State and local government fiscal position in 1989.

Sullivan, David F.

State and Local Government Fiscal Position in 1989

The surplus of State and local governments, as measured on a national income and product accounts (NIPA) basis, was $44 billion in 1989, $5 1/2 billion less than in 1988 (table 1). This deterioration in the overall fiscal position was the net result of a $7 billion increase in the surplus of social insurance funds and a $12 1/2 billion increase in the other funds deficit. The fiscal position of State and local governments has deteriorated steadily since 1984: The other funds surplus declined through 1986 and a deficit appeared in 1987. In 1988, the deterioration was the result of a slowing in the pace of personal tax and nontax receipts and a strong increase in expenditures. The continued deterioration in 1989 - despite a strong rebound in personal tax and nontax receipts - was the result of a decrease in corporate profits tax accruals, a slowing in the pace of indirect business tax and nontax accruals, and another strong increase in expenditures.

Receipts

State and local government receipts increased 6 1/2 percent in 1989, 1/2 percentage point less than in 1988 (table 2). General own-source receipts - that is, receipts excluding contributions for social insurance and Federal grants-in-aid - showed a similar deceleration in 1989. The deceleration in total receipts was more than accounted for by corporate profits tax accruals, which decreased 9 percent in 1989, following a 12-percent increase in 1988. Receipts other than corporate profits taxes increased 7 percent in 1989; they increased 6 1/2 percent in 1988. Personal tax and nontax receipts accelerated sharply in 1989, following a sharp deceleration in 1988. Indirect business tax and nontax accruals and Federal grants-in-aid decelerated in 1989, following accelerations in 1988. Contributions for social insurance increased at about the same rate in 1989 as in 1988.

The decrease in corporate profits tax accruals reflected corporate profits before tax, which decreased 6 percent in 1989, following a 15-percent increase in 1988.(1) In its effect on accruals, the decrease in corporate profits more than offset tax rate increases imposed by several States on corporate profits in 1989.

Personal tax and nontax receipts accelerated; these receipts increased 81/2 percent in 1989, up from 4 1/2 percent in 1988. The acceleration was traceable to income taxes, which increased 10 percent in 1989, up from 2 1/2 percent in 1988. The pattern of income taxes continued to reflect both behavioral responses of taxpayers to the Tax Reform Act of 1986 and State and local legislative actions. Beginning in 1986, taxpayers have deferred income to later years to take advantage of lower income tax rates provided by the Tax Reform Act after 1986. This and other behavioral responses to the Tax Reform Act had the largest effect on 1987 income taxes, but also affected 1988 and 1989. The net effect on income taxes of these taxpayer responses was to add an estimated $3 billion in 1987, $1/2 billion in 1988, and $1 1/2 billion in 1989. In addition, State legislation reduced income taxes an estimated $2 1/2 billion in 1988 and $1/2 billion in 1989. This legislation included actions, particularly in 1988, by a number of States to return all or part of the "windfall" associated with the Tax Reform Act. In the absence of both the taxpayer responses and the legislative actions, income taxes would have increased 8 1/2 percent in 1988 and 9 1/2 percent in 1989.

Indirect business tax and nontax accruals decelerated in 1989; these accruals increased 6 1/2 percent, down from 7 1/2 percent in 1988. Both sales and property taxes decelerated about 1 percentage point. Sales taxes would have decelerated about 1 1/2 percentage points in the absence of legislative actions, which added nearly $3 billion to sales taxes in 1989; they had added about $2 1/2 billion in 1988. In the absence of these actions, sales taxes would have increased 4 1/2 percent in 1989 and 6 percent in 1988. Other indirect business tax and nontax accruals increased 4 percent in 1989, about the same as in 1988.

Contributions for social insurance increased 6 1/2 percent in both 1989 and in 1988, reflecting the steady growth in wages and salaries of State and local government employees. Federal grants-in-aid decelerated in 1989; they increased 7 percent, down from 8 1/2 percent in 1988. The deceleration was more than accounted for by decreases in 1989 in grants for highways, social services, and community development. In contrast, grants for medicaid, education, mass transit, and some other types of grants increased more than 9 percent in 1989.

Expenditures

State and local government expenditures increased 7 1/2 percent in 1989, slightly less than in 1988 (table 3). Purchases of goods and services and transfer payments to persons, the two largest categories of expenditures, decelerated slightly in 1989.

Purchases of goods and services increased 7 1/2 percent in 1989, down from 8 percent in 1988. Compensation of employees decelerated slightly, purchases of structures decelerated sharply, and purchases of other goods and services accelerated. The deceleration in purchases of structures was accounted for by highway construction, which decreased $1/2 billion, after a $3 billion increase in 1988. Construction other than for highways increased $3 1/2 billion in 1989; the largest increases were for educational buildings, sewers, and other buildings, such as offices and prisons.

