Virginias Economy and Its Impact on State Revenues

1
Virginias Economyand Its Impact on State
Revenues

• Virginia Association of Realtors
• July 24, 2007
• Anne E. Oman
• House Appropriations Committee Staff

2

• The rise and fall of state spending
• Review of the late 90s through today
• 2001 recession
• What drove the recovery?
• Its all about Northern Virginia
• Impact of federal spending in Virginia
• Impact of housing industry on Virginias revenues
  
• Conclusions

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The Rise and Fall of State Spending

• Review of the Budget
• 1990s through 2001

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Rise of State Spending Review of the late 1990s
through 2001

• 1996-98 biennial budget was structurally
  balanced
• From 1998 to FY 2001, Virginia experienced strong
  revenue growth, with each year stronger than the
  last and healthy year-end surpluses
• Three consecutive years of growth above 10
  percent
• Rainy Day Fund grew to 940.0 million
• Growth drivers of the early 1990s had abated
• Corrections, Medicaid and K-12 enrollment
• New spending and commitments were made
• Car tax, tax policy changes (military income,
  double weight, coal tax credit, sales tax on
  food, etc), school construction, Medicaid
  provider rate increase, repaid the TTF, full
  funding of 599, deputy sheriff 11500, special
  pay and benefit increase for public safety
  employees, rollback and freeze of college tuition

5
General Fund Budget Growth FY 1998 to FY
2001General Fund Budget Growth 3,552.4
BillionDollars in Millions
6
2001 RecessionManaging the Budget Problem

• Fiscal Years 2002 - 2004

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2002 Session

• FY 2000-2002 Biennium Caboose Bill
• Revenue reforecast presented in January 2002
  revealed a FY 2002 budget gap nearly 1.5 billion
  for fiscal year ending June 30, 2002
• Revenue shortfall of 1.2 billion plus 300
  million new spending pressures
• Given the limited time left in FY 2002, HB 29
  attempted to manage the budget problem rather
  than fix it
• 2002-2004 Biennium
• Combination of insufficient revenues and spending
  pressures resulted in
• FY 2003 shortfall 2.3 billion
• FY 2004 shortfall 2.1 billion

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2002-04 BudgetActions to Close Budget Gap

Action in Millions Percent of
Total Reductions to Gen. Fund Agencies
1,001.6 23.0 (Includes Medicaid
containment strategies) Non-general Fund
Transfers 725.7
16.7 (includes budget reductions, i.e., DMV,
VDOT) Reductions to Local Aid
452.6 10.4 Rainy Day Fund
374.4 8.6 Half-cent Sales Tax From TTF
317.0 7.3 Fee Increases
276.3 6.3 VRS Rate Reductions
(GFNGF) 265.8 6.1 Tax
Policy/Revenue Changes 239.0
5.5 Literary Fund for Teacher Retirement
231.3 5.3 Supplant General Fund
Dollars 124.4
2.9 Freeze Car Tax at 70
118.8 2.7 Use Debt for Capital Projects
98.1 2.3 Other
Actions 70.0
1.6 Technical Forecast Adjustments
58.4 1.3 Total
4,335.4 100.0
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Use of One-time Actions 2002-04 Budget

• Chapter 899 and Chapter 1042 used one-time
  actions to help manage the budget problem
• The use of one-time actions in FY 2004 create a
  structural imbalance in the 2004-06 budget
• One-time fixes include actions that are not
  ongoing (Rainy Day Fund, Tax Amnesty, Capital
  Balances) or that require overriding the Code
  (Transportation funds, Game Fund, 4-for-Life)
• In total, Chapter 899 and Chapter 1042 contain
  approximately 500.0 million in FY 2004 one-time
  actions, excluding Literary Fund and sales tax
  acceleration
• Some of these Code overrides could be continued
  next biennium
• Literary Fund transfer totals 118.7 million in
  FY 04
• Can be used for Teacher Retirement under the
  Constitution
• Sales tax acceleration totals 139.0 million
• During the 1990s recession, one-time actions
  were also used to help manage the budget problem

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General Fund Appropriations Compared to General
Fund Tax Revenues and Lottery Profits 1990 - 2004
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The FY 2004-2006 Budget
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Overview of Governors 2004-2006 Budget Proposal

