This latest dispute is likely to further defer lawmakers’ attention from focusing on the challenges in constructing the budget for the year ahead. With less than three months until the Legislature’s scheduled adjournment, this is worrisome. For if this year’s budget situation has been bad, next year’s quite frankly, looks  catastrophic.

Let’s start by reviewing what had been decided for this year. The leadership agreement announced in mid-February called for 3/8ths of the Rainy Day Fund, or $223.7 million, to be used in FY ‘10. Money from the RDF is targeted to the Department of Common Education ($193.7 million in HB 2352) and the Oklahoma Health Care Authority ($30 million in HB 2353).  Leadership has also decided to dig deeper into federal stimulus funds for FY ‘10. Common Education is now set to receive an additional $37.1 million from the State Fiscal Stabilization Fund, while an additional $144.6 million of enhanced Medicaid matching funds, or FMAP, made available by the stimulus will go to the Health Care Authority and Department of Human Services (all but $3 million of this amount is to offset a loss in General Revenue, rather than being additional funds). Other additional revenues made available for Fy ‘10 include $38.3 million in gross production taxes,  $30 from the Unclaimed Property Fund (in the disputed bill), and $15.7 million being transferred from the State Transportation Fund.

As can be seen from the Table, the Legislature has now used over $800 million in stimulus funds in the FY ‘10 budget. When the Rainy Day Fund is added in, the amount of non-ongoing revenue being used this year exceeds $1 billion. According to my figures, these non-ongoing revenues will account for some 15  percent of this year’s total state appropriations, which look to be some $6.965 million.

How big of a hole does this leave for next year? The Board of Equalization has certified $5.415 billion in available revenue for FY ‘11. Using the revised FY ‘10 appropriations as the starting point, there is a $1.55 billion revenue gap.

Available non-recurring revenue will close this gap some, but far from entirely. There has already been agreement to use an additional 3/8ths, or $223.7 million, of the Rainy Day Fund in FY ‘11 (This would leave the fund with just under $150 million that is available upon declaration of an emergency). The State Fiscal Stabilization Fund, which can only fund Common Education and Higher Education, has a remaining balance of $199 million.  The amount of enhanced FMAP still available is less certain, because it involves multiple agencies and depends on actual expenditures. But the allocation of the additional $145 million in stimulus funds to the FY ‘10 Health Care Authority and DHS budgets significantly worsens the FY ‘11 outlook.  At this point, however, there is likely well under $300 million of remaining enhanced FMAP funds available.  (That number could, however, rise if the enhanced FMAP rate is extended for an additional two quarters as part of the jobs bill currently being considered by Congress).  Along with the remaining State Fiscal Stabilization Funds, we can expect to have under $450 million in stimulus funds for FY ‘11, or $350 million less than in FY ‘10.

The bottom line is that even after Rainy Day Funds and stimulus, there looks to be some $850 million less available revenue next year than this year. That’s equal to 12 percent of total state funding for this year applied across all government agencies. We can’t forget that many state agencies have already absorbed 5 – 7 percent cuts going into FY ‘10 and up to 7.5 percent mid-year cuts, forcing furloughs, lay-offs and closures. We can’t forget that even agencies that have been partially protected by stimulus funds and supplementals have already been forced to reduce payments to health care providers and cut back services to seniors, children with mental illness, and other vulnerable populations.

The Governor in his FY ‘11 Executive budget offered a series of revenue-enhancing proposals that together were estimated to generate over $700 million, including expanded tax collections of remote sales,  additional bonding, and suspension and elimination of tax breaks. Not all the Governor’s ideas are likely to fly. But if and when the final remaining FY ‘10 issues are resolved, it will be urgent to start concentrating really seriously about what revenue options and cost-cutting measures should be on the table for next year to avoid a budgetary apocalypse.

However, as we noted at the time, the announcement left a key question unanswered:

Given projected shortfalls of $809 million and cuts of $295.5 million, the question that still needs to be sorted out is where exactly the $513.5 million in additional revenue needed to bring the FY ‘10 budget into balance will come from.

