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Nov 02, 2020

With Historic Election on Tap, a Look at the Fiscal Health of Pennsylvania

On the eve of one of the most significant elections of our time, we meet with three guests – Republican Sen. Patrick M. Browne, Democratic Rep. Matthew D. Bradford, and Matthew Knittel, director of the Pennsylvania Independent Fiscal Office – to discuss the impact that the coronavirus pandemic has had on Pennsylvania’s governance, economy, small businesses, tax agenda, and more.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

Over the last few months, this program has been able to cover in depth the effect that the coronavirus pandemic has had on many different aspects of the accounting and business landscape. We've covered its impact on financial institutions, accounting education, enterprise risk management, and so much more. Today, we continue this mission with a three-part interview addressing the effect this crisis has had on Pennsylvania governance itself. In three separate interviews, we spoke to Republican Senator Patrick M. Browne, Democratic Representative Matthew D. Bradford, and Matthew Knittel, director of the Pennsylvania Independent Fiscal Office, to get their perspective on Pennsylvania budget and economic matters as we head to the conclusion of a hectic election season, still wracked by the dangers of COVID-19.

First up, we have Senator Browne and Representative Bradford. We wanted to get both of their perspectives on these important matters. For each question, the first response will be Senator Browne and the second response will be Representative Bradford. Let's go to the conversation.

In May, the General Assembly and Governor Wolf agreed on a $26 billion stop-gap budget that funds state operations through the end of November. What was the rationale for that action?

[Sen. Browne] As the members of the Institute are aware, every year we advance a 12-month, fiscal-year budget in June and, under normal circumstances, our ability to project out revenue for that fiscal year is something we can do within a couple percentage points plus or minus based on the models we use and based on history of receipts in normal times. Unfortunately, when you have probably one of the worst economic quarters in U.S. history – second quarter 2020 – you really don't have any real line of sight going forward, given that difficult quarter and the unpredictability going forward as to the ability to estimate public revenue and our revenue capacity for a full year. Just like we do in financial statements, we book things when they're probable and that circumstances of this year don't make that possible for a full year.

What was something we could do is we could advance an interim budget, knowing that our receipts, given they're in the past year, have been in the range of $35 billion, that we could at least project out for $25 billion. That wouldn't be a problem. That was definitely probable. Others saying that we have to close the rest in November, but there were certain things, important things, in this document that were funded for a full year. One of them was things that the public markets evaluate us on. We didn't want to give the public markets a reason to think that we weren't going to meet our recurring obligations, the debt service and the pension payments, so they are in that $25 billion, that includes a full year of funding for those.

And for our education commitments, the commitments to our primary, secondary education systems and our higher education systems, we had provided a full year of funding there too, because they have to budget as well. Those are the systems that are most dependent on funding from us, but we need to finish the appropriations process in November and, right now, in order to get to where we were last year, it's another $9 billion that we would need to appropriate in November. We'll see throughout October how that's looking.

[Rep. Bradford] As you likely know, House Democrats unanimously did not support this idea. We believe actually, quite frankly, for too long we've been deferring making tough decisions in Harrisburg and have real questions about the wisdom to deferring, especially because it was done after such a consequential election, in such a brief period of time. The scope of the problem we face – the idea that sometime between the November 3rd election, consequential leadership elections that will take place and all the caucuses and with all the issues regarding both counties – we've really put ourselves up against a wall. Now having said that, I understand why there were those who wanted to put off and hope that maybe federal stimulus money would be forthcoming. Obviously, in light of the dysfunction coming out of Washington, D.C., and the White House, that does not look like it is in the offing. I think there was a hope that, deferring to November, things would be different. I think the reality is House Democrats have been largely proven right in their concern about pushing off until after the election.

How are general fund revenues doing the first few months of the 2020/2021 fiscal year?

[Sen. Browne] Well, actually they're performing better than our estimates are, which is a good thing. One of the things that reflects the unpredictability in our revenue that we certify for each year is the estimate that comes out of the Department of Revenue. We also have the Independent Fiscal Office that does it for us, too, as a comparison against the administration and allows us to do some due diligence as to the strength of the administration's estimate. And that's a billion dollars more this year than what the administration is, which is an enormous variance based on historical trends. At least in July, August and September, we're performing $500 million above what the administration's estimate is, which is a good thing because based on our projected revenue from the administration in May to appropriate as much as we did last year, understanding that usually appropriations go up by at least inflation.

Every year, we have a $4.7 billion hole. With performance over July and August and September being $450-500 million above what the estimates were, it's obviously going to make things easier for us in November to close because the goal hopefully will be the need to be supportive of the things that we appropriate for, and that's our schools and our human services for healthcare for low income folks, support for seniors, support for individuals with disabilities. We would like to at least appropriate what we did last year, which would be, given the circumstances, a pretty significant achievement, but that is at least the goal. The performance over the last several months is making that a little easier.

