Overview
The State of Texas will have $58.4 billion in general revenue-related funds to finance appropriations in the 2004-05 biennium. (See Table 1 and Table 2.) This revenue will come from three sources: tax collections; non-tax receipts such as fees, lottery proceeds, and interest; and the 2002-03 biennium ending balance.
Tax collections will generate $49.1 billion; and non-tax revenues will produce an additional $9.3 billion. Factoring in the $88 million ending balance carried forward from 2002-03, these three sources total $58.5 billion. Against this amount, $347 million must be placed in reserve for future transfers to the Economic Stabilization ("Rainy Day") Fund, and $290 million must be added in adjustments to general revenue-related dedicated account balances. (See Table 3.)
Texas Economic Outlook
Throughout the 2004-05 biennium, the Texas economy will gradually improve, but, because of the still-recovering national economy, business conditions are not expected to improve significantly until fiscal 2005. Adjusted for inflation, year-over-year economic growth should average 4.0 percent in 2004-05. (See Table 4.) Although this figure represents an improvement on the 2.3 percent average annual growth rate registered in 2002-03, it is still well below the 5.5 percent average annual gains enjoyed during the economic boom of 1995-2000.
Following the succession of job layoffs that occurred throughout 2002-03, statewide employment growth should pick up steam in 2004-05 as economic output gradually accelerates. After declining by almost 1 percent from 2001 through 2003, statewide non-farm employment is expected to increase at a 2.0 percent average annual rate in 2004-05. Given the expected acceleration in wage growth, state personal income should climb at a 5.9 percent average annual growth rate. Consequently, the unemployment rate, which averaged 6.5 percent in 2003, should fall to 5.9 percent in 2005.
The majority of Texas' population growth will continue to be driven by natural increase (i.e., births minus deaths), as opposed to migration, which is more sensitive to economic factors. The state's population growth rate should remain relatively steady throughout 2004-05. From fiscal 2003 through fiscal 2005, Texas' population will increase by 820,000, or 3.7 percent-to reach almost 23 million.
Oil and Gas Trend Downwards. Since the beginning of this decade, the Texas oil and gas industry has benefited from generally high prices. In fiscal 2003, the average taxable price of Texas oil rose to an 18-year high of $28.57 per barrel as political instability in the Middle East and Venezuela raised concerns about the reliability of world oil supplies. In addition, taxable natural gas prices spiked to an average of $4.12 per mcf, mainly because of higher gas demand and lower inventories from a colder-than-usual winter.
As anticipated, oil prices dropped at the end of the Iraq-U.S. war, and prices are expected to fall lower-to an average of $22.28 per barrel in fiscal 2005-as constraints on the world oil supply diminish. Likewise, natural gas prices are expected to fall to $3.43 per taxable mcf in fiscal 2005 as crude oil prices drop and liquefied natural gas sources come on line.
Despite the earlier price run-ups, oil and gas production volumes in Texas have declined since fiscal 2001; this trend is expected to continue through 2005. Consequently, the role of oil and gas is expected to fall from 9.6 percent of state economic output in 2000 to 8.3 percent in 2005.
Forecast Concerns. At least three potential developments could adversely affect the generally positive forecast for Texas. Of primary concern is the potential for lackluster employment growth. So far, the economic upturn in the U.S. and Texas has been largely a "jobless recovery" because business has been hesitant to hire new employees until increased demand for goods and services is sustained. If the employment picture fails to improve in the near future, consumers may curtail spending and threaten the overall recovery.
Second, increasing long-term interest rates could threaten housing sales and construction. Over the past three years, record-low mortgage rates have allowed the U.S. and Texas housing markets to flourish despite weak income growth. As mortgage rates rise, some slowdown in sales and construction activity is anticipated; but if rates rise more than expected, one of the strongest pillars in the national and state economies could be undermined.
