State and local government fiscal position in 1988.

Sullivan, David F.

State and Local Government Fiscal Position in 1988

THE surplus of State and Local governments, as measured on a national income and product accounts (NIPA) basis, was $55 billion in 1988, $2 billion more than in 1987 (table 1). This slight change in the overall fiscal position was the net result of a $6 1/2 billion increase in the surplus of social insurance funds and a $4 1/2 billion increase in the other funds deficit. The fiscal situation of State and local governments has deteriorated steadily since 1984: The other funds surplus declined through 1986 and a deficit appeared in 1987. The deterioration was largely due to slower growth in receipts than in expenditures. The appearance of a deficit in 1987 was the result of a decrease in Federal grants-in-aid and a slowdown in the pace of indirect business taxes. The further deterioration of the fiscal situation in 1988--despite a strong rebound in grants-in-aid--was the result of slowdowns in the pace of personal tax and nontax receipts and of corporate profits tax accruals and a strong increase in expenditures.

Receipts

State and local government receipts increased 7 percent in 1988, 2 percentage points more than in 1987 (table 2). As just indicated, Federal grants-in-aid increased substantially, following a decrease. Contributions for social insurance accelerated in 1988. The total of other receipts--general own-source receipts (GOSR)--decelerated in 1988, reflecting the course of corporate profits tax accruals and personal tax and nontax receipts.

Federal grants-in-aid increased at a rate exceeding their growth from 1983 to 1986; the 1988 increase was attributable to large increases in grants for medicaid, highways, and education and to smaller increases in a number of other types of grants. The 1988 increase followed a 4-percent decrease in 1987, which was largely accounted for by the end of the general revenue sharing program.

Among the components of GOSR, the deceleration was sharpest in corporate profits tax accruals, reflecting a deceleration in profits before tax. The large increase in 1987 was traceable to the effects of the Federal Tax Reform Act of 1986, which broadened the corporate tax base for States that follow Federal practices in determining taxable income.

Personal tax and nontax receipts also decelerated; these receipts increased 7 1/2 percent in 1988, down from 10 percent in 1987. The deceleration was traceable to income tax receipts, which increased 8 percent in 1988, down from 12 percent in 1987. The larger increase in 1987 was partly due to two types of behavioral responses to the Tax Reform Act. First, tax-payers realized a large volume of capital gains in late 1986 to take advantage of the preferential tax treatment of capital gains income before its repeal in 1987. Second, taxpayers deferred income from 1986 to 1987 and from 1987 to 1988 or later to take advantage of the lower income tax rates provided by the act after 1986. The net effect of these taxpayer responses was to add an estimated $1/2 billion to receipts in 1986, $3 billion in 1987, and $1/2 billion in 1988. In addition, State

Table 1.--State and Local Government Receipts, Expenditures, and Surplus or Deficit, NIPA Basis [Billions of dollars]

 Calendar years
 1984 1985 1986 1987 1988
Receipts 540.5 581.8 623.0 655.7 702.6
Expenditures 475.9 516.7 561.9 602.8 647.7
 Surplus or deficit (-) 64.6 65.1 61.2 52.9 54.9
 Social insurance funds 44.8 51.3 56.2 62.1 68.5
 Other funds 19.8 13.8 5.0 -9.2 -13.5

NOTE.--These estimates are found in NIPA table 3.3. For 1987 and 1988, see the "Selected NIPA Tables" in this issue; for 1984-86, see the July 1988 SURVEY OF CURRENT BUSINESS.

Table : 2.--State and Local Government Receipts, NIPA Basis legislation reduced income tax receipts an estimated $2 billion in 1987 and $1 billion in 1988; the legislation included actions in both years 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 tax receipts would have increased 11 1/2 percent in 1987 and 12 percent in 1988.

Indirect business tax and nontax accruals, in contrast, accelerated in 1988; these accruals increased 6 1/2 percent, up from 5 percent in 1987. Property taxes increased at the same rate as in 1987. Sales taxes increased 7 percent in 1988, up from 6 1/2 percent in 1987. Legislative actions added more than $2 billion to taxes in 1988; they had added more than $3 billion in 1987. In the absence of these actions, sales taxes would have increased about 5 1/2 percent in 1988 and 4 percent in 1987.

The third category of indirect business tax and nontax accruals--the "other" category in table 2--accounted for most of the acceleration. These taxes increased 5 percent, following a 3 1/2-percent decrease. The 1987 decrease was traceable to large, one-time payments in 1986 resulting from the settlement of court cases involving violations of Federal oil pricing regulations. In the absence of these one-time payments, the "other" category would have increased 3 1/2 percent in 1987 and 5 percent in 1988. Severance taxes, another energy-related receipt, also contributed to the acceleration in indirect business taxes. Severance taxes declined in 1988, but the decline was smaller than in 1987. Excluding the one-time payments and severance taxes, the "other" category increased 6 1/2 percent in 1988, up from 6 percent in 1987.