[Rep. Bradford] We shifted a lot of revenues, as you know, understandably that would have otherwise been due in last fiscal year into this year. And we're collecting a decent percentage of those, but not nearly at the numbers we expected. And the concern continues to be because of, frankly, the dysfunction out of D.C., we're not getting the level of growth that we need to sustain these revenues. Unemployment, I believe, is now about 10.8% in Pennsylvania. These numbers, despite some claims to the contrary about a V-shaped recovery, if we don't get stimulus dollars into these businesses at a time where, frankly, the virus continues to ravage our economy, we're going to be in bad shape in terms of revenues going forward.

What challenges do you foresee in enacting a budget for the rest of the fiscal year during a sine die session?

[Sen. Browne] It's going to be, as I indicated in my prior comments, trying to come up with a plan that accommodates an appropriation for the entire fiscal cycle – 2021 – that's consistent with last year. In order to get there right now, we're carrying a hole that's $4 billion plus and that will lead to some difficult decisions to get there. As long as things improve, we can probably be more aggressive on the revenue estimate. We can recertify it in November. In order to close that hole and not cause significant stress on the systems that we fund, we will potentially have to make some difficult decisions. None of those have been decided as of yet, but that's the biggest challenge. If we decide that it's important for us in supporting our local governments, our local school districts, our services for our most needy citizens, and keeping those services where they are in a very difficult time, then to close that hole is going to be our biggest challenge.

[Rep. Bradford] I touched on that a second ago, but let me kind of walk you through the calendar and why I think it's going to be so problematic. Again, not impossible, but problematic. I think we need to keep in mind, these challenges are in front of us. We have an unbelievably consequential election on November 3rd, but, as we all know, ballots are going to be counted for some days after November 3rd, potentially, if we don't come to an agreement on some kind of pre-canvasing, which will allow us to get ballots counted closer to Election Day. You have this very consequential election. Because of the political winds blowing so strongly, it's possible that one or both chambers' leadership will change in terms of party majority. And then you have just the individuals within those caucuses’ leadership elections taking place November 10. That all assumes COVID doesn't wreak havoc on our schedule like, frankly, it happened in the House last week.

You have this very compressed time period, an election on November 3rd, counting of ballots, hopefully leadership elections November 10th, you've got Thanksgiving, you've got the possibility of the virus continuing to resurge and rear its ugly head, even in the chambers potentially. So you're trying to do this in about a two-week period, dealing with the size of a budget hole in the $5 billion range. The political timeline is difficult, and we also just don't know what the consequences out of D.C. is. If there’s a President Biden, things may look better in terms of federal money forthcoming, but the reality is new Presidents don't get sworn in till January 20th. We don't obviously know what the outcome of the Presidential election is. There are so many variables and moving targets that I guess I just say all that to say, sine die is already problematic to the political timeline and so it's the variables that we have no control over.

Does your caucus have a plan to provide assistance for Pennsylvania small businesses, particularly restaurants and other service industries?

[Sen. Browne] It will be difficult for us to do any more out of what we have available to us because, as the members of the Institute know, we don't control the money supply. We can't deficit-spend. To close the hole that we have and also spend above what we did last year for assistance out of our own capacity is going to be very hard. Hopefully there is some conversations after the election in the U.S. Congress and the White House regarding the support we need and then we can hopefully follow up.

[Rep. Bradford] We realize the scope of the challenge brought on by this pandemic is much larger than any small business and, frankly, any local government and, frankly, state government can handle on its own. Thanks to CARES, the Commonwealth is still sitting on about a billion dollars in CARES money that we want to target specifically towards those small businesses, restaurants, hospitality, service industries. We believe it's, frankly, past due to get that money out into our economy. I touched on before the increases that we're seeing in unemployment and the challenges in our economy. We need to keep this stimulus in this economy to keep it going. We obviously support $225 million in forgivable loans and grants to small businesses through the COVID Relief Statewide Small Business Assistance Program, and $100 million in forgivable loans and grants for the hospitality, leisure, and service industries, including restaurants, bars, salons, and barbershops. But, again, we recognize it's, frankly, past due to get that money into our economy.

What tax policy changes are on your agenda? Do you envision a sales tax on professional services?

[Sen. Browne] We usually have what's called a tax comprehensive tax code as part of our budget process. It is undecided at this point in time whether we will have one in November. November is a very unusual month for us to do this budgetary-related work. The goal right now is to keep it focused, but there may be a tax code which will include various items as they always do, as in the November conversation. There is a budget, different proposals that members have advanced for economic development, for assistance for children with pediatric cancer, for foster systems for families, childcare assistance. Each one of those is part of the conversation and then we'll see in the end, in the context of closing a budget, because the tax code includes tax credits and tax system provisions will carry a fiscal impact on it. That has to be factored in to closing the overall budget.

As far as the possible use of a tax on professional services for purposes of general fund revenue capacity, that is not on the table and has never been on the table for that purpose. The only time it's been really talked about is in relation to as a replacement revenue for property tax elimination, which is not our agenda for the fall. I can say pretty clearly that the prospects of that are zero. That's not something we'll be doing.

