BUDGET DIRECTOR ROBERT L. MEGNA’S OPENING STATEMENT AT “QUICK START” BUDGET HEARING

Representatives from the Division of the Budget, Senate Finance Committee, Assembly Ways and Means Committee, and Office of the State Comptroller are today holding their annual “Quick Start” budget meeting to discuss revenue and expenditure projections for the 2009-10 and 2010-11 fiscal years. Excerpts from Budget Director Robert L. Megna’s opening remarks at that meeting, as well as his full statement, are provided below as prepared for delivery.

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Deep, Sustained State-level Recession

“While the Division of the Budget forecasts that the US economy began to recover in the third quarter of 2009, we project that the current state-level recession will not end until the second half of 2010. In addition, there exist significant downside risks to the projected timing and strength of the coming state-level recovery, given the historically unprecedented decline in wages witnessed during the current downturn, particularly among high-income earners. It is clear that New York will continue to remain mired in one of the worst economic downturns in its history for a prolonged period of time, depressing tax collections across all revenue sources.”

Deficit Projections

“As we move forward toward the November 10 session, it is encouraging to see that all parties recognize the serious nature of New York’s fiscal difficulties. The individual Quick Start budget reports that you have each submitted project 2009-10 budget gaps of at least approximately $3 billion. Though there are some differences between our respective estimates, we are in agreement when it comes to the fact that we have a substantial mid-year budget deficit of unprecedented magnitude.”

Wall Street Bonuses

“Fundamentally, perhaps the gravest challenge, and question, we face is what the current restructuring on Wall Street means for our long-term revenue base. During the early-to-mid part of this decade, rapid increases in financial services sector compensation fueled double-digit annual growth in state tax collections. Those days may never return again.”

“The Division of the Budget projects that fiscal year 2009-10 financial sector bonuses will decline by 22 percent. Though some point to strong earnings from certain individual firms or the recent rebound in equity markets as signs for optimism, they are unlikely to have a substantial, positive impact on state revenues in the short-term. Beyond the fact that surges in tax collections generally tend to lag a recovery by several quarters, there are other industry-specific reasons behind this phenomenon, as well.”

“First, a large portion of bonus payments often come in the form of stock that is not taxed immediately. Second, while some investment houses have reported stronger than expected profits, other major firms, such as Lehman Brothers and Bear Stearns, have disappeared altogether during the recent financial crisis. It’s important to look comprehensively at the industry as a whole, rather than simply at selected segments. Third, efforts are continuing at the federal level to constrain executive compensation. And fourth, while stock market indexes have rallied more than 50 percent from their March 2009 lows, they remain substantially below peak levels. In fact, the Division of the Budget projects that the S&P 500 will not return to its 2007 high until at least the year 2015.”

Federal Reserve Policy and Wall Street Profitability

“There are also substantial risks on the horizon for the financial services industry that could threaten its future profitability.”

“Recent Wall Street earnings were driven in greater part by rapidly declining interest costs, which resulted from a Federal Reserve’s target rate that is hovering near 0 percent.”

“Based on the most recent data available, on an annualized basis, interest expenses at New York Stock Exchange member firms have declined by more than 90 percent compared to 2007 -- from $250 billion to $24 billion. During that same time period, interest expenses as a percentage of total operating costs for those businesses dropped from 69 percent to 11 percent.”

“When the Federal Reserve inevitably ends its policy of quantitative easing, these interest costs will rise substantially. The Division of the Budget projects that the Federal Reserve will begin to increase its target rate during the second quarter of 2010. But if this process takes place sooner than anticipated because of the specter of rising inflation, there could be significant downside risk to the state’s revenue forecast.”

Future Spending Commitments

“These difficulties on the revenue side of the ledger are only compounded by the substantial state spending commitments forecast in the future. Over the next three years, School Aid spending is projected to increase by an average annual rate of 6.2 percent (more than twice the rate of inflation) and state Medicaid spending is projected to increase by an average annual rate of 11 percent (more than three times the rate of inflation).”

The Need for Action

“The risks underpinning the economic forecast and the rapid increase in state costs projected during the financial plan period underscore the necessity of both prudent budgeting and the implementation of recurring spending reductions. Long-term fiscal discipline is critical for the future stability and prosperity of our state.”

