Virginia Budget Explodes

The new spending over the next two years by major category. This is for the smaller $48 billion general fund. No such pie chart was published by the Department of Planning and Budget for the combined $139 billion full budget.

The interesting thing is not how Virginia’s overall budget has grown 20% in just two years (seen that number reported anywhere else?) What’s interesting is how many interest groups are openly pushing to make it even larger. The $23 billion increase is not enough!

Just two years ago, in December 2017, Governor Terry McAuliffe dropped in his proposed budget for the budget cycle we are still in, Fiscal Years 2019 and 2020.  Before the 2019 General Assembly worked its magic, the baseline two-year total for spending he proposed was $116 billion.

Comparing an apple to an apple (which the political class discourages) the equivalent figure for the budget Governor Ralph Northam published last month is $139 billion, growth of $23 billion or 20%. That is the general fund and the non-general fund combined. It becomes more and more obvious that the non-general fund is the cart pulling this horse. At $90 billion over the next two years, it is almost double the proposed $48 billion general fund. Soon it will be more than double.

The proposed gasoline tax increase of four cents per year for three consecutive years is included in non-general funds. The continued explosion of university tuition charges is in the non-general fund. The undefined, “sum sufficient” hospital assessments behind the massive increase in Medicaid costs are non-general funds, as are the matching federal dollars they leverage. The days of putting the main focus on the smaller general fund with its direct taxes are over.

As noted, advocates for public education (call it K minus two to 12, since pre-K is expanding) want far more money from the state. The $1.2 billion spending increase the Governor has proposed is mainly focused on adjusting the base cost of existing programs for enrollment and inflation, plus a modest teacher raise. They want more for teacher salaries and other programs, the Full Monty from the Board of Education.  Expect additional spending amendments from human service advocates, including a coalition that now wants to expand dental benefits for Medicaid recipients.

The wish will become flesh with many of these later this week, when proposed amendments to the budget must be filed with the money committees. State employee groups, noting that neither year in the proposed budget includes raises for them, will be among the hardest to deny.  The $200 million slush fund the Governor left unspent for the Assembly to play with will not be sufficient.

Some key talking points: 

To start with something positive, the Governor held discipline and is significantly increasing the state’s reserves to almost $2 billion. Thank goodness Virginia has that beloved AAA credit rating and no governor or finance secretary wants to be remembered for losing it. We go to AA+ and nothing will hold them back.

By the second year of the budget Virginia achieves so-called “structural balance,” when revenues and expenditures match without relying on reserves or by moving money between years. That will hold until the next economic hiccough or full recession, unless the General Assembly now blows it.

Tax increases have funded this explosive growth, some open and some hidden. The hidden tax increase is the added state revenue created by conforming to all the tight new restrictions on deductions created by the federal Tax Cuts and Jobs Act, while keeping Virginia’s tax rates the same. This budget abandons the legislative requirement to track and hold that extra money aside for future tax relief, something discussed here just a few weeks ago.

The taxpayer relief fund was enshrined in law as well as in the budget, but a budget bill language provision directly repeals the law, too. “17. That the fifth enactment of Chapter 17 of the Acts of Assembly of 2019 and the fifth enactment of Chapter 18 of the Acts of Assembly of 2019 are repealed.”  That’s clear, right?

Over two years the state will reap hundreds of millions from individual and business taxpayers paying more than they would have on the same income two years ago. But President Trump’s tax cuts also stimulated the economy, so incomes are up as well – a double windfall for the state from him, and one impossible to track and calculate. Politicians love tax hikes you cannot see. 

The tax hikes you can see are not that clear, either. The two hospital taxes created to fund the Medicaid expansion and the hike in Medicaid provider payments are intentionally hard to track. Nowhere in any of the presentations made December 17, from the Governor, the Secretary of Finance, or the Director of Planning and Budget, will you find the dollar value of those hospital taxes mentioned.

In prior years there has been a table spelling out the specifics on all tax rule changes, positive and negative. That is lacking this year, a disappointing retreat from openness. But there is a $250 million over two years estimate in one of the slide sets on the proposed tobacco and vaping taxes, with another reference to $61 million from the first stage of the gas tax increase. New taxes on certain gambling machines (“games of skill”) may produce another $125 million over two years.

