Joseph Krist

Publisher

CALIFORNIA BUDGET GAP

The Legislative Analysts Office in California has released its Fiscal Outlook prepared for the upcoming budget season. This along with the Governor’s budget and the May revision are the three key dates in the budget process. The report identified three key areas of concern. Largely as a result of a severe revenue decline in 2022‑23, the state faces a serious budget deficit. Specifically, under the state’s current law and policy, the LAO estimates the Legislature will need to solve a budget problem of $68 billion in the coming budget process.

Typically, the budget process does not involve large changes in revenue in the prior year (in this case, 2022‑23). This is because prior‑year taxes usually have been filed and associated revenues collected. Due to the state conforming to federal tax filing extensions, however, the Legislature is only gaining a complete picture of 2022‑23 tax collections after the fiscal year has already ended. Specifically, the LAO estimates that 2022‑23 revenue will be $26 billion below budget act estimates.

One positive takeaway notes that while addressing a deficit of this scope will be challenging, the Legislature has a number of options available to do so. In particular, the Legislature has reserves to withdraw, one‑time spending to pull back, and alternative approaches for school funding to consider. 

Budget gap drivers include the finding that the state’s economy is in a downturn. The number of unemployed workers in California has risen nearly 200,000 since the summer of 2022. This has resulted in a jump in the state’s unemployment rate from 3.8 percent to 4.8 percent the state’s economy into a downturn. The number of unemployed workers in California has risen nearly 200,000 since the summer of 2022. This has resulted in a jump in the state’s unemployment rate from 3.8 percent to 4.8 percent. Inflation‑adjusted incomes posted five straight quarters of year‑over‑year declines from the first quarter of 2022 to the first quarter 2023.

The portion of income taxes collected directly from workers’ paychecks was down 2 percent over the last twelve months compared to the preceding year. Collections data now show a severe revenue decline, with total income tax collections down 25 percent in 2022‑23. Reflecting the risk of continued weakness, the LAO revenue outlook shown anticipates collections will be nearly flat in 2023‑24, after falling 20 percent in 2022‑23. The LAO outlook then has revenue growth returning in 2024‑25 and beyond. Based on this trajectory, the LAO revenue outlook expects collections to come in $58 billion below budget act assumptions across 2022‑23 through 2024‑25, with about half of this difference ($26 billion) attributable to 2022‑23. 

What can be done? The state has $23 billion in the Budget Stabilization Account under LAO estimates, plus about $1 billion in the Safety Net Reserve. Over a three‑year period, the state could reduce General Fund costs by $16.7 billion if it were to lower school spending to the constitutional minimum allowed under Proposition 98. The state has at least $8 billion in one‑time and temporary spending in 2024‑25 that could be pulled back to help address the budget problem.

This ride on the downside of the roller coaster which is California’s credit is a bit out of the norm. The unique situation which extended the tax payment deadline into the fall is a one off. The strikes in the entertainment industry likely had a bigger impact than anticipated. The timing of these two factors accompanied the fact that the number of California companies that went public in 2022 and 2023 is down over 80 percent from 2021. Capital gains have an outsized impact on the State’s finances given the overall structure of its income tax base.

MEDICAID EXPANDS IN ONE MORE STATE

On December1, nearly 600,000 North Carolinians will be eligible for Medicaid. They qualify under the terms of the Affordable Care Act. Half of these people will be automatically enrolled. Single adults aged 19-64 who earn up to $20,120 per year are now eligible, and a family of three who earns a little more than $34,300 is now eligible. The state’s prior Medicaid structure covered parents earning only about $8,000 per year combined for a family of three. Childless adults had no coverage.

As with the case with the many other states, the federal government will pay 90 percent of the costs of expansion. Under another piece of the legislation the initial costs will be covered at an even higher rate. A provision in the 2021 American Rescue Plan provides an additional 5 percent “bonus” to previous holdout states to help offset the first two years of expansion. In North Carolina, that amounts to almost $1.8 billion. 

There are now only 10 holdout states remaining. They share the common trait of having a Republican governor, a GOP-majority legislature or both. Six are in the Southeast. The two largest by population are Texas and Florida (no shock there). Kansas, Georgia, Wyoming and Wisconsin rely on legislative action. In Florida, a ballot initiative effort from 2020 stalled out.

