|Washington's Financial Outlook
and Key Budget Considerations
I N MANY RESPECTS, Washington State's fiscal outlook is more promising now than at any point in the past two decades. Brisk hiring by companies - in fields ranging from aerospace and microchip processing to agricultural products and business services - has helped to invigorate the state's economy, which is both more stable and more diversified than in years past. Unemployment rates are down and personal income is up, improving the financial position of individuals and businesses alike. This economic revival comes at a time when cost-saving measures adopted by Governor Lowry and the Legislature have held growth in state expenditures to the slowest rate in more than a decade, contributing to a healthy reserve.
Still, Washington State faces some major challenges in the years ahead. Local communities are just beginning to feel the effects of federal budget reductions, while state and local governments are facing mounting financial pressures in such areas as public safety, higher education, and social services for children, senior citizens, and people with disabilities. Rigid spending formulas prescribed by Initiative 601 will limit the state's ability to respond to these pressures and may require further reductions in services already strained by federal cutbacks. Governor Lowry's budget proposal to the 1997 Legislature is designed to meet this challenge in a way that supports future economic expansion while ensuring that all people in Washington State will benefit from the state's growing prosperity.
Federal Funding Reductions
Financial Impact on Washington State
According to the latest projections by the state Office of Financial Management (OFM), Washington will lose $1.7 billion in federal funding through the year 2002 as a result of federal cost-cutting measures already signed into law. This figure includes $164.3 million in losses during the current biennium and another $618.9 million in the 1997-99 Biennium. Estimates are based on the amount of federal support that individuals, local communities, and programs administered by the state would have received under previous federal law.
Of the $618.9 million in total federal losses anticipated in the 1997-99 Biennium, $474 million are in programs outside of the current state budget, primarily in direct benefits to individuals (e.g. food stamps) and in programs administered by local governments (e.g. housing assistance). However, many of these reductions will have a significant impact on the state budget.
For example, thousands of elderly, blind, or otherwise disabled immigrants - all living legally in Washington State, but without status of citizenship - will lose eligibility for federal Supplemental Security Income (SSI) under the new federal welfare law, saving the federal government $141 million over the next two years. Under state law, most of these people will qualify for assistance under the state-funded General Assistance-Unemployable (GA-U) program, resulting in a net cost to the state of $80.5 million in the 1997-99 Biennium.
In addition to actual cutbacks, the new federal welfare law also imposes a number of new costs on state government, none of which are included in the estimated impacts of federal reductions cutbacks discussed previously. For example, the Governor's 1997-99 budget proposal includes $4.1 million GF-S to bring state computer systems at the Department of Social and Health Services (DSHS) into compliance with the new federal welfare law.
These and other ramifications of the new federal welfare law are discussed in greater detail in the summary of the Governor's budget proposal for DSHS in Part III of this document.
The Federal Welfare Law
Approximately $379 milllion of the $618.9 million in total reductions in federal revenues anticipated in the 1997-99 Biennium is the result of the new federal welfare law, titled The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L. 104-193). By any estimation, this law represents the most significant change in federal public assistance policy in more than 60 years.
P.L. 104-193 eliminates the long-standing individual entitlement to federal welfare benefits, abolishes Aid to Families with Dependent Children (AFDC) and other income-assistance programs, and replaces them with a capped block grant that puts new restrictions on who can qualify for assistance. It also makes sharp cutbacks in the federal Food Stamp Program and denies aid to millions of legal immigrants who are not U.S. citizens. (Illegal immigrants do not currently qualify for food stamps, AFDC, or Supplemental Security Income - a major target for cutbacks under the new law.)
