The state budget is at risk, but how much risk and for how long?

COVID-19 Policy Analysis: As our nation confronts the COVID-19 pandemic, OK Policy will be analyzing state and federal policies that impact our state and its residents during this national health emergency. These posts reflect the most current information available at publication, and we will update or publish follow-ups as new information becomes available.

NOTE: OK Policy is not a state agency and we cannot assist in applying for state services or provide legal advice.

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The State Board of Equalization is scheduled to meet Monday, April 6 at 1:00 p.m. to consider declaring a revenue failure, requiring most state agencies cut their budgets. The Legislature is also returning to the Capitol and will discuss the budget for the current and next fiscal year. This article summarizes OK Policy’s budget forecasts and recommendations to contain damage from the impacts of COVID-19 on Oklahomans and their public services.

The economic slowdown resulting from the spread of COVID-19 will have significant and harmful impacts on our state’s budget. It is impossible to know how long and deep a downturn might be, and how it will affect the public services on which all Oklahomans depend. However, it’s essential that we do our best to understand the possible implications and be ready to respond quickly. This article surveys current thought on the economic outlook, illustrates possible impacts on the state budget, and discusses available tools to lessen the damage.

Our analysis shows that revenue will fall short in the current fiscal year, requiring across-the-board cuts to all agency budgets. It shows that next year’s budget depends on how the economy responds when the virus is under control. The state’s ample reserves may or may not be sufficient to restore budgets to their current levels, again depending on the depth and duration of the downturn. 

While Oklahoma will largely be in reactive mode, it is important to think creatively about using all available resources to inject more money into the state’s economy by supporting the most vulnerable Oklahomans. This is our best path toward a faster recovery.

The range of economic outcomes

Most experts suggest a very deep downturn, but there is wide disagreement on how deep. All national economists now forecast a decline in gross domestic product (GDP, a measure of the value of all goods and services produced in the country) with their forecasts varying from a 14 to 50 percent drop in GDP in the current quarter (April-June). 

There is little agreement on how long the downturn will last. Some say a recovery will occur in 2020, others suggest it will take until 2021. There is increasing talk of a recession lasting even two or three years

Two revenue scenarios

In order to forecast possible impacts of the economic downturn on state revenues and the budget, we’ve developed two scenarios — a moderate downturn and a severe downturn. They are selected to illustrate two points on the ranges of possibilities described above, but not a best and worst case.

The moderate scenario assumes a V-shaped pattern in which the GDP drops eight percent between now and June, falls at a more modest rate for four months, and then fully recovers over the next eight months. This scenario could be possible if COVID-19 cases and deaths are falling by June, if federal and state actions to support the economy are sufficient, and if businesses and households are willing and able to return quickly to normal activity.

The severe scenario assumes an L-shaped pattern, in which GDP drops 15 percent between now and June and does not fully recover until 2024. This scenario could occur if coronavirus cases and deaths keep growing, if businesses are unable to restart production and hire back employees, or if people are hesitant to resume working, eating out, and shopping. 

The chart below shows how these two scenarios would affect the state’s General Revenue Fund (GRF) revenue through fiscal year 2023, which ends June 30, 2023. The General Revenue Fund represents 80 percent of the total state budget and is the only unrestricted fund, meaning it can be budgeted for any legal purpose of the state. Other state funds, particularly the Education Reform (HB 1017) Fund, will also lose revenue.

The No Virus line represents a likely path for revenues had the  coronavirus not been present. It shows that GRF revenue in the current year (FY 2020) was already on pace to be less than the previous year and that only moderate growth was likely for the coming year, FY 2021. After that, the No Virus line shows GRF growth returning to the historical average for the last 20 years.

The moderate case, with its assumption of a relatively shallow, V-shaped downturn, shows a drop in revenue of $500 million from FY 2019 to FY 2020 and then a $300 million increase for FY 2021. While normal growth would return after that, revenue would still be $100 million below the No Virus level every year in the future. 

In the severe case, with a deeper and longer downturn, revenue would fall by $800 million from FY 2019 to FY 2020 and another $500 million in FY 2021. While growth would return in FY 2022, it would take three years to return to the FY 2019 level, and revenue would still be more than $600 million below the No Virus Case.

This analysis shows that state revenue will plunge for the rest of this fiscal year, but the path for next year and beyond is much less certain. In any case, revenue will be lower than it would have been without  coronavirus for years to come. The next two sections describe options to cushion the blow over the next year and the last section offers ideas that can both lessen short-term damage and improve the outlook for the long term.

Tools for addressing a revenue downturn

For FY 2020, which ends June 30 of this year, the total state budget is $7.999 billion, of which $6.423 billion is appropriated from the General Revenue Fund. Under Oklahoma’s Constitution, the Legislature can only budget 95 percent of the Board of Equalization’s revenue certification for the coming year for each fund. That means that revenue can be as much as five percent below the certified amount without requiring any reduction in the budget. When revenue is expected to fall more than five percent below the certification, the state declares a revenue failure for a fund, which requires reducing the budget of the fund by an equal percentage for all agencies.

