Oregon Office of Economic Analysis

Mark wanted to provide some additional insights into the revenue outlook. His thoughts are below.

The Revenue Forecast and Oregon’s Budget Gap

On December 12, 1980, Governor Vic Atiyeh issued Executive Order # EO-80-21, which created the Governor’s Council of Economic Advisors. The Council answered a need not only to improve the advice concerning future economic activity of the State of Oregon, but also to improve fiscal planning and revenue forecasting. The Council recently met with state decision makers to talk about the state budget gap and its impact on the economy.

Council members come from a range of academic and industry backgrounds, and hold a range of political ideologies. The Council’s main role is to advise our office on the quarterly economic and revenue forecast. It was with the reluctant blessing of the Council that the largest drop ever was put in the quarterly forecast the other week. Although the revenue outlook is a big piece of Oregon’s budget gap, it is far from the only one. Other key factors entered the discussion as well.

The Revenue Forecast  

The record drop in the June quarterly forecast was a reflection of the unique nature of this downturn. The sudden stop of economic activity made it immediately clear that Oregon was in recession, and that job losses would be severe. In the typical recession, it takes some time before the downturn is fully incorporated into the baseline outlook.

This time around, the damage was incorporated into the forecast all at once. Other than the timing, the change in revenue expectations is not unusual relative to past recessions. Over the 40 years that the Council has advised our forecasts, big recessionary declines have been the norm, with the notable exception of the early 1990’s. The stable forecast during the 1990’s recession was admittedly more a function of luck than foresight. Incomes and tax revenues did not decline in Oregon at that time–growth only slowed.

The chart below shows General Fund forecast errors over the past 40 years. The composition of the General Fund has been very stable over time, making comparisons possible. However, Oregon now relies significantly on other discretionary revenues such lottery sales and the new corporate activity tax, making the overall revenue hit larger than is reflected by General Fund changes alone.

How has the forecast performed? It depends on how you look at it. During the average two-year budget period, General Fund revenues have come in 1.3% higher than was expected when budgets were written. Not bad.

Unfortunately, it is rare that we actually experience something that looks like an average budget period. In practice, large forecast errors happen frequently. In roughly half of all budget periods, there is either a large revenue shortfall or a significant kicker payment issued. Over time, forecast errors on the downside and upside have offset each other, but can be very large in any given budget period. Our office depends heavily on the God of Offsetting Errors. Even in a year when the overall revenue forecast hits the mark, forecasts for some revenue components will be way too high, with others way too low.

If current expectations hold, the revenue decline for the current biennium will be something that policymakers have dealt with before. The June forecast calls for $1.5 billion less in General Fund revenue than was expected when the budget was drafted. The 2001-03 biennium saw a forecast drop of $2.3 billion in a General Fund less than half its current size.

That said, this historical forecast comparison does not fully capture the difficulty facing policymakers today. Timing has helped. The current biennium’s revenue outlook would have been revised downward even more if several months of it were not already in the books. In particular, income tax liability for the 2019 calendar year was already set before the downturn.

Also, the historical forecast comparison does not capture the strain on future budgets. We cannot estimate a budget gap until there is a budget, but know there will be fewer resources going forward. Relative to the last forecast, we now expect $3.5 billion less in General Fund revenue during the 2021-23 budget period, and over $4 billion less in overall discretionary revenues.

Unlike the federal government, Oregon and most other states must run a balanced budget. As a result, more revenue must be found or services must be cut. The Council’s discussion centered on best strategy to bridge the gap.

Falling tax revenues are only one component of the state budget gap. The expenditure side of the ledger and other funds and balances are equally important.

Balances and Reserves   

Before now, Oregon has never had the benefit of entering a downturn with a significant amount of reserve funds or balances. Automatic deposits into the Rainy Day Fund (out of corporate taxes and General Fund ending balances) and Educational Stability Fund (out of lottery sales) have added up over the decade-long economic expansion leaving us with sizable resources. If left untapped by the end of the biennium, the two reserve funds together are expected to reach $1.75 billion or 9% of the General Fund.

In addition to dedicated reserve funds, the Oregon budget also had a large expected ending balance heading into the recession. Due in part to the incomplete way the 2020 short session ended, the budget had more than a $1 billion cushion for the current biennium. Although the June revenue forecast erased this and then some, the budget gap is smaller because of it.

Although reserves are welcome, they alone will not be enough to bridge Oregon’s budget gap over the extended horizon. At request from Governor Brown, the Council discussed how to best deploy these reserves strategically over time balancing the dire need for public services today with the long-term nature of the expected revenue shortfall.

Federal and Other Funds   

Although most of the attention falls on the General Fund and Oregon’s other discretionary revenues, they represent a minority of the state’s resources. Oregon’s agencies collect a wide range of dedicated revenue streams that together account for almost twice the General Fund. Some of these revenue sources are already weakening due to the recession. For a look at the range of Other Fund revenues from fishing licenses, to PERS investment earnings, to gasoline taxes. See out office’s Other Funds Report for more information.

Federal funds are also larger than the General Fund, and are particularly important during recessions. State and local governments deliver the core services that distressed households and businesses require during downturns. With the ability to run deficits, the federal government can support these services when state policymakers cannot.

The CARES Act delivered a significant amount of aid to states, but much of it was restricted from being used to support core state services. Federal policymakers dedicated $1.6 billion to Oregon as part of the CARES Act to be used to support pandemic-related costs. Across the country, state and local governments have pushed for more flexibility in the use of these funds. Despite some success in these efforts, many core services remain unable to benefit.

There is a saying that state governments do only three things: Educate, Medicate and Incarcerate. There is an element of truth to this. Together, Education, Human Services and Public Safety account for 92% of Oregon’s General Fund expenditures. Federal support for core educational and healthcare services in the CARES act is only half as large as what was included in the American Recovery and Reinvestment Act of 2009, despite arguably more need today.

Expenditures   

There are two sides to the state budget–revenues and expenditures. While revenues drop during recessions, the need for a wide range of core public services rises. Caseloads for unemployment insurance, health services, housing support and many other programs will increase going forward. Agencies are currently drafting their budget requests for the upcoming biennium which will reflect the new reality. We will get a first look at how much need has risen when Governor Brown releases her recommended budget in the fall.

Much of the Council’s discussion with policymakers revolved around how to prioritize state programs in the current economic environment. Long-term investments in the economy were also discussed, as was the merit of tapping bond markets to backfill crucial programs in the way businesses secure working capital loans. Additional discussion sessions are in the works to help policymakers with the difficult choices ahead.