That is the dire warning sent to the Legislature in November by numbers crunchers at the Joint Legislative Budget Committee (JLBC).
This would appear to be stunning news. After all, the state has had money pouring in so fast the past couple of years that legislators were hard-pressed to spend it all. When the dust settled on fiscal 1998, which ended June 30, there was $523 million available to be carried over to fiscal 1999.
But now, on the eve of Governor Jane Hull's first legislative session as an elected governor, suddenly there's a major budget crisis looming for next year.
It seems more than a little strange--especially in light of the fact that Hull and legislative leaders are still talking about a $50 million to $100 million tax cut.
So what gives?
How can the state really be facing a massive budget shortfall at the same time key policymakers are prepared to add to the string of tax cuts ushered in by former governor J. Fife Symington III?
As with most things legislative, the answer is complex.
First, the projected $282 million deficit is a worst-case scenario prepared by a JLBC forecasting team that has vastly underestimated the recent vigor of the Arizona economy.
Private economists and key legislators say the deficit projection will narrow considerably as state revenue--especially from personal income tax and sales tax receipts--continues to increase at a brisk pace. The JLBC will issue an updated forecast on the nearly $6 billion budget next week when the Legislature convenes.
A waning deficit is not necessarily good news to the Republicans who control both the state House and Senate. Many Republican legislators welcome projections of a hefty deficit because it abets their mission of slashing the size of state government.
"I'm glad to see that there is going to be a shortfall that is going to force us to prioritize our spending," says Senate Finance Committee chairman Scott Bundgaard. "At some point this session we will come up with a budget that better reflects our priorities."
A tax cut proposal makes it all the more likely some legislators will push to eliminate certain state agencies (particularly the Department of Commerce), slash welfare spending and tighten the screws on university budgets.
Hull doesn't seem eager for a cutting frenzy, and instead is expected to present a budget proposal next week that calls for a tax cut, but little in the way of significant spending reductions.
There are two essential elements to the Republican governor's budget, and both revolve around spending for new-school construction.
First, Hull wants to roll over $110 million in unspent school-construction funds from this year's budget into fiscal 2000.
Second, the governor wants to sell up to $200 million in revenue bonds in fiscal 2000 to pay for school construction and repairs, rather than taking the money out of the state's general fund. Instead of a $200 million hit to the general fund, state payments on the revenue bonds would only be about $30 million next year.
Implementing the two proposals would free up about $300 million in fiscal 2000, allowing the governor to cut taxes, fund school construction and expand other programs she strongly supports.
Key Republican legislators are dead set against Hull's carry-forward and revenue bonding proposals. Ironically, some of the Republicans who fought the school-funding measure passed last spring now insist that the measure be financed fully out of general funds rather than using revenue bonds.
The looming battle over how to pay for school construction could evolve into a round of nasty GOP infighting.
The school-finance issue was foisted on the Legislature by the state Supreme Court, which ruled that relying on property taxes to fund such capital expenditures as construction and repair of public schools is unconstitutional because wealthy districts could fund capital outlays more readily than poorer neighborhoods. Poorer districts had sued the state, seeking equity. After years of contentious debate, legislative foot dragging and two legislative fixes that were rejected by the court, lawmakers last year passed a bill that requires the state to spend up to $200 million a year to fund construction of new schools.
The new spending obligation for school construction is squeezing the state budget. Conservative Republicans see the spending obligation as an opportunity to support public education while exerting pressure to trim spending in other areas.
Further complicating matters is the fact that for the first time, lawmakers this session will prepare budgets for the next two fiscal years. They hope that passing budgets for two years will allow them to more closely study individual state agencies next year.
The complex agenda almost guarantees a lengthy and fractious budget debate. Such a scenario will force Hull to crack her leadership whip--a practice she has eschewed since ascending to the executive office in September 1997, upon Symington's resignation.
rojecting budget surpluses and deficits is always tricky business. No one knows for sure how the nation's economy will perform over the next two years. The fortunes of state and national economies are inextricably linked.
The U.S. economy has continued to surprise forecasters with its robust strength, even in the face of international economic shocks in Asia, Russia and South America. The U.S. economy looks recession-free through at least 1999--and Arizona stands to benefit.
"Although the [Arizona] economy will post slower growth in 1999, there is no recession in sight," states the Arizona Blue Chip Forecast published by Arizona State University's College of Business.
The state is expected to remain among the top five in growth, a position it has held for 70 consecutive months.
This should all be good news to JLBC analysts. The committee, however, is known for vastly underestimating the amount of revenue state government will collect each year. The conservative forecasts play a crucial role at the Legislature, where lawmakers decide how many tax dollars to collect and how they should be spent.