The non-general fund tax hikes are really fueling higher general fund spending. For example, the new tax on those now-unlicensed games in bars will transfer to school spending. The gas tax revenue will displace general funds that were being used for transportation. This is more reason to focus on the full budget and end the distinction between general and non-general funds.

>Stand by for updates. There is plenty in this budget yet to be explored in detail, and if the pattern holds both the House and Senate money committees will publish detailed analyses soon. Maybe one of them will put all the tax changes on one table or chart and save me an exercise in Excel.

This commentary originally appeared in the January 7 edition of the online Bacon’s Rebellion.

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Virginia’s Cost-Benefit System Provides More Efficient Transportation System

Each year when we release the Annual Highway Report, I receive a flurry of calls asking how states can improve their highways. Maintaining a quality state highway system is obviously difficult and complicated. While many factors play a role, the adoption of an accurate quantitative process based on cost-benefit analysis is one of the most important steps to improving the overall highway network.

Unfortunately, a recent Federal Highway Administration (FHWA) survey of state departments of transportation (DOTs) officials found that only five or six states systematically use cost-benefit analysis to evaluate transportation projects. FHWA’s survey found that state DOTs also use life-cycle cost analysis and multifactorial scoring systems to make decisions on whether to fund a project. Most state DOTs do not include measurements of transportation projects’ effects on emissions or freight. There are also problems with the accuracy of state estimates of traffic demand.

Two states, North Carolina and Virginia, have the most objective selection processes. Prior to 2013, the North Carolina Department of Transportation (NCDOT) used a transportation project funding assessment model that failed to measure costs of design, construction, regulatory compliance, and operations and maintenance. In 2013, the North Carolina Legislature adopted the Strategic Transportation Investments Act, which established a Strategic Mobility Formula that allocates transportation project funding on the basis of how the projects perform on different criteria.

The Strategic Mobility Formula gives the following weights to these evaluative categories:

  1. The needs of the state’s 14 transportation divisions (30 percent);
  2. regional impact (30 percent); and
  3. statewide impact (40 percent).

Since implementing this, North Carolina has been able to dedicate more resources to capital and bridge spending while maintaining top-25 rankings in all four of the Annual Highway Report’s pavement condition categories without increasing taxes.

Similarly, prior to 2014, Virginia used a multi-criteria evaluation system that used qualitative factors (such as, local and regional support) to determine whether to fund a project. This system failed to include quantitative metrics such as cost-benefit analysis. In 2014, to address this problem, the Virginia Legislature adopted the HB 2 Prioritization Process for Project Selection, which instituted a method for quantitatively scoring prospective transportation projects before they were reviewed by the Commonwealth Transportation Board (CTB). (In Virginia, the CTB allocates funds for transportation projects).

HB 2 created Smart Scale, which uses 10 criteria to measure project effectiveness. The criteria are weighted as follows:

  1. The reduction of congestion (35 percent);
  2. project readiness (25 percent);
  3. service deficiencies (5 percent);
  4. reduction in vehicle-miles traveled (5 percent);
  5. improvements in transportation safety (5 percent);
  6. increased connections between activity centers (5 percent);
  7. increased regional and modal integration (5 percent);
  8. improved bicycle and pedestrian travel options (5 percent);
  9. improved management of existing operations (5 percent); and
  10. cost-sharing with other entities (5 percent).

I have some minor concerns with the Virginia model. By examining benefits on a regional or local level as opposed to a statewide level, the system risks prioritizing small projects over large projects. For example, a bicycle project could score better than highway capacity or expansion of the Blue Line/Orange Line/Silver Line Metrorail tunnel under the Potomac.

I also don’t think the current system weighs safety highly enough. Regardless, it is a major improvement over the previous process, which dispersed funding over so many projects that there was seldom enough money to build any major projects. And, similar to North Carolina, Virginia maintains top 25 rankings in all four pavement categories, although urban traffic congestion is a major problem in several areas of the state.