“Governor Paterson believes that we not only need to address the immediate crisis of eliminating our current-year imbalance through a responsible Deficit Reduction Plan, but we should also seek to make significant strides toward lowering our $44 billion structural gap through smart reforms like Tier V and a state spending cap, which will lower taxpayer costs for years to come.”

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Opening Statement, As Prepared for Delivery
Quick Start Public Budget Hearing
November 9, 2009
Robert L. Megna
New York State Director of the Budget

Good morning, everyone. My name is Robert L. Megna and I am the state budget director. I am joined today by representatives from the Assembly Ways and Means committee, the Senate Finance committee, and the Office of the State Comptroller.

Today’s public hearing is a component of the Quick Start budget process. Instituted as part of the Budget Reform Act of 2007, it requires the Division of the Budget, the Assembly, the Senate, and the Office of the State Comptroller to separately publish revenue and spending estimates for the current and upcoming fiscal year, and then publicly meet to discuss those projections.

After today’s public hearing, the Division of the Budget and the Legislature will work together to complete a joint “Quick Start” budget report, which will be released no later than November 15.

The Quick Start process’ overarching goal is to encourage the enactment of an on-time budget. It seeks to foster a productive dialogue – well in advance of the release of the January Executive Budget – about the difficult fiscal choices policymakers must confront in the upcoming fiscal year.

During this particular Quick Start process, however, we are faced with a unique set of circumstances. Governor Paterson has called for a November 10 special session to address a substantial projected current-year budget deficit. Fiscal staff members from both the Executive Branch and Legislature have been holding five-way meetings over the course of the last several weeks on the Governor’s two-year $5 billion Deficit Reduction Plan.

As we move forward toward the November 10 session, it is encouraging to see that all parties recognize the serious nature of New York’s fiscal difficulties. The individual Quick Start budget reports that you have each submitted project 2009-10 budget gaps of at least approximately $3 billion. Though there are some differences between our respective estimates, we are in agreement when it comes to the fact that we have a substantial mid-year budget deficit of unprecedented magnitude.

Mid-year Estimates

The Division of the Budget’s mid-year financial plan projects budget gaps of $3.2 billion in 2009-10, $6.8 billion in 2010-11, and a cumulative structural deficit of $44 billion over the next five- years. This forecast reflects unprecedented declines in revenue during a period of historic economic difficulty, at a time when we have made substantial, current-law spending commitments in health care, education, and other areas.

Economic Overview

At the national level, the longest and most severe recession since the Great Depression appears to be coming to an end. Aggressive, federal monetary and fiscal policies have played a critical role in stabilizing our country’s economy. Third-quarter real GDP grew at an annualized rate of 3.5 percent, aided by government programs such as “Cash for Clunkers,” the first-time home-buyer tax credit, and the American Reinvestment and Recovery Act.

It is important, however, to distinguish between the gains seen at the national level and the continued struggles of our own state economy, which remains entangled in a deep recession. This is due, in no small part, to New York’s reliance on Wall Street. In 2007, the financial services sector accounted for 22 percent of all wages paid in our state, but only 6 percent of total jobs. Because we are so dependent on such a volatile segment of the economy, New York recessions tend to be deeper and more severe than their national counterparts – lasting, on average, twice as long. This trend is only exacerbated when difficulties in the financial service sector are a core cause of the downturn, as was the case during the current crisis.

While the Division of the Budget forecasts that the US economy began to recover in the third quarter of 2009, we project that the current state-level recession will not end until the second half of 2010. In addition, there exist significant downside risks to the projected timing and strength of the coming state-level recovery, given the historically unprecedented decline in wages witnessed during the current downturn, particularly among high-income earners. It is clear that New York will continue to remain mired in one of the worst economic downturns in its history for a prolonged period of time, depressing tax collections across all revenue sources.

Reflecting this continued weakness in the economy, General Fund personal income taxes through the second quarter of the 2009-10 fiscal year were $606 million below July projections. Overall, year-to-date 2009-10 personal income tax collections have declined by $4.4 billion or 22 percent from 2008-09.