Speaker Benge was quoted at the time as saying that the agreement would leave over half the $597 million in the state Rainy Day Fund unspent in FY ‘10. However, when the Governor’s budget was released last week, it included $485.6 million from the Rainy Day Fund – or over 80 percent of the total balance – to make up for shortfalls in the FY ‘10 budget. The remainder of the FY ‘10 shortfall (which is likely closer to $545 million in total) would be filled with surplus oil revenues and transfers from agency balances.

When asked about this, Speaker Benge downplayed the discrepancy:

“I don’t think it’s an agreement breaker,” Benge said. “We can continue forward. We will use (federal) stimulus money for the balance. I think it will work out just fine.”

To my mind, what this uncertainty reveals is that this year’s budget cannot be fully resolved until there is a deal on next year’s budget.  The budget negotiators are looking at a total pool of potentially available funds – including state tax revenues, federal stimulus dollars, reserve funds, and possible new revenues from other sources – that need to be stretched to cover the remaining months of FY ‘10 and all of FY ‘11.  Revenue decisions will also be closely linked to decisions about how deeply to cut agency budgets in FY ‘11. Until  the whole picture is drawn at least in outline, it doesn’t seem like there can be agreement on the size of each of the parts or how they fit together.

Yup, it’s for sure going to be a bumpy ride.

We all will be asked to sacrifice. But we cannot balance the budget at the expense of the most vulnerable among us.

His speech was most eloquent, perhaps, when he spelled out what’s really at stake when it comes to cutting government:

As we proceed, I implore you to remember there are very real – and human – consequences to budget cuts. The men and women who make state government work are not numbers on a spreadsheet.

Government is the schoolteacher grading papers at night. It is the meat and poultry inspector ensuring a safe food supply. It’s the child welfare specialist investigating suspected child abuse. It’s the nursing home attendant caring for a loved one … the speech pathologist working with special-needs children … the corrections officer tasked with keeping dangerous criminals behind bars.

The challenge for the Governor, and for legislators hoping to mitigate the of budget cuts and protect core government services, is how to balance the budget when revenues are projected to come in some $800 million below initial appropriations for this year and when certified state revenues for FY ’11 are some $1.9 billion below the initial FY ’10 budget of $7.2 billion. Other than making the case for tapping the state’s Rainy Day Fund, the Governor’s speech itself offered no details on how to accomplish this task. However, the Executive Summary to his FY ’11 does lay out the Governor’s strategy for bringing the budget into balance.

The broad outlines of the Governor’s approach are as follows. First off, as announced last week in an agreement between the Governor, House Speaker, and President Pro Tem, the FY ’10 revenue shortfall will be filled in part by across-the-board annual budget cuts averaging 7.5 percent of funding from General Revenue. These cuts, which amount to some $465 million, are to be offset by some $180 million in supplemental funding divided between common education, higher education, Medicaid and corrections. That still leaves an FY ‘10 gap of over $500 million, which the Governor proposes to fill with $485 million from the Rainy Day Fund and transfers from agency revolving funds.

For FY ’11, the budget would be balanced as follows under the Governor’s plan:

• FY ’10 cuts would be annualized and increased by an additional 0.5 percent to 3 percent for all agencies.  In addition, pass-through funds to several agencies would be suspended. In total, this represents some $380 million in budget reductions for FY ‘11 compared to initial FY ’10 appropriations;
• $696 million in remaining stimulus funds;
• $67 million in Rainy Day Funds.  (This would leave the RDF with some $44 million);
• $53 million in anticipated savings from agency consolidations and consolidation of information technology services;
• $233 million from new bond issues that would free up General Revenue;
• $85 million in transfers of cash balances from revolving funds;
• $239 million from a variety enhanced tax collection proposals, particularly increased sales tax collections on Internet sales and automated enforcement of vehicle insurance.
• $103 million from eliminating or suspending various tax credits;
• $58 million from increases in fees and permits.