Not all quantitative scoring processes work well. FHWA cited the cost-benefit methodology of the California Department of Transportation (Caltrans) and the cost-efficiency methodology of the Washington State Department of Transportation (WSDOT) as examples of methodological shortcomings of state DOT evaluation processes.

Caltrans formulated the Cal-B/C methodology to evaluate the costs and benefits of transportation projects on the basis of:

  1. Time savings for travelers;
  2. vehicle operating cost savings;
  3. safety cost savings;
  4. lowered air pollution emissions;
  5. construction costs; and
  6. operations and maintenance costs.

However, CalTrans’ methodology has a major problem — In calculating travel time savings, it does not include travel demand network data. As a result, this skews the analysis inputs, making the conclusion of the cost-benefit analysis inaccurate.

Similarly problematic, the WSDOT’s cost-efficiency evaluation only uses travel time savings to estimate users’ benefits, which potentially ignores other benefits including safety and redundancy.

Almost every state could benefit from a quantitative review process, including states viewed as effective and innovative. Recently, an audit of the Georgia Department of Transportation (GDOT) found that the agency does not have a formal cost-benefit analysis process. Auditors found that GDOT’s initial project selection process is not transparent and includes very few objective criteria. Further, the $2 billion project to build truck lanes on I-75 between I-475, north of Macon, and Henry County in the southeast Atlanta suburbs, was approved without any cost-benefit analysis. To its credit, GDOT has refined its scoring method and revised scoring criteria to meet objective goals.

GDOT ranks first or second in delivering projects on-time and under-budget. The state’s pavement condition ranks relatively high. And much of the criticism of the agency has come from the Southern Environmental Law Center, a group that opposes nearly every type of roadway project.

Further, developing an accurate scoring system for state transportation projects is daunting and challenging. Implementing a system with major flaws, as has happened in California and Washington, would be a step backward for many states. Yet, as North Carolina and Virginia have shown, it is possible to adopt an effective, accurate system that improves a state’s process and infrastructure. In addition to improving project selection, developing an effective cost-benefit analysis system can make it easier for transportation departments to generate support from both elected officials and taxpayers, which is critical to building and maintaining an effective transportation system.

Baruch Feigenbaum Email this author

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Forecast for 2020 Looks Better Than it Did a Year Ago

What a difference a year makes. Last year at this time there was talk of recession, in part, because the stock market and yield curve were signaling warning signs. At the end of 2018, the Dow Jones Industrial Average had its worst year since 2008.

If the stock market is falling, then investors must think the sale of goods and services are going to decline to the degree that profits fall. That is a recipe for recession.

The yield curve was relatively flat at the end of 2018 and then inverted in 2019, with the interest rates for the 10-year Treasury lower than the shorter-term maturities such as the 3-month Treasury.

An inverted yield curve often proceeds a recession as the Federal Reserve is pushing the target federal funds rate higher, which causes 3-month bills and short-maturity Treasuries to rise above the longer-term 10-year Treasury.

Potential trade wars with China were a concern as 2018 closed and continued to escalate over the year, which eroded confidence to the degree that firms pulled back on plans to invest in equipment and expansions. Presumably, the concern was caused by uncertainty regarding demand for products as well as the ability to purchase supplies other from countries instead of China.

One year later, the Dow gained 22.3% while the benchmark S&P 500 index soared 28.9% for the year and the Nasdaq Composite gained 35.3.

The Federal Reserve lowered the federal funds rate target by 75 basis points over the past six months. As a result, the yield curve is no longer inverted with the 3-month Treasury, closing out the year at 1.54% and the 10-year at 1.92%.

Both the stock market and steeper yield curve point toward growth in 2020. Also, the first phase of the Chinese trade deal negotiated by the White House is said to be signed in mid-January. With Chinese trade uncertainty behind us, we might see businesses investing again in plant and equipment.

Aside from the increased sales to firms that construct plants and manufacture equipment, business investment will ultimately increase productivity, which enables the economy to grow faster.

Increasing productivity is critical to boosting the growth rate of the U.S. economy and improving living standards.

One trend that has not changed since last year is strong growth from the consumer sector, which makes up about two-thirds of gross domestic product. Although official numbers have not been reported, increasing employment and rising wages most likely gave retailers a strong holiday selling season.

