#1Revenue Volatility: The Rhode Island Experience Paul L. Dion, Ph.D. Chief of Revenue Analysis Rhode Island Department of Revenue FTA Revenue Estimation and Tax Research Conference 2013 Annual Meeting October 5-9, 2013 Springfield, Illinois#2• • Background The basis for this presentation is McGranahan and Matoon, State tax revenues over the business cycle: Patterns and policy responses, Chicago Fed Letter, The Federal Reserve Bank of Chicago, June 2012, Number 299. • Revenue data contained in this presentation was compiled by the Office of Revenue Analysis from state government sources rather than the U.S. Census Bureau. The nominal revenue data was converted to real terms using the CPI-U for the Boston region as provided by Moody's Analytics. September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2#3Background The coincident indicator for Rhode Island was downloaded from the Philadelphia Fed's website and used as the measure of Rhode Island economic activity. • Due to data access limitations, the period covered by the analysis is generally from 1994:Q3 through 2013:Q2. Quarterly data is used to the greatest extent possible. The charts in the presentation look at year-over-year growth rates in revenues, sources of income and the Rhode Island coincident index. To the extent possible adjustments have been made to the data to account for anomalies in the data. September 30, 2013 FTA Revenue Estimation and Tax Research Conference 3#4Total Taxes and RI Economic Conditions Rhode Island's total tax revenues appear to be getting less volatile from the 1990s to the 2000s. 0.15 0.10 0.05 0.00 АА -0.05 -0.10 -0.15 1994:Q3 1995:Q3 1996:Q3 1997:Q3 1998:Q3 1999:Q3 2000:Q3 2001:Q3 2002:Q3 2003:Q3 2004:Q3 RI Coincident Index на 2005:Q3 2006:Q3 2007:Q3 Total Taxes 2008:Q3 2009:Q3 September 30, 2013 FTA Revenue Estimation and Tax Research Conference Ay 2010:Q3 2011:Q3 2012:Q3 4#5Sources of Tax Volatility: PIT Rhode Island's personal income tax (PIT) has been consistently volatile over the time horizon. 0.20 0.10 0.00 -0.10 -0.20 -0.30 Income Tax Rate Phase Down 1994:Q3 1995:Q3 1996:Q3 1997:Q3 1998:Q3 1999:Q3 2000:Q3 2001:Q3 2002:Q3 2003:Q3 2004:Q3 RI Coincident Index 2005:Q3 2006:Q3 2007:Q3 PIT Net Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG 2008:Q3 2009:Q3 2010:Q3 September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2011:Q3 2012:Q3 5#6PIT Components: Estimated Payments Rhode Island estimated personal income tax payments have been very volatile regardless of state economic conditions. 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 Income Tax Rate Phase Down 1994:Q3 1995:Q3 1996:Q3 1997:Q3 1998:Q3 1999:Q3 2000:Q3 2001:Q3 RI Coincident Index 2002:Q3 2003:Q3 2004:Q3 2005:Q3 2006:Q3 2007:Q3 PIT Est Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG 2008:Q3 2009:Q3 2010:Q3 September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2011:Q3 2012:Q3 6#71.00 PIT Components: Final Payments Rhode Island personal income tax final payments have become more volatile over time especially after 2008. 0.80 0.60 0.40 0.20 0.00 -0.20 WW -0.40 -0.60 1994:Q3 1995:Q3 1996:Q3 1997:Q3 1998:Q3 1999:Q3 Income Tax Rate Phase Down 2000:Q3 2001:Q3 RI Coincident Index 2002:Q3 2003:Q3 2004:Q3 2005:Q3 2006:Q3 PIT Fin 2007:Q3 Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG 2008:Q3 2009:Q3 September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2010:Q3 2011:Q3 2012:Q3 7#8PIT Components: Refunds Rhode Island personal income tax refunds have shown consistent and large volatility but appear to be less volatile recently. 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 Income Tax Rate Phase Down Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG 2009:Q3 2010:Q3 2011:Q3 2012:Q3 1994:Q3 1995:Q3 1996:Q3 1997:Q3 1998:Q3 1999:Q3 2000:Q3 2001:Q3 2002:Q3 2003:Q3 2004:Q3 RI Coincident Index September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2005:Q3 2006:Q3 PIT Ref 2007:03 2008:Q3 8#90.10 PIT Components: Withholding RI personal income withholding tax payments follow the state's economic conditions closely but are surprisingly volatile. 0.08 0.06 0.04 0.02 0.00 -0.02 -0.04 -0.06 -0.08 Income Tax Rate Phase Down 1994:Q3 1995:Q3 1996:Q3 1997:03 1998:Q3 1999:Q3 2000:Q3 2001:Q3 2002:Q3 2003:Q3 2004:Q3 2005:Q3 RI Coincident Index 2006:Q3 -PIT With 2007:Q3 2008:Q3 September 30, 2013 FTA Revenue Estimation and Tax Research Conference Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG M 2009:Q3 2010:Q3 2011:Q3 2012:Q3 9#10Dynamics of Taxable Income Non-investment income has moved in accord with RI's economic conditions but investment income has shown wide swings. 0.50 0.40 0.30 0.20 0.10 0.00 -0.10 -0.20 -0.30 -0.40 -0.50 1997 1998 1999 2000 2001 2002 RI Coincident Index September 30, 2013 2003 2004 2005 2006 2007 2008 2009 2010 2011 Non-Investment Income Investment Income FTA Revenue Estimation and Tax Research Conference 10 10#11Components of Investment Income Investment income volatility is not only due to net capital gains as both taxable interest and dividends have had large swings. 