Committee Hears Recommendations On Reducing Revenue Volatility

State officials have some ideas about how to insulate the State budget from volatile revenue streams – and those ideas will likely materialize in the form of legislation this session.

On Thursday, January 12 in the Senate Budget and Taxation Committee, the Department of Legislative Services (DLS) reported on revenue volatility, drawing largely from the Report on Revenue Volatility and Approaches to Reduce Risk to the State Budget, issued last November by DLS, the Department of Budget and Management (DBM), and the Comptroller of Maryland in response to a requirement set by the General Assembly last session. The requirement asked the three agencies to “examine the volatility in Maryland’s revenue structure and recommend an approach to reducing volatility.”

Income and sales taxes account for 80 percent of general fund revenue. Gross receipts for income tax can be broken down into two categories – payroll withholding and nonwithholding. Nonwithholding receipts account for about 22 percent of income tax gross receipts, on average. DLS staff members showed committee members the graph, Inflation-adjusted Year-over-year Percent Change of income and sales tax gross receipts from Fiscal 1987-2016, pointing out significantly increased volatility in nonwithholding gross receipts following the Great Recession.

Capital gains make up about 25 percent of nonwage income.  DLS pointed out a table of Maryland Taxable Capital Gains Income which shows how the top 0.1 percent of Maryland income earners – about 2,500 returns – contributed approximately half of the state’s total capital gains income. This contributes to the revenue source’s volatility.

The working group responsible for the Revenue Volatility report looked into how other states take efforts to help insulate their budgets from the volatility of revenues. In Delaware, the general fund budget is limited to 98% of available revenues. A few states apply a limit to the revenue estimate itself. In Michigan and Missouri, revenues are limited to a certain percentage of the prior year’s state personal income. While not altering the revenue forecast itself, California and Massachusetts have sweeper provisions in statute tied to tax revenue from capital gains income. California recently adopted a system that also sets aside excess revenue from capital gains income in a reserve fund.

Virginia has taken a different approach, focusing on nonwithholding income tax revenue rather than capital gains specifically. Rather than a sweeper provision, Virginia puts a cap on their estimate of nonwithholding income tax revenues, referred to as a collar.

The point of the collar is to dampen/lower the revenue estimate, potentially increasing the likelihood that the revenue estimate will be exceeded ( or miss will be smaller) and at the same time, lowering allowable (ongoing) spending. This helps reduce the potential or magnitude of budgetary shortfalls.

DLS analysts told the Senate Budget and Taxation Committee that they were “enamored with the Virginia model.” The working group recommended that Maryland limit estimates of nonwithholding income tax revenues at a pre-established cap, or collar. To estimate the cap, the State should determine the average share on nonwithholding revenues to total General Fund revenues – approximately 15 percent, according to the average over the last 10 years. DLS pointed to its Impact of Collar on Closeout General Fund Revenues, Fiscal 2011-2016, to show how such a cap, or collar, would have prevented revenues falling below estimates over the past six years.

Any extra revenue that comes in over and above the estimates should be targeted for “fiscally responsible activities”: expanding PAYGO capital or paying for unfunded liabilities. This would help promote long term structural balance and soften any negative impact of future recessions.

Finally, the work group recommended increasing the balance in the Rainy Day Fund to 10 percent of General Fund revenues. The State must maintain a minimum fund balance at 5 percent to maintain its AAA bond rating, DLS staff members testified. At 10 percent, the State could draw from the extra cushion during tougher times.

Answering questions from committee members, DLS testified that in upcoming weeks, the Department would be presenting analysis and recommendations for addressing risks of Affordable Care Act and Federal workforce changes coming out of the new presidential administration. They also suggested that legislation be passed to implement the above-mentioned recommendations – and stated that a bill was already being drafted for introduction.

Find the Report on Revenue Volatility and Approaches to Reduce Risk to the State Budget here.

The committee hearing can be viewed here.