The acceleration in other purchases of goods and services was most marked in purchases of nondurable goods, although purchases of durable goods and of services other than compensation also contributed. Measured in constant (1982) dollars, other purchases increased at about the same rate in 1989 as in 1988 (table 4); purchases of durables decelerated slightly, while purchases of nondurables and of other services increased at about the same rate as in 1988. A sharp acceleration in prices of nondurables was the major the steady increase in the constant-dollar measure. The fixed-weighted price index for nondurables purchased by State and local governments increased 6 1/2 percent in 1989, up from 2 1/2 percent in 1988, primarily because of a sharp increase in petroleum prices, following a decrease in 1988. The fixed-weighted price indexes for durables and for other services also accelerated in 1989, but not as sharply (see table 7.16 in the "Selected NIPA Tables" in this issue).

Expenditures other than purchases accelerated in 1989; these expenditures increased 7 1/2 percent in 1989, up from 6 1/2 percent in 1988. Transfer payments to persons increased 8 1/2 percent in 1989, down from 9 percent in 1988; this slight deceleration was traceable to State and local retirement benefits and medical care transfers. In 1989, interest paid decelerated for the fifth consecutive year; interest recieved also decelerated, so that the increase in net interest paid was less in 1989 than in 1988.

Fiscal position

The fiscal position of State and local governments as indicated by the other funds measure deteriorated in 1989; the deficit increased from $28 billion in the fourth quarter of 1988 to $44 1/2 billion in the fourth quarter of 1989 (chart 5).(2) The year began, however, with an improvement in the fiscal position, reflecting a large increase in receipts, specifically in Federal grants-in-aid. The fiscal position deteriorated throughout the rest of the year, ending with a $10 billion increase in the other funds deficit in the fourth quarter. The deterioration resulted from increases in expenditures that consistently exceeded increases in receipts. After a $16 billion increase in the first quarter, receipts slowed to an average increase of $9 billion a quarter; much of the slowing was due to the pattern of corporate taxes, which decreased $2 billion a quarter in the last three quarters of the year. In the fourth quarter, Federal grants-in-aid increased $4 billion; this increase included a $1 1/2 billion increase in disaster relief grants in response to Hurricane Hugo and the Loma Prieta earthquake.

Expenditures, on the other hand, increased at an average of nearly $13 1/2 billion throughout the year. A smaller-than-average increase in the third quarter was due to a slight decrease in purchases of structures and to a smaller-than-average increase in purchases of nondurables resulting from a decrease in prices of petroleum products. A large increase in the fourth quarter was due to a $4 1/2 billion increase in purchases of structures, an increase in prices of petroleum products following the third-quarter decrease, and spending by State and local governments in response to Hurricane Hugo and the Loma Prieta earthquake. Purchases of goods and services and transfers to persons increased an estimated $1 billion and $1/2 billion, respectively, in the fourth quarter as a result of these two natural disasters.

Outlook

A major factor in the outlook for the State and local fiscal position in 1990 will be the pace of economic activity; this discussion assumes year-to-year economic growth of about 2 percent in 1990, less than the nearly 3 percent attained in 1989. General own-source receipts are likely to increase about 7 percent, assuming a modest increase in corporate profits before tax in 1990 that would reverse the decrease in corporate profits tax accruals experienced in 1989 and assuming no further tax legislation. Legislative changes already enacted should reduce personal income taxes about $1 billion in 1990 and should increase sales taxes about $2 billion. Federal grants-in-aid are likely to increase about 8 percent, reflecting substantial increases in grants for medicaid, aid to families with dependent children, and health care. If contributions for social insurance increase at about the same rate in 1990 as in 1989, total receipts are likely to increase to about $795 - 800 billion.

On the expenditures side, the increase in purchases is likely to be smaller in 1990 than in 1989. Given the deterioration in the fiscal position, State and local governments are likely to curb the growth of expenditures, particularly purchases other than compensation structures. Purchases of structures, in contrast, are likely to increase more in 1990 than in 1989, despite little change in the level of grants for capital purposes. Another source of funds for purchases of structures, new borrowing by State and local governments, increased in 1989. In addition, State and local government construction will probably include some rebuilding of highways and other structures damaged in the Loma Prieta earthquake. Assuming a 6-percent increase in structures, total purchases would increase about 7 percent. Transfer payments are likely to increase slightly faster in 1990 than in 1989, led by increases in medical care transfers, which are largely financed by Federal grants. Increases in other expenditures similar to those experienced in 1989 would bring total expenditures to about $750 - 755 billion in 1990.

Accordingly, the NIPA surplus would increase slightly, to about $45 - 50 billion. The social insurance funds surplus is likely to increase to about $85 billion, so that the other funds deficit would increase to about $35 - 40 billion.