This past budget season lawmakers and Governor Tom Wolf enjoyed the rare luxury of deciding how to spend a surplus of revenue generated largely because of a massive inflow of federal dollars intended to combat the impact of the COVID-19 pandemic.
Now storm clouds are on the horizon.
In the immediate, mid-range and long-term futures fiscal and demographic trends are conspiring to create what will be painful spending and taxation decisions for budget-makers. And those challenges will have to be met by a rookie crew. When the 2023-2024 state budget process begins in January Penn’s Woods will have a new governor and new chairmen will be at the helm of both the Senate and House appropriations committees.
The historic high rate of inflation has prompted the Federal Reserve Open Market Committee to implement a series of significant target interest rate hikes designed to cool off an economy overheated by trillions in federal spending financed through borrowing and the “printing” of money. The increase in the money supply has not been matched by a corresponding increase in productivity, the primary cause of the current inflationary spiral.
Many economists fear the Fed may go too far in raising rates thus triggering a recession, if in fact we are not already in one. Pennsylvania is not well positioned to weather a recession. Although the Corporate Net Income Tax (CPI) was cut by 1% this budget year the state still has one of the highest such taxes in the nation. The Tax Foundation ranks our business climate at 33rd – below the national average and actually slipping one spot since last year.
According to The Center Square Moodys “stress tested” every state for how well its finances could handle a recession and found that Pennsylvania would have a tax revenue shortfall of 11.3% or about $4.5 billion. Moody’s noted: “Recessions in the business cycle are a fact of life. Therefore, preparing for recessions is an equally inescapable concept, with potentially devastating consequences for those who treat it as an after though.”
It should be noted that Republican lawmakers successfully fought efforts by Governor Tom Wolf and legislative Democrats to spend all of the federal windfall this year opting instead to bolster the “rainy day” fund. However, future fiscal traps remain.
A report by the Commonwealth Foundation termed Pennsylvania a “Wayward Welfare State” and details how expansion of Medicaid eligibility and suspension of verification of eligibility have resulted in cost increases along with people getting benefits who do not qualify for them. The report notes one-third of the Pennsylvania state budget goes toward Medicaid, and significant growth is expected especially as the state’s population continues to age and the working-age population shrinks.
For many years the unfunded liability of Pennsylvania’s public pension funds has been a fiscal sword of Damocles hanging over state finances. The significant losses suffered by the equity markets this year have dramatically exacerbated the problem.
Estimates have varied but entering this year the Public School Employees Retirement System (PSERS) and the State Employees Retirement System (SERS) were underfunded by approximately $44 billion. As a result of the current bear market, PSERS has seen a 6% drop in the value of its investments, about $4.8 billion and the SERS portfolio has lost $3.7 billion in value.
Add that to the already existing funding gap, along with aging demographics increasing the number of annuitants, and the systems may soon face a challenge meeting their obligations. Since both are defined benefits (contractually required) pension plans they have no choice but to meet those obligations. If and when a shortfall occurs, taxpayers will be obligated to make up the difference dealing a potentially devastating blow to the state budget as well as to homeowners who will face higher property taxes.
Demographics are also working against us. A new report from the Independent Fiscal Office projects near term population growth in Pennsylvania will remain flat and will decline slightly in the long term.
The most worrisome aspect of the report is that the population of younger residents (0-19) is likely to decline by nearly one percent per year. The working-age population is also expected to decline. Conversely, the number of retirees is projected to increase by almost 1% per year over the long term.
The report concludes: “Unless a dramatic change occurs, Pennsylvania political leaders will face population stagnation and decline that could limit economic growth.”
The window for making the necessary changes to the commonwealth’s spending patterns, tax policies, and business climate is very short. As the 2023-2024 session of the state legislature begins, and a new governor takes office, bold and decisive action must be taken before it is too late to prevent a state fiscal disaster.
(Lowman S. Henry is Chairman & CEO of the Lincoln Institute and host of the weekly Lincoln Radio Journal and American Radio Journal. His e-mail address is [email protected].)
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