MUSEUMS AND THE POST-PANDEMIC WORLD

This week, New York’s Guggenheim Museum announced staff layoffs. While tourism has been recovering in the city, lower number of visitors are patronizing museums. After long closures, museums have sought to revive both attendance as well as revenue and many have raised the price to enter in their effort to shore up their finances. The price of admission to the Guggenheim was increased from $25 to $30. Nevertheless,

In November, the San Francisco Museum of Modern Art announced the elimination of 20 staff positions, citing a 35 percent drop in attendance from 2019. Like the Guggenheim, it raised its prices by 20%. A month earlier, the Dallas Museum of Art also reduced headcount by 20 and said it would no longer be open to the public on Tuesdays to save money.

TAX REALITIES IN NEW YORK

One of the enduring features of the political debates in blue states over taxes is the constant specter of mass migrations out of a state driven by marginal tax rates. This is especially true of California and New York. The significant impact of COVID in those states brought the issues to light as the pandemic drove migration to other areas. Those issues were recently revived during the debate between the Governors of Florida and California. A variety of statistics were cited by both to buttress their arguments over taxes. It has become harder to find objective analysis of the issue.

There was much focus on the movement of people from California and New York to Texas and Florida respectively. The lack of an income tax in Texas and California and fewer COVID restrictions were cited as driving factors. Now, a new report from the Fiscal Policy Institute seeks to separate myth from reality. The findings are not what many expected. Here are the main findings.

High earner migration out of New York during Covid was temporary, and primarily driven by work-from-home and flight from New York City. In 2022 — after two years of elevated, pandemic-induced out-migration — high earners’ migration rates returned to pre-Covid levels. While New York lost 2,400 millionaire households over the past three years (2020- 2022), New York gained 17,500 millionaire households in the same period due to a strong economy and rising wages.

There is no statistically significant evidence of tax migration in New York: High earning New Yorkers move out of New York State at one-quarter the rate of the rest of the population during typical, non-Covid years. High earners do not move in response to tax increases: Out-migration for those most impacted by recent effective tax increases (in 2017 and 2021) did not increase significantly in response to the tax increases. When New York’s high earners move, they are more likely to move to other relatively high tax states.

A huge driver of out migration was not tax policy but the work from home movement and concentration of lower wage earners in NYC. Prior to Covid, the city was already a source of disproportionate out-migration: 51.1 percent of New York State’s out-migrants from households with income in the bottom 95 percent (less than $354,000) originated from the city, as did 64.5 percent of households with income in the top five percent. This was greater than the city’s share of the state population — the city is home to 42.7 percent of those in the bottom 95 of incomes and 45.5 percent of those in the top five percent.

This drives the continuing hollowing out of the middle class in NYC. The people leaving New York at the fastest rate last year were families making between $32,000 and $65,000. A disproportionately high share of these movers was Black and Hispanic. They were followed by people earning $104,000 to $172,000 a year. More than three-quarters of rich people (the top 1 percent of income-earners, making more than $815,000 a year) who left during the pandemic moved to other high-tax states, including Connecticut, New Jersey and California. 

Over the same years that saw a rise in domestic out-migration by high earners, the overall number of high earner New York tax filers has increased. The only year since 2015 that saw an overall decrease in full-year residents making over $200,000 was 2020 — a year that also saw growth in the population making over $5 million in annual earnings. In 2021, New York State enacted higher personal income tax rates on incomes over $1 million, $5 million, and $25 million. In the same year, the only income group affected by this change — the top one percent — began out-migrating at a lower rate than they had in 2020, falling further in 2022.

MISSION ACCOMPLISHED?

The utility industry has been successfully lobbying for changes to net metering schemes which have long supported private home installations of solar energy panels. The best example is in California. The state’s three IOUs – PG&E, SoCal Edison, and SDG&E – are benefitting from a new payment scheme to solar customers who send excess generation to the companies.

Under the terms of the scheme which was replaced on April 15, utilities paid customers the full retail rate for solar power produced in excess of their own electricity consumption. The new rules significantly reduce that rate. The new policy doesn’t apply to the 1.5 million rooftop solar installations already in place. For installations post- April 15, 2023, the new scheme will reduce utility-bill savings from new solar systems and extend the amount of time it takes owners to recoup the cost of installing them. 