Indeed, recent data indicates that the state economy deteriorated more quickly during the first half of 2009 than was anticipated in DOB’s July forecast. According to the Bureau of Labor Statistic’s Quarterly Census of Employment and Wages, New York State wages fell 15.0 percent in the first quarter of 2009, the largest quarterly decline in the 34-year history of that data-set. Annual state wages are now projected to fall by 5.8 percent in 2009, which would also represent the largest annual decline in the history of this data.

These types of staggering declines are not just limited to the area of wages, however. Large commercial real estate transactions fell by about 80 percent in the first half of 2009 compared to the same period in 2008 — and that market is expected to remain weak going forward due to the inaccessibility of credit. Personal income and non-agricultural employment are also projected to drop by 2.8 percent and 2.3 percent, respectively, in 2009.

Wall Street Bonuses

Fundamentally, perhaps the gravest challenge and question we face is what the current restructuring on Wall Street means for our long-term revenue base. During the early-to-mid part of this decade, rapid increases in financial services sector compensation fueled double-digit annual growth in state tax collections. Those days may never return again.

The Division of the Budget projects that fiscal year 2009-10 financial sector bonuses will decline by 22 percent. Though some point to strong earnings from certain individual firms or the recent rebound in equity markets as signs for optimism, they are unlikely to have a substantial, positive impact on state revenues in the short-term. Beyond the fact that surges in tax collections generally tend to lag a recovery by several quarters, there are other industry-specific reasons behind this phenomenon, as well.

First, a large portion of bonus payments often come in the form of stock that is not taxed immediately. Second, while some investment houses have reported stronger than expected profits, other major firms, such as Lehman Brothers and Bear Stearns, have disappeared altogether during the recent financial crisis. It’s important to look comprehensively at the industry as a whole, rather than simply at selected segments. Third, efforts are continuing at the federal level to constrain executive compensation. And fourth, while stock market indexes have rallied more than 50 percent from their March 2009 lows, they remain substantially below peak levels. In fact, the Division of the Budget projects that the S&P 500 will not return to its 2007 high until at least the year 2015.

Federal Reserve Policy

There are also substantial risks on the horizon for the financial services industry that could threaten its future profitability.

Recent Wall Street earnings were driven in greater part by rapidly declining interest costs, which resulted from a Federal Reserve’s target rate that is hovering near 0 percent.

Based on the most recent data available, on an annualized basis, interest expenses at New York Stock Exchange member firms have declined by more than 90 percent compared to 2007 -- from $250 billion to $24 billion. During that same time period, interest expenses as a percentage of total operating costs for those businesses dropped from 69 percent to 11 percent.

When the Federal Reserve inevitably ends its policy of quantitative easing, these interest costs will rise substantially. The Division of the Budget projects that the Federal Reserve will begin to increase its target rate during the second quarter of 2010. But if this process takes place sooner than anticipated because of the specter of rising inflation, there could be significant downside risk to the state’s revenue forecast.

Conclusion

Indeed, above all, I think one area that we all agree upon is that we are in the midst of a period of extraordinary economic risk. The level of volatility we have seen over the last two years has been staggering and out of virtually any historic proportion.

These difficulties on the revenue side of the ledger are only compounded by the substantial state spending commitments forecast in the future. Over the next three years, School Aid spending is projected to increase by an average annual rate of 6.2 percent (more than twice the rate of inflation) and state Medicaid spending is projected to increase by an average annual rate of 11 percent (more than three times the rate of inflation).

The risks underpinning the economic forecast and the rapid increase in state costs projected during the financial plan period underscore the necessity of both prudent budgeting and the implementation of recurring spending reductions. Long-term fiscal discipline is critical for the future stability and prosperity of our state.

Governor Paterson believes that we not only need to address the immediate crisis of eliminating our current-year imbalance through a responsible Deficit Reduction Plan, but we should also seek to make significant strides toward lowering our $44 billion structural gap through smart reforms like Tier V and a state spending cap, which will lower taxpayer costs for years to come. As we work toward those goals, we look forward to partnering with our colleagues in the Legislature and the Office of the State Comptroller to help preserve the fiscal integrity of our state’s finances. Thank you.

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