Budget Wrap-Up: Red Riding Hood delivers goodies but big bad wolves still lurking

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At the start of the legislative session, we compared Maryland’s budget situation to the story of Little Red Riding Hood and the Three Big Bad Wolves (okay – we changed things around a bit to make our point).

We said that it should not be too hard for the legislature to enact a balanced budget for the next year. It should be as easy as walking through the woods to deliver a basket of goodies to Grandmother’s house. 

However, we warned there were some risks. In particular, there were three Big Bad Wolves lurking who could endanger the budget before the legislature can deliver the basket in April. The wolves were the federal fiscal cliff, the hungry state transportation fund, and the state’s ongoing “structural deficit."

What happened? Let’s find out.

Governor O’Malley proposed a budget that included no significant revenue increases, no catastrophic cuts, and preserved a fund balance over $1 billion. The legislature made modest amendments and enacted the budget without drama.

What about those wolves?

1. The first wolf was called Cliff: Fiscal Cliff. 

Congress acted early in the year to avert the worst effects of large automatic tax increases on everyone. However, Congress deferred decisions related to automatic spending cuts and the federal debt limit. Deadlocks on these issues, or unsound resolutions of them, could have resulted in serious losses of federal revenue for Maryland and maybe some negative shocks to the state economy, which would also affect the budget. 

Congress allowed the “sequester” cuts to take effect March. This will cut about 5 percent from most domestic programs and about 8 percent from military budgets. The effects on Maryland’s revenue and economy are still uncertain, but will be significant. Late in March, Congress enacted a budget “continuing resolution” that holds spending levels at the sequestered level through September 30, 2013. Congress is in the early stages of negotiating a budget for federal fiscal year 2014, which begins October 1, 2013. Congress also extended the federal debt ceiling until May.

So, there remain ample opportunities for trouble from this wolf. The budget enacted by the legislature leaves balances of over $1 billion as a cushion for the state to manage the ill effects of federal budget problems.

2. The second wolf was the hungry Transportation Trust Fund.  

Maryland needed more funding for roads, transit, and other transportation improvements. The dedicated transportation fund was running low - mostly because its major source - the gas tax - had not been adjusted in 20 years. However, quite a few legislators were skittish about raising gas taxes. The concern was that in seeking a way to feed the transportation wolf without touching the gas tax, the legislature would divert general funds (still under stress and still needed for education, healthcare, public safety, environmental protection, and other important priorities). 

Once Virginia approved a transportation package, Maryland leaders came together on a funding plan for the Old Line State. It will raise gas taxes gradually over a number of years, while providing needed revenues for roads, transit and other transportation improvements.

This wolf may be back, though. The legislature's transportation bill relies on gas tax increases to start with  – the traditional and responsible way to fund the transportation system. However, the bill has one tricky provisions to it: for the final increment of transportation funding, it uses sales tax revenues from internet and catalog sales. Here’s how it works: right now, states cannot legally require out-of-state sellers to collect sales tax on purchases made through websites, phone or mail. But there’s a bill in Congress that would give states that authority. If Congress passes that bill by December 2015, then a 4 percent share of the sales tax (a rough estimate as the sales that will come from internet and catalog sales) goes to the transportation fund. And this is going to be a problem for schools, health providers, police departments and other services that rely on sales tax and other traditional “general fund” revenues. 

3. The third wolf is a familiar one: the state's "structural deficit." 

Even though the budget is balanced through the next 15 months, the state is still taking in less that it's paying out over the course of the year. The difference is called a "structural deficit." The state can balance its budget for the year by using cash from revenue surpluses from previous years. But if there's a structural deficit, that budget cannot be repeated in future years without running into a real deficit.

The structural deficit was $1.7 billion back in 2009. Since then, the legislature and governor have consistently reduced it through a balanced program of spending cuts and new revenues (including gambling proceeds and some moderate tax increases). The state used temporary measures to achieve a positive balance at year end. Maryland did not actually go into "the red" at any time during this period.

The structural deficit for the 2014 budget the legislature just enacted is $174 million – about one tenth the size of the structural deficit at the height of the recession. Budget projections call for the remaining structural deficit to be eliminated by 2017 (and a little bit of good revenue returns could wipe it out earlier).

That’s very good news. However, this is one wolf who never goes very far away. As the state’s annual surplus rises and falls, it’s very important to keep an eye on the structural balance. Maryland has worked very hard to restore our finances to long-term balance. Many states across the country are considering precipitous tax cut programs after just one year of favorable revenue performance. Maryland needs to be more responsible than that.