Kentucky Governor Steve Beshear signed a budget reduction order Wednesday, announcing that there would be a $21 million dollar transfer from reserves bringing the state's rainy day fund to $77 million. Murray State Distinguished Professor of Economics Dr. Jim McCoy serves on the Kentucky Consensus Forecast Group. He puts in perspective the origins, anomalies, and implications of the Commonwealth's $91 million shortfall during Sounds Good.
Beshear's decision comes roughly a week after the revelation that Kentucky's general fund is short $91 million dollars, which Kentucky’s Budget Director Jane Driskell says was caused, in part, by President Obama's proposal to raise federal capital gains tax and unanticipated shortcomings in stock market trading and investments.
How The Budgeting Process Works
The Kentucky Consensus Forecast Group meets in the fall of odd-numbered years to put together a forecast for the next two fiscal years (July 1 - June 30), to predict tax revenue based on economic performance. Forecasts are an inexact science so when looking ahead over two years out can be tricky business, especially in the current economic climate.
The group found that their first fiscal year predictions were accurate and that the second year was very good (Fall of 2013 revenues came in at a predicted pace). Coming into January of 2014, however the general economy had, for the first time since 2011, dropped in GDP by about 2.9%. This unexpected event led to less tax revenues being collected in 2014.
Kentucky's $91 Million Shortfall
The shortfall from the past fiscal year sounds like a lot of money, and indeed is, but in percentage terms amounts to roughly 1% of the general fund. Therefore, McCoy says the Forecast Group was only off by about 1%. However, on top of 14 budget cuts over the past five years totaling $1.6 billion, the extra 1% makes a difference.
"We're well past the fat, we're well into the meat and certainly getting close to the bone in terms of hardship and coming up short on those revenues."
The Fiscal Cliff
Most of the shortfall accounted for due to the phenomenon relating to personal income tax. In April 2014, Kentucky's tax collection fell by 8% compared to the previous year. One of the contributing factors was the capital gains tax issue, aka the "fiscal cliff" from 2011/12. Investors fearful of the fiscal cliff, that their capital gains taxes would be increased and that previous tax cuts would be let to expire causing them to pay at a higher rate in the future, led to a large amount of cashing in when they wouldn't have done so otherwise. As it turns out, there was no increase, but in 2012 investors didn't know that, thus an increase in stock sales in 2013. This accounts for $63 million of the shortfall.
The rest of the shortfall amount is related to less overall tax collections in cigarette, coal severance, lottery, property, and business taxes as related to the general economy.
Looking Ahead: The Next Two Years
The Kentucky Consensus Forecast Group convened in December 2013, before the shortfall discovery, and made a conservative forecast for the fiscal year that just started (July 1, 2014) with an increase of 2.6%, feeling general economic growth would be somewhere between 3 to 4%. As for recovering the $91 million, the Kentucky Constitution requires a balanced budget. So the shortfall must be paid for and the government can't borrow money to do it. So the only way to recoup the amount is by dipping into the "rainy day fund" of $90 million and the unused balance of $80, both of which were already being used for planned spending. McCoy says Kentucky will either need to have faster economic growth than forecast or engage in about 1% of budget cuts.