In March, the industry released a study which forecasted that new residential solar installations in California, after doubling in size from 2020 to 2022, were expected to decrease by nearly 40 percent through 2024. A subsequent report from the California Solar and Storage Association had data showing a 77 to 85 percent drop in rooftop solar projects since April. 

Two of the state’s three major investor-owned utilities subject to the CPUC’s net-metering rules. Those utilities have seen a 66 to 83 percent drop in residential rooftop-solar interconnection applications in the five months since the new structure took effect, compared to the same months in 2022. Solar installers in the state are forecasting that 17,000 jobs will disappear by the end of 2023, which amounts to roughly 22 percent of the state’s solar workforce. Most of those jobs are in installation, where workers earn an average of $70,000 per year.

This mirrors the experience of public utilities in California whose customers have already been subject to less favorable net metering payment schemes. Installations also declined by more than 50 percent in the California regions where public utilities reduced net-metering compensation between 2015 and 2017.  Arizona, Hawaii, Nevada, Utah are other states where rooftop solar installations have declined dramatically after regulators or utilities reduced the compensation value that customers can receive from them.

GETTING THE LEAD OUT

The Environmental Protection Agency (EPA) announced a proposal to strengthen its Lead and Copper Rule that would require all US water utilities to replace 100% of lead service lines within 10 years. The proposed requirement is considerably more ambitious than the existing rule, which requires that only utilities exceeding certain thresholds of lead concentrations replace 100% of lines in 30 years. The EPA estimates that replacing lead service lines would cost utilities about $20-$30 billion over the next decade, with additional costs for new monitoring and treatment requirements.

The estimated $20-$30 billion in costs to replace lead service lines nationally over the next decade are substantially higher than the $1-$3 billion estimated under the existing rule. The Infrastructure Investment and Jobs Act provides funding for lead pipe replacement (about $7.4 billion is allocated in grants and principal forgiveness, with another $7.6 billion in low-interest loans). The remainder will be funded out of rates. That will be especially challenging for utilities with significant proportions of lower income residents. Cities like Chicago, Milwaukee and Detroit are examples of the latter.

The EPA requires every utility to submit an inventory of lead service lines by October 2024, but existing data indicates that lead service lines tend to be more prevalent in Midwestern cities with older housing stock. The installation of lead service lines was banned by Congress in 1986. The proposed Lead and Copper Rule Improvement allows for extensions in limited circumstances. The proposed rule caps the number of required service line replacements at 10,000 annually.

Chicago’s water utility has one of the highest concentrations of lead service lines in the nation would likely qualify for a deferral. State of Illinois data shows that the city has approximately 410,000 lead service connections, comprising over 80% of total retail connections. The city would have approximately 41 years to complete the replacements, though the Illinois EPA could require a faster timeline if deemed feasible. Chicago recently closed on a low-interest WIFIA loan for $336 million to help fund the replacement of some 30,000 existing connections.

NYS THRUWAY P3 FAIL

It took a long time for the New York State legislature to authorize the use of public private partnerships for major infrastructure projects. Fortunately, the first few projects – multiple bridge replacements in the NYC metro area and projects at the airports went off well and the P3 concept was seen as a useful tool in overcoming historic difficulties in the State with infrastructure projects. Those successes built support for P3 projects so additional such projects were approved.

One of those projects is the refurbishment and modernization of service areas along the Turnpike. There are some 27 of them. I’ve been wondering for a while why the service area refurbishments on the New York State Thruway were taking so long. As a life long New Yorker it was easy to assume that each rest stop would be over built and designed and that traditional inefficiencies were plaguing this project.

Now the Authority has admitted that the projects are way behind schedule and facing serious cost overruns. An Irish firm Applegreen leads the private side of the partnership. The deal was for Applegreen to rebuild the weathered and outdated rest areas in exchange for a 33-year lease of the facilities and a share of revenues. Construction began almost two years ago, less than half of the work has been done, and it’s running well behind schedule.

The partners have cited increased costs due to inflation and supply chain issues related to the pandemic. There are no provisions in the agreement for increased funding from the State. Efforts were made in the State Legislature to generate support for funding part of an estimated $250 million funding shortfall. Those efforts were undertaken as part of the fiscal 2024 budget process and failed. The hope for the partners is that the issue will be reconsidered in the fiscal 2025 budget negotiations.

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