Governor McAuliffe announced last Friday that the state would not meet its revenue projections for fiscal year 2016, which just ended June 30, with the result that this year’s budget will be short a projected $266.3 million. Revised forecasts for the state’s two-year budget (which ends June 2018) places that shortfall at $1.2 billion. This has put much-needed pay raises for teachers and state employees this next year in peril, and will require further belt-tightening and possible curtailment of some state services. Why did this happen? Could it have been averted?

Revenue Projections

Budgets are always built around assumptions. We project state revenues and then build a budget to ensure that spending does not exceed them. In Virginia’s case, almost every expert and elected official – the Governor’s Budget office, House Appropriations and Senate Finance Committee staffs, legislators, the state’s independent fiscal advisory board (GACRE), the Joint Advisory Board of Economists – officially projected revenue growth at slightly over 3 percent for fiscal year 2016. Instead, total general revenues rose only 1.7 percent, thereby creating the shortfall.

Since, under our Constitution, we cannot operate without a balanced budget, we are forced to cut expenditures and/or increase revenues to cure the shortfall.

Effects of Sequestration

The wisdom of hindsight suggests that perhaps we could have seen this coming. Commentators have argued for several years that federal sequestration would lower growth rates and affect jobs in Virginia. Gov. McAuliffe has spoken frequently about federal sequestration and its impact on state finances since he took office, and is building his legacy around efforts to diversify Virginia’s economy and make it less dependent on Washington, D.C. These concerns have been borne out by the data. Growth rates in NOVA have lagged behind the U.S. average since 2013, and are only now bouncing back to earlier levels. Job growth following sequestration has only begun to rebound in 2016; many of those newly created jobs now pay less than those which preceded them. This has meant lower income tax withholdings and lower sales tax revenues for Virginia.

Placing blame is not terribly helpful as we address this shortfall, but much of the problem arises from the gridlock in the nation’s capitol, where House Republicans used their majority at the beginning of the decade to resist the phase-out of the budget-busting Bush era tax cuts. Sequestration emerged as a short-term compromise by which the debt ceiling could be lifted and the U.S. government would remain in operation. Because of the draconian cuts that sequestration requires, few believed that it would be fully implemented. They were wrong.

At the time of the sequestration debate in 2013, a number of us argued that it would be folly for our Congressional delegation to support it. And we now see the results. One trillion dollars in automatic cuts has a huge impact. The effects have been felt dramatically in Northern Virginia and Hampton Roads, areas heavily dependent on Department of Defense spending and federal procurement. The result has been less economic activity, lower-paying jobs, and less revenue for the Commonwealth. And the process threatens to repeat itself, with the next round of federal sequestration budget cuts to take effect in the next several years.

Hindsight is 20/20

Could the Commonwealth have done anything to avert the shortfall?  Maybe.  Perhaps we could have said “no” to the experts and based our budget on lower budget revenues.  This would, of course, affect other budget choices, including the $1 billion in extra money we appropriated in this budget for K-12 spending.

We could have expanded Medicaid, and held the savings derived from federal funds being sent to the Commonwealth in escrow to protect against a downturn. While there is some concern about the long-term fiscal impact of expansion, bringing our taxpayer monies back to Virginia to cover almost 400,000 citizens would have actually decreased, if not eliminated, the immediate state budget shortfall. Not only would the federal government pay 100 percent of Medicaid expansion costs, but money returning to the state could have been used to supplant other state funding (e.g., more than $100 million for state-funded indigent care), thereby freeing it for other uses, including balancing the budget. Unfortunately, politics prevented this option.

What Lies Ahead

At present, two problems face us. First, we need to address this year’s shortfall and fiscal year 2017. That probably means eliminating the projected state pay raises for next year and cutting other operations. Cutting these raises is extremely troubling. Our state employees are the first ones asked to do “more with less” and they are seemingly the first who are asked to sacrifice when the budget gets tight. Perhaps we could still provide them one-time bonuses and still balance fiscal year 2016. We could also look for savings elsewhere. Our tax credits program, for example, involves transfers of millions of dollars each year; these transfers are baked into state code, and involve everything from land preservation to coal subsidies. When across-the-board cuts are enacted, tax credits are never affected. The top 10 tax credits cost the taxpayers over $320 million in 2015, a substantial amount which is not subject to yearly budget scrutiny. A one-time across-the-board 10 percent freeze on all credits could raise over $30 million.

Our second issue involves the biennial budget for fiscal years 2017-18 where projections now suggest a shortfall of $1.2 billion. Fortunately, our “Rainy Day Fund” can be used to help address a major portion of the imbalances for fiscal year 2017. But unless the economy improves more than we saw in 2016, this will not be enough, and other measures will be necessary, including cuts by agencies, which have never recovered from the post-recession tightening. Our budgetary prospects would improve if Congress passed the Marketplace Fairness Act, so Virginia can replace sales taxes lost to internet sales. Many of us want to preserve monies for education spending and economic initiatives designed to build the New Virginia Economy, and will fight to do so. Few of us see any tax increases as realistic in this political climate, so more cuts are likely.

As we develop strategies to balance the budget, I hope we can avoid budgetary gimmicks and one-time fixes, while keeping the focus on diversifying our economy. We have faced these shortfalls before, and have made the tough decisions necessary to address the problems. We will do so again.