 10% of programs by 2018 and for 60% by mid-2020;
    Create a system-wide policy for monitoring and reporting teaching workloads and rewarding those who teach more than a standard academic load;
    “Codify the System’s commitment to academic freedom” and review and revise related policies; and
    Implement an option for students to opt out of allocable fees for student organizations and “select campus activities.”
    Medical Assistance
    Medical assistance, or Medicaid, is a federal-state program that provides health care to the poor, elderly, and disabled. In the past decade, it has been the fastest-growing major state program. Cost increases are related to increased enrollment and to overall health care inflation.
    Slowing Medicaid costs is one of the elements responsible for the projected budget “surplus” in 2017. The Department of Health Services projects it will return $137 million to the general fund in 2017, partly due to lower caseload, resulting from lower unemployment.
    The budget projects little caseload change in categories for parents, children, and caretakers, resulting in a cost-to-continue increase of $279 million GPR over the next two years. Total all-funds spending for the biennium would be $20.1 billion, with the state providing $6.1 billion GPR.
    Included in the Medicaid budget are a $70 million (2% annual) increase in nursing home provider payments and a $19 million (2% annual) rise in personal care provider payments.
    other major GPR programs
    The budget would make changes in other major programs, as detailed below.
    Unlike the U.W. System and Medicaid, the state’s prison system is funded almost entirely with GPR, which will increase $57.1 million over the next two years, to $1.1 billion (or 5.7%).
    The budget would eliminate the separate Parole Commission in 2018 and replace it with an office within the Department of Corrections. Since the “truth in sentencing” law eliminated parole in 1999, the number of inmates eligible for parole has declined steadily.
    Shared Revenue
    Shared revenue, officially known as county and municipal aids, are unrestricted payments the state makes to local governments. These aids will remain nearly unchanged over the next two years, at $692.1 million in 2018 and $690.2 million in 2019.
    On the revenue side, the budget would make several changes to state income and sales taxes that will affect future general fund tax collections.
    Income Taxes
    The budget would reduce the two lowest marginal income tax rates: from 4.0% to 3.9% for the lowest bracket (in 2016, individuals with taxable incomes below $11,120 and married couples filing jointly below $14,820) and from 5.84% to 5.74% for the second-lowest (individuals below $22,230 and married couples below $29,640). The budget would also expand the latter bracket with incomes up to $37,450. The budget does not alter rates on higher incomes. The governor estimates these changes would reduce collections by $104 million in 2018 and $99 million in 2019.
    Earned Income and Homestead Tax Credits
    The budget would make changes to tax credits aimed at low-income and elderly taxpayers.
    It would increase the Earned Income Tax Credit (EITC) for low-income workers with one child from 4 % of the federal EITC to 11%.
    The budget would also restrict the Homestead Tax Credit that now benefits all low-income homeowners. The governor proposes adjusting the credit by inflation (“indexing”) for those over 62 or who are disabled.
    For taxpayers who are not disabled or over 62, the budget would end separate calculation of the Homestead Tax Credit, instead tying it to earned income, similar to the EITC. Taxpayers with business and investment losses above $15,000 in a year would be prohibited from claiming the credit, except for those with small family farms.
    Sales Tax Holiday
    The budget would create a 10-day sales tax “holiday” for school supplies, clothing, and computers in both August 2017 and 2018. This is estimated to reduce state revenues by $11 million annually.
    Property taxes
    The property tax is the largest single tax in Wisconsin, mainly funding schools, counties, and municipalities. The proposed budget makes several changes to property taxes, including more general school aid passed through to taxpayers (see page 4).
    Forestry Tax: The governor proposes eliminating the state forestry tax and funding the program instead with state GPR. The funding shift would require $88.8 million in 2018 and $91.7 million in 2019.
    Credits: The state has three credits that directly reduce property taxes: the lottery credit, which is funded with a portion of the proceeds from the state lottery; the school levy tax credit; and the first dollar credit. The governor seeks to increase the school tax levy credit by $87 million this December but would pay for it in 2018-19. This shifts the cost of the tax credit in 2018-19 biennium into 2019-21.
    As in 2015-17, transportation is one of the most contentious issues heading into work on the 2017-19 budget. Transportation revenues have increased modestly in recent years, while the cost of state highway projects has grown from original estimates. State road aids to local governments have increased little over the past decade, leading to a decline in local road quality.
    The governor’s proposed budget addresses some of these issues but not others. He requests no increases in major taxes and fees.
    Overall transportation spending would increase 8.0% in the first year and decline 1.9% in the second, reaching $3.21 billion (see Table 2). The budget proposes $421.7 million of new spending over the two years.