Two points need to be made about these budget balancing proposals. First, many of those I spoke with at the Capitol who had learned of the Governor’s ideas for generating additional revenues and savings through efficiencies were skeptical that the proposals would gain legislative support or would have the fiscal impact promised in the budget. Without these measures, however, cuts would have to be even deeper than those the Governor recommends. (On the other hand, if the revised certification to be presented later this month to the Board of Equalization projects stronger revenue collections over the next 17 months than December’s initial estimates, the budget gap will not be as sizable.)

Secondly, even with these optimistic assumptions about savings and new revenues, the impact of the proposed funding levels in the Governor’s budget remain extremely worrisome.   With a few exceptions, most agencies are facing FY ’11 funding that is 10 to 17 percent below their budgets for FY ’09. Even those core agencies in education, health and human services, and public safety that are partially protected will take cuts in FY ’10 and FY ’11 and are not funded in FY ’11 to deal with rising operating costs and caseloads.

The bottom line is, for all of us who count on government – on those school teachers, safety inspectors, child welfare specialists, nursing home attendants, and corrections officers – to protect our safety and well-being and make us a stronger state, this fiscal storm still looks to have a devastating effect.

To see OK Policy’s updated spreadsheet of agency-level and overall appropriations for FY ‘09 through FY ‘11, and related budget information, click here.

OFRG argues that the Rainy Day Fund needs to be as full as possible for FY 2012 because stimulus funds will no longer be available, leaving a $600-million dollar hole in the budget, about the same amount as the Rainy Day Fund has.

The problem of the FY ‘12 budget hole after stimulus funding runs out is a real one, but OFRG is off base in suggesting that the Rainy Day Fund can be put aside and used later. A quick refresher on the rules governing use of the RDF from our online budget guide:

• Up to three-eighths of the amount in the Fund may be used to make up for a shortfall in the current year’s collections.
• Up to three-eighths of the amount in the Fund may be used in the budget for the next year if General Revenue collections are forecast to be less than the current year’s collections.
• Up to one-fourth of the amount in the Fund may be spent through the appropriations process for an emergency.

The full amount of the RDF can be used in FY ‘10, and the three-eighths that is available for declining revenue will remain available in FY ‘11. However, if, as is widely expected, the economy recovers and revenues begin to rebound, then only the one-quarter of the RDF that is subject to an emergency declaration would potentially be available in FY ‘12. (The chart below shows OK Policy’s projections for revenue collections over the next several years).

OK Policy has in fact argued repeatedly that the rules governing use of the RDF, which are currently biased towards spending at the onset of a downturn, should be revised. We’ve proposed that a portion of the RDF remain available so long as revenues are projected to remain below pre-downturn levels.  We hope Oklahomans for Responsible Government will join us in promoting such a change. However, under the rules in effect now, not spending most of the Rainy Day Fund this year and next will lead to even greater cuts to public services without helping us out of the hole in FY ‘12.

Based on the revised estimates for FY ‘10 certified by the Board of Equalization in December, the state is looking at a total mid-year shortfall of $809 million in FY ‘10, made up of  $729 million in the General Revenue Fund and $80 million in the HB 1017 Education Reform Fund. The leadership agreement involves the following main features for bringing the FY ‘10 budget into balance:

• Continued across-the-board cuts in monthly General Revenue (GR) allocations of  to each agency of 10 percent for the remaining five months of FY ‘10. This means agency budgets will have been cut 5 percent for four months and 10 percent for seven months (there were no cuts to July allocations). This equates to a 7.5 percent cut in GR over the full course of FY ‘10. Total across-the-board GR cuts will equal $385.7 million.
• The agreement also includes supplemental funding for four agencies.  The Department of Education will get an additional $104.4 million. The bulk of these funds are intended to make up for the $80 million projected shortfall in the HB 1017 Fund, crating a net increase of $24.4 million.  Additional funds will also be provided to the Oklahoma Health Care Authority ($33 million), Regents for Higher Education ($25.6 million) and Department of Corrections ($7.2 million). Excluding the funds intended to address the HB 1017 Fund shortfall, total supplementals will equal $90.2 million

In total, OK Policy calculates that the agreement calls for appropriations to be cut by $295.5 million. Please see this spreadsheet (PDF) that provides agency-level calculations of FY ‘10 cuts and revised appropriations under the agreement.