Finally, continued weak growth in the rest of the world could threaten the impending rebound in Texas and U.S. exports. The U.S. remains the major engine of growth in the world economy, but because of the relatively anemic world market, net U.S. exports have fallen. In Texas, after faltering for two years, year-to-date exports were up by just over 3 percent in the first half of calendar 2003 as Texas moved ahead of California to become the nation's largest exporting state. But if U.S. international trade continues to deteriorate, Texas could suffer the consequences.
The 2002-03 Ending Balance
With the help of mandated spending cuts in fiscal 2003, the state was able to end the 2002-03 biennium with an available General Revenue balance of $88 million. This balance, in addition to estimated revenues, will be used to fund the 2004-05 appropriations.
The Economic Stabilization Fund
In only the fourth time since the creation of the Economic Stabilization Fund (ESF) in 1989, the 78th Legislature drew down the fund balance. For the three-year period 2003-05, the Legislature appropriated and/or transferred $1.3 billion from the ESF. This is by far the largest use of the fund in the state's history.
Transfers from state natural gas tax collections to the ESF are now estimated to total $680 million over the three-year period 2003-05. As required by the Texas Constitution, estimated transfers to the ESF have been deducted from available revenues and balances. In addition to the transfer of $84 million from fiscal 2002 tax collections and $353 million from fiscal 2003 tax collections, this estimate anticipates that an additional $243 million will be transferred to the ESF in 2005. At the end of fiscal 2005, the ESF balance should exceed $356 million.
Tax Revenue
Taxes provide the most important source of general revenue for the state. As in years past, sales and use tax collections will continue to dwarf all other tax revenue sources, with motor vehicle sales tax revenues a distant second. The franchise tax, which serves as the state's general business tax, is the third largest general revenue source and the largest state tax not levied on consumption.
Sales Taxes. In fiscal 2003, Texas sales and use tax receipts totaled $14.2 billion, down 1.7 percent from 2002. Prior to the 1.1 percent decrease registered in 2002, sales tax collections had not declined since 1983.
The 2003 decline resulted from downturns in several major sectors of the Texas economy. Sales and use tax collections from the retail sector, which accounted for over 54 percent of all taxable collections, were down 1.2 percent. Collections from the services sector were down 0.8 percent, while collections from the economically hard-hit communications and manufacturing sectors were down 5.4 percent and 4.2 percent, respectively.
In recent years, low inflation has served to restrain the growth in state sales tax collections. After increasing an average of 3.2 percent annually in fiscal 2000 and 2001, the U.S. consumer price index (CPI) inched up by only 1.5 percent in fiscal 2002. Although the fiscal 2003 CPI rose by 2.4 percent, that was largely because of surging energy prices. Excluding food and energy, sales of which are in many cases exempt from sales tax, the increase was only 1.7 percent.
A generalized economic recovery is expected to generate overall growth in sales and use tax collections in 2004-05, contributing $30.1 billion for the biennium. Compared to the $28.7 billion collected in 2002-03, this represents a 4.8 percent biennium-to-biennium increase.
Franchise Tax. In 2002-03, franchise tax collections totaled $3.7 billion, compared to $4.0 billion in the previous biennium. The 9.3 percent drop largely reflects the decline in national corporate profits that began in 1998 and the increased usage of tax planning techniques. Between calendar 1997 (the peak of the profits cycle) and calendar 2001, corporate profits fell 19.7 percent.
Propelled by higher productivity and lower costs, a recovery in corporate profits began in calendar 2002 and is expected to continue through 2004-05. Because of tax reporting requirements, however, franchise tax collections lag corporate profits by about two years. In addition, business losses suffered during the national recession will be used by corporations to offset the earned surplus tax component in the early stages of the upturn. For these reasons, collections are expected to remain level at $3.7 billion.
Motor Vehicle Taxes. The state's principal motor vehicle taxes consist of the motor vehicle sales and use tax, the motor vehicle rental tax, and the manufactured housing sales and use tax. As a group, these taxes should contribute $5.7 billion to state revenue in 2004-2005, up 1.3 percent from the $5.6 billion collected in 2002-03.