The Urban Institute estimates that P.L. 104-193 will increase the number of Americans living in poverty by 2.6 million, including 1.1 million children. How this law affects Washington's families and communities will depend in large part on how the state responds to the following issues:
The Governor's Response
Throughout the debate in Congress over welfare reform, Governor Lowry opposed federal changes that would undermine the nation's social safety net and impose additional costs on state and local governments. In response to the new law, the Governor has proposed a plan that will allow Washington to continue its current welfare-to-work program, reducing the cost of implementing new federal requirements from $30 million down to $8.2 million. In addition, his proposed budget for the 1997-99 Biennium recommends $220.8 million in state funding to make up for federal cutbacks in areas ranging from nutrition programs and social services for children to cash assistance for families with children, senior citizens, and people with disabilities.
These funds, together with $88.7 million from federal and other sources, will help offset approximately half of the federal cutbacks anticipated in the 1997-99 Biennium. Although the state does not have the resources or the spending capacity to make up for all federal losses, the Governor believes that Washington State must do what it can to preserve those services essential to a healthy society and a strong economic future.
Economic and Revenue Projections
In many ways, Fiscal Year (FY) 1996 marked a turning point in the state's recent economic history. After six years of downsizing by Washington's largest private employer, the Boeing Company increased its work force by 3,800 employees in the last two quarters of the fiscal year, with plans to hire 10,000 more by the end of calendar year 1996. This marked a dramatic turn-around for the state's aerospace industry, which lost a total of 25,000 jobs between the first quarter of 1993 and the second quarter of 1996.
Other industries have also experienced a resurgence in growth, due in part to new tax incentives proposed by the Governor and adopted by the Legislature to encourage business investment in Washington State. New and expanded operations by such companies as Intel, SEH America, Matsushita, and Taiwan Semiconductor have contributed to an increase of nearly 10 percent in electrical machinery employment, the state's fastest-growing economic sector in FY 1996. Personal income in Washington, a key measure of economic vitality, outpaced the national average over the past year, and is expected to grow at more than 6 percent per year through 1999 - at least a full percentage point higher than the national average.
1997-99 Revenue Forecast
After two years of slow growth in state revenues, revenue collections are expected to show a healthy increase in the 1997-99 Biennium. Based on current tax rates, the state will collect $19.43 billion in General Fund-State (GF-S) revenues during the 1997-99 Biennium according to the November 1996 revenue forecast by the Economic and Revenue Forecast Council (ERFC). This represents a 10.5 percent increase in GF-S revenues over the next two years, compared to a growth rate of just 6.2 percent during the current biennium.
While still relatively modest by historical standards, the projected 10.5 percent growth in 1997-99 revenues reflects not only an improving economy but also the restraining effect of tax reductions approved over the past three years. Without these reductions - which have more than offset tax increases approved in 1993 - GF-S revenues would have grown by 11.8 percent in the next two years, according to ERFC's November forecast.
The Governor could not, however, support a 1995 property tax bill that would have reduced state revenues by $92 million in the current biennium and $135.8 million in the 1997-99 Biennium by making across-the-board property tax reductions worth just $18 per year to the average owner of a $100,000 home. While recognizing that rising property taxes can impose a significant financial burden on homeowners with modest incomes, the Governor believes this problem can best be addressed by creating a new tax deferral program specifically designed to help those in need - without compromising the state's own financial stability.
Proposed Tax Deferral Program
As in previous years, the Governor is proposing a new tax deferral program that would allow homeowners with modest incomes to defer a portion of their property taxes to help them cope with increases in their property tax bills. Under the plan he will present to the 1997 Legislature, homeowners with an adjusted gross income of less than $50,000 could defer the portion of their property tax bill that exceeds 5 percent of their income. This, for example, would allow a homeowner with an annual gross income of $40,000 to defer paying any property taxes over $2,000 per year until the homeowner's death or the property is sold.
In total, qualified homeowners could defer taxes amounting to as much as 80 percent of their home equity. The deferred taxes would then be paid back to the state, with interest, upon the sale of the property or death of the homeowner, if there is no surviving spouse. Research by the Department of Revenue indicates that approximately 21,000 people would participate in the program during the 1997-99 Biennium, requiring $40.9 million in state funding in the 1997-99 Biennium. This proposal would provide significant and immediate tax relief to those homeowners who need it most, without impairing the state's ability to meet other public responsibilities.