    Spending on state highways comprises the largest transportation expenditure category. Over the next two years, the governor proposes to spend an additional $225 million in this area, mostly in the first year of the biennium. State highway spending is budgeted to rise from $1.31 billion in 2017 to $1.47 billion in 2018, and then decline to $1.37 billion in 2019.
    Following years of little change to local road aids, the governor wants to increase three major aids—general transportation aid, local roads improvement program (LRIP), and local bridge improvement assistance. General transportation aids would increase from $419.7 million in 2017 to $436.5 million in 2018 and to $459.7 million in 2019, a 9.5% increase over two years. LRIP expenditures would rise from $28.0 million in 2017 to $35.0 million in 2018 and 2019. Local bridge aids would rise from $22.9 million in 2017 to $35.3 million in 2019, a 54% jump.
    The combined two-year increase in the three programs is 12.6%. However, spending on all other local assistance declines 3.8% over the two years.
    Among the major spending categories listed in Table 2, debt service has the largest percentage increase over the biennium, 15.8%. Debt service paid for with transportation fund revenues would rise from an estimated 20.2% in 2017 to 23.6% in 2019.
    future risks?
    From the outset, the state’s 2017-19 budget was characterized as different from many others in the post-recession era. Cost savings and upward revision of tax estimates combined to boost the expected 2016-17 general fund surplus, while also providing additional revenue in 2017-19.
    The result was proposals for popular expenditure increases. However, because $371 million of those were funded by spending down the one-time surplus, some less welcome issues also emerge. Among the most serious are those relating to ending balances, the realization of estimated revenues, and “structural imbalances” between revenues and expenditures in both of the next two years.
    Ending Balance
    Due to the drawdown of surplus, the general fund would end the next biennium with a closing balance of $81.7 million. This is a large amount to a small business or a school district, but, for the state, it represents less than 0.5% of net expenditures in 2018-19, or the equivalent of less than two days of state spending.
    How adequate that percentage is can be evaluated in several ways. First, it would be the smallest percentage since 2006 (0.4%). Second, it would be less than Wisconsin’s 2008 surplus (1%), when the state entered the Great Recession with one of the smallest reserves in the country, second only to Arkansas.
    Third, state budget experts prefer reserves equal to 5% or more of spending, with 2% being a minimum. The reason is simple: Economic and tax forecasters often err, particularly two or more years into the future. A budget cushion of at least 2% is sufficient to cover most routine errors.
    Revenue Estimates
    Projecting state tax collections is not easy because economic forecasting is not easy. That is particularly true when the economy is changing course, either accelerating out of a downturn or slowing into one.
    Wisconsin’s most significant forecasting errors—and most serious budget crises—have come during these times of economic uncertainty. The current U.S. recovery is already one of the longest since World War II, so change in the economy’s direction will come. The only question is when.
    Even if the expansion continues for several years, Wisconsin’s state tax revenues—and budget—are vulnerable to almost any kind of slowdown. As mentioned earlier, average annual tax growth for next two years is projected at 3.4%. This is about a half-point higher than last November but more than a half-point lower than what was experienced in four of the five years after the last recession.
    A half-point revenue swing seems trivial, but with GPR tax collections at about $16.5 billion per year, a shift in revenue growth of this magnitude translates into about $80 million, an amount roughly equal to the surplus projected for mid-2019 when the next biennium ends.
    Structural Imbalance
    Fiscal analysts not only worry about the short-term likelihood of deficit but also about how state finances are positioned for the long term.
    Drawing heavily on this year’s $453 million surplus to pay for ongoing expenditures results in the 2017-19 budget having a “structural imbalance” in both 2018 and 2019.
    This can be seen by returning to the final line of Table 1 (page 3), where ongoing revenues and expenditures for 2018 and 2019 are compared. In the first year, the difference between revenues and spending is negative (-$155.2 million); the same is true in the second year (-$216.1 million).
    The negative amount, or structural imbalance, presents a potential problem when the state starts preparing its 2019-21 budget, for it would be spending $216.1 million more than revenues. And its carryover surplus ($81.7 million) would be too small to cover the difference.
    In Case of Emergency
    It is comforting to know that the state maintains a “rainy day fund” separate from its ending surplus. Its official name is the budget stabilization fund. At the end of 2016, the fund’s balance was $281.2 million.
    To his credit, the governor proposes adding $20 million to the budget stabilization fund next year. However, this sum is more than offset by the
    $371 million drawdown of state surplus. It is also important to remember that rainy day monies are not available to routinely balance budgets but only to provide fiscal help in times of serious economic downturn. o


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