Spending Decisions Tougher With Tax Collections Down

Members of the Joint Ways and Means Committee -- including (upper seats, from left) Sen. Cynthia Friedman, Sen. Michael Rodrigues, Rep. Aaron Michlewitz, and Rep. Ann-Margaret Ferrante -- listen to testimony from Gov. Maura Healey on her fiscal 2025 budget proposal on Feb. 7, 2024.

SHNS

Hemmed in by tough fiscal news, lawmakers kicked off their review of Gov. Maura Healey's $58.1 billion fiscal 2025 budget on Wednesday with a far more somber tone than they deployed in the past few cycles.

The clouds that have formed in connection with seven straight months of below-expected revenue collections hung over the opening deliberations about fiscal 2025, especially after the state found out on Monday that it missed its already downgraded tax collection forecast for January by $263 million.

The revenue forecasts that top legislative budget writers agreed upon are not holding up, and it's forcing them to adjust.

"If this worrying trend continues over the second half of this fiscal year, it will require additional adjustments and solutions to bring our current budget into balance. Although we are well-positioned to weather this ongoing storm, the work ahead to manage the remainder of FY24 and craft a responsible FY25 budget will require collaboration, a steady hand and strong fiscal discipline," Senate Ways and Means Chairman Michael Rodrigues of Westport said. "This means adjusting spending expectations to account for slumping tax revenues, utilizing one-time monies in a judicious manner, and dedicating the resources we do have available to sustain investments that support post-pandemic opportunities for our residents and our communities."

He added, "We have our work cut out for us in the months ahead."

House Ways and Means Chairman Aaron Michlewitz of Boston's North End was more blunt in his commentary Wednesday.

"Winter isn't just coming, folks. It's already here," he said.

After Healey made mid-year budget cuts and dimmed the outlook for tax collections through June, January tax revenues came in about 7 percent less than what was collected last January. Now the state finds itself in a position where revenues have decreased year-over-year and are now trailing the projections the Healey administration made last month by $263 million.

"If that's January, many of us are worried what's going to happen in April, right, the big month," Rodrigues said. The chairman later added that while it's difficult for any governor to make mid-year 9C budget cuts in January as Healey did, "it's even more difficult in April."

Healey's team on Monday signaled they were not making further budget adjustments due to January revenues. April is the tenth month of the fiscal year, so most state spending has already occurred by then, leaving less room for spending cuts.

Healey said Wednesday that she appreciated and supported the comments from Rodrigues and Michlewitz, the two men who will be most responsible for the budget until it eventually gets back to the governor's desk this summer.

"We need to manage our spending and make smart strategic choices," she said. "That's what our budget recommendation for this year does."

Administration and Finance Secretary Matthew Gorzkowicz said the reasons for the tax collection slump are something that "we're trying to get a handle on" along with the Department of Revenue. The secretary added that his team "is looking at doing a mid-year spending review now" and promised to share the results of that with the Ways and Means Committee.

"Every month that goes by, we get more information. Unfortunately, we'll have a lot more information after April, and we'll probably be able to tell you a really good picture of what's been happening. But I realize that that is, you know, sort of looking in the rearview mirror," the secretary said. "We try to do our best to get the information in front of us in real time and provide you with that to be able to understand what's happening, but it is evolving. ... But how that will play out in our big month, like April remains to be seen. But I share the concern."

Sen. Peter Durant asked Gorzkowicz whether the 4 percent surtax on income above $1 million that voters approved in 2022 is contributing to the revenue slump by encouraging some residents to move elsewhere. The secretary said it was a question for which he had no definitive answer because there is not yet enough data.

He explained that many high-wealth individuals file extensions, meaning that their tax returns are not due until October rather than April.

"So we'll know a little bit more this April and we'll know a lot more come, you know, October 15," Gorzkowicz said.

At least for now, Gorzkowicz said, the now-sinking tax collections in fiscal 2024 do not warrant a change to the governor's proposal to increase spending by about $2 billion in fiscal 2025.

"We base that number on the best estimates available to us through our consensus revenue process," he said. "I would say that what we're seeing what we have for [fiscal] '25 is consistent with what I think we all agreed upon and what we heard from our economists, which is: look, there is a soft landing that is occurring in fiscal year '24. We expect that revenues will rebound, but with very slow growth into FY25, perhaps the second half of '25."

Gorzkowicz and the Legislature's budget chiefs agreed to expect $40.2 billion in tax revenue, plus another $1.3 billion from the surtax on higher earners, that can be used in the fiscal year 2025 budget. Altogether, the forecast is roughly flat compared to the original estimates for fiscal 2024 and a bit higher than the most recent midyear projection for '24.

The secretary said there are a few signs that tax collections might begin to trend upward next year, including the ongoing strength of the stock market and the potential for federal officials to reduce interest rates.

"At this point, we believe that what we have is the best information available, and we think it's prudent to continue on this path," Gorzkowicz said.

One consideration high on the minds of policymakers was the state's bond rating.

In 2017, S&P Global Ratings lowered its rating for Massachusetts bonds from AA+ to AA, criticizing the state's "failure to follow through on rebuilding its reserves." At the time, the "rainy day" stabilization fund had a balance of about $1.2 billion, and state government faced a sizable gap between projected revenues and actual collections.

Beacon Hill stashed away billions more dollars in the ensuing years, and last April, S&P bumped the state's bond rating back up to AA+. The stabilization fund's balance is up to about $8.2 billion, which one analyst said Tuesday is the third-largest reserve fund of any state in the country.

"All decisions that we have made in putting forward this recommendation were made with an eye on and a commitment to maintaining the strong bond rating of our state," Healey said.

Treasurer Deborah Goldberg told lawmakers the rainy-day fund "is in a very good place," but she stressed that Healey's proposal to divert a sizable amount of potential savings as a budget backstop "will catch the attention of the rating agencies."

Capital gains tax revenues above a certain threshold are automatically deposited into the stabilization fund. Healey's budget would use up to $375 million of that amount to balance the books, trimming the amount headed to the rainy day fund down to about $97 million, according to projections.

House Ways and Means Committee Vice Chair Ann-Margaret Ferrante asked during Wednesday's hearing how rating agencies would respond to the automatic deposit falling by 90 percent year over year.

"As we do these things, it's going to get their attention, and they're going to be asking the questions. It's not going to just be, 'Okay, everybody's having reduced revenues, so it is what it is,'" Goldberg replied. "These are the kinds of things they flag as they're moving forward and watch how we manage. We're at a fairly critical stage."

The treasurer added that she "remember[s] very well" meeting with representatives from ratings agencies in 2015, who had their attention on both the state's spending from the rainy day fund and its diversion of automatic savings.

"What we use it for and how we do it, the type of guardrails that we put on it -- those are critical pieces," Goldberg said of the proposed diversion. "[It's] something I talked to the secretary of A&F about on how we need to continue dialogue on how that moves forward so that we can ensure that we are not in any way disturbing how the rating agencies view us."