REPORT OF THE MAINE STATE REVENUE FORECASTING COMMITTEE  
December 2004

  EXECUTIVE SUMMARY  

This report summarizes the Maine State Revenue Forecasting Committee’s review and revisions of the estimates of General Fund, Highway Fund, and Fund for a Healthy Maine (Tobacco Settlement Fund) revenues for the fiscal years ending June 30, 2005 (FY05) through June 30, 2009 (FY09).  This forecast establishes the base revenues that must be used by the Governor in submitting the 2006-2007 biennial budgets for the General Fund and the Highway Fund.  This forecast represents an increase for the General Fund and the Highway Fund over the March 2004 forecast as adjusted by legislative changes.  The primary driver of the increase of revenue in this forecast is the improvement of the economic projections for the current calendar year, which more than offset slightly lower projections of growth through the remainder of the forecast period.   

SUMMARY TABLE OF DECEMBER 2004 FORECAST

Note: FY05 equals the fiscal year ending June 30, 2005; FY06 equals fiscal year ending June 30, 2006; etc.      Amounts may not add due to rounding.  

General Fund: The change in the General Fund forecast presented here is driven primarily by the updated economic forecast of the Consensus Economic Forecasting Commission (see Appendix C).  The Commission’s November projections are more optimistic about employment growth than its previous forecast.  Its forecast of personal income growth is more optimistic as well compared to the previous forecast. That increase is primarily driven by a substantial increase in the calendar year 2004 projection (the growth rate increased from 4.0% to 5.5%), but the longer term projections for growth are less optimistic compared to the previous forecast (calendar years 2005, 2006 and 2007 growth rates were revised downward from 4.5% growth to 4.0%).  The 2004 calendar year increase more than offsets the longer-term slower growth and was the primary driver of the increase in the revenue forecast.  The Commission also revised its inflation estimate for the 2004 calendar year – increasing it from 2.0% to 2.8%.  The longer-term projections for inflation were lowered, resulting in a 2% inflation assumption for calendar year 2005 through calendar year 2009. 

The modest growth in the General Fund revenue pattern between FY04 and FY05 and the negative growth between FY05 and FY06 reflect the impact of the 121^st Legislature’s changes to the revenue pattern, which included a number of substantial “one-time” revenue increases.  These include the upfront payment for the lease of the wholesale liquor operation, some delays in tax changes to conform to federal tax changes, Highway Fund contributions to revenue sharing, increases in the General Fund share of the Real Estate Transfer Tax and the Tax Amnesty program.  

Highway Fund:  Highway Fund revenue is projected upward for all major lines based on strong historic performances.  The major increases in the Highway Fund revenue forecast are in the Fuel Taxes line and the Motor Vehicle Registrations and Fees line.  The increase in the Fuel Taxes line is driven by the increase in the Personal Income economic variable.  Like the General Fund major tax lines, the short-term increase in that variable more than offset the longer-term slower growth assumptions.  The increase in the assumed inflation rate in calendar year 2004 in the economic forecast (2.8% instead of 2.0%) resulted in a higher assumed tax rate as a result of the automatic indexing of the fuel taxes that began in FY04.  Motor vehicle registration and fees increased based on strong historic performances.  

Fund for a Healthy Maine:  The Fund for a Healthy Maine is revised downward as a result of new estimates of the tobacco settlement payments, which indicate that the adjustments that are part of the settlement (particularly the volume adjustment that is based on national cigarette sales) will reduce the payments below previous estimates.  In addition, further downward revisions for the short-term (FY05 and FY06) result from a revised start date assumption for the “Racino” (video slot machines facility) at the Bangor Raceway.  An unexpected payment received in August 2004 from a new participating manufacturer lessened the downward reduction in FY05.  The additional increase in the revenue flow to this fund stems from a new series of payments (Strategic Contribution Payments) that begin in FY08 that have been part of the Master Settlement Agreement from the beginning.  (Note: the estimates in this final report include additional adjustments to the estimates of tobacco settlement payments that did not get included into the December 1^st memo.)  

I.  INTRODUCTION AND BACKGROUND TO REVENUE FORECAST  

This report represents the major update of the revenue forecast and provides the estimates of the revenue available for the Governor’s biennial budget submissions due by January 7, 2005.  This report and appendices provide a description of all of the key elements to the revenue forecast for the General Fund, Highway Fund and the Fund for a Healthy Maine.  In addition, this year’s report includes a projection of the estimated revenue throughout the forecast period of certain  taxes on service providers dedicated to the Medicaid/MaineCare program that, while dedicated, represent a substantial shift of resources from the General Fund.  

