Thursday, July 06, 2006

Mixed Results for Economic Development from New State Budget

Early on Sunday, the Pennsylvania General Assembly passed a new state budget for the 2006-2007 fiscal year. Although a little over a day late, the budget is more on-time than in recent years. (In contrast, New Jersey is shutting down state government services because of the resistance to raising the sales tax from 6% to 7% in order to close a $4.5 billion deficit in the state budget.)

Pennsylvania's budget deliberations this year were much easier than last year because the state ended the 2005-06 fiscal year with a more than $700 million surplus. Moreover, the challenge last year in balancing the budget was the growth in Medical Assistance expenditures. This year, the state used nearly $250 million from the Lottery Fund to pay for Medical Assistance expenditures, which enabled General Fund expenditures for Medical Assistance to be reduced by over $200 million compared to last year, thereby freeing up that amount to be spent on other programs.

All told, the adopted General Fund budget for 2006-07 is $26.1 billion, $1.4 billion (5.8%) more than 2005-06. Newspaper accounts indicate that this is the largest increase in spending in a decade. If you count the $200 million shift in Medicaid costs to the Lottery, the state had over $1.6 billion in additional funds to allocate. To what extent were these funds used to foster economic development?

Little Progress in Making Business Taxes More Competitive

As noted in previous posts, Pennsylvania's business taxes are extremely uncompetitive. Although the Governor's press release touts the fact that the budget cuts business taxes by $297 million, over 80% of this (about $244 million) was the continued phaseout of the uncompetitive Capital Stock and Franchise Tax that was enacted in 2000. (The law passed in 2000 phases out the tax by 1 mill per year, which reduces revenues each year by over $200 million.) Although it's good news that the budget didn't delay the phaseout of the tax (as two previous budgets had done), this is not a new tax cut, merely a continuation of a previously enacted one.

The budget did reduce the Capital Stock and Franchise Tax rate by a very small additional amount beyond the previously planned level (from 4.99 mills to 4.89 mills in 2006, and from 3.99 mills to 3.89 mills in 2007), but this cost the state less than $6 million to accomplish.

In terms of the Corporate Net Income Tax (CNI), the budget made a small amount of progress in improving competitiveness:

First, the General Assembly passed legislation increasing the cap on Net Operating Loss Carryforwards -- instead of being limited to $2 million in any year, companies can now carry forward losses of up to $3 million or 12.5% of their income, whichever is greater. This is good news for both startup companies and manufacturing firms in cyclical industries. However, the state did not eliminate the cap, and it remains one of only two states (the other is New Hampshire) that even has a cap on NOL carryforwards at all. So despite the progress, Pennsylvania remains uncompetitive here. This change is estimated to cost $21 million.

Second, the state changed the sales factor for income apportionment under the CNI from 60% to 70%. This reduces the current tax penalty on multi-state businesses that make investments or hire employees in Pennsylvania. But other states have moved to a single sales factor (i.e., a 100% sales factor), so Pennsylvania is still not as competitive as it should be. This change is estimated to cost $14.1 million.

And finally, the state increased the cap on the Research & Development Tax Credit from $30 million to $40 million. This will help to foster R&D by companies, which is a good thing for the state. The cost to the state budget is $10 million (the cap is on the total amount of credits available statewide, not on a per-company basis -- companies have to apply for credits, and when the cap is reached, no more credits are awarded).

But the state failed to make any change at all in the most uncompetitive aspect of the CNI -- its rate. The tax rate remains 9.99%, the second highest in the country, and the highest of any major state. A reduction of the tax rate back down to 8.5%, where it was between 1987 and 1990, would have made the state dramatically more competitive. And this reduction, if phased in over four years, could have been accomplished for only about $33 million next year.

So out of a total of more than $1.6 billion in funds available for new spending, only $50 million, or 3%, was used to address tax competitiveness. There was clearly room to do more -- a lot more -- but the opportunity was lost.

Little New Funding for Biotechnology

The three Life Sciences Greenhouses received no General Fund appropriations and a mere $3 million in Tobacco Settlement Funds, despite the fact that their initial funding awards run out at the end of this year. The Pittsburgh Life Sciences Greenhouse received $33.6 million in Tobacco Settlement Funds in 2001 to cover five years of operation (approximately $6.6 million per year), and that funding will end this year. Assuming that the Pittsburgh Life Sciences Greenhouse receives 1/3 of the total funds appropriated (i.e., $1 million), the proposed budget would result in a 70% or greater cut in its state funding, jeopardizing its important programs at a critical stage in their development.

The Governor's major initiative in this area, the Jonas Salk Legacy Fund, was not approved by the General Assembly. This was a plan to cut in half the $72 million currently allocated to biomedical research each year from the Tobacco Settlement Fund, and use the other half to issue $500 million in bonds to pay for new facilities and equipment for bioscience. While the $500 million for facilities and equipment would be desirable, the $36 million annual reduction in funding for research would have been undesirable. And although the $500 million would be a one-time program, the reduction in research funding would not have been a one-time cut - the same $36 million cut in research funding would have to be made every year for the next 20 years in order to support debt service on the bonds.