Initiative 601 Spending Limits
Even so, Governor Lowry has warned that the Legislature will eventually have to reassess the way expenditure limits are determined under the various formulas and constraints prescribed in the initiative. Given the growing financial responsibilities facing state government, including those recently passed down by the federal government, the Governor is recommending two modifications to Initiative 601 that will affect the spending limit for the 1997-99 Biennium.
Initiative 601 was designed to limit increases in state spending to the combined rate of inflation and population growth. In practice, however, the expenditure limit currently projected for the 1997-99 Biennium will fall behind these growth rates because of various other factors that affect the way the limit is calculated. Thus, while population and inflation will grow at an average annual rate of 4.5 percent in 1997-99, the spending limit will allow GF-S expenditures to grow by only 4.0 percent during those years. Moreover, this mismatch between the expenditure limit and actual growth pressures facing Washington is exacerbated by the fact that the current formula fails to take into account many of the new responsibilities "devolved" to state government and local communities under the "new federalism."
As part of his budget recommendation to the 1997 Legislature, Governor Lowry is proposing that two provisions of Initiative 601 be modified to reflect these realities, which were not readily apparent at the time the initiative was voted into law. While neither of the changes proposed by the Governor alters the basic structure of the initiative, they will make future spending limits more responsive to actual demands and prevent a steady erosion of the state's ability to meet its financial responsibilities.
The two modifications discussed below have the effect of increasing the expenditure limit applicable to the Governor's 1997-99 budget proposal by $249.5 million. Without these changes, allowable growth in average annual expenditures will fall from 4.3 percent in the current biennium to 4.0 percent in the 1997-99 Biennium - just as the people of Washington State begin to feel the impact of federal budget reductions.
The erosive effect of rebasing is especially pronounced in the 1997-99 Biennium, because the legislative budget for FY 1996 held authorized expenditures $107 million below the spending limit for that year. This, together with the $31 million in reversions, has the effect of reducing the spending limit in the 1997-99 Biennium by $150 million. Any expenditures below the limit in FY 1997 - whether by legislative intent or through agency efforts to reduce their own costs - will further reduce future spending capacity, resulting in growing disparity between the spending formula and the needs of a rising population.
To remedy this situation, the Governor is proposing that the spending formula be based on previous expenditure limits rather than actual spending. This will not only prevent the future erosion of state spending capacity, but will also eliminate the current financial penalty state agencies face if they don't spend all of the funding appropriated to them in a given year.
This presents a significant problem this year, since many of the deepest cutbacks made by the federal government (e.g. food stamps) do not directly affect the state budget but will have a major impact on low-income families and local communities throughout the state. For this reason, Governor Lowry is seeking clarification in the law so that expenditure limits can be adjusted for any transfer of responsibilities from the federal government that the state Legislature chooses to fund. This would allow the state to accommodate new costs passed down by Congress without undermining its ability to meet current responsibilities.
By assuming these modest modifications in the way the expenditure limit is calculated under Initiative 601, Governor Lowry was able to address growing pressures on public services and construct a responsible budget for the 1997-99 Biennium. In the long term, however, the Governor believes that the Legislature will need to make more fundamental changes in the initiative, since several major components of the budget - notably corrections, higher education, health-care costs, and debt service - will continue to outpace their percentage of allowable growth under the expenditure formula.
Changes in sentencing policy supported by the public and passed by the Legislature will cause growth in the state's prison population to exceed the Initiative 601 growth factors for the remainder of the decade. These pressures - together with an increase in debt service for capital projects already approved and a precipitous rise in the college age population - will add to the gap between policies demanded by the public and allowable spending under the current Initiative 601 formula.
Of the 23 other states with expenditure limits, nearly 60 percent base their formulas on growth in personal income, rather than general population and inflation. The current Initiative 601 formula limits state government spending to a rate of growth about 1 to 2 percentage points per year slower than economic growth. As a result, Initiative 601 prohibits the public and Legislature from spending any part of income gains derived from a stronger economy to improve public services.