Hard on the heels of the decline in growth that began in the preceding biennium, auto sales in 2004-05 are expected to recover slightly, in tandem with increasing employment and improved economic conditions. In turn, tax revenues are also expected to recover modestly. Used vehicle prices are expected to rebound slightly, adding more revenues.
Motor Fuels Taxes. After deducting for transfers to the State Highway Fund, motor fuels tax revenues, tracking the economic growth rate, will increase by 3.6 percent in 2004-05, reaching $1.6 billion, compared to the $1.5 billion collected in 2002-03. New legislation, effective in January 2004, is expected to generate moderate gains in revenue collections.
Oil and Gas Severance Taxes. Fiscal 2003 was a volatile year for oil and gas prices. Oil prices surpassed $34 per barrel and remained in the $30 range during the first quarter of 2003 as war broke out. By April 2003, oil prices had dropped to the $26 range, but in August prices returned to $30 when it became apparent that near-term restoration of the Iraqi oil production to pre-war levels was unachievable.
Although the fiscal 2003 average taxable oil price of $28.57 was higher than the $27.70 price in fiscal 2001, fiscal 2003 oil production and regulation tax revenues fell $19 million short of the $443 million collected in fiscal 2001 (a ten-year high), largely because of continuing production declines. Oil production and regulation taxes are expected to generate only $672 million in the 2004-05 biennium, compared to $762 million in 2002-03-an 11.9 percent decline.
Natural gas prices spiked in 2003 because of cold weather and have remained high because of declining North American production, coupled with the inadequate drilling to replace supplies. The December 2003 spike in spot market prices notwithstanding, the taxable price of Texas natural gas is expected to fall from $4.12 per mcf in fiscal 2003 to $3.92 per mcf in fiscal 2004 and then to $3.43 per mcf in fiscal 2005.
Natural gas tax receipts are expected to total $1,662 million in 2004-05-down 2.1 percent from the $1,698 collected during the previous biennium. The magnitude of this decline, however, is understated because fiscal 2002 only included 11 months of revenue collections under a now-repealed law.
Insurance Taxes. Total insurance tax revenues for 2002-03 came in at $2.2 billion-a 37.0 percent jump over the $1.6 billion in 2000-01, reflecting strong premium growth in virtually all insurance lines. Although insurance premiums are expected to increase again in 2004-05, net insurance tax revenues are expected to fall by 3.4 percent to $2.1 billion. This apparent paradox is because the premium tax prepayment schedule requires insurers to prepay each year their estimated tax liability for the next fiscal year based on their tax base from the previous year. Thus, when premiums take an unusual, sudden jump in one year, the next year's revenues benefit from large "settle-up" tax payments. This is because of the insufficiency of prepayments collected in the previous year, plus significantly higher prepayments for the next year's tax liability.
In addition, insurance maintenance tax collections came in well above estimate in fiscal 2003 and 2004-05 appropriations remained relatively flat, thereby creating significant surpluses. Because those surpluses must be taken into account when setting the next year's tax rates, fiscal 2004 maintenance tax collections are also expected to fall.
Tobacco and Alcoholic Beverage Taxes. In 2004-05, combined cigarette and tobacco tax collections-$1,069 million-are expected to drop by 4.8 percent relative to the $1,123 million in 2002-03 receipts.
Cigarette consumption is expected to continue to decline in response to health concerns, legal restrictions on smoking, and the higher prices imposed by tobacco companies to make tobacco settlement payments to the states. In fiscal 1999, the manufacturer price for a pack of premium cigarettes jumped 46 percent above the price in the previous year. Over the next three years, manufacturer prices increased by an average of 12 percent per year. More price hikes-and ensuing declines in consumption-are likely in 2004-05.
Mixed beverage tax collections are expected to continue rising through the forecast period, bringing in $827 million in 2004-05-an increase of 3.3 percent over the preceding biennium.
Unlike the value-based mixed beverage tax, the other alcohol taxes are based on the volume or quantity sold. Of these, the beer, liquor, and wine taxes are expected to generate moderate revenue increases 2004-05. As a group, all alcoholic beverage taxes are expected to generate $1,158 million in 2004-05, up 2.7 percent from $1,128 million in 2002-03.