• Using the baseline revenue forecast,
  approximately 1.8 billion in net new general
  fund resources were anticipated to be available
  above the base budget
• Net new spending totaled approximately 3.0
  billion
• Remaining budget gap was approximately 1,167.9
  million
• Governors tax proposal generated approximately
  1,177.1 billion

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House and Senate BudgetsTwo Different Paths

• Respective budgets reflected different approaches
  to balancing the budget
• Both budgets assumed the need for additional
  revenue above normal economic growth
• House assumed less revenue than Governors
  proposal. Senate budget assumed more revenue
  with additional spending in public education and
  transportation
• Senate subsequently dropped the transportation
  package - 1.5 billion
• Both budgets shared many common features
• Preserving the Triple A bond rating
• Re-benchmarking of SOQ, full funding for
  Medicaid, new investment for higher education in
  order to address enrollment growth and moderate
  tuition increases
• Major sticking point was funding the new
  Standards of Quality

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Final Revenue PackageHouse Bill 5018 and Senate
Bill 5005

• On April 28, 2004 the General Assembly adopted HB
  5018 which it expected to generated 1.45 billion
  in net additional revenue over the 2004-2006
  biennium. Key components included
• One-half cent increase in sales tax increase
  one-quarter to the General Fund one-quarter
  earmarked for public education/tax relief
• Increase in cigarette tax 17.5 cents in FY 05
  and 27.5 cents in FY 06 (total tax of 20 cents
  and 30 cents)
• Revenue is deposited into a special health care
  fund
• Modification to the senior age deduction
  grandfathers everyone that was 65 on January 1,
  2004. Establishes a means test for persons
  turning 65 after January 1, 2004.
• Increase in recordation tax additional 10 cent
  per 100 increase in recording fee
• Reduced taxes 1.5 cent phase-out of food tax
  starting July 1, 2005, increased the personal
  exemption from 800 to 900, eliminated the
  marriage penalty
• SB 5005 - Capped car tax at 950 million per year
• Effective July 1, 2006
• Localities will receive a percentage share based
  on CY 2005 reimbursement
• Localities will be required to set tax rates that
  provide relief for personal vehicles valued at
  20,000 and less
• Establish a base rate applied to all vehicles
  below 20,000 and a separate rate for values over
  20,000
• Business vehicles will be assessed a single rate

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Virginias Economy A Mild Recovery?

• Why did economists believe this?

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Would We Get the Bounce?

• The factors that made the 2001 recession mild led
  economists to believe Virginia would have a mild
  recovery
• No pent-up consumer demand
• Consumers held this economy together they
  account for 2/3 of economic activity
• Aided by strong housing market and home
  refinancing
• Slow job growth
• Statewide low unemployment rate
  full-employment
• Majority of employment growth was occurring in
  Northern Virginia federal procurement, homeland
  and national security
• Hampton Roads held its own during recession and
  did not lose jobs
• It was expected that job recovery would not be
  completed until the end of fiscal year 2004
• Productivity allowing companies to do more with
  fewer employees
• Manufacturing job loss - most likely permanent

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Virginias Economy Bounced To Expansion

• The job growth rate underpinning the December
  2003 forecast assumed growth would total only
  1.2 in FY 2004. The consensus forecast
  anticipated that job growth would accelerate in
  the second half of the fiscal year, recovering to
  the pre-recession peak by June 30
• Actual job growth occurred in Virginia about 3-6
  months earlier than anticipated
• Driven largely by growth in Northern Virginia,
  which accounted for over 50 of the job gains in
  2004

Expansion
Pre-Recession Peak Employment -3,555.0
Fall Forecast
Source Bureau of Labor Statistics
18
Not All Regions Recovered Back to Peak

• By March 2004, Virginia economy was expanding,
  having recovered all of the jobs lost during the
  recession. As of June 2004, Virginia had gained
  nearly 30,000 new jobs
• All but three sectors experience jobs gains,
  manufacturing information and transportation,
  warehousing and utilities
• Other than Northern Virginia and Hampton Roads,
  the remaining areas of the state had not
  recovered from their pre-recession peak

