Vermont's Fiscal Fitness

Economist Jeff Carr looks at the state's fiscal past with an eye toward the future

by Jeff Carr

Jeff Carr is vice president of Economic & Policy Resources Inc. in Williston, a full-service consulting firm providing economic, financial, and public policy research and analysis throughout northeastern United States and eastern Canada. Carr, a resident of Vermont since 1974, is a graduate of the University of Vermont.

When the Legislature returns to the Statehouse for this upcoming session, it returns with a state budget that remains on solid ground. All three of the state's major funds — the General Fund, the Transportation Fund and the Education Fund — have fully-funded reserves called Rainy Day Funds. The Dean administration and the Legislature have been able to resist the sirens' call of fiscal irresponsibility that has often plagued the public sector throughout history, keeping spending well under control despite calls for the contrary.

By choosing not to expend the state's surplus resources in a way that builds unsustainable commitments for government spending, Vermonters have been able to simultaneously enjoy the financial fruits of a declining tax burden (per person state tax revenues fell from 22nd highest in the United States in 1994 to 30th highest in 1998) and a state government that has met the social and environmental interests of Vermont. But all of that is past. The question going forward is how we are going to continue to build on that strong foundation in a new era of slowing national and state economies and the significant revenue constraints that environment will bring.

One way of discovering how to proceed in the future is to examine the lessons of the past. Let's take a look at Vermont's fiscal history of the last 15 to 20 years with an eye towards how that experience might apply to the future.

A Look at Vermont's Fiscal Past

Chart: State of Vermont General Fund Revenues by Month
Sound budgeting practices and a strong fiscal climate were not always the norm in Vermont. It is not too difficult to remember a time at the end of the 1980s when the Vermont economy was last growing at a very heady pace. The state's unemployment rate was below the 2 percent level where, incidently, it is today. Economic growth as measured by Gross State Product exceeded 5 percent, and job growth was clipping along at the heady rate of more than 2.5 percent as well. In this environment of apparent economic prosperity, state spending took off at an unsustainable rate, growing by 12.0 percent, 13.7 percent, and 17.2 percent during fiscal years 1987, 1988 and 1989, respectively.

"Husky is a solid, high-quality, environmentally sensitive company, and an excellent fit for Vermont," Carr says of the Husky Injection Molding Systems plant in Milton.

That spending was fueled by economic growth that clearly had to return to earth at some point in time. The forces that were underpinning economic growth in Vermont and New England at the time including increased defense spending during the Reagan military build-up, the explosion in the personal computer industry that was a major employer in New England, and the real estate and financial services boom were changing.

First, the national buildup in defense spending that occurred during the 1980s and was very good for the earnings of workers the New England economy was cut back drastically as the Cold War began to wind down. Second, the production and development centers for personal computers moved out west to places like California. Much of the research and development work for the personal computer had occurred in New England, providing a significant boost to the standard of living of all New Englanders and underpinning the "Massachusetts Miracle." Third, the speculative bubble in real estate and financial services burst at a time when nearly 25,000 Vermonters statewide had jobs in the construction trades and financial services industry.

Sure enough, the recession hit the Vermont and New England economy in late 1989, well before the national recession began in July of 1990. The Vermont downturn continued with a vengeance through all of 1990. Five banks in neighboring New Hampshire (each with more than a billion dollars in assets) failed, and at least one bank in Vermont also failed. IBM, Vermont's largest employer, hit hard times, and Digital Equipment Co. closed its Vermont plant throwing nearly 2,000 Vermont workers out of their jobs by the time all was said and done. We also had hundreds of condos around several of the state's major ski resorts that were without owners except for the struggling banks and development companies that financed them. There were unoccupied commercial developments nearly everywhere around Vermont.

By early 1991, the Vermont economy began to turn more positive (the Vermont economy did not actually experience a turning point from recession to recovery until mid-1991), but it did so at an agonizingly slow pace. News stories about the jobless recovery or the half-speed recovery filled the newspapers and the airwaves at the time. The damage to Vermont's fiscal condition was done. State government's deficit in the General Fund swelled to a whopping $65 million, even though both Governors Kunin and Snelling rushed to implement emergency spending-cut measures to control the fiscal hemorrhaging. Broad-based taxes were then increased during the 1991 legislative session to prevent a further deterioration in Vermont's fiscal condition. Since then, the Dean administration and the Legislature have worked hard to hold the line on expenditures. This is true despite the fact that the state has had to take on significantly more responsibility to fund K-12 education in Vermont in the aftermath of the Brigham decision by the Vermont Supreme Court in 1997.

Looking at the spending record over the FY 1991-99 period shows a sound record of fiscal prudence. General Fund spending over the eight-year period increased at an average rate of 3.4 percent per year including the state's increased contribution to local education. That level of budget growth corresponded to a time when inflation averaged between 2 percent and 2.5 percent per year (depending on which inflation measure is used) and the inflation-adjusted rate of growth in the Vermont economy (as measured by Gross State Product) averaged 3.2 percent per year.