Contributions for social insurance accelerated in 1988; these contributions increased 6 percent, up from 4 1/2 percent in 1987. However, the relatively small percentage increase in 1987 resulted from a one-time contribution in 1986 of $1/2 billion to the Los Angeles County, California, general employees retirement system. In the absence of this transaction, contributions would have increased 5 1/2 percent in 1987.

Expenditures

State and local government expenditures increased 7 1/2 percent in 1988, the same as in 1987 (table 3). Purchases of goods and services, the largest category of expenditures, recorded an increase in 1988 similar to that in 1987; transfer payments to persons, the next largest category, accelerated slightly in 1988.

Purchases of goods and services increased 7 1/2 percent in 1988. Compensation of employees increased at about the same rate as in 1987, purchases of structures accelerated, and purchases of other goods and services decelerated. The acceleration in purchases of structures was more than accounted for by construction of highways and educational buildings; these categories showed a combined increase of more than $5 billion in 1988, following a combined increase of about $1/2 billion in 1987. Construction of hospitals, water supply facilities, and other buildings (such as offices and prisons) increased about $1/2 billion in 1988. All other categories of construction combined decreased $1 1/2 billion in 1988.

The deceleration 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. Other purchases also decelerated in constant (1982) dollars, but less markedly than in current dollars (table 4). In contrast to the deceleration in current dollars, however, the deceleration in constant dollars was sharpest in purchases of durables and of services other than compensation and very slight in purchases of nondurables. A deceleration in prices of nondurables was the major reason for the contrasting growth rates. The fixed-weighted price index for nondurables purchased by State and local governments increased 2 1/2 percent in 1988, down from 5 percent in 1987, while the fixed-weighted price indexes for durables and for other services increased at slightly higher rates in 1988 than in 1987 (see NIPA table 7.16).

Expenditures other than purchases accelerated in 1988; these expenditures increased 6 1/2 percent in 1988, up from 5 1/2 percent in 1987. Transfer payments to persons increased slightly more in 1988 than in 1987; the acceleration was traceable to State and local employee retirement and medical care transfers. Interest paid decelerated for the fourth consecutive year, despite an increase in new borrowing; interest received also decelerated in 1988, so that the increase in net interest paid was about the same in 1988 as in 1987.

Fiscal position

The fiscal position of State and local governments indicated by the other funds measure deteriorated in 1988, as the deficit increased from $15 billion in the fourth quarter of 1987 to $19 billion in the fourth quarter of 1988 (chart 2).(1) 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 $6 billion increase in the fourth quarter. The deterioration resulted from increases in expenditures that consistently exceeded increases in receipts. After the large increase in the first quarter, receipts slowed to an average increase of $10 1/2 billion a quarter; much of the deceleration in receipts was due to the pattern of corporate taxes and grants-in-aid. Expenditures, on the other hand, increased at an average of $13 1/2 billion throughout the year. A smaller-than-average increase in the third quarter was due to a deceleration in purchases of goods and services. The fourth-quarter increase, the largest of the year, was boosted by a rebound in purchases--paced by structures--and a strong increase in transfer payments.

Outlook

A major factor in the outlook for the State and local fiscal position in 1989 will be the pace of economic activity. If year-to-year economic growth in 1989 is slightly less than the nearly 4 percent attained in 1988, GOSR are likely to increase about 6 1/2 percent. This estimate assumes some effort on the part of State and local governments to increase property taxes and various fees. It assumes, however, no further tax legislation; legislative changes already enacted should reduce personal income taxes about $1 billion in 1989 and increase sales taxes by a slightly smaller amount. In addition, the Tax Reform Act should have a smaller effect in 1989 than in 1988, when it added an estimated $1/2 billion to personal income tax collections. The 1989 effects are largely from the deferral of income to take advantage of lower tax rates and from the reduced deductibility of personal, nonmortgage interest. Federal grants-in-aid are likely to increase about 5 percent. If contributions for social insurance increase at about the same rate in 1989 as in 1988, total receipts are likely to increase to about $745-750 billion.

On the expenditures side, the increase in purchases of structures is likely to be smaller in 1989 than in 1988, given a slight decrease in the level of grants for capital purposes. Assuming a 3-percent increase in structures, total purchases would increase about 7 1/2 percent. Transfer payments to persons are likely to increase faster 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 1988 and a stronger increase in current surpluses of government enterprises would bring total expenditures to about $695-700 billion in 1989.

Accordingly, the NIPA surplus would remain about $50-55 billion. The social insurance funds surplus is likely to be about $75 billion, so that the other funds deficit would increase to about $20-25 billion.

(1.) The quarterly State and local governments receipts and expenditures estimates for 1988 are shown in table 3.3 of the "Selected NIPA Tables" in this issue of the SURVEY OF CURRENT BUSINESS.

Table : State and Local Government Expenditures, NIPA Basis

Table : State and Local Government Purchases in Constant Dollars