Richmond
Roanoke
Cville
Danville
Lynchburg
Hampton Roads
Statewide
NoVA
Source Bureau of Labor Statistics
19
Northern Virginia Continues to Lead the State in
Total Job Growth

• Job growth in Virginia continues to out perform
  the nation Adding over 78,000 jobs in FY 06
• Northern Virginia accounted for over half of the
  job gains, followed by Hampton Roads and Richmond
  
• Charlottesville had the largest percentage
  increase in job growth among all MSAs in the
  state
• Is approximately 2,200 jobs ahead of
  pre-recession peak
• Roanoke, Lynchburg and Danville still had not
  recovered all of the jobs lost during the 2001
  recession by close of 06
• Danville continues to lose jobs

Source Virginia Employment Commission
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Whats Driving the Train?

• Between FY 2004 and 2006, Northern Virginia
  accounted for nearly 54 percent of the states
  total job growth
• NoVa employment growth has not fallen below 3
  percent since fiscal year 2003
• Nearly 60 percent of the job gains in Northern
  Virginia have been concentrated in two industries
• Professional and Business Services
• Construction
• Employment growth has been driven by federal
  spending, which accounts for one-third of the
  regions economy and the increase in both
  residential and commercial real estate

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Professional and Business Services and
Construction Job Growth Since 2004

• 24 of the states total jobs are in two
  industries professional and business services
  and construction
• Since the recovery began in 2004, over 50 percent
  of the jobs created have been in these
  occupations
• In NoVa, they account for nearly 60 percent of
  the total new jobs

Source Virginia Employment Commission
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Impact of Federal Spending on Virginias Economy

• Is the Federal Government the Engine in Northern
  Virginia?

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Northern Virginia and the Federal Government

• Federal spending constitutes 35 percent of the
  regions economy (payroll and procurement)
• Procurement spending represents nearly 50 percent
  of total federal spending
• 78 percent of the contracts are in the service
  industry high wage jobs like data processing,
  telecom services, professional and managerial
  support
• Federal procurement spending has been the biggest
  gainer among the major sources of federal
  spending since 1996
• Gains have been greatest since 9/11
• According to the Center for Regional Analysis at
  George Mason University, nearly 7,000 jobs are
  created for every 1.0 billion in federal
  procurement spending
• Estimated that approximately 50 percent of all
  new jobs in DC area tied to federal procurement
• Department of Defense accounts for 56 percent of
  the contracts

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Federal Spending Growth Has Slowed

• From Fiscal year 2002 through 2004, procurement
  spending increased by approximately 18.7 billion
  in the Washington MSA to 52.6 billion
• Nationwide, 16 cents of every federal procurement
  dollar is spent in the Washington MSA
• Up from 4 cents in 1983
• Over 50 percent of the procurement spending is in
  Northern Virginia
• Preliminary data indicates that federal
  procurement spending increased only about 3.0
  percent in 2005
• Down from the 19 percent gain the previous year
• Data excludes spending by the Postal Services,
  FAA, CIA and certain defense intelligent agencies

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What is the Impact of Slower Federal Spending?

• Impact will not be as significant as the late
  1980s size and diversification
• Not all procurement is the same
• Services and RD procurement account for 84
  percent of the total spending actually saw an
  increase of 6.8 percent
• Northern Virginias share of procurement
  increased 5.4 percent
• The District saw a decline of 5.8 percent

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Near Term Outlook

• Continued deceleration in federal spending will
  dampen employment growth in the region in 2007
  and 2008
• NoVa accounts for nearly 60 percent of the Metro
  employment growth
• Prior year federal monies are still being spent
• Pig in the python
• Overall, employment is expected to grow at or
  slightly less than 3 percent, below the 3.5 - 4.0
  percent growth rates seen over the last 3 fiscal
  years

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Impact of the Housing Industry on General Fund
Revenues
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How Does Housing Industry Impact State Revenues?

