1. Presentation for Thomas Jefferson Institute’s 2007 Innovations in Government Conference Jody M. Wagner Secretary of Finance Commonwealth of Virginia 1111 E. Broad Street, 3 rd Floor Richmond, Virginia 23219 Phone: (804) 786-1148 Email: jody.wagner@governor.virginia.govjody.wagner@governor.virginia.gov December 17, 2007 An Overview Of Virginia’s Budget Issues

2. 2 2008-2010 Budget: General Fund vs. Nongeneral Fund Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget “Nongeneral Fund Revenues” do not include bond proceeds. Appropriations – $76.4 Billion NGF 52.7% GF 47.3% $36.1 billion General Fund $40.3 billion Nongeneral Fund

3. 3 FY 2007 o In FY07, individual nonwithholding, corporate income, and recordation tax payments accounted for $4.2 billion of GF Revenues, up significantly from FY02’s $2.0 billion. o In FY02, 83% of GF Revenues were from withholding and sales tax collections. In FY07 75% were from those sources. FY 2002 Components of General Fund Revenues Note: The percentages below each source reflect the percent share of total general fund revenues. The sum of the components exceeds 100 due to the exclusion of individual refunds and other revenue sources.

4. 4 Withholding and Nonwithholding Fiscal Year Percent Change

5. 5 o Net individual income taxes fell $111.8 million below forecast in Fiscal Year 2007. o Both withholding and nonwithholding receipts grew, but much of the gains were given back in refunds. o When the Fiscal Year 2007 shortfall was added to the reduced revenue forecast for Fiscal Year 2008, the total initial estimate of the shortfall grew to $641 million for the current biennium. o Today we announced that as a result of administrative actions and a revised revenue forecast, the appropriation or budget shortfall is $522 million. Virginia Completed Fiscal Year 2007 $234 Million Shy of the Forecast

6. 6 The FY07 Forecast Variance was In Line With the Average Historical Forecast Variance…  The 20-year average forecast variance is  1.6 percent. Annual Revenue Surplus/Shortage Forecast Error on the Revenue Estimate (millions of dollars)

7. 7 Revenue Growth is Slowing Across the Nation & State Numerous states are experiencing revenue problems  Florida is expected to face a $1.5 billion shortfall due to the weakening housing market. (Florida alone collected $2 billion in real estate taxes in 2004 – 30% of the total collected by all states.)  Maryland and Michigan each face $1.7 billion deficits for FY08. Both are cutting spending and raising various taxes.  Arizona is facing a $600 million shortfall in its current biennial budget.  California’s operating deficit is now expected to be more than $8.6 billion – 40% higher than the $6.1 billion gap projected as recently as August. Virginia localities also are expected to face revenue challenges  Fairfax County receives more than 60% of general fund revenues from real estate taxes. Residential real estate assessments declined for the first time since 1998 by -0.33 percent.  Prince William County faces declining property tax revenues, resulting in a budget shortfall of $8.6 million in FY08 and $51 million in FY09.  Virginia Beach is facing a $30 million budget shortfall in FY09.

8. 8 Withholding and Corporate Fiscal Year Percent Change

9. 9 Corporate Income Tax Receipts Were Slightly Weaker Than Expected in FY07, Finishing $21.8 Million Below Forecast…  Corporate income tax collections increased 1.4 percent in FY07, down substantially from the 32 percent annual increase averaged over the previous four fiscal years. Growth in Net Corporate Income Tax Receipts, FY82-07 Percent Growth Over the Prior Year

10. 10 The Share of Corporate Income Tax Receipts Attributable to Housing Declined Significantly Between FY06 and FY07…  The top 200 corporate payers represent about 53% of total gross payments.  Housing is defined as mortgage companies, home builders, and real estate-related companies. Fiscal Year 2006 Fiscal Year 2007 Defense Housing Trade Other Corporate Income Tax Receipts From Large Companies Final and Estimated Payments in April-June By Industry Percent Share of Total $232 million $191 million

11. 11 Note: Recordation growth rate is adjusted to remove the rate increase. Withholding and Recordation Fiscal Year Percent Change

12. 12 Total General Fund Revenues Have Become Increasingly Volatile…  The increased significance of individual nonwithholding, corporate income, and recordation tax have introduced additional variability into collections. Taken together, the three most volatile revenue sources represented 28 percent of total revenues in FY07 compared with the historical average of 21 percent. Volatility in Total Revenues, FY91-07 Percent Growth Over the Prior Year

13. December Revenue Forecast

14. 14 The December Forecast Is Essentially Unchanged From The August Interim Revenue Forecast… Summary of the December 2007 Revenue Forecast (millions of dollars)

15. 15 The December Forecast Is Essentially Unchanged From The August Interim Revenue Forecast (continued)… Summary of the December 2007 Revenue Forecast (millions of dollars) Notes: a)Adjusted for the Estate Tax repeal, underlying growth is 3.6% for fiscal year 2008. b)Adjusted for the Estate Tax repeal and HB 3202 (Transportation Plan), underlying growth is 5.2% for fiscal year 2009.

16. 16 The December Revenue Forecast Reflects An Economy That Continues To Expand Over The Forecast Horizon…  Economic-based revenue growth is expected to improve over the next biennium. Total General Fund Revenues (annual percent change)

17. 17 Tax Policy Changes That Reduce Or Reallocate General Fund Revenues Are Affecting Revenue Resources…  Tax policy changes remove $724.3 million from General Fund Revenue in the 2008-2010 biennial budget. Tax Policy Changes Affecting General Fund Revenues (millions of dollars)

18. 18 Year-to-date Revenue Collections Through November Are Running Very Close To The December Forecast… Summary of Fiscal Year 2008 Revenue Collections July through November (a) Adjusted for nongeneral funds interest earnings for October and November that will be transferred in January. Not adjusted for the transfer, all other revenue growth is 11.7 percent and total general fund revenue growth is 3.6 percent.