Those figures show that the growth in spending by Vermont state government has risen more slowly than the overall rate of growth in economic activity and the rate of inflation in the state. Those statistics point to the fact that the burden of state government on Vermont citizens is declining as it should be in these "good" economic times. They illustrate how Vermont's sustained period of expenditure restraint and a healthy rate of economic growth have acted to restore balance to the state's fiscal environment.

The ability of the governor and the Legislature to avoid the common trap of increasing public spending to unsustainable levels during good economic times has not gone unnoticed by the credit rating agencies on Wall Street. Over the last year, these independent financial analysts have rewarded Vermont's sound and improving fiscal condition with significant rating upgrades.

The importance of these upgrades should not be overlooked since they mean that Vermonters will be able to save millions of dollars over many years because of lower interest rates and corresponding interest charges on the monies that state government and other levels of government (including quasi-government entities) borrow when funding long-term building and infrastructure projects (e.g. facilities at state colleges, state parks, and waste water treatment plants). It was not all that long ago, back in 1991, when these same Wall Street rating agencies were warning of a state financial crisis in Vermont and downgrading the credit-worthiness of the State's bonds thereby increasing the cost of state borrowing.

Perhaps the best illustration of how Vermonters have saved substantial sums of monies through a strong fiscal/budget environment is through savings on short-term borrowing. Short-term borrowing in Vermont and other states is routinely done to provide funds so that state government can pay its everyday bills (e.g. for salaries, support of local school districts, and human services programs) until the annual flush period for tax revenues such as during the spring tax filing season. One way to reduce, if not eliminate, the need for short-term borrowing is to have cash on hand to pay those bills through carrying-over small budget surpluses. From FY 1991 to FY 1998 when the State's fiscal condition was poor, Vermont spent a total of $38.5 million to pay the interest costs of its short-term borrowing. FY 1992 was the worst year of that period when a total of $8.2 million was spent to pay the interest costs of Vermont's short-term, cash flow borrowing.

The strong financial position of the state budget supported by continued fiscal spending discipline has enabled Vermont to eliminate the need for short-term cash flow borrowing and its attendant interest costs altogether over the last two years. State government has in fact saved enough cash to cover all of its day-to-day expenses while it waits for the revenues from the spring tax filing season. As a result, state government now uses the people's precious fiscal resources to support the important functions of state government (e.g. education, public safety, environmental protection) rather than pay interest on borrowed money.

This period of fiscal prudence and economic prosperity has also enabled state government to return a significant portion of monies to the taxpayers themselves. Last session, the governor proposed and the Legislature adopted a one percentage point reduction in Vermont's personal income tax, effective Jan. 1, 2000. In addition, clothing purchases of less than $100 were also made exempt from the state's sales and use tax. The combined tax revenue reduction to the state from these tax reductions means that Vermonters will or have enjoyed the benefit of nearly $45 million in state tax reductions during the two-year period covering FY 2000-01.

Looking to Vermont's Fiscal Future A Modest Suggestion

All of this means that Vermonters today are enjoying the financial fruits of a well-run fiscal "ship-of-state." This is true despite all of the unsupported hyperbole and acrimony associated with the last election cycle. But as was indicated above, all of that is now in the past. Where do we go from here?

Carr rates the economic impact of companies such as IBM, IDX and Husky as "very positive." Pictured: IDX Systems Corp. headquarters in South Burlington. "IDX recognized that Vermont is a good place to grow a business, because of the quality of the people and the ability to attract and retain them," Carr notes.

At the risk of providing unsolicited advice to budget policymakers, it seems the lessons of history show that "more of the same" appears to be in order. Given the successes of the past three years, staying the course of sustainable spending is as valid a concept today as it was back in 1991 and throughout the last nine fiscal years. Vermont's fiscal record shows it simply makes good public-policy sense to make social and environmental commitments in a way in which they can be maintained over the long-term in both "good" and "bad" economic times.

Too often throughout history, the public sector not just Vermont has tried to make commitments to either program beneficiaries or the taxpayers that it could not keep in both good economic times and bad. During the inevitable down times for the economy (no one has yet been able to repeal the national business cycle), sooner or later policymakers had to face the unpleasant choices of reducing the level of support for programs or raise tax burdens or both at the very same time when taxpayers were contending with the formidable challenges of economic recession.

Today, staying the sustainable spending course seems especially appropriate in light of the now changing economic and revenue growth environment. This change, which has occurred within the context of the apparent success of achieving the national economic "soft-landing" (a.k.a. the much anticipated slowdown), is almost sure to place increasing financial constraints on future legislatures if not the upcoming session.

The surge in personal income tax revenues that has occurred over the last three years from capital gains income will soon run its course as the weaker stock market performance this last year works its way through the tax-paying system. Gone are the one-time boosts in tax revenues from IPO activity (e.g. Vermont Teddy Bear, Ben & Jerry's, IDX and the like), and merger and acquisition activity (e.g. Bruegger's Bagels).

As the slower-growing economy will eventually translate into slower growing revenues, it will become a test of our resolve to remain committed to the proven fiscal concept of "sustainable spending." It is often said that those who fail to learn from history are doomed to repeat it. Let's hope that axiom will not apply to Vermont's fiscal future after our recent hard-won victory.

Originally published in January 2001 Business People-Vermont