The state can take actions to reduce or eliminate the revenue failure by appropriating from the Rainy Day Fund (RDF) or other savings accounts. The RDF balance today is $806 million and the two other accounts have $229 million. The Legislature would have to change laws governing those two accounts before using them to make up for lost revenue.

For the current year, up to three-eighths of the Rainy Day Fund can be appropriated by the Legislature to make up for a revenue shortfall, but only up to the amount of the shortfall. An additional one-fourth of the RDF may be appropriated for an emergency, which requires an emergency declaration and a supermajority vote, which is two-thirds if the governor declares an emergency or three-quarters if the emergency is declared by legislative leaders. 

For the next fiscal year, the Rainy Day Fund is also available to address a revenue reduction. When the certification for the coming year is less than the one for the current year, the Legislature can appropriate up to the amount of the difference, not to exceed three-eighths of the balance of the RDF. 

Recent federal action has provided additional resources for the state to address revenue downturns. Congress passed legislation to increase the federal share of state Medicaid spending (FMAP), which frees up approximately $85 million in state funds for every calendar quarter that the President’s emergency declaration is in effect. This analysis does not include funds available to states under the Coronavirus Relief Fund from other federal legislation, as it is not yet clear whether that fund can be used to make up for lost state revenue.

Savings can cushion the impact of COVID-19 on the budget but may not be sufficient

The graph below compares the original budget for FY 2020 to budgets after revenue failures and use of federal funds and savings to restore the budget. Both the moderate and severe scenarios would result in FY 2020 revenue failures, from $329 to $586 million. 

In the case of the moderate scenario for FY 2020, $170 million in state funds freed up by six months of increased FMAP can be used to make up for some of the shortfall. An additional $159 from the RDF would restore the budget to its original amount, leaving an RDF balance of $647 million. 

In the severe scenario for FY 2020, the amount needed to restore the budget from the RDF increases to $416 million. In this case, both the three-eighths for revenue failure and some of the one-fourth for emergencies would be required, leaving an RDF balance of $390 million.

For FY 2021, the Legislature has not yet adopted a budget. The FY 2021 original amount of $6.854 billion assumes the Legislature would adopt a GRF budget at the amount authorized by the Board of Equalization as their final estimate in February. That estimate shows a revenue decline of $259 million from the FY 2020 estimate. The Oklahoma Constitution allows up to three-eighths of the balance of the RDF to be added to the budget, but not to exceed the $259 million shortfall. Both scenarios include that amount from the RDF, as well as state funds freed up from the FMAP increase ($85 million more in the case of the severe scenario, as the emergency would last longer). After addressing the FY 2020 revenue failure and the FY 2021 shortfall, the RDF balance on July 1, 2020 would range from $131 to $388 million.

In the moderate scenario for FY 20201, savings would not be needed to support the FY 2021 budget and $388 million would remain in the RDF at the end of that year. The severe scenario would result in a revenue failure of more than $1 billion. Under this scenario, the budget could not be restored to the original level even when accounting for the maximum amount of the Rainy Day Fund, all other state savings, and funds freed up from the FMAP increase. After using all available actions, the FY 2021 budget would be $625 million, or 9 percent, below the original FY 2020 budget and the state would have no savings left. In this instance, state services and spending will be needed more than ever if businesses are not investing or hiring and too many Oklahomans remain unemployed. This scenario’s budget, however, would be insufficient to meet that need.

The state must take action now to shorten the downturn and speed the recovery

Responding to and containing the growth of COVID-19 must be the highest priority for the Legislature and Governor. However, they also need to think creatively about how the state can inject more resources into the state’s economy and build the confidence that leads to a quicker recovery. In addition to the state’s savings accounts, the state has federal Temporary Assistance to Needy Family (TANF) reserves, a robust unemployment trust fund, well-funded retirement funds, and new resources available from federal relief. These resources should be leveraged to support our most vulnerable neighbors, to increase spending across the state, and to encourage re-training, re-hiring, and re-investing. As we do this, our state can move closer to the more moderate scenario. In turn, this would improve Oklahoma’s ability to weather this storm and better serve the needs of our residents.

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Paul Shinn

Paul Shinn served as Budget and Tax Senior Policy Analyst with OK Policy from May 2019 until December 2021. Before joining OK Policy, Shinn held budget and finance positions for the Oklahoma House of Representatives, the Department of Human Services, the cities of Oklahoma City and Del City and several local governments in his native Oregon. He also taught political science and public administration at the University of Oklahoma, University of Central Oklahoma, and California State University Stanislaus. While with the Government Finance Officers Association, Paul worked on consulting and research projects for the U.S. Environmental Protection Agency, the U.S. Department of Transportation, and several state agencies and local governments. He also served as policy analyst for CAP Tulsa. He holds a Ph.D. in Political Science from University of Oklahoma and degrees from the University of Oregon and the University of Maryland College Park. He lives in Oklahoma City with his wife Carmelita.

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