A. Economic Forecast 

As directed by the originating Executive Order and the subsequent statute, the Committee closely examined the economic assumptions developed by the Consensus Economic Forecasting Commission (CEFC). (See Appendices A and C for background and report).  First, projected employment, income, interest rates and inflation changes were used directly in the tax revenue estimating models maintained and operated by Maine Revenue Services.  Second, Committee members assessed revenue trends predicted by models and by other agencies against economic expectations offered by the CEFC.  

The CEFC met October 7, 2004 to prepare the economic assumptions that would become the basis of the Revenue Forecasting Committee’s revenue projections.  Given that Maine’s economic health is highly dependent on national economic activity, the Commission examined national economic trends and projections.  It concluded that growth in the current calendar year based on data through 3 quarters would be significantly higher than previously projected.  The Commission was less optimistic for the subsequent 4 years and projected slightly slower growth.  

The CEFC has been asked to expand the number of economic variables that it forecasts and provides to Maine Revenue Services to incorporate in their tax models.  A detailed list of these assumptions can be found in Appendix A.  The Revenue Forecasting Committee directly adopted the Economic Commission's forecast and incorporated these assumptions into its revenue forecasting models.   The major economic growth assumptions underlying the December 2004 revenue projections are as follows:  

B. Capital Gains Forecast   

A major variable that is not included in the economic forecast is a projection of net capital gains.  Maine’s exceptional capital gains growth during the stock market “bubble” of the late 1990’s (in excess of 20% annual increases for 5 consecutive years through tax year 2000) came to an abrupt end in tax year 2001 plummeting 53.1%, resulting in a very unpleasant April surprise in 2002.  Capital Gains during the “bubble” were overly conservative with respect to this variable, resulting in sizeable positive variances in the Individual Income Tax line.  While Maine did have the direction right in 2001, the Committee did not anticipate the extent of the reduction that was more than twice what the Committee had forecast.  The extent of the appreciation in the stock market and the amount of income derived from capital gains significantly increased the volatility of Maine’s already volatile General Fund revenue stream.  

The Revenue Forecasting Committee and Maine Revenue Services, like their counterparts in other states, have had much difficulty trying to accurately forecast this variable.  Maine data is not captured at the state level and may only be accessed through federal tax data.  That information is shared with Maine Revenue Services, but it lags by as much as 2 years.  Since November 1999, Maine Revenue Services has been required to provide a report on the net capital gains and losses realized by taxpayers filing Maine individual income tax returns.  That report was initially reported to the Joint Standing Committee on Appropriations and Financial Affairs and the Joint Standing Committee on Taxation.  Now, the report is provided just to the Revenue Forecasting Committee, which includes this information in its annual December report.  (Appendix D provides a copy of that report).  

With the bursting of the “bubble”, the extent of the individual income tax liability derived from net capital gains has dropped down from its peak in 2000 of 17.5% to a level more in line with historical patterns before the “bubble.”   The committee is now forecasting that taxes on net capital gains will be in the 6.5% range for the foreseeable future.   The Table below presents some history and the current projections of net capital gains that are factored into the forecast for the Individual Income Tax line.  

C. Legislative Changes 

The Revenue Forecasting Committee bases the revenue forecast on current law.  The Committee does review the revenue derived from legislative changes.  While the Committee did make some small adjustments to the amounts budgeted for General Fund revenue from enacted legislative changes, this forecast is particularly affected by the shift of budgeted revenue from enacted legislative changes.  The table below shows that the 121^st Legislature enacted net budgeted increases for the 2004-2005 biennium totaling $319.1 million in order to address the General Fund structural gap and to address subsequent Medicaid/MaineCare shortfalls.  The one-time nature of many of those proposals is evident in that the budgeted revenue from those same legislative changes that carry over to the 2006-2007 biennium total only $146.4 million, a drop in revenue between the biennia of $172.7 million.

III. OVERVIEW OF REVENUE PROJECTIONS  

This section provides narrative descriptions of each of the forecasts of the major revenue sources of the General Fund and Highway Fund and a summary of the outlook for the Fund for a Healthy Maine.  This report also includes a projection of certain new taxes on health care providers that are set aside as dedicated revenue for the Medicaid program.   The Tables in Appendix B provide some recent historical data of actual revenue collections for each of these funds, a comparison by major revenue source of actual FY04 revenue compared to final budgeted amounts, and a comparison of current projections to revised projections for FY05 through FY09.  In these tables, the General Fund “Other Revenue” component, which has become a substantial and largely unexplained piece, has been broken out into some categories for the first time to help explain the forecast of “Other Revenue” in the General Fund.  The amounts in the tables in the narratives that follow may not add due to rounding.  

A. General Fund 

            The projections of major sources of General Fund revenue are summarized in the following as narrative descriptions of the major assumptions and unusual legislative changes that affected the revenue stream.  

Sales and Use Tax