19. Key Risks to the Outlook

20. 20 The National And Virginia Economies Face Significant Risks…  There are downside risks that members of the Governor’s Advisory Board of Economists (GABE) and Governor’s Advisory Council on Revenue Estimates (GACRE) highlighted: Housing Market – not expected to recover until early calendar year 2009 Energy Prices – oil prices over $90 per barrel could stall the economy Federal Government Spending – future spending priorities unknown Dollars Per Barrel Price of West Texas Intermediate Crude Seasonally-adjusted 3-month moving average 20002001200220032004200520062007

21. 21 One Key Risk To Economic Growth Is From The Slowdown In The Housing Market…  Recent data reveal a significant slowdown in housing- related economic activity. The seasonally-adjusted, three-month moving average of home sales fell 22% in October. Pending home sales in Northern Virginia were down 18%.  Sales volume in Northern Virginia is 56% below the October 2004 level. The average sale price declined 2.8% in October, the third consecutive monthly year-over-year decline.  The average sale price has declined in 4 out of the last 6 months. Over the last 10 years, it has declined in only 8 months.

22. 22 Pending Home Sales, A Leading Indicator Of Future Closings, Illustrate The Weakness In Housing…

23. 23 The Risk From The Slowdown In The Housing Market Is That It Could Spread To The Overall Economy…  The general slowdown in housing and the subprime mortgage meltdown broaden risks to overall economic growth. Tighter credit requirements for consumers and businesses. Negatively impacts consumer spending. Weakens related sectors of the economy.

24. 24 Other Key Risks For The Fiscal Year 2008-10 Forecast…  Other factors will influence economic and revenue growth: Stock market volatility Defense and federal procurement spending International instability S&P 500 Index – Calendar Year 2007

25. 25 The December Global Insight National Economic Outlook Is Signaling Caution…  The latest monthly forecast put probability of recession at 40%.  The October probability was 30%.  A recession would delay the recovery well into fiscal year 2009.  Moody’s Economy.com puts the probability of recession at 48%.

26. How the General Fund Revenue is Appropriated in the 2008-2010 Biennium

27. 27 Where the Money Goes 2008-2010 (General Fund Operating) = $35.1 Billion  80.8% of state general fund revenues are for education, public safety, and health programs. “Other” includes legislative and judicial branches, technology, natural resources, commerce and trade, independent agencies, and non-state agencies. “General Government” category includes administration, finance, executive offices, and central appropriations. “Other Education” includes Education Secretariat and Museums. Excludes Capital Outlay. Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget Education $16,874.4 46.7%

28. 28 Almost One-half of the General Fund Operating Budget Goes to Localities Source: Governor Kaine’s Proposed 2008-2010 Biennial Budget

29. Proposed Budget Actions

30. 30 Steps Taken To Close The Fiscal Year 2008 Budget Shortfall…  Agency-based budget reductions contained in the Governor’s Budget Reduction Plan released October 1, 2007.  Carryforward of unexpended appropriations from fiscal year 2007.  Transfer funds from the Revenue Stabilization Fund.

31. 31 What Are the Permitted Uses of the Revenue Stabilization Fund? 1. A shortfall in current enacted budget YES 2.A projected severe downturn in economy in next biennium NO 3.An emergency spending event (i.e. natural disaster or terrorist attack) NO

32. 32 How Much Can Be Withdrawn From The Revenue Stabilization Fund? Rule #1 – The General Assembly may appropriate a withdrawal from the Revenue Stabilization Fund if there is a revenue shortfall of 2 percent or greater in certified tax revenue ($278.8 million for FY2007). FY2008 calculation – uses data from FY2007 Individual Income + Corporate Income + Sales Tax = Total x 2% Shortfall $9,787.8 $879.6 $3,274.3 $13,941.6 $278.8 Rule #2 – The withdrawal cannot exceed ½ of the revenue shortfall ($522.3 million). Shortfall Potential Withdrawal $522.3  2 = $261.1 A Withdrawal From The Revenue Stabilization Fund May Be Possible In The Event Of A Revenue Shortfall ($ in millions)

33. 33 The Governor Is Proposing A $261.1 Million Withdrawal From The Revenue Stabilization Fund In Fiscal Year 2008… HistoryForecast Millions of Dollars Revenue Stabilization Fund -- June 30 Balance FY 1995-07 Actual and FY 2008-10 Forecast (millions of dollars)

34. The Governor is Proposing a General Obligation Bond to Address Construction of Higher Education Buildings

35. 35 Virginia’s Fiscal Health And Financial Management Practices Are Reflected In Our “AAA” Bond Rating… Historic Debt Capacity (millions of dollars)

36. 36 The Governor’s Proposal For Higher Education Improvements Will Still Leave Virginia With Debt Capacity… Historic Debt Capacity Plus New and Potential Authorization (millions of dollars) Notes: (1)Represents 2006 Base Capacity plus debt authorized during 2007 Session. (2)Represents 2006 Base Capacity plus 2007 authorization plus potential 2008 Proposed Authorization ($1.5 Billion of General Obligation Bonds and $700 Million of VCBA/VPBA Bonds) (1)(2)

37. 37  Construction costs have historically outpaced inflation.  Breakout of type of building: $728.3 million is related to the sciences/technology $896.2 million to classroom and administrative space $27.5 million is infrastructure Constructing The Higher Education Buildings Now Will Save Money Over The Long Term… Percent Historical Increase in Construction Cost For Buildings