Long-Term Structural Deficit Imperils Maryland Budget

Published January 1, 2007

Despite projections of steady economic and revenue growth, Maryland leaders will soon have to come to grips with a long-term structural budget deficit in the state.

Maryland enjoyed an estimated $1.3 billion surplus in the 2006 fiscal year, but state spending commitments in the coming years will produce deficits approaching 10 percent of general fund revenue by FY 2011. The cumulative gap between revenues and spending will exceed $5 billion over the next five years.

Given current levels of taxation and the state’s spending commitments over the coming years, total personal income in Maryland would have to grow at a rate of more than 9 percent per year–nearly double the expected rate–in order avoid a deficit.

‘Antiquated’ Tax Structure

Maryland’s tax structure has been criticized as “antiquated,” and evidence suggests that charge may be valid.

Between the 1990 and 2005 fiscal years, general fund revenue collections averaged 5.1 percent of total personal income. Revenues today are increasingly falling short of that benchmark, despite the state’s vigorous economy.

Lackluster performance of the sales and use tax, business franchise taxes, and lottery revenue are keeping the state from realizing its “potential” revenue. Closing that gap could reduce Maryland’s structural deficit by approximately 40 percent.

Big Spending Hikes

Compounding the problem is Annapolis’s willingness to take on new spending commitments without determining how they will be paid for.

For instance, the Thornton Act has boosted state K-12 spending by 59 percent since fiscal year 2002, and K-12 spending now equals one-third of the entire state general fund. That budget item is projected to grow to 36 percent of the general fund by fiscal year 2011, crowding out other spending priorities.

Expenditures on Medicaid and the Maryland Children’s Health Program are projected to increase at an annualized rate of 7 percent over the coming years, also significantly outpacing revenue growth.

Without fundamental changes, Maryland will spend nearly one-fifth of its general fund budget on medical assistance by FY 2011, and that percentage will continue to grow as the Baby Boom generation ages.

Recommendations Offered

Each year Annapolis delays in addressing its structural imbalance adds to the severity of the coming budget crisis. With that in mind, here are some recommendations lawmakers and the governor should consider:

Recapture lost “potential” revenue. Maryland should rethink its reliance on lottery revenues, which have proven to be very unstable. Those revenues should be replaced by an alternative revenue source, or lawmakers should reconsider legalizing slot gaming and other casino games. In addition, Maryland should examine the decline in the sales and use tax and business franchise taxes (relative to historical norms) and make the necessary adjustments to recapture the lost base.

Reform Medicaid. Under the federal Deficit Reduction Act of 2005, Congress gave states new latitude to alter Medicaid benefits, restructure cost-sharing, emphasize preventative care, expand the role of private insurers, and encourage patients to take more personal responsibility for their health care decisions. Program managers should use this flexibility to retool Medicaid and reduce the program’s overall cost.

Reform education. One-third of Maryland’s education spending goes to Baltimore City and Prince George’s County, yet academic performance in those regions remains lackluster. This suggests the school woes in Baltimore and the county are the product of poor policy, not poor financing. Those school systems should be overhauled so their children will actually benefit from the state’s education dollars.

Minimize the opportunity cost of the Rainy Day Fund. Bond rating agencies place such priority on Rainy Day Funds that the current administration has been unwilling to tap into the fund, even in times of need. The opportunity cost of this money, especially given Maryland’s fiscal outlook, is significant: more than $600 million in FY 2006. Budget officials should recognize the Rainy Day Fund as the resource it is designed to be and use it prudently.

Reduce, abolish, or re-evaluate spending agreements on perennial money-losing ventures. Maryland taxpayers subsidize many ventures of questionable public benefit, from sports venues to entertainment complexes. Individually, none of these reforms will significantly reduce the structural deficit, but saving nickels and dimes can go a long way toward making ends meet.

Increase budget discipline. Maryland has adopted several procedures aimed at achieving budget stability, including five-year revenue and spending projections, a spending affordability process, and a well-managed reserve fund. But more is needed. Lawmakers should consider establishing five-year discretionary spending caps; adopting pay-as-you-go requirements so state spending won’t eclipse revenues; and instituting entitlement “triggers” to check mandatory spending growth.

Tori Gorman ([email protected]) is Concord Coalition policy analyst, a former economist for the Maryland General Assembly, and a visiting fellow at the Maryland Public Policy Institute. Karin Flynn ([email protected]) is a management consultant.

For more information …

This article drew on material the authors presented in the Maryland Public Policy Institute book, Maryland: A Guide to the Issues. Information about the book is available online at http://www.mdpolicy.org/books/bookID.9/book_detail.asp.