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 -0.80 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 RI Coincident Index Taxable Interest Dividends Net Capital Gains September 30, 2013 FTA Revenue Estimation and Tax Research Conference 11#12Components of Non-Investment Income Wage and salary income tracks RI's economic conditions closely but proprietor's income and retirement income are more volatile. 0.20 0.15 0.10 0.05 0.00 -0.05 A -0.10 1997 1998 RI Coincident Index 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Wage and Salary Income Proprietor's Income Retirement Income September 30, 2013 FTA Revenue Estimation and Tax Research Conference 12#13Alternative Flat Tax Rate Phase In PIT Reform Preferential Tax Treatment of Long-term CG RI Personal Income Tax Policy RI personal income tax policy has seen tax rate changes preceding opposite changes in the state's economic conditions. 0.08 0.06 Income Tax Rate Phase Down 0.04 0.02 0.00 -0.02 -0.04 -0.06 -0.08 -0.10 -0.12 -0.14 1994 1995 1996 1997 1998 1999 September 30, 2013 2000 2001 2002 2003 2004 -2007 -2006 2005 2008 RI Marginal Tax Rate -2010 2009 2011 FTA Revenue Estimation and Tax Research Conference RI Coincident Indicator 13#140.10 0.08 Sources of Tax Volatility: SUT Rhode Island's sales and use tax (SUT) has tended to follow the state's business cycle but generally underperformed it. 0.06 0.04 0.02 0.00 -0.02 -0.04 -0.06 -0.08 -0.10 1994:Q4 1995:Q4 1996:Q4 1997:Q4 1998:Q4 1999:Q4 2000:Q4 2001:Q4 2002:Q4 RI Coincident Index SUT 2003:Q4 2004:Q4 2005:Q4 2006:Q4 2007:Q4 2008:Q4 September 30, 2013 FTA Revenue Estimation and Tax Research Conference 2009:Q4 Sales Tax Base Expansions 2010:Q4 2011:Q4 2012:Q4 14#15Adjusting to the Volatility of Revenues McGranahan and Matoon suggest four ways that state policymakers can adjust to revenue volatility: 1. Adjust revenue policy 2. Rely on the federal government for aid 3. Adjust expenditures 4. Manage state assets to offset volatile revenue streams September 30, 2013 FTA Revenue Estimation and Tax Research Conference 15#16Adjusting to the Volatility of Revenues How has Rhode Island performed on these benchmarks? 1. Adjust revenue policy September 30, 2013 ● ● Enacted a personal income tax reform that a. Lowered marginal tax rates b. Taxed all income as ordinary income c. Eliminated the use of itemized deductions d. Reduced the number of credits that could be used against personal income tax Expanded the sales tax base to exempt items a. Over-the-counter drugs b. Software downloaded digitally c. Road transportation services d. Pet care services FTA Revenue Estimation and Tax Research Conference 16 16#17Adjusting to the Volatility of Revenues How has Rhode Island performed on these benchmarks? 2. Rely on federal government for aid ● ● YES! Used federal largesse in FY 2002 in the form of $50.0 million in expenditure credits and $50.0 million in cost share changes in the Federal Medical Assistance Percentages (FMAP) Used ARRA education monies in FY 2009 to supplant state education aid payments and cost share changes in the FMAP September 30, 2013 FTA Revenue Estimation and Tax Research Conference 17 17#18Adjusting to the Volatility of Revenues How has Rhode Island performed on these benchmarks? 3. Adjust expenditures September 30, 2013 In FY 2009 eliminated the reimbursement of foregone local property tax revenue from the exemption value of motor vehicles Passed constitutional amendment that reduced the percentage of estimated general revenues that can be budgeted from 98.0 percent to 97.0 percent increasing the budget reserve fund In 2011 passed the Treasurer's Rhode Island Retirement Security Act which reduced the unfunded state pension liability by $3.0 billion FTA Revenue Estimation and Tax Research Conference 18#19Adjusting to the Volatility of Revenues How has Rhode Island performed on these benchmarks? 4. Manage state assets to offset volatile revenue September 30, 2013 streams In FY 2002 and FY 2003, the State used $353.8 million of MSA payments (annual and securitized) In FY 2001 through FY 2013, the State has used $95.0 million of "scooped" excess reserves from quasi-government agencies In FY 2007 and FY 2008, the State used $166.5 million of securitized MSA payments Expanded gaming at state operated facilities FTA Revenue Estimation and Tax Research Conference 19#20Effectiveness of RI's Adjustments So how has Rhode Island's response to revenue volatility worked out? You be the judge. .... Operating Surplus/(Deficit) $50.0 $0.4 $- $(50.0) $(100.0) $(150.0) $(149.2) $(200.0) $(250.0) $(215.3) $(300.0) $(350.0) $(325.0) $(400.0) $(450.0) $(410.4) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 September 30, 2013 FTA Revenue Estimation and Tax Research Conference 20 20#21Revenue Volatility: The Rhode Island Experience Thank You September 30, 2013 FTA Revenue Estimation and Tax Research Conference 21