"There are legislative agendas that are advanced as a result of artificially deflating revenue," explains Senator George Cunningham, a Tucson Democrat. "You create the perception in the Legislature and the general public that there isn't any money and we need to tighten the belt and swallow hard."
Conservative Republicans have controlled the legislative agenda in recent years--a period in which the JLBC budget forecasts have been increasingly off the mark. In fiscal 1993, forecasters underestimated the state's year-end budget surplus by $75 million. The error increased to $227 million in 1994, $266 million in 1995, $397 million in 1996, $516 million in 1997 and $513 million in 1998.
Legislators say JLBC forecasters were directed by former Senate Appropriations Committee chair Carol Springer, a Prescott Republican, to issue very conservative revenue projections. Springer was elected state treasurer in November. Her successor as Senate Appropriations chair is Randall Gnant, who is taking a different approach to budget forecasting.
"I want the forecast to be accurate," Gnant says. "I don't want large swings up or down."
Gnant believes the revised JLBC budget forecast for fiscal 2000 that will be released next week will be far more accurate than it has been recently.
"The chances of there being a major change in revenue for this year (fiscal 2000) are considerably less than in previous years," Gnant says.
While politics certainly have influenced the JLBC forecasts, economic variables have played havoc with the numbers as well. Year after year, economists have been forced to revise upward their economic growth predictions as the Arizona economy continues to expand.
"Over the last few years, we all, not just JLBC, have been short of the mark in forecasting economic growth in Arizona," says Brian Cary, an economist with Arizona Public Service Company, the state's largest electric utility. "It's continued to defy economic expectations favorably."
LBC's dire predictions of a $282 million deficit for fiscal 2000, and $205 million for fiscal 2001, have not been accepted as gospel by the governor's office.
"We don't agree with the $282 [million] or the lesser amount of $205 [million] at the end of the second year," says Ted Ferris, the governor's deputy chief of staff and JLBC's former director.
Ferris says he expects state revenue will be fattened by strong personal income-tax collections, which have been driven up by last year's cut in the federal capital-gains tax and continued strength in the stock market.
Sales-tax collections also are running ahead of JLBC projections for this year, further evidence that revenue will be higher than anticipated for fiscal 1999, which means there should be a surplus that can be used in fiscal 2000.
The only major state revenue source showing a decline is corporate income-tax collections. But Ferris says that downturn "may not be as great as anticipated."
The governor wants to bolster fiscal 2000 revenue by carrying forward about $110 million in unspent school-construction funds from this year's budget. The Legislature appropriated $375 million in the current budget for K-12 capital expenses.
Of this, $200 million was for new school construction, $125 million for repairs to existing schools and $50 million intended for equipment such as computers. Ferris says it is impossible for school districts to spend the full $200 million during fiscal 1999 on new school construction.
The state School Facilities Board says it can spend only $75 million of the $200 million this year. Ferris says the governor wants to shift $110 million of the leftover $125 million into next year's budget.
By carrying forward the unspent money into fiscal 2000, the governor essentially increases state revenue next year by $110 million. The money would still be earmarked for new school construction, Ferris says.
The combination of greater than anticipated state tax collections plus the $110 million in unspent school-construction funds would go a long way toward eliminating the projected $282 million budget deficit, Ferris says.
Hull wants to wipe out the projected deficit--and create a surplus which can be used to finance a tax cut--by selling revenue bonds to fund the $200 million annual school-construction outlay for fiscal 2000.
Ferris says the state should take advantage of historically low interest rates to build schools. The bonds would be relatively short term--seven to 10 years--and would be repaid out of existing general revenue.
"There would be no need for a tax increase to pay for the bonds," Ferris says.
Revenue bonds would also shift the repayment burden to taxpayers whose kids will use the schools in the future rather than simply dumping the burden on today's taxpayers, he says.
But most important, the use of revenue bonds would allow the state to meet its legal obligation to build new schools while keeping funds available for other programs.
"From our standpoint," Ferris says, "it allows you to fully fund [school construction] and keep commitments on other fronts, whether that's K-12 education, universities, opening new prisons, increasing state-employee pay, and instituting some further modest tax cuts."
He says Hull believes the state personal income tax has been reduced enough, and that other taxes--such as the vehicle-license tax--should be curbed. "We are very much out of line with other states," Ferris says of the license tax.
While Ferris was mum on how much of a tax cut Hull wants, other sources say to expect a reduction of around $50 million.
Hull also is expected to seek reductions in certain business taxes, particularly business property taxes, which run more than twice the rate that homeowners pay.
The magnitude of the governor's tax cuts will not be as great as in previous years, when the Legislature was routinely passing hundreds of millions of dollars in cuts, Ferris says.
"She is reducing the pace because it is late in the business cycle and she doesn't want to get behind the eight ball on the budget," Ferris says.