Basing the Initiative 601 formula on personal income would maintain controls on government spending, while also giving the public and the Legislature the option of investing the fruits of a growing economy in better public schools, more opportunities for higher education, safer streets, and improved services for the state's growing elderly population. While not part of his budget proposal, the Governor recommends that the Legislature consider this approach, which many economists believe is a more realistic benchmark for state financial policy.
General Fund-State Expenditures and Reserves
The proposed 1997-99 operating budget of $19.531 billion reflects an average annual growth rate of 5 percent for GF-S supported activities. This total is $1.761 billion above the 1995-97 Biennium budget, after taking into account the Governor's proposed FY 1997 supplemental budget.
Approximately 80 percent of this increase goes toward the maintenance of current services, recognizing higher enrollments and caseloads in public schools, corrections, and social services programs; as well as the state service impact of federal budget reductions. Also included in this total is a cost-of-living salary adjustment for teachers and state employees, and an increase in vendor rates and income-assistance grants, based on the rate of inflation.
Based on available funding, the Governor is also recommending the net addition of $300 million to meet priorities in several critical areas. The single largest addition is in public schools, where $120 million is targeted toward the expansion of new technology, levy equalization, partial replacement of federal nutrition programs, and the continuation of learning improvement grants.
Increases of $121 million in Human Service agencies are targeted to address needed improvements in state services for children and families. Funding will be used to further reduce social service workloads, implement welfare reform, and partially replace lost federal funds for food. Approximately $90 million is made available to meet higher education enrollment needs, expand student accessibility to financial aid, and institute new instructional initiatives. These increases will be partially offset by savings due to efficiencies, elimination of inflation adjustments, rate changes, and program reductions throughout state government.
Based on the November 1996 revenue forecast, the state will end the current biennium with an unrestricted GF-S reserve of $445 million after consideration of the Governor's proposed 1997 supplemental budget. The Governor's 1997-99 operating budget and policy initiatives would still leave an estimated $303 million in reserve at the end of the 1997-99 Biennium.
Since the state's rebounding economy has increased revenue projections with each quarterly forecast since June 1996, the Governor feels confident that this reserve will continue to grow well into the 1997-99 Biennium, providing a sufficient cushion to meet unexpected costs in the future.
State Staffing Levels
In the 1995-97 Biennium - including 108 FTEs assumed in the Governor's 1997 supplemental budget - staffing levels are currently expected to grow by 2,083 FTEs, primarily due to staffing demands in higher education and state prisons. If higher education faculty (including staff funded through federal grants and contracts) and other higher education personnel are excluded from these calculations, staffing levels during the current biennium are expected to grow by only 523 FTEs, less than 1 percent.
The Governor's budget proposal for 1997-99 recognizes that some additional state employees will be required to meet new responsibilities shifted to the state by the federal government as well as to meet staffing demands in recent growth areas of the state budget - most specifically corrections, higher education, and children services. Even after meeting these demands, the Governor's budget proposal holds total growth in staffing to 2,725 FTEs or 2.9 percent as compared to general population growth of 3.7 percent. When K-12 and higher education personnel are excluded from this calculation, the total number of FTEs added by the Governor's recommended budget falls to 2,036.
To prevent further erosion of compensation levels during the next two years, Governor Lowry is proposing across-the-board salary, vendor, and grant increases of 2.5 percent in the first year of the biennium and 2.7 percent in the second year. These cost-of-living adjustments (COLAs) correspond to the projected rate of inflation for those years, as determined by the Implicit Price Deflator (IPD). In addition, the Governor recommends several special salary adjustments to address salary inequities, special recruitment and retention issues, and other concerns. The total of the Governor's proposal, including health benefits costs, is $527.2 million General Fund-State and $108.1 million other funds.