Given projected shortfalls of $809 million and cuts of $295.5 million, the question that still needs to be sorted out is where exactly the $513.5 million in additional revenue needed to bring the FY ‘10 budget into balance will come from.  The leadership announcement remained short on details. According to the press release:

…state leaders also agreed to use reserve dollars from the Rainy Day Fund and the state stimulus account to help balance the budget.

The amount of additional stimulus and Rainy Day Fund dollars that will be injected into the FY ‘10 budget is not specified in the release; however, Speaker Benge is quoted saying:

This agreement maintains more than half of our state’s total reserve dollars for fiscal year 2011 and beyond

The Rainy Day Fund has a current balance of $597 million; if less than $300 million of that amount will be used in FY ‘10, then the agreement would seem to require well over $200 million in additional federal stimulus dollars or other unspecified revenues for FY ‘10. The initial FY ‘10 budget included $640 million in stimulus dollars, which was seen to represent one-half of total available dollars from the stimulus package that could be used to stabilize the state budget.

The conclusion of an agreement on the FY ‘10 shortfall will certainly make the Legislature’s task in the upcoming session much less complicated and hopefully bodes well for the ability of the Governor, Senate and House to reach consensus. But it’s necessary to point out two things. First, even with the injection of well over $1 billion in  stimulus and Rainy Day Funds to buttress the FY ‘10 budget, the cuts agencies are facing this year are having serious and worsening effects on public services over a wide swath of state government. Many agencies that took 5 – 7 percent cuts going into FY ‘10 are now looking at 12 – 15 percent cuts compared to last year’s budget, while even those agencies that were spared steep cuts going into the year are reducing or eliminating core services. The Oklahoma Health Care Authority, which has already cut provider rates and scaled back benefits in recent months,  indicated yesterday it will have to implement another round of cuts to manage ongoing 10 percent monthly budget reductions over the remainder of this year.

Secondly, this agreement should result in final FY ‘10 appropriations of some $6.935 billion. The initial FY ‘11 certification of available ongoing state dollars is for $5.295 billion, or 24 percent less than the revised FY ‘10 total. The one certainty at this point is that the challenge of finding revenues to fill that shortfall and mitigate the severity of cuts in FY ‘11 will remain daunting.

Like most every state, Oklahoma has established a budget reserve fund to put money aside during times of robust growth that is then made available to cushion the impact of economic downturns.  Oklahoma’s Constitutional Reserve Fund, known as the Rainy Day Fund (RDF), was created by a vote of the people in 1985. Under the Constitution, deposits are made into the Rainy Day Fund of all General Revenue (GR) collections that exceed 100 percent of the final certified estimate made by the State Board of Equalization for a given year. Deposits are capped at 10 percent of the General Revenue Fund certification for the preceding year.  If the RDF is already at its cap, additional surpluses spill over to the General Revenue Fund.

Since adoption of constitutional amendment SQ 708 in 2004, the RDF can be accessed as follows:

• Up to 3/8ths of the Fund may be appropriated to make up for a shortfall in the current year’s collections;
• Up to 3/8ths of the Fund may be appropriated in the budget for the forthcoming year if General Revenue collections are forecast to be less than the amount originally projected for the current year;
• Up to 1/4 of the Fund, or $149 million, may be appropriated upon the declaration of an emergency.

There are two changes to the Rainy Day Fund that would allow it to work better. The first, as has been proposed recently by Treasurer Scott Meacham and Senators John Ford and Andrew Rice, is to raise the maximum amount the RDF can hold, from 10 percent of the annual General Revenue Fund budget to 15 percent. The current limit is too low to sustain state services through even a mild recession, much less a major economic dislocation. If a 15 percent cap had been in effect prior to the current downturn, the RDF would have been allowed to grow to close to $900 million, rather than the roughly $600 million the Fund currently holds.