Utility Taxes. Total utility tax revenues increased by 6.0 percent to $640 million in 2002-03, relative to 2001-02. In response to population gains and usage increases, utility tax revenues are expected to show moderate to strong growth-on the order of 6.7 percent-to $683 million in 2004-05.
The gas, electric, and water utility tax is the largest of the state's utility taxes, accounting for almost 86 percent of the total. Revenue collections in 2004-05 are expected to climb to $586 million, a 7.7 percent increase above the $544 million collected in 2002-03.
Public utility gross receipts assessments, which are paid by electric and telecommunications utilities, are expected to remain basically unchanged in 2004-05. Overcapacity in long distance telephone lines, increased bundling of telecommunications services, and competition for consumers consequent to electric and telecommunications deregulation should continue to moderate the growth of this revenue source.
Gas utility pipeline tax revenues are expected remain stable over 2004-05 because the cost to transport natural gas within the state is not expected to change in the short term.
Other Taxes. Revenue from the hotel occupancy tax dropped during 2002-03 as a result of decreased tourism and business travel consequent to the slowdown in the state and national economies and terrorist attacks. Hotel receipts through fiscal 2005 are expected to recover moderately, with 2004-05 tax revenues rising by 4.3 percent to $478 million for the biennium, compared to the $459 million in collections for 2002-03.
The inheritance tax in Texas is a "pick-up" on the federal inheritance tax. Pursuant to a 2001 change in federal law, each estate's exemption from inheritance taxes increases from $1 million in calendar 2003 to $3.5 million in 2009. In addition, the amount of the "pick-up" that states can collect was reduced by 25 percent for deaths occurring in calendar 2002 and by 50 percent for deaths occurring in calendar 2003. This reduction will increase by 25 percent each year until it is eliminated in calendar 2005 and thereafter.
In 2002-03, Texas collected $521 million in inheritance taxes. Due primarily to changes in federal law, the inheritance tax is expected to generate only $165 million for the 2004-05 biennium-a 68.3 percent decrease.
The state's remaining taxes, levied on such disparate entities as cement, sulphur, coin-operated machines, oil-well services, attorneys, and bingo rental receipts, are expected to produce $87 million in 2004-05, down 0.3 percent from the $88 million collected in 2002-03.
Non-Tax Revenue
In addition to the $49.1 billion in tax revenue estimated for the 2004-05 biennium, the state's general revenue-related funds are expected to collect $9.3 billion in non-tax revenue. Non-tax revenue comes from the Permanent School Fund (PSF) interest and investment earnings, state lottery proceeds, fees, and other sources. The 2004-05 estimate represents a 2.8 percent increase from the $9.0 billion collected in 2002-03.
Interest and Investment Income. Interest and investment income is expected to increase by 12.1 percent to $1.7 billion in 2004-05. The $18 billion Permanent School Fund (PSF) produces most of the investment income accruing to general revenue-related funds. Approval by the voters of the constitutional amendment proposed by HJR 68 in the September 2003 election established a total return distribution policy for the PSF. Total return will result in larger distributions to the Available School Fund.
Lottery Proceeds. In fiscal 2003, overall sales from the Texas lottery increased by 5.5 percent, though sales in the Lotto Texas game experienced an 11.6 percent decline in 2003. This falloff occurred in the face of a matrix change designed to raise sales by increasing the probability of higher jackpots. All game types combined, Texas lottery sales totaled over $3.13 billion in fiscal 2003, of which $888.2 million was transferred to the Foundation School Fund.
The 78th Legislature approved Texas' participation in a multistate lottery game, and Mega Millions tickets went on sale in Texas in December 2003. With the addition of the multistate game, lottery transfers to the state are projected to total $1,825 million in 2004-05, up 3.8 percent from the $1,758 million in 2002-03.
