Recession expected to take toll on state budget shortfall

By Kathy Helms-Hughes
STAR STAFF

   There's no more tiptoeing around the "R" word by market analysts. Most admit the nation is now in a recession. The two-fold question is: How severe will it be and how long will it last?
   Dr. Steb Hipple, East Tennessee State University professor of Economics, said that while the terrorist attacks of Sept. 11 have taken a toll on the economy, the worst is yet to come.
   What might have been a short, shallow recession now is expected to take its place among the more severe recessions of 1974-75 and 1980-81, Hipple said.
   "It will be a couple more months before we start to get some clean data. Anything that's overly affected by an event like that is not going to be a good indicator," he said.
   "For example, retail sales were up in October because the automobile companies were selling record numbers of cars. They sold every car at a loss and they've never had more red ink in their history either. So a lot of the statistics that are coming out are very muddied by the reaction to the events," he said.
   The national economy slipped into the first economic recession in 10 years during third quarter 2001. While monetary and fiscal policy changes are being made at the federal level to offset the business downturn, the prospect of further terrorist attacks and the U.S. war against terrorism, in conjunction with simultaneous contractions in the economies of U.S. allies and trading parties, all point to a major downturn in business, according to Hipple.
   The national picture does not bode