Although the Jonas Salk Legacy Fund wasn't approved, that doesn't mean that there is no funding for biotechnology facilities and equipment. The facilities projects can be funded through the state's Redevelopment Assistance Capital Program (RACP), and the funding for that program was increased by $500 million last December. This bond-funded program is specifically designed for economic development projects, and priority could be given to facilities that will support biotechnology research and businesses. Using the state's Redevelopment Assistance Capital Program to build research facilities and incubators, while maintaining or increasing funding for research through the Tobacco Settlement Fund, would be a win-win approach to stimulating growth in biotechnology research and business development.

A Lot of Funding for Economic Development Programs, But Where Will It Actually Go?

The Department of Community and Economic Development (DCED) received a 29.21% increase in funding, the second-largest percentage increase of any state agency (the largest went to the Department of State). The DCED budget was increased by $150 million, the third largest increase of any state agency (the two larger dollar increases were for the Department of Education and Department of Public Welfare, which operate the state's largest programs). This is probably a bigger increase in economic development funding than at any time in the state's history.

There is some good and bad news for the Pittsburgh Region's innovation and entrepreneurship initiatives in the DCED budget. The appropriation for "Digital and Robotic Technology," which goes to The Technology Collaborative, increased from $1.5 million to $3.0 million (the Governor had proposed eliminating it). The appropriation for the Pittsburgh Supercomputing Center increased from $1.5 million to $2.5 million (the Governor had proposed reducing it to $1.2 million).

But the appropriation to the Ben Franklin Technology Development Authority (which funds Innovation Works and other special projects, such as the Pennsylvania Nanomaterials Commercialization Center) remained flat, despite having been cut the previous year, and the appropriation for the Keystone Innovation Zones was also held flat, despite an increase in the number of KIZs across the state.

So if the $150 million in new money for DCED isn't going to these programs, where will it go?

A big chunk of the money -- nearly $29 million in new funds, for a total appropriation of $37 million -- is going to the Commonwealth Financing Authority to pay debt service on the bonds issued as part of the Governor's Economic Stimulus package. Another $10 million in new funds, for a total appropriation of $15 million, is going to the Infrastructure and Facilities Grant Prorgram, which funds debt service on local economic development projects based on the increases in sales tax, hotel tax, or personal income tax revenues the projects are expected to generate (essentially a state-level Tax Increment Financing Program).

A new $15 million appropriation is going to the Governor's "World Trade PA" initiative, which is designed to increase the number of Pennsylvania businesses exporting overseas and the number of international firms locating in Pennsylvania, two very laudable goals.

But for a lot of the new money, it's hard to know where it will go at this point, because it was appropriated to line items that do not have specific program guidelines attached to them. In most cases, no one will be able to apply for these funds, because the Governor and General Assembly have already decided how the money will be spent.

Many people have heard of the Community Revitalization Program, which holds the "walking around money" used by the General Assembly and Governor to fund special projects around the state. At first glance, it would appear that the budget reduces the amount of these discretionary funds dramatically, from $56.7 million last year to $44.3 million this year, a 22% reduction.

However, several other discretionary appropriations have increased dramatically. For example, the appropriation for "Regional Development Initiatives" increased from $900,000 in 2005-06 to $19,370,000 in 2006-07 -- over $18 million in new funding available. The appropriation for "Cultural Exhibitions and Expositions" (which provided some of the money for the Bassmaster Classic in southwestern Pennsylvania in 2005), increased from $4,930,000 to $11,725,000, an increase of over $6 million. The appropriation for "Urban Development" increased from $7,000,000 to $18,900,000, an increase of nearly $12 million. On top of this, the appropriation for "Manufacturing and Business Assistance" was increased from $2,500,000 to $3,000,000, and the appropriation for "Market Development" remained at $10 million.

In February, the Governor had eliminated all five of these appropriations in his proposed 2006-07 budget, saying that the 2005-06 funds had been used for "nonrecurring projects." (This is a sure sign that the funds are controlled by the General Assembly, rather than the Governor.) Rather than eliminating them, the final budget increased them dramatically, and added a new $9,175,000 appropriation for "Cultural Activities" which was also not included in the Governor's proposed budget. None of these programs has specific authorizing legislation or program guidelines associated with them.

As a result, there will now be at least $72 million in discretionary funding in these programs, $45 million more than last year, and more than enough to offset the $12.4 million reduction in the Community Revitalization Assistance program. Not a surprising result in an election year. Time will tell how much of these funds will come to southwestern Pennsylvania and whether they will be used for initiatives that advance the economy.


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