A second worthwhile reform aims to keep the RDF available over the course of a prolonged downturn. Under current rules, 3/8ths of the fund may be used to make up for a deficit in the next budget year, but only if revenues are expected to fall from the current year’s estimate. That means we we will likely be able to access the fund in the coming year, FY ‘11, but probably not in FY ‘12, because revenues will in all likelihood be growing again. However, we might well need the Rainy Day Fund more that year than ever. Our forecasts suggest that FY ‘12, and possibly FY ‘13 revenues will remain below those of FY ‘08. With federal stimulus dollars having been spent, the state will have to make up for the loss of over $600 million in federal funds that are sustaining services during the initial phases of the downturn. It would be advisable to change the Constitution to allow the 3/8ths to be appropriated in any year that revenues are expected to remain below their peak of any of the four previous years.

At the same time, an additional means of easing the volatility of Oklahoma’s revenue collections would be to create a reserve fund specific to gross production tax (GPT) revenues, our most volatile and unpredictable revenue source. Under one possible scenario, a Gross Production Tax Reserve would collect revenues whenever GPT collections increased beyond a certain limit – say 12 percent – and would automatically disperse revenues back to General Revenue when gross production taxes fall.  Our calculations suggest that had such a Gross Production Tax Reserve been in effect over the past decade, it would have accumulated a balance of over $1 billion by FY ’09. This reserve  would have been disbursed to make up for plummeting gas revenues in FY ’10 and the remainder of the downturn, thereby greatly cushioning the severity of the downturn.

Together, increasing the cap on the Rainy Day Fund and creating a specific Gross Production Tax Reserve would greatly increase available reserves heading into a downturn and cushion the magnitude of budget cuts once revenues fall. Increasing the size of our reserve funds would involve accepting more modest spending growth during the peak years of growing revenues. That is a trade-off most Oklahomans are likely to endorse.

There is currently $597 million in the Rainy Day Fund.  Since adoption of a constitutional amendment in 2004, the RDF can be accessed as follows:

• Up to 3/8ths of the Fund, or $224 million of the current amount, may be appropriated to make up for a shortfall in the current year’s collections upon declaration of a revenue failure by the Board of Equalization.
• Up to 3/8ths of the Fund, or $224 million, may be appropriated in the budget for the forthcoming year if General Revenue collections are forecast to be less than the amount originally projected for the current year. A letter [PDF] from the Attorney General’s office indicates that this portion of the RDF can still be appropriated by the Legislature for  FY ’10. (Earlier OK Policy materials assumed this money was no longer available for FY ‘10.) It is likely that conditions for using this money will also be met for FY ’11.
• Up to 1/4 of the Fund, or $149 million, may be appropriated upon the declaration of an emergency. This requires either an emergency declaration by the Governor with 2/3rds approval of both Chambers, or 3/4ths approval by both chambers without the Governor.

The unfortunate reality is that even using the maximum available amount from the Rainy Day Fund is unlikely to make up for revenue shortfalls without cuts and/or other new revenues. OK Policy has forecast that current year GR collections are likely to come in around $700 million below appropriations. In total, using the full 3/8ths “revenue failure money” and 3/8ths “forthcoming year money” could provide up to just under $450 million from the Rainy Day Fund for the current year. The $250 million difference between the estimated shortfall and this draw from the RDF would be equivalent to full-year across-the-board cuts of 5.0 percent, unless additional revenues can be identified. If only 3/8ths of the Rainy Day Fund is used this year, our projected shortfall would be $476 million, equivalent to full-year across-the-board cuts of 9.4 percent in the absence of other revenue. Other scenarios are equally possible, but all will involve a trade-off between using more RDF revenues to help fill this year’s shortfalls versus saving more for what is certain to be a long and slow fiscal recovery.