• Recent housing boom has affected three core GF
  revenue sources
• Recordation taxes
• Corporate/Nonwithholding
• Sales Tax
• Direct impacts
• Recordation revenues
• Business income growth in building and real
  estate industry profits
• Sales tax building materials and home
  furnishings
• Indirect impacts
• Wealth effect of housing allowed for general
  consumer spending growth

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Recordation Taxes Major Source of Recent Revenue
Growth

• Previously, recordation taxes were a minor
  general fund revenue source
• In FY 2000, recordation revenues totaled 123
  million and comprised 1.1 of GF revenues
  collected
• But over the past 5 years, economic-based
  recordation tax collections (exclusive of tax
  increase) have grown 260 percent, and comprised
  2.7 percent of total GF revenues last year
• Grew 9.9 in FY 2006 following 5 years of
  double-digit increases averaging 22.7 per year
• Exclusive of tax increase, grew to 373.5 million
• Inclusive of the tax increase, recordation
  revenues totaled 622.5 million and comprised
  almost 5 percent of GF revenues in FY 2006
• Recordation tax revenue increases account for 20
  percent of total general fund revenue growth
  since 2000
• FY 2007 recordation revenues fell between 15-20
  percent
• Still waiting on year end data.
• Source didnt fall quite as dramatically as
  anticipated

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Growth in Recordation Tax Revenues(exclusive of
tax increase)
( in thousands)
260 percent increase over past 5 years
31
Recordation Revenues Decline

• Official forecast assumed recordation tax
  revenues will decline 20.2 percent in FY 2007 a
  drop of close to 100 million
• Based on performance through May, FY 07 revenues
  declined by approximately 15 percent
• Recordation tax collections are driven by three
  factors
• Homes sales
• Price appreciation and
• Refinancings
• Recent slump in recordation taxes and housing
  market overall has been driven primarily by
  declining sales volume to date
• Statewide volume of home sales has declined
• Statewide, sales through May 2007 down 16 from a
  year ago
• Represents an improvement NAR reported drop in
  year-over-year sales of 25 percent last August
• Decline in Northern Virginia felt earlier
  September 2006 down almost 36 percent compared to
  September 2005, down 12 percent current year
• Northern Virginia generally accounted for 37 of
  home sales and 50 of recordation revenues one
  year ago, fallen to 30

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Source Department of Taxation
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Recordation Revenues Role of Price Appreciation

• In addition to historically high levels of home
  sales, record price appreciation drove growth in
  recordation revenues the past 3 years
• Between January 2003 and May 2007, average home
  prices in the major urban areas increased at
  following rates
• Although price appreciation continued after the
  sales volume began to decline, pricing flattened
  and then declined in some regions as well
• As of May, Northern Virginia prices have
  increased 1 percent year over year from last May
• Declined from highest price point in November
  2005 (from 524k to 516k)
• Use of builder incentives has staved off price
  declines to a certain extent
• General rule of thumb is that price depreciation
  occurs about 18-24 months after the peak in sales
  volume
• NoVa pending sales have been declining since 2005
• Drop off in rest of state more recent Richmond
  only recently going South

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Impact of Housing on Business Taxes

• Recent Trends
• Like recordation taxes, both corporate and
  nonwithholding taxes have been buoyed by the
  housing industry over past 4 years
• Similarly, along with recordation revenues,
  corporate and non-withholding taxes have been
  major sources of GF revenue growth
• Corporate income taxes have grown an average over
  32 percent each year for past 4 years and account
  for 15 percent of total GF growth since 2002
• Nonwithholding tax revenues have increased an
  average of 22 percent a year for past 3 years and
  account for 28 percent of total GF growth since
  2002
• Much of this growth has been driven by expansion
  of home building and real estate industry
• Share of GDP attributable to residential
  construction exceeded 6 percent in 2005 higher
  than at any time in 35 years

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Large Company Corporate Income Taxes Final
Estimated Payments by Industry
FY05
FY06
Housing
Note Large companies represent 60 percent of
all payments
37
Impact of Housing on Business Taxes

• Forecast
• Leading home builders have been reporting far
  weaker results
• Toll Brothers said contracts for new homes are
  down 20 percent from a year ago Centex, Ryan
  report similar fall-offs
• Statewide housing permits are down almost 40
  percent in Virginia from high in 2005
• Down 28 percent over past year (May 07 compared
  to May 06)
• Corporate income tax receipts lag economic
  trends, declining corporate profits are projected
  to impact that source by FY 2008

