Projecting state revenues around an uncertain corner

HOW MUCH money will the state bring in during fiscal 1981? Both the governor's Bureau of the Budget (BOB) and the legislature's Economic and Fiscal Commission agree that state revenues will grow during the present fiscal year, pushing the general and common school funds beyond the $8 billion mark and total combined revenues above $11 billion. But revenue growth will be slower than in previous years. The BOB's last report (issued in June) did not include detailed numbers but simply revised revenue figures downward by $70 million. The commission's May report (one of the four it makes each year as required by law) was slightly more optimistic than the BOB report of June, and as of August the commission saw no need to change its forecast. Both agencies will come out with updated forecasts in time for the veto session in November.

The commission does not make spending estimates because the timing of state spending is very much under the control of the executive branch of government, but the BOB predicted in August that at the end of fiscal 1981 the state will have an ending balance of $250-300 million. This, said the BOB, means the state will have dipped into the $390 million reserve it had at the end of fiscal 1980, which could pose some problems in fiscal 1982 — especially if recovery is slow and public aid expenditures increase.

What the fiscal commission, the BOB — and the Office of the Comptroller — all agree on is that fiscal 1981 is a hard year to predict. Forecasting economic trends is like trying to steer a car down the road by looking through the rear view mirror. It works pretty well until you have to turn a corner. And we have just turned a corner. The recession that was supposed to occur in March 1979 finally hit us almost a year later. Now forecasters are trying to figure out when we will turn the next corner into economic recovery. Most believe the current recession will be of short duration with the national economy moving into a slow recovery near the end of calendar 1980. If that proves to be the case, the Illinois economy, which is keyed very closely to the national, should begin to recover. And by late summer there were already signs of recovery — or at least indications that the recession is bottoming out. But sharp increases in the price of food or a hike in interest rates could change the picture again.

The fact that the recession did not arrive when it was supposed to has already has its effect. In 1977 and 1978 many states (including Illinois) were too low in their revenue estimates for fiscal 1978 and 1979. Because of inflation, the oil and gas producing states and states which have a progressive income tax raked in huge surpluses. Most states, including Illinois, did not bring in that kind of surplus, but they were spared the ravages that inflation inflicts on individuals, businesses and local governments,—This is because state governments are not as involved as individuals, businesses and local governments in the direct purchase of goods and services. Also, income taxes and sales taxes, the major sources of state income, are very responsive to inflation. Implicit in the state income tax is an "inflation bonus." Because deductions are not keyed to inflation, a higher proportion of income is taxable when salaries and profits are pushed upward.

But whether state surpluses were big or small, they prompted tax relief drives across the nation and caused Congress to decide to cut state revenue sharing.

Now we are in a recession, and that too has had its effect on state governments. States like Michigan which engaged in ambitious tax relief programs are coming up short. Wisconsin, Ohio and Oregon are also having difficulties.

Illinois entered the recession with a healthy general funds balance of $390 million. There is no debate over the need for a surplus, but there is disagreement between the governor and his Democratic opponents as to how big that surplus should be. As far as economic forecasting is concerned, the more debate the better. There is healthy competition between the execute BOB, the legislative fiscal commission and the comptroller's office — which since its creation in 1970 has been headed by a Democrat if the governor is a Republican and vise versa. Beginning with Comptroller George W. Lind-berg's accurate forecast that Gov. Dan Walker's administration had seriously over-estimated state revenues for fiscal 1976, neither the governor, the legislature nor the comptroller has been able to get too far out of line without being corrected by one of the others. As a result, Illinois has a better record on forecasting than other states, including California where the legislature failed to call Gov. Jerry Brown on his underestimate of state revenues in the mid seventies.

Looking ahead, both the BOB and the fiscal commission are balancing the effects of recession and unemployment against the effects of continuing inflation and some signs of an economic upturn. Corporate income taxes which respond quickly to economic conditions are expected to be lower in fiscal 1981 than in 1980. This would affect the corporate surtax which makes up most of the corporate personal property replacement tax. Lower revenues from the replacement tax in 1981 should take some of the edge off complaints by business that the tax is more than a replacement.

The commission still expects revenues from the personal income tax to grow slightly in fiscal 1981, However, a deep recession or a slow recovery could change that forecast.

Sales taxes are hard to predict because they depend on the consumers decision to buy taxable goods. It is hard to see how sales tax revenues can continue to grow when more and more people are going into bread lines and

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2/October 1980/Illinois Issues

The state of the State

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Projecting state revenues

soup kitchens. Yet it is quite possible that continued inflation at a core rate of 9-10 percent will keep sales tax revenues up. The fiscal commission is more optimistic than the BOB on that score but emphasizes that the whole picture could change if inflation rates and consumption go down. In its June report the BOB predicted a decrease in sales tax revenues from its March estimate, but totals would still be higher than in fiscal 1980.

Fiscal 1981 is the year of the second penny reduction on the sales tax (revenue losses are going as expected); the second year of the exemption on machinery and manufacturing equipment (there have been bigger revenue losses here than expected); and the first year of the phased-in exemption of the sales tax on farm machinery.

Then there's the gas tax. The 7 1/2 cents per gallon tax on gasoline was already producing reduced revenues in 1979 when the General Assembly passed the compromise road program to fund the state's highways and the RTA. But now cuts are expected in federal aid, and projections for sales tax contributions to the road fund are also down. Gov. James R. Thompson may propose an ad valorem gas tax which goes up with the price of gas, and that could be the big issue before the lame duck General Assembly this fall. But whatever happens, the long-range prospects for the gas tax are dim. What kind of revenues can it raise from electric cars?

The corner that we still can't see around is that big bend taking us into the so-called "energy future." That curve has already thrown all our other economic choices out of kilter. It certainly made the art and science of econometrics and revenue forecasting a necessity in the 1970's, and it may make economists of us all in the 1980's.

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