When consumers are buying, retailers need to replenish inventories and that leads to more orders for manufacturers, who then give employees more hours to work or employ more people — a cycle that supports economic growth.

Based on these trends as well as slower population growth, Chmura Economics & Analytics is forecasting slower U.S. growth in the gross domestic product and in employment. GDP growth should increase 1.9% in 2020, compared with 2.3% growth last year. Employment growth should be 1.1% this year compared with 1.5% in 2019. We expect employment growth in the state and Richmond metro area to be about the same as the nation in 2020.

Our forecast is not looking for a repeat of the roaring ’20s, but predicts growth that will support expanding employment and wages.

This commentary was originally published in the January 5, 2020 edition of The Richmond Times-Dispatch.

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Agriculture Takes California to Court

The National Pork Producers Council and American Farm Bureau Federation delivered an early Christmas gift for American farmers on Dec. 5, 2019. The gift is in the form of a Complaint filed in U.S. District Court in Southern California. It is likely the two representatives of agriculture will have a more sympathetic judge than the Hollywood judge ruling on the case of the North American Meat Institute.

The new Complaint clearly states, “Proposition 12 has no relation to Foodborne Illness or Human Health.” Finally, someone has decided to take on California’s ludicrous claim that concentrated animal feeding operations (CAFOs) contribute to human health problems.

The Complaint states, “The idea that square footage provided to sows has bearing on the safety of the food product derived from their offspring is incredible.” The Complaint also declares there is virtually no likelihood that a sow’s piglets would ever develop salmonella. The Complaint tells the Court and the world that “strains of salmonella found in food products at grocery stores are more commonly traced to strains of salmonella found at slaughter and processing plants than at farms.” In fact, the Complaint is very clear that research shows moving from 16 to 24 square feet will have no impact on public health either for the consumer or the sow. “There is no link between Proposition 12’s sow housing requirements and food safety or foodborne illness.”

The Complaint even demonstrates the silliness of having hogs housed in fields. In fact, the Complaint declares there is a greater risk of pathogens coming from hogs being fed and housed in open fields. When hogs were fed outside, they were likely to be exposed to Trichinella and Toxoplasma. When the industry moved to CAFOs, these diseases were virtually eliminated. Hogs fed outside are likely to contact Toxoplasma which come from the feces of infected cats, and Toxoplasma has been considered to be one of the top 5 causes of death.

For a change, the two farm organizations have gone on the offensive, which is great news for agriculture. Clearly Proposition 12 poses a threat to agriculture and no assistance to sow welfare. As expected, a number of declarations were filed by producers across the country. One producer from Minnesota produces approximately 250,000 hogs a year. He suggested that smaller sows in his herd were attacked by the larger and more dominant sows and now houses his sows individually. This producer indicates he will not comply with California’s Proposition 12 because the requirements will hurt the welfare of his animals, cause the productivity rates to fall and of course Proposition 12 will increase his production costs. Therefore, this producer’s product will be unable to be sold by his packer into the California market.

The most interesting declaration was from a leader of a Hutterite colony in Montana. This colony has a number of pork producing farmers, and they rely on hog production for most of their income. Just as important is their hogs are shipped into the state of California, and the packer has demanded the Hutterites comply with Proposition 12. These farmers “…would need to reduce their sow populations by 20%.” In addition, “the colonies would also need to purchase 20% more replacement gilts to replace sows that are injured in fights between sows held in group housing.”

Common sense tells us that Proposition 12’s requirements will force sow farms to either build new housing that provides 24 square feet per sow or retrofit existing barns. One producer estimated such construction for his herd of 10,000 sows will be approximately $3,000,000. All this money for no improvement of human health. California is attempting to impose its police powers beyond its own borders.

What we have is two farm organizations attempting to stop California in engaging in regulation of hog production in the other 49 states. What a New Year’s gift we all will receive when this case is adjudicated in favor of agriculture. Happy New Year!

This commentary originally ran in the December 24 edition of the online Farm Futures.

