Outlook 2015 – Finance Market Briefing

Prepared for Mark Funkhouser

“The New Normal”

• Long term growth rates lower than historical averages and lower than projected long-term liabilities • CBO report output will grow slower than in the past

• Little more than 2% each year beyond 2017• Long-term growth 1% drop from last year’s projection

• $748 billion FY2015 general fund spending 2% below the pre-recession peak

Revenue & Expenditures

• Rate of state spending growth is slower than the 5.5% average since 1979• Projected state spending growth for 2015 is 3.3%

• Medicaid was a major driver of 2014 spending increases• Spending was up 5.7% in FY 2014; 2.2% in FY 2013; 1.1% in FY 2012

• Federal dollars given to states for Medicaid increased by ~18% this year to cover millions of newly eligible people

• Medicaid makes up ¼ of all state spending, with about $41.8 coming from the federal government

Procurement• Latest census data indicated SLG expenditures on government administration is

$81.6 billion (top 10 states below)*

• Center for Digital Government (CDG) estimates State and Local Governments (SLG) will spend over $48.1 billion on finance and administration technologies in 2015

• Concentration of state expenditures; spending taking place in these top 10 states ($44.21B) represents over 54% of all spending in this vertical

State Amount Spent State Amount Spent

California $11.8B Ohio $3.48B

New York $6.04B Illinois $3.41B

Florida $4.77B Georgia $2.31B

Texas $4.11B Virginia $2.30B

Pennsylvania $4.10B New Jersey $1.89B

• States are not yet out of the woods• Nearly half faced at least two of four major budget stressors in 2014

• A lot of states missed their revenue forecast and had to tap reserves

• Budgeters will approach the current year more conservatively

• Counties are not yet out of the woods• Out of 3,000 counties only 65 have fully recovered to pre-recession levels

• Cities are not yet out of the woods• Only 33% of cities recovered past their pre-recession revenue peak by 2012

• State aid is likely to continue to decline

• Even progressive mayors will have to be fiscally conservative

Republican Governors & Democratic Mayors• Republicans have their largest lawmaking majorities since the 1920s

• Many democratic-dominated cities are likely to take matters into their own hands this by passing progressive measures that go beyond or even conflict with state laws

• Minimum wage • 29 states and D.C have minimum wage at a higher rates then the federal $7.25 an

hour• Many of the larger cities in those states have far exceeded the state increase

• San Francisco• Seattle• Chicago

• States are pushing back by passing laws barring local governments from enacting certain measures• From fracking to broadband network expansion to capping soda sizes • 15 states prohibit local governments from adopting their own minimum wages

Increased Spending is Unlikely

• FY 2015 economy will grow a little more than the cost of inflation

• Little room for increased spending in areas that saw funding drops during the recession

• Cities that are sales-tax-dependent are not going to have huge increases in revenue sources in the future

Bond Rating Agencies Disagreeing

• Credit ratings agencies increasingly disagree about the health of state and local governments, causing a number of high-profile issuers to change their firms and leave investors to question their guidance

• 40% of jurisdictions have a split rating

• Some issuers are going straight to the banks

Public Pensions Seen As #1 Source of Pressure at SLG Level• May be a difficult year for states that haven’t been stocking their

pension funds the way they are supposed to

• New accounting unfunded liabilities• For many plans those new estimates suggest much larger unfunded liabilities

than before

• The rule change is only making SOME plans appear worse-off• Most aren’t using a blended discount rate and are sticking with their usual

return assumptions to calculate the long-term liability

Public Pensions & GASB

• GASB’s new rules on pension accounting will become visible for the 1st

time ever on government balance sheets

• Stricter view of unfunded liabilities likely to encourage talks of reform in states that are struggling to fund their pensions (NJ, Il, PA, KY, CT, RI)

• GASB approach to calculating pension funding, caused NJ’s funded level to decrease to 30% from 50% and its liabilities to $50B from $37B

• GASB is also looking to require governments to report as lost income the tax incentives they award to companies

Tax Policy• With a large group of Republican governors coming into office, most tax

changes will be in the direction of lower tax rates• MD Governor-elect plans to cut over $1.75 billion in waste, fraud and abuse from

state government; will roll back taxes without cutting government priorities

• Other states will change tax law to provide more revenue for broadly popular programs (MI)

• In 2012, KS Gov. Brownback cut the state’s income tax to boost the state’s fortunes, build up the economy and bring in new jobs• Included zeroing out taxes for 200,000 businesses and lowered rates for top earners• Now the state is facing a huge budget deficit that will require either overturning the

tax cuts or cutting hundreds of millions from the state’s budget • Brownback reversed his position a bit and is now willing to entertain some limited

tax increase going forward

• SLG tax structures are increasingly disconnected from the economy

• By 2011 80% of the national GDP was service-based• Over 50% now results from knowledge-based activity

• Less and less of the economy is based on producing and selling “stuff”

• Broaden sales tax structure by extending it to service delivery and knowledge creation

Our Out-of-Whack Tax System

Tax Policy

The pressure on taxes is more than ideological – it stems from stagnant wage growth. And lack of trust. And neither of those is going to change

soon, so the only way to meet demands for core services and infrastructure is to improve efficiency.

Looking Forward

The shape of public policy will be the result of the collision between what legislators and governors want to deal with and what they have to deal with

Republican agendas versus problems that have been festering for decades and now appear almost impossible not to confront

What Does It All Mean for Companies Doing Business with States and Localities

and Advocacy Groups Trying to Influence Policy?

Moving the Needle

• CO, Gov. Hickenlooper – focus on efficiency is the new imperative• “Delivering Results” – aims to make state government work in the most

efficient, cost-effective way possible through innovative management and hiring practices, new and emerging technologies, government process improvement and appropriate regulation

• New systems and procedures scaled up • Bringing innovation to scale

• Transforming small pilot projects into major programs with meaningful service delivery impacts and improved outcomes

• ROI has never been more important