The governor's budget plans--especially the provisions related to school construction--appear to be dead on arrival in the Legislature.
The chairs of the House and Senate appropriations committees are against Hull's proposal to carry forward the $110 million in unspent school construction funds and are opposed to issuing revenue bonds.
Senate Appropriations Committee Chairman Gnant says the state should pay for school construction out of current funds.
"Revenue bonding for an ongoing need is little more than passing the price tag for future wants and needs on to succeeding legislatures and taxpayers," he says. "It is not something we want to do."
House Appropriations Committee Chairman Bob Burns concurs, saying, "We are not going to go the revenue-bonding route."
Senate Finance Committee Chairman Scott Bundgaard calls the revenue-bonding proposal "ridiculous."
"It's kind of like a cocaine addict looking for a quick fix," Bundgaard says.
Burns and Gnant agree that the $110 million Hull wants to move into the fiscal 2000 budget should remain in the current budget.
"It is our plan to leave at least $110 million on the shelf and park that money," Burns says.
Gnant says keeping the $110 million in the fiscal 1999 budget will force the state to act responsibly and offer an opportunity to take a closer look at government's role.
"What we have chosen to do is live within our means," Gnant says. "This is an excellent opportunity to adopt the value approach to state government."
If Burns, Bundgaard and Gnant get their way, the Legislature will make significant cuts in spending in other areas to balance the budget.
"There are some public-policy changes that the Legislature is going to have to weigh in on," Gnant says.
One area likely to take a hit is university budgets.
"They are probably not going to be very happy," Burns says.
One proposal being discussed would reduce the faculty-salary base at Arizona's three universities by up to $50 million--equivalent to a 7 percent reduction. The decrease would likely spur an exodus of talented professors away from the state, says Cunningham, a strong supporter of universities.
In addition, Cunningham says further reductions of state funds to the universities will increase pressure on the Board of Regents to hike tuition fees.
Universities are just one potential item on the chopping block. Legislators are reviewing JLBC suggestions for cutting $602 million, including:
* Eliminate the Medically Needy/Medically Indigent program in AHCCCS, saving $118 million.
* Cutting Department of Education spending by about $100 million.
* Slashing $20 million in a variety of programs from the Department of Economic Security.
* Delaying prison openings for nine months, saving $9 million.
* Reducing spending for the Department of Public Safety by $12 million.
* Eliminating the Arts Endowment Fund, saving $2 million.
And this list doesn't include a proposal to abolish the Department of Commerce and its $21 million annual budget.
While Republican leaders want to slash spending, there is strong support for additional tax cuts. On this issue, the Legislature and the governor appear to agree that the vehicle-license tax should be further reduced.
However, there is one big difference. Legislative leaders--including Burns, Gnant and Bundgaard--want to finance a tax cut by reducing spending. The governor's tax cut could only come about by issuing revenue bonds to cover school construction.
Not even the Democrats appear to have the stomach for Hull's idea of enacting a tax cut on the back of bonds.
"You don't go out and place yourself in debt so you can have a tax cut," says Cunningham.
The significant policy differences between the governor and the Legislature would offer a serious challenge in a normal budget year.
And this year is anything but normal, thanks to the new, double-budget writing system, which Gnant says will allow lawmakers to "go in and kick the tires" of state programs instead of fighting over another budget next year.
The process is expected to give legislators more information about state agencies. But the trade-off is a far heavier workload this year. The extra work increases the potential for gridlock, especially as the differences between the governor's budget and the Legislative leadership's budget become more defined.
Gnant hopes that the Republican-controlled Legislature will stick together and that Senate Democrats will support the budget. Gnant predicts the budget will be passed by late March and hopes it will be supported by at least 20 senators. Republicans hold a narrow 16-14 edge over Democrats in the Senate.
Others are less certain that the budget process will flow as smoothly.
Burns says it's too early to tell whether the rank and file will support leadership's budget proposal.
"We have to find out what the mood of the Legislature is. We really won't know until we get into it," Burns says.
Bundgaard says budget conflict could stretch the legislative session past the 100-day goal for adjournment.
"It could get down to the end of session and get very ugly," Bundgaard says. "We could take the gloves off and duke it out between the House, Senate and governor. The serious decisions would not be made until the end of the session."
If Bundgaard's fears come to pass, Hull's leadership skills will be put to the test.
The governor's challenge will be even more difficult if the more conservative House passes budget provisions that generate strong opposition from about a half-dozen moderate Republican senators.
Democrats only need one Republican to defect in the Senate to throw a monkey wrench into the budget.
"I think we are going to be around for a long time," says one Democratic lawmaker.
Contact John Dougherty at his online address: [email protected]