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The Most Progressive Budget in Virginia’s History

In the introduction to his budget statement released yesterday, Governor Ralph Northam described his proposed 2020-22 budget as “the most progressive in Virginia’s history. If by “progressive” he means “leftist,” with a strong propensity for taxing, spending and wealth redistribution, it’s hard to argue with him. That’s exactly what it is.

In previous posts on my blog Bacon’s Rebellion, I’ve critiqued the governor’s major spending initiatives, totaling about $2.5 billion in ongoing and one-time spending proposals, so I will not repeat myself here. Instead, I focus on the revenue side of proposed budget. I’ll address the negatives first, then touch upon a couple of silver linings.

Northam proposes to raise taxes even while the economy is growing and tax revenues are increasing. According to the Economic Outlook and Revenue Forecast for the 2020-2020 Budget, General Fund revenues are predicted to grow 4.5% in FY 2021 and another 3.7% in FY 2022. That represents a healthy increase over inflation, which is running around 2%. If Virginia needs to raise taxes when revenues are growing, what will happen when a recession makes them shrink?

The governor is obscuring how much the tax hikes add up to. Bits and pieces have been made public, but the big picture is elusive. Northam proposes to gain $340 million over two years from killing last year’s tax relief fund; $230 million in taxes on cigarettes and other tobacco products; $125 million on so-called “games of skill” that compete with the Virginia lottery; and a 12-cent increase in the gasoline tax over three years, partially offset by killing annual auto inspections and cutting the state vehicle registration fee in half.

Of all the tax increases, the gasoline tax will be the most politically problematic. Little wonder, then, that the Governor’s Office did not put a dollar value on the tax hike. Calculations are difficult because “the gas tax” consists of a mix of wholesale taxes, at-the-pump retail taxes, and special taxes on diesel and gasohol. According to the Virginia Department of Transportation budget, the “sales tax on motor fuels” yielded about $850 million in revenue in FY 2019. If we guesstimate that boosting Virginia’s 16-cent-per-gallon excise tax by another 12 cents yields a 60% revenue increase when all sources are considered, we’re talking about $500 million a year in extra revenue. That will be offset by about $130 million in savings from the automobile license fees, plus $20 per automobile for eliminating the mandated annual inspection — a big loser for taxpayers. Hopefully, the General Assembly will insist upon seeing hard forecasts for those numbers.

Add up all the tax increases, and net damage to taxpayers will run in the neighborhood of $500 million a year when the full gasoline tax increase goes into effect. Such a number, or anything close to it, would make for terrible headlines, so the Governor’s Office declined to release it.

The governor has packaged his tax increases shrewdly. One of the governor’s gambits is to say that the revenue generated by the increase in tobacco taxes will be used to help reduce health insurance premiums 20% by setting up a state reinsurance plan to stabilize premiums for the 400,000 Virginians who purchase private insurance. What better source of revenue for such a program than tobacco, considering that smoking costs Virginia taxpayers nearly a half billion dollars a year in Medicaid?

Similarly, Northam proposes a tax on unlicensed, untaxed electronic “games of skill” that are cutting into Virginia lottery revenues and to funnel those revenues to K-12 schools. This tax supposedly would substitute for lost lottery revenues that would have gone into K-12 schools.

In a shred of good news, Northam proposes adding $300 million to the state’s cash reserve. Between the cash reserve and the rainy day fund, the state would have a $1.9 billion cushion by mid-2020, about 8% of the General Fund budget, to buffer a loss of revenue in an economic downturn. One could argue that $300 million is small potatoes given the gusher in revenue the state will likely enjoy if the economy grows as predicted and Northam’s tax hikes are adopted. But at least it’s a gesture toward fiscal responsibility.

Although Northam wants to hike transportation taxes, at least he’s inching back to a user-pays funding system. I’m not convinced that the tax increase is necessary, but if you’re going to increase transportation taxes, make motorists pay in proportion to which they use the transportation system. Under a gasoline tax, the more people drive (and put a strain on the transportation system), the more they pay. By contrast, the vehicle registration fee is a flat tax that applies equally whether you’re a little old lady who drives about 2,000 miles a year or a road warrior who drives 20,000 miles a year. We still need a mechanism to get people who drive hybrids or electric vehicles to pay their fair share, but it’s a small step in the right direction.

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