38
Building Construction Jobs in Virginia
12-month growth rate
Source NAR
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Housing Impact on Sales Taxes

• Housing boom had substantial direct and indirect
  impacts on sales tax collections
• Direct impacts on both consumer and business
  purchases
• Producer side building material, lumber etc.
• Lumber, building materials and supplies were the
  fastest growing subcategories of sales tax in
  both FY 2004 and FY 2005, growing 18.3 percent
  and 16.6 percent in the respective years
• Consumer side home furnishings and accessories
  expenditures which account for about 3.0-3.5
  percent of consumer expenditures

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Direct Effects of Housing on Sales Tax
Collections Producer SideBuilding Material as
Share of Sales Tax Revenues
41
Indirect Impacts of Housing Boom on Sales Tax
Collections

• Major indirect impacts of housing boom on sales
  tax collections were on the consumer side of the
  equation
• These effects are harder to quantify
• Wealth effect of price appreciation
• Spending based on general consumer confidence
• Impact of cash-out refinancings

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Sales Tax and Personal Income GrowthThree-month
Moving Average of Year-over-Year Growth
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Consumer Impacts of Indirect Impacts of Housing
Boom on GF Revenues

• Growth in refinancings had substantial impacts of
  consumer spending
• Three-quarters refinancings are cash-out
• Mortgage withdrawals accounted for close to 8
  percent of disposable income and more than 4
  percent of consumer spending in 2005

44
How Are Funds Used in Cash-Out Refinancings?
Source Federal Reserve Survey on use of funds
from cash out re-financings 2001/2002.
45
Mortgage Equity Withdrawal Has Eased
(Percent of disposable income)
Source Federal Reserve - Kennedy/Greenspan data
updated as of September 2006
46
What is the Potential Impact of a Housing Market
Decline?

• How substantial and long-lasting will the housing
  decline be and how will it affect the general
  fund revenue outlook?
• Negative Pressures
• Rapid price increases have placed home prices
  somewhat out of synch with true values based on
  underlying economics
• Market specific NoVa one of more over-valued
  regions in nation, rest of state more in line
  with values
• Use of alternative financing has sustained
  activity in recent quarters as interest rates
  have risen and affordability has declined
  reaching its limits
• ARMs accounted for 35 of loans in 2005,
  interest-only loans above 25 in same year
• Increases in delinquencies/foreclosures have led
  to tightening of mortgage market and reduced
  qualifications
• Northern Virginia MAY have reached bottom of
  market prices could drop in the other areas of
  the state and market projected to remain flat for
  the next 12 months

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What is the Potential Impact of a Housing Market
Decline?

• Stabilizing Forces
• Unlike previous housing declines, other
  fundamentals in economy remain strong
• Interest rates still relatively low, not
  projected to spike
• Average rates in current decades have been 9
  percent in 1970s, 13 percent in 1980s, 8 percent
  in 1990s
• Even with increases, average rates in 2000s to
  date has been about 6.5 percent
• Job and income growth continuing albeit at slower
  rate on statewide basis
• Job growth expected to remain in 35-40,000 new
  jobs per year range in Northern Virginia for next
  two years, exceeding the 10-year average
• 10 percent decline in house prices not expected
  to severely dampen consumer spending

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Foreclosures
Very Low Concern
Source MBA
49
Conclusions
50
Risks to Virginias Economy

• Harder landing in the housing sector
• Energy price increase
• Federal deficit reduction efforts could impact
  defense and overall procurement spending

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2008 SessionWhy Restraint Should Be the Rule

• Known 2008 - 2010 budget obligations include
• Estate tax Due to the effective date of the
  Estate tax repeal, only 35 million in revenue
  loss was recognized. The annual impact is
  estimated at 140 million
• Biennial updates for SOQ and Medicaid re-basing
• Dedication of recordation taxes for
  transportation - 65 to 70 million per year
• Debt service for General Obligation Bonds
• Bond issues phased-in
• Operating and equipment costs of new buildings
  coming on-line
• Avoid new programs that expand the base