State’s budget woes cast shadow on economic growth

Edward M. Mazze and Edinaldo Tebaldi

11/20/2010

The Great Recession has taken a big toll on Rhode Island’s economy. In the last three years, Rhode Island has seen virtually no new jobs created, a higher-than-national unemployment rate, home price – and homeowner equity – declines, revenue from gambling decrease, property taxes increase and growing underfunded public pension funds.
And, the outlook moving forward is not bright.
The New England Economic Partnerships forecast indicates that the state’s Gross State Product will grow from 2010 to 2014, but the growth rate will be smaller than the average growth rates in New England and across the United States. And it will not be sufficient to re-create the jobs lost during the recession. Moreover, the potential benefits to the economy of modest growth in personal income will be offset by an expected high state and local tax burden, causing real per capita disposable income to stay roughly constant from 2010 to 2014.
The projected state budget gap runs about 10 percent through fiscal 2015; with the forecast deficit for fiscal 2012 expected to be more than $350 million. Federal stimulus funds that supported past budgets will no longer be available to plug the gap. A budget deficit of $400 million is projected for fiscal 2013, with $500 million deficits for fiscal years 2014 and 2015. And the state does not have an overwhelming amount of resources to apply to the problem. Rhode Island has one of the highest ratios of net state-supported debt (municipal borrowing) as a percentage of gross state domestic product, 4.7 percent compared with a national median of 2.2 percent.
Bold decisions will have to be made by local and state government leaders to reduce expenditures and increase revenue. Furthermore, job creation in Rhode Island is difficult because of an unfriendly and costly business environment and the lack of business confidence in the direction of the state. While many Rhode Islanders want to see jobs created, they oppose change in their communities that affect their lifestyles, such as business development, consolidation, airport expansion or a port. This attitude will need to change. HIGHLIGHTS, SUCH AS THEY ARE
After seeing a decline in GSP from 2004 to 2009 of 0.1 percent, Rhode Island’s GSP is expected to increase 3.1 percent from 2009 to 2014, including 2.6 percent in 2011 to $39.8 billion. Accompanying growth in the state’s economy will be employment increases. Average total nonfarm employment was forecast to be 451,600 in 2010 and 453,700 in 2011, while from 2011 to 2014, it is forecast that 28,800 new jobs will be created. By 2014, Rhode Island’s nonfarm employment is expected to be 482,500, still significantly smaller than the employment level observed in the pre-recession period.
Personal income is expected to be $44.13 billion in 2010, increasing to $44.70 billion in 2011, as per capita income increases 1.2 percent to $42,408 in 2011.
In 2011, some job creation will take place in the trade, transportation and utilities, information, leisure and hospitality, and high-tech sectors. No job creation is forecast for education and health services, manufacturing, construction or the government sector. Small job losses are anticipated in financial services, and professional and business services. Beyond next year (from 2012 to 2014), the leading job-creation sectors in the state are expected to be leisure and hospitality, trade, transportation and utility services, education and health services, and high-tech.
With slow job growth will come a slow decline in the unemployment rate, as it hovers at about 11 percent in 2011, drops to 10 percent in the first quarter of 2012, and reaches 8 percent by mid-2013. A 7.4 percent unemployment rate is forecast for 2014, above the New England and U.S. averages.
The median price of a home will continue to fall, hitting $195,800 in 2011 but rising to $230,100 by 2014, as sales will remain at roughly 10,000 units in the period. Housing permits from 2009 through 2014 are expected to increase 11.3 percent, compared with a 17.6 percent decline in 2004 to 2009.
FISCAL IRRESPONSIBILITY NOT AN OPTION
Rhode Island’s continuing budget deficit has been a result of not solving the state’s structural economic problems in good times, much less since the Great Recession hit. With double-digit unemployment rates since 2009, the median price of houses decreasing each year and a nationally recognized unfriendly business environment, tax revenue has not grown to support expenditures. State deficits, before final passage of a budget, amounted to almost $1 billion for fiscal years 2009 and 2010. And before it closed the gap, Rhode Island had to solve a $395 million budget gap when preparing its budget for fiscal 2011. Looking forward, the state is expected to face more than a $350 million budget gap in fiscal 2012. Overspending, poorly funded public pension programs and weak economic-development programs have created challenges to maintaining a balanced state budget, one that is required by law. Budget shortfall solutions have included the use of federal stimulus dollars, the use of one-time gains from legal settlements, early retirement benefits offered to public employees, school-aid cuts, reducing payments to cities and towns, delayed tax refunds, pension deferrals, not filling vacant government positions, furloughs and reducing government services.
A STRATEGY FOR THE FUTURE
With the lack of federal stimulus funds in fiscal 2012, Rhode Island will face a significant budget deficit. Absent strong fiscal discipline, fiscal 2012 could bring the elimination of more government programs, as well as reduced support for education, fewer funds for cities and towns, and increases in public pension fund liabilities. In turn, the deficit will affect economic development and the state’s ability to retain and attract businesses.
Taxpayers are likely to face increased personal property taxes, an increased sales tax on some goods and services, and increases to existing fees for various services unless a way is found to balance the budget. Proposals for closing the budget gap by selling or leasing public assets will probably be presented.
Expense cuts could come from consolidating services – including reducing the number of school districts – requiring cities and towns to match personnel needs and services with population, raising the age of retirement and removing guaranteed annual increases in pensions. It is likely that more work force reductions, furloughs, salary freezes and wage and benefit concessions will be proposed. All of this likely will lead to fewer services being provided to residents. A new approach to writing the state’s fiscal plan – zero-based budgeting – will need to be implemented. Zero-based budgeting starts with all department spending assumed to be zero. By building the budget up item by item, wasteful spending is more easily eliminated, in contrast to traditional budgeting, in which only increases require justification.
Zero-based budgeting emphasizes analysis and comparison of programs, and leads to the termination of low-priority programs.
There also needs to be a commitment by government leaders to implement a strategic planning process to identify strengths and weaknesses of each activity. A target reduction in government expenditure might be used as part of the strategic planning together with zero-based budgeting (for example, a government might choose to cut expenditures by 10 percent in the first year).
States that have been successful in reducing and correcting budget deficits have at least three common characteristics:
• Government leaders are committed to operating with a balanced budget by making difficult decisions.
• Government leaders recognize the importance of the business sector and are business-friendly.
• Government leaders place a high priority on education to support economic development.
Rhode Island can no longer afford to operate as it has. Only once its fiscal and regulatory problems are solved will its economic outlook improve. •

Edward M. Mazze is the distinguished university professor of business administration at the University of Rhode Island. Edinaldo Tebaldi is an assistant professor of economics at Bryant University. This piece is adapted from a presentation they gave at the New England Economic Partnerships November 2010 economic-outlook conference.

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