How VT fell into a $113 million budget gap

MONTPELIER – If a curious Vermonter wants to understand all the talk of the state's cutting jobs, reducing low-income heating assistance and consolidating facilities, the person might start with the "alligator chart."

On this line graph, revenue and spending are the alligator's upper and lower jaws. The mouth yawns open, representing an ongoing projected gap of $96 million to $130 million between Vermont's general fund spending and revenues — for the next four years.

"The alligator's mouth is what's killing us," Gov. Peter Shumlin said as he reviewed the graph in a recent interview with the Burlington Free Press.

The governor expects the state to be able to bring those lines together.

"We're going to have a little more work to do next year, quite possibly," Shumlin said. "But we've got to match."

The beast, as it turns out, is difficult to tame. Shumlin has called this year's budget the most difficult of his time in office. Republicans counter that Shumlin has been wrestling with a problem of his own making.

Beneath all the controversies over budget cuts or new taxes is a deeper controversy about how Vermont got here. And, naturally, everyone sees something different in the numbers.

Last Thursday, just before the House of Representatives considered its budget proposal, Rep. Mitzi Johnson, D-South Hero, who led the effort as chairwoman of the Appropriations Committee, offered a brief narrative.

Government grew under Republican and Democratic governors, Johnson said. Then the economic recession hit, then Tropical Storm Irene, all while health care costs, labor costs and retirement payments put pressure on the budget.

"We've been waiting for natural revenue growth to pop back up, but trends nationwide don't support that hope," Johnson said. "We're left with budget pressures growing faster than revenue growth, and it's our job to wrestle that alligator mouth closed."

The governor said the simple reason for the budget gap is the same as for many other states: a "massive shift" in economic forecasts about nine months ago.

"Historically, when we've come out of recession, we've seen growth rates of 5 percent," Shumlin said. "All economists agreed nationally that we were going to see a similar growth rate coming out of this recession. It never happened. ... About nine months ago, they all nationally agreed, not only is it going to be a 3 percent growth rate, but for the Northeast, it's going to stay that way for many years to come. So that's really the challenge."

Slower-than-expected revenues account for about $44 million of the budget gap — less than half. So does Shumlin blame revenue downgrades for Vermont's current budget challenge?

"No, we're facing a challenge for the simple reason that we have been spending at a consistently faster rate than our revenue's coming in," Shumlin replied. "We all expected that to change, and it didn't."





The revenue side

The first consensus revenue forecast Shumlin saw as governor in January 2011 predicted that general fund revenues would grow by close to 6 percent in the following two years. In general, forecasts have fallen since then.

RELATED: VT House OKs tax bills, $4.75B budget

Revenue growth varied from a high of 11 percent coming directly out of the recession to a low of 3.1 percent last year. Vermont has seen annualized revenue growth during the past five years of about 4 percent.

Even with strong growth in any single year, the administration has known since July 2013 that the long-term annualized forecast was closer to 3.5 percent, said Tom Kavet, the economist hired by the Legislature.

"It wasn't really saying this is a 5 percent world," Kavet said. "It's a 3.5 percent world."

Jeffrey Carr, the economist hired by the Shumlin administration who works with Kavet on revenue forecasts every January and July, referred questions to administration officials.

During the past five years, state general fund spending has clipped along at an annualized rate of about 5.3 percent through this year's proposed budget adjustment. The overall budget, including all state and federal dollars, has grown at about 3.2 percent.

The two fastest-growing budget categories in that time were human services at 5.1 percent and general government at 4.8 percent, according to the Joint Fiscal Office.

"I think that there had been a hope and an expectation that revenues would be growing at a faster pace and more in alignment with the rate of growth of the budget," said House Speaker Shap Smith, D-Morristown.

Part of the challenge, Smith said, was that Vermont has been "making up for past sins" such as underfunding of employee retirement.

Now, the current year's revenues have not come in as expected, and state government has tightened its belt and used one-time funds to get through the year.

Tom Pelham, former finance commissioner under Democratic Gov. Howard Dean and tax commissioner under Republican Gov. Jim Douglas, believes that regardless of the revenue forecasts, state officials should have accounted for flat economic indicators such as population growth and employment.

"At least from my perspective," Pelham said, "this has not been a surprise."

RELATED:House budget gives call centers reprieve

Pelham worries what would happen if another recession comes.

"This fiscal mess at the Statehouse needs to get settled," he said, "and we need to become squirrels again and store away reserves."

The budget under debate

Vermont officials have known since last January that fiscal year 2016 — the budget year everyone is working on now — likely would see revenue growth closer to 3 percent.

When the governor talks about the fiscal 2016 budget gap, he ties it to lower-than-expected revenues in fiscal year 2015. If revenues had been higher this year, Shumlin said in his budget address, Vermont could "grow our way back to a balanced budget."

Revenue downgrades are just one factor in the budget gap, said Finance Commissioner Jim Reardon. "I don't want to overplay that."