K-12 Employees ($221.6 million GF-S)
Under the Governor's proposal, all teachers, classified staff and administrators will receive salary adjustments of 2.5 percent on September 1, 1997 and 2.7 percent on September 1, 1998. K-12 staff had no general increase in the 1993-94, 1994-95, or 1996-97 school years. Not reflected in the above total is $29 million for seniority increases, which more than half of all teachers are scheduled to receive over the course of the biennium based on education and years of service.
Under the state allocation salary schedule, a beginning teacher with a bachelor's degree will earn $22,839 in base pay for the 1997-98 school year, increasing to $23,456 the following year. A beginning teacher with a master's degree will earn $27,383 for the 1997-98 school year, increasing to $28,122 the following year. Top base pay for a teacher with 15 or more years of experience and a master's degree plus 90 additional college quarter credit hours or a Ph.D. is $47,908 in the first year of the biennium and $49,202 in the second.
Higher Education ($80.3 million GF-S)
All classified staff will receive salary adjustments of 2.5 percent effective July 1, 1997 and 2.7 percent effective July 1, 1998. Funding is also provided for institutions to provide faculty and exempt personnel with an average increase of 2.5 percent effective July 1, 1997 and an average increase of 2.7 percent July 1, 1998. In addition to the COLA, the University of Washington and Washington State University will receive $2.25 million to help retain faculty, and the community and technical college system will receive $3.1 million for faculty incremental pay.
State Employees ($81.1 million GF-S, $86.1 million Other Funds)
All classified staff will receive COLAs of 2.5 percent on July 1, 1997 and 2.7 percent effective July 1 the following year. Funding is also provided to provide similar average COLAs to exempt personnel at the discretion of agency directors.
Grants, Vendors, and ECEAP ($67.9 million GF-S)
COLAs of 2.5 percent in July 1997 and 2.7 percent in July 1998 will be provided to public assistance grant recipients ($15.3 million), selected vendors ($50.9 million), and the Early Childhood Education and Assistance Program (ECEAP, $1.7 million). Providing a COLA to recipients of income assistance will help mitigate the impact of cutbacks in federal funding for food stamps and other forms of aid, discussed in Part III of this document in the overview of the proposed budget for the Department of Social and Health Services.
Special Salary Adjustments ($20.6 million GF-S; $8.7 million Other Funds)
In addition to general across-the-board increases, Governor Lowry is proposing several special salary adjustments to address issues discussed below.
Health Benefits ($55.7 million GF-S, $13.3 million Other Funds)
Although inflation for medical services has leveled off in recent years, rates are still increasing at approximately 5 percent to 6 percent per year for employee coverage. To maintain current benefits, the Governor has proposed additional funding that continues employee contributions at current levels, and assumes full utilization of the surplus in the Health Care Authority Insurance Fund, except for a one percent contingency reserve. For state, higher education, and K-12 employees, the health benefit rate for Fiscal Year 1998 will be $324.66/month per employee and $344.14 for Fiscal Year 1999 under the Governor's proposal.
In 1996, the Legislature approved ESSB 6680, which directs OFM to develop a six-year plan to "merge the budget development process with agency performance assessment measures." [RCW 43.88.090(5)] As part of the 1997-99 budget process, OFM instructed all state agencies to include strategic plans and performance measures along with their requests for funding. These measures provide a baseline for assessing the relationship between dollars invested and results achieved. Examples of performance measures included in the Governor's budget include:
Performance data selected for publication are intended to reflect the measures most closely aligned with an agency's mission, strategies, and expenditure needs. Ideally, the measures are understandable and useful to policy makers, agency managers, and the public alike.
Once the 1997 Legislative Session is concluded, agencies will also be asked to report actual performance data to OFM on a periodic basis. Assistance to agencies during the interim will focus on documenting performance measurement systems, enhancing the validity and reliability of measures, and assisting with strategic planning efforts. It is Governor Lowry's expectation that performance measures developed as part of his 1997-99 budget proposal will contribute an important new dimension to the budget process in Washington State.