As part of my presentation this session to the Joint Legislative Budget Committee’s Finance Advisory Committee (FAC), I briefly addressed concerns related to the economy eventually slowing. While I remain more bullish on Arizona’s economy than at any other time in my professional career, business cycles will continue to exist and policymakers can choose to either plan ahead or ignore this economic reality.

MEMORANDUM:

From:               Jim Rounds

Date:                May 29, 2019

Re:                   Arizona’s Budget Stabilization Fund and the Relationship with the Business Cycle

As part of my presentation this session to the Joint Legislative Budget Committee’s Finance Advisory Committee (FAC), I briefly addressed concerns related to the economy eventually slowing. While I remain more bullish on Arizona’s economy than at any other time in my professional career, business cycles will continue to exist and policymakers can choose to either plan ahead or ignore this economic reality.

My concluding position was one of support for the Governor’s $1.0B recommendation for the Budget Stabilization Fund (BSF). I am very pleased, as an economist and policy analyst, that the Governor’s plan was taken seriously and the full amount was set aside to help us manage the next economic downturn. A balanced budget is one of the most important economic development tools and the State took a major step forward towards securing a strong economy during the next decade.

In addition to securing the BSF and the additional investment in education, the $190M in debt reduction and modest tax reform moved us closer to having one of the most stable fiscal positions in the country. The strength in the local economy did not happen by accident; it happened because of quality public policy. Despite the criticisms of the long legislative session, I am more bullish on the State’ economy than at any point in my career.

The following explains in more detail why a properly funded BSF is not just a political issue. It is a fundamental financial issue that is applicable to everything from family budgeting, to running a small business, to managing a large company, and even to economic development in general.

Summary

• A BSF of $1.0B is not excessive. In fact, it will only shield the State from a portion of the next economic downturn.
• A very mild downturn, similar to 2001 (our best estimate of what is to come), will require between $2.0B and $2.5B in reserves if no budget cuts are implemented and a 7% baseline rate of revenue growth is utilized for non-recession comparison purposes.
• If a more conservative 5% baseline rate of revenue growth is utilized (reflective of current and projected trends), the cost of the economic downturn declines to between $1.0B and $1.5B.
• While a downturn similar to 2008 is not expected, revenue reserves would need to be 5X to 10X compared to what is listed above.
• For planning purposes, expect to fully use the $1.0B BSF and be prepared to slim government by another $500M or raise revenues by this amount. This sounds like a lot, but this would likely place us at #1 in the country for properly managing an economic downturn.
• If severe disruptions in the State’s budget are avoided and we continue to be a role model for economic planning and growth, Arizona will be a top five state in every key economic category for the remainder of the 2020s – maybe longer. The fiscal consequences of maintaining this economic strength are massive.

Visual of a Downturn’s Fiscal Impact

The figures previously presented are best captured in a business cycle chart comparing actual revenue growth during economic downturns with baseline scenarios of revenue collections and spending that would have occurred during the same time period absent a recession. For perspective, annual growth rates for total tax collections are displayed below. The analysis was also completed at the individual tax category level.

Arizona typically outperforms the U.S. in times of expansion and recession. However, business cycles will continue to exist locally and fluctuations in tax collections will continue to cause budget problems. We cannot fully control business cycle impacts. We can control how to manage those periods where the revenue cycle dips below a baseline value.