The Governor’s strategy is to hold off making any decisions about how to fill the budget gap until the Board of Equalization meets on December 21st to certify a formal estimate of revenue collections for this year and next, with a special legislative session to follow in January.  In this, he seems to be supported by Speaker Benge.  Senate Republicans, however, are calling for a Special Session in December.

The bottom line is that if  economic conditions look to be improving, it may be possible to use most of the RDF this year to minimize the severity of budget cuts, with a combination of remaining RDF and stimulus dollars used to avert deeper cuts next year. That’s the optimistic “we-get-wet-but-only-catch-a-minor-cold” scenario -  although one that still involves painful cuts and that creates the prospect of enormous revenue holes for FY ‘12 once stimulus and reserve fund dollars expire. If, however, the projections are for a much slower and weaker revenue recovery over the next 18 months, nothing short of new revenue streams is going to keep public services, and the Oklahoma citizens who depend on them, from being exposed to the full wrath of a hard, hard rain.

In addition to plunging compared to the prior year, September’s GR collections again fell far short of the certified estimate on which this year’s appropriations were based. September revenues were 29.2 percent below the estimate, falling short by a greater amount than in July (-18.1 percent) and August (-28.2 percent). For the third straight month, the Treasurer announced an immediate 5 percent across-the-board cut to agency allocations.

The shortfalls are grim news for state agencies and for those who are served by state-funded programs and services. In recent weeks we have begun to learn more about the unavoidable  consequences of monthly 5 percent cuts. The Department of Human Services has announced$14.6 million in cuts, including a $7.4 million reduction for senior nutrition programs. The Office of Juvenile Affairs announced the cancellation of a $1.3 million program for troubled youth in Pryor, along with 5 percent cuts to all their contractors and up to 22 furlough days for their staff.  The Department of Mental Health and Substance Abuse Services has indicated that cuts are forthcoming to youth substance abuse services and treatment for persons with severe mental illness.  At a meeting we held last week, the Director of the Department of Corrections indicated that private contractors would be cut starting this month and that by February the agency, which is already staffing at 77 percent of capacity, would start imposing furloughs on prison staff.

The budget cuts that are now being implemented and proposed are likely to create real hardships for Oklahomans. Social service and health care programs are threatened at a time when many families and communities are already suffering from the downturn. Cutting rates to local contractors and furloughing public employees  is harmful to the state’s  economy.  In many cases, cuts that will provide some short-term savings will cause greater long-term costs, as when funding is cut from community-based services that may help seniors or persons with disabilities stay out of institutions, or when prevention efforts are abandoned.

But the reality is that there are no good or easy solutions. OK Policy’s preliminary projection, which we will be fine-tuning based on yesterday’s figures, is that the GR shortfall over the entire course of FY ‘10 is likely to equal the full amount that can be accessed from the Rainy Day Fund plus across-the-board cuts of 5 percent or greater. Easing the burden of budget cuts for some agencies would require cutting other agencies even more deeply, or identifying new revenues – which are extremely hard to come by in a state with such deeply-entrenched political and constitutional obstacles to raising taxes.

There are some steps we could take now, though, to smooth the rest of this year and improve our ability to deal with the rest of this recession and the one that comes next. We’d like to see our elected leaders and top managers explore:

• developing and sharing revenue forecasts for the rest of this year and the next couple years, so our elected officials can develop a comprehensive approach and so agencies, their constituents, and citizens can know what to expect;
• holding hearings so state agencies and their partners in local government and direct service agencies can use those revenue forecasts to anticipate and prepare for the impact on services and citizens;
• working toward an improved forecasting process; and
• starting to reconsider how we handle reserve funds by evaluating whether the Rainy Day Fund cap is too low  and the restrictions on its use are too great, as well as whether we should get volatile revenues like taxes on oil and natural gas out of the stream of recurring revenues.

Oklahoma is, to a certain and alarming extent, stuck with the current revenue shortfall and service squeeze as long as the national economy heads downhill and gas prices stay low. We are not, though, doomed to face the bottom and recovery without better information to help guide policymakers towards the best possible decisions.