Reardon blames the budget gap on three factors: Past reliance on one-time funds, revenue predictions that never materialized, and pent-up demand for government services that put pressure on the budget.

Vermont saw larger budget gaps, Reardon said, during the recession. But there was federal stimulus money then.

Steve Klein at the Joint Fiscal Office described the gap as a result of mismatched revenues and spending, decreases in federal money for Medicaid, revenue downgrades and replacements for one-time money.

Susan Bartlett, a former Democratic senator and chairwoman of the Senate Appropriations Committee for about 10 years, said legislators worked with the best information they had.

"I think everybody was doing the right thing, and then we hit a bump in the road where suddenly revenues were coming in a lot less than anybody expected," Bartlett said.

Paul Cillo, founder and president of the tax policy think tank Public Assets Institute, said two problems are contributing to the current budget gap.

Health care costs have grown and crowded out other areas of state spending, Cillo said. He estimates that about a third of the entire state budget relates to health care.

"Essentially, we're cutting state services," Cillo said. "So this idea that this is just somebody out there wanting to spend as much as possible is ridiculous."

On the revenue side, Cillo said Vermont's consumption taxes such as the sales tax aren't keeping up with the economy. He wants to expand the tax base to include services.

Republicans blame spending for the financial difficulties the state faces.

The Vermont Republican Party has taken the state's budget challenge as a chance to lambast Shumlin and House Speaker Smith — simmering resentment from lawmakers' override of a budget veto by then-Gov. Douglas in 2009.

"For the last three years we've been opposing the governor's budget because the administration has been spending more than the revenue can support," said House Republican leader Don Turner, R-Milton. "What they've been doing is using one-time money and additional federal dollars to fill the gap."

Former Gov. Jim Douglas called the budget gap "entirely predictable and entirely avoidable."

Asked how he would handle the gap if he were still in state government, Douglas replied, "We wouldn't be there, frankly, because the rate of increase of spending has been, as I suggested, greater than we can accommodate."

Democrats brush off the hindsight criticism.

"While it can be frustrating to be in the minority," former senator Bartlett said, "you don't have to be responsible, you don't have to fill in the blanks of what would you do. You just get to criticize."

The governor, on his part, said the Republican blame of his budget override represents "Washington partisan rhetoric."

Minding the gap

Vermont has faced a budget gap every January for at least six years, dating back to the economic recession.

The $113 million model, for fiscal 2016, consists generally of the following major budget pressures:

• Higher caseload for Medicaid and Agency of Human Services programs, plus other Human Services costs totaling about $49 million.

• State employee Pay Act salary and benefits — about $23.5 million.

• Absorbing a revenue downgrade of about $18.6 million.

• Paying back one-time funds that were used for Human Services this year: $12.7 million.

• A $7.5 million increase in the transfer from the general fund to the education fund, as required by law.

• $7.6 million for teachers retirement.

Some of these factors, such as Medicaid payments, are expected to continue to strain the fiscal 2017 budget process as well, according to the Joint Fiscal Office.

Back on track?

Gov. Shumlin said the pattern of major budget gaps is about to stop.

Asked whether he was increasing spending for the coming year, Shumlin said, "No, I'm not. If you go look at my budget that I submitted, it is 1.9 percent higher than the budget that we passed a year ago. ... If we can get back on track to 2 percent growth rate, even a 3 percent growth rate, we'll be OK."

The governor's recommendation was 1.9 percent higher than the budget approved last May, but 4.4 percent higher than this year's best estimate of spending, the January adjusted budget.

Shumlin said Vermont still might face a budget gap next year — but not on the $100 million magnitude seen this year.

In the House, Republicans pushed for a level-funded budget with no new programs and no new taxes.

"Expanding the economy is the long-term solution to the financial problems in this state," said Rep. Bob Bancroft, R-Westford, "but that's going to take a number of years before we can see any significant improvement from that expansion in the form of increased tax revenue. So what we're confronted with for the next four to five years is budget cuts."

Other observers, such as the Public Assets Institute, have called for eliminating tax breaks for wealthy Vermonters in a new tax structure. A coalition of House Progressives, independents and liberal Democrats pushed unsuccessfully for higher taxes for high earners and a hotel room occupancy fee on the House floor last week.

Rep. Mitzi Johnson, the South Hero Democrat who led the creation of the House budget, said the proposal could become a bridge to more sustainable finances.

This year's budget is different, Johnson said, because some of the one-time funds are connected to long-term savings. She wants Vermont to start budgeting for less money than is expected to come in and build reserves, but said that's about four or five years away.

The House budget, which closes a larger gap than the governor had to deal with in January, as of Friday afternoon represented a 1.4 percent increase over the previous year. General fund spending would rise 4.8 percent.

"The structural deficit," Johnson said in an interview, "was too ingrained and too large to solve in one year."

Contact April Burbank at 802-660-1863 or aburbank@freepressmedia.com. Follow her on Twitter at www.twitter.com/AprilBurbank.