Other Revenues. In fiscal 1999, Texas began receiving regularly scheduled court settlement payments from tobacco product manufacturers. Beginning in 2000-01, payments were adjusted for changes in the general consumer price index, the volume of domestic cigarette sales, and manufacturers' domestic operating profits. In 2002-03, Texas tobacco settlement receipts were $1,030 million, which included repayments to the state treasury of $143 million from a fiscal 1999 "loan" to counties and hospital districts. Even with declining cigarette sales, Texas' tobacco settlement receipts in 2004-05, at $980 million, will be only slightly lower than receipts in the previous biennium, primarily because scheduled court-ordered payment levels will rise, before the adjustments are applied.
Future tobacco settlement payments may be affected by two factors. First, recent and expected increases in state/local tobacco taxes-resulting in price increases and declining cigarette consumption-may further reduce tobacco settlement payments. Second, decisions in several recent court cases-most notably in California and Illinois-have gone against tobacco manufacturers and could thereby reduce their ability to make future settlement payments.
Among major Medicaid-related revenue sources, the state share of vendor drug rebates and premium credits will continue to grow in 2004-05. General revenues from these sources should increase by $95 million, or 31.4 percent, to $397 million. Enhanced by supplemental state rebates authorized by HB 2292, passed during the 2003 regular legislative session, general revenue rebates from major pharmaceutical manufacturers participating in Medicaid's vendor drug program are expected to increase by $65 million (23.1 percent) in 2004-05, as the use and cost of prescription drugs continue to escalate. Premium credits, based on the historical differential between state Medicaid premium payments and the cost of patient care, are expected to increase by $30 million in 2004-05 because of one-time audit gains on past Medicaid claims.
The general revenue allocation from Medicaid's Disproportionate Share Program (through which the federal government helps compensate the state for the costs of taking care of indigent patients at psychiatric, chest, and university teaching hospitals) is expected to fall by $28 million, or 4.8 percent, to $550 million in 2004-05. This decline reflects past congressional actions originally designed to help balance the federal budget by limiting state payments from the program. Also, because of the higher premiums and other co-payments imposed on families participating in the Children's Health Insurance Program (CHIP), premium co-payments for low-income children should increase by $57 million-184 percent-to total $88 million in 2004-05.
Not included in the estimate are increases in share payments to the states authorized in the recently enacted "Medicare Prescription Drug, Improvement, and Modernization Act of 2003." In any event, the expected gains accruing directly to the state are expected to be relatively small: almost all of the payment increases will go directly to local hospitals.
Finally, as part of the federal Jobs and Growth Tax Relief Reconciliation Act of 2003 (H.R. 2), Texas has received $709.1 million in federal state fiscal relief monies from the Flexible Grant Program. This money, an unconditional federal grant that is considered to be general revenue, was received in two equal payments of $354.5 million-one in fiscal 2003 and the other in fiscal 2004.
Revenue to All Funds
Revenue to all funds will total $118.1 billion in 2004-05. Of this amount, general revenue-related receipts will total $58.4 billion, and dedicated federal income will account for $41.1 billion. Most of the federal funds will be used for health and human services, highway construction and maintenance, and public education programs. A second large source of all funds revenue is the State Highway Fund's share of motor fuels tax revenue, which is constitutionally dedicated to highway construction and maintenance and public transportation.
Total revenue to all funds does not equal appropriations to all funds because the total estimated revenues do not include the fiscal 2003 ending balance in the General Revenue Fund, which provided part of the $118.2 billion appropriation for 2004-05.
In addition, total estimated revenues do not include certain local funds that are appropriated but not deposited into the State Treasury, but they do include certain revenues that are deposited in the state treasury but not appropriated, such as royalties deposited to the Permanent School Fund. (See Table 5.)
Finally, it should be noted that recent legislation will now allow colleges and universities to use flexible tuition rates to achieve strategic goals such as improving graduation rates, more efficient use of facilities, and improving academic programs. Because the final extent to which tuition income might increase remains unknown, the estimate of dedicated General Revenue student tuition fees is unchanged from what is portrayed in the 2004-05 Biennial Revenue Estimate, issued in January 2003.