Texas Weekly: Reversal of Fortune

The comparative economic fortunes of California and Texas have gotten a lot of attention in the news media lately. Texas has done remarkably well during the recession. California—not so much. California, in fact, has been perhaps the hardest-hit state. Its economy was pummeled by the housing market meltdown, and its state finances are a shambles.

Comparisons of that sort are enjoyable when you are winning, and Texas has been. However, with a new legislative session only a little over a year away, we should pay attention to what my old boss, Bob Bullock, used to call the thorns among the roses here in Texas.

It would have been ridiculous to believe that Texas could avoid the national recession entirely, and it hasn’t. The state economy is in recession and has been for several months. Unemployment is sharply higher than a year ago. Housing, commercial real estate, manufacturing and retail sales are all weak. The good news is that the national economy may be recovering, and Texas will follow, hopefully by spring. The bad news is that it is going to be a long, slow, painful recovery nationally.

Between now and the return of the good times, Texas state finances will experience problems of their own. You can get a sense of just how big those problems could be by looking at recent sales tax performance. October sales tax receipts were down 12.8 percent from a year ago. That’s the fifth consecutive month of double-digit drops. The state hasn’t had a positive month of sales tax growth since January.

This trend matters because of the sales tax’s importance in state finances. California is criticized for its dependent the personal income tax, which tends to drop like a rock during a recession. Texas is no less dependent on the sales tax. The tax accounts for nearly 60 percent of state general revenue (which doesn’t include federal funds), and right now, the tax is in free fall.

The last five months are the worst string of sales tax months since the tax was enacted in 1961 and are much worse than during the 2002-03 recession when collections fell by “only” 1.1 percent in 2002 and 1.7 percent in 2003.

State revenue forecasters have noticed national conditions, and the state’s current budget assumptions were built on projections of weak sales tax growth in 2009 and 2010. Weak growth, but still growth. Unfortunately, the tax declined by 2.7 percent in fiscal 2009 (the state fiscal year ends in August), and it is down by better than 12 percent so far this year. Results like those are guaranteed to produce heartburn aplenty for revenue forecasters.

The rest of the tax system isn’t providing much reason for comfort. Motor vehicle sales tax collections were down 22.5 percent in October. Oil and natural gas taxes have been down all year, although state forecasters saw that one coming after the price spike in 2008. Hotel taxes are sagging. Motor fuel taxes are down. The newly reformed state business franchise tax has underperformed projections from the start. Only alcohol and cigarette taxes are up right now. Given the economy, it figures.

The revenue situation could pose real problems for budget writers in 2011 if there isn’t some improvement soon. The state will already be without the federal stimulus dollars that filled a lot of holes in the current budget. Deteriorating revenue conditions could add to what already promises to be a tough budget year.

How much worse could things become? That’s a question I’m glad I don’t have to answer, having retired from the perilous line of work that is revenue estimating. On the plus side, the economy is supposed to be recovering. The next few months could provide evidence of that improvement—or not. A good indicator will be January tax collections. January is the biggest month of the year for the sales tax and reflects a lot of holiday sales. If there’s no recovery by then, we can hope for a spring awakening. If things don’t improve by spring, the state better start squirreling away nuts. It may be a long, cold winter.

We can, however, take comfort that we aren’t alone. I just checked, and California’s revenue collections are already lagging behind projections this year. Then again, their sales tax revenue was down by only 2.4 percent in the most recent month compared to the 12.8 percent drop in Texas. In the current economic circumstances, you take your victories where you can find them.

Billy Hamilton, now a consultant, is a former deputy comptroller of public accounts, and was once the state's chief revenue estimator.