[Rep. Bradford] I don't. I say this in a good news/bad news way again. In the past, I believe the legislature, Democrat and Republican – both chambers; this isn't about being partisan – have gone out of their way to avoid tough decisions. So what they would pick is these little revenue sources. “Oh, well, we can get nickel and dime revenue here and there.” I would argue that the day of reckoning is clearly here and we need to have a larger discussion. Not about these little things where we're going to pick on professional services or go for these revenues, but have a larger discussion about tax policy. To me, out of this challenge, and it is a great challenge, is opportunity to really look at implementing a tax policy that's fair, but is also pro-investment. That is about getting Pennsylvania back on its feet. Out of this time of tremendous economic carnage that we're seeing caused by this pandemic and our inability to deal with it at the federal level, we believe there's an opportunity at the state level to really look at our tax policy holistically and say, "What can we do?"

Yes, to balance this budget, and we need to meet the needs coming out of this pandemic, but also what can we do going forward to create a tax policy that makes people want to invest in Pennsylvania, that makes us stronger in terms of infrastructure? We need to look at these challenges after a decade, frankly, of avoiding big choices and big challenges. Now's the time for us to get about the business of looking at much bigger things and, again, stop going with these nickel-and-dime, bubblegum-and-paper-clip solutions that have solved nothing in terms of the long-term structural deficits that we continue to have in Pennsylvania.

Now we move to IFO Director Matthew Knittel, who spoke to us about the impact the pandemic has had on the budget, the economy, and revenue forecasts both immediate and longer-term.

What impact has the COVID-19 shutdown had on Pennsylvania's current year budget?

[Knittel] I think it's had a dramatic impact on the budget for the current year. As you know, we had a five-month budget through November, so, after the election, the legislature will need to return to pass the budget for the full year, but both on the spending side and the revenue side. We're seeing dramatic changes; certainly on the spending side of the budget, we have a lot of new demands, new outlays for funds that are related to COVID. Also on the revenue side, there's been a lot of dramatic movement. We think that for both last fiscal year and this fiscal year, there's roughly a $4.5 billion gap between the revenue collections we would ordinarily collect if there wasn't every session, versus what we expect to collect under COVID-19.

What is your revenue forecast for fiscal year 2020/2021? And how about fiscal year 2020/2021 through 2024/2025 for a longer-range look? What's it looking like?

[Knittel] For the current fiscal year, we have in general fund revenues of about $34 billion. And let me note that that excludes some monies that were shifted into the year. About $2 billion was shifted from last year to this year, due to some payment delays and some relief that was provided. That's about a flat growth rate. It's even from last year and, at the end of last year, we had a major hit to our revenues in April, May, and June, so we're coming off a lower base. Most of our revenue sources are down year over year, corporate net income down, most of the personal income tax is down. The one exception I would point to for the current year is we do have sales tax revenues going up and that's been very surprising how well sales taxes have been holding up in the current environment, where we've lost currently about half a million jobs. That is surprising.

Longer-term, we're currently updating our forecast, but we do have some concerns that this is going to linger for a number of years. I don't doubt that the job losses we have now – we're at about half a million – I think we're going to have an issue with permanent, long-term unemployment, possibly. I suspect a lot of these jobs are not coming back.

How, in an overall sense, has Pennsylvania's economy fared during the pandemic?

[Knittel] We'll go back to April and we had lost a little over one million payroll jobs, so about 17% of the workforce and that's not even counting self-employed folks, independent contractors, and we don't really have a reliable number on that. But given that we lost over a million jobs, the revenues and the economy, generally I say, did not drop off as much as we expected and there's really two or three reasons for that. One is just the massive federal stimulus that came into the economy, just tens of billions of dollars through unemployment or small-business loans. The other thing that was surprising, given the consumer spending and how it held up, was the shifting. Folks didn't go away on vacation; instead, they spent it on home-improvement projects or what we've seen is a lot of refinancings. They've more than doubled on a year-over-year basis for the last six months. Folks are lowering their monthly payments and pulling out money from their home. All of this has kind of underpinned the growth and I'd say it's held up better than we expected.

Has the IFO looked at the financial impact COVID-19 has had on our local governments? If so, what have they found?

[Knittel] We did receive a request back in May to look at local governments and the impact of COVID-19, and we accepted the request and we looked at municipalities and school districts. And although municipalities collect a number of different revenue streams, we really only look at earned income taxes and property. Our results from municipalities found that, for calendar-year 2020, that earned income tax revenues would fall by about three and a half percent or $60 million. I'd caveat that this doesn't sound like a lot, but a recall for calendar-year 2020, COVID-19 was only impacting the revenues for two quarters so that's why it's not more dramatic than that.

Then for property taxes, we thought for municipalities it would drop off by about one and a half percent or $40 million. For school districts, we looked at the school year 2020 to 2021 and, there, COVID-19 is impacting all four quarters so we get more of a dramatic result. For school districts, we thought the EIT revenues would drop off by about 115 million or 7.3%. For property taxes, we had a year-over-year reduction of about 2%, which would translate to about 280 million.


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Podcast transcripts are provided as a summary of the conversation and have been lightly edited for the written medium. The transcript is not a verbatim representation of the interview.
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