Economy rebounding but hold the party

10 December 2003

What a difference a year makes. Last December, the state government faced an almost incomprehensibly large deficit of $2 billion. By January 2003, it had grown, unbelievably, to $3 billion.

And now? No one's shouting it from the rooftops, but at legislative hearings this week administration officials and outside economists allowed that perhaps things just might be getting a bit better. To be sure, they were subdued about it. The next year would see some "modest revenue growth," said Michael Widmer, who heads up the Massachusetts Taxpayers Foundation. State budget chief Eric Kriss, while acknowledging an improvement, stressed that "the state still is lagging."

They understate the case. If the recent stunning rise in economic indicators holds true, Massachusetts may be headed for one of the fastest turnarounds it has ever seen. A year or two from now, we very well may be awash in cash.

Pop the champagne corks! Break out the truffles! It's time to gorge again!

Well, maybe not yet. But the improving numbers will change considerably this year's budget debates. Sure, the fiscally responsible thing would be to stand firm and keep spending tamped down. But for the last two years we've been like kids salivating outside a candy store. Once we're let in, it will be hard to resist.

Building a budget first involves figuring out how much you have to spend, a process in which the Legislature is now engaged. The lion's share of revenues boils down to annual collections from three sources: personal income tax, sales tax and corporate income tax.

All three are fickle, notoriously subject to the ups and downs of the economy. It's really pretty simple stuff. If people are unemployed, they don't pay income tax (they don't have any income) and don't pay a lot of sales tax (they're short money to buy things). The same is true of businesses. If they're losing money, they're not paying income taxes either.

You can see that in the state's tax collections. In fiscal 2001, the state collected an all-time high of $16.7 billion. The following year? Revenues collapsed, falling by $2.4 billion to $14.3 billion. Collections increased slightly in fiscal 2003 but after the effects of inflation, it wasn't much of an improvement.

But in a reversal of Newton's second law, in the economic world things go in cycles: What goes down must also come up. Slumps wreak havoc on tax collections. But economic recoveries pump up revenues dramatically.

How dramatically? At this week's hearing, the administration, the Massachusetts Taxpayers Foundation and the Beacon Hill Institute all presented their numbers. The Romney administration was the most conservative, predicting revenues next year would rise $489 million. The MTF forecast a $620 million increase. The BHI, the most optimistic of all, estimated revenues would grow by $730 million.

They're all probably wrong.

Take for example, the MTF's estimate. It based projections upon predictions about national and state economic growth. The numbers, prepared in October before the most recent spate of good economic news, were decidedly pessimistic. For example, they assumed that the current national unemployment rate was 6.3 percent and would rise slightly next year to 6.4 percent. Yet the unemployment rate today is actually a much lower 5.9 percent and is dropping steadily.

In other words, the MTF - and pretty much everyone else - is relying on excessively grim economic data. The MTF admits as much. Given the third quarter results, its projections are now "more unlikely than likely," says the foundation's Cam Huff.

So what really might happen? If the MTF looks at a modestly less conservative scenario (and one that's still more pessimistic than current data would support), state revenues jump another $300 million. And if the economy surges? It could be the '90s all over again.

Which should serve as a warning.

When it comes to budgeting, the time to start planning for the next recession is when the current one is ending. Massachusetts' mistake last time around was that it ignored what Gov. Mitt Romney and others call the structural deficit: Certain costs climb seemingly inexorably (this year, for example, Medicaid rose $600 million despite significant cuts). Moreover, human service needs rise during a recession. Given all that, one can see that it would make sense to hold back on new spending, funding programs we already have and adding to the state's rainy day fund so monies are there when they're truly needed.

Still, that will be hard to do. Everyone loves to spend. Mass Pike chief Matt Amorello plans to spend $200,000 in public funds for yet another foolish Big Dig grand opening. Cities and towns can hardly be blamed for wondering why, if the economy continues to improve, the state can't find the funds to repair their bridges.

Talk back to Tom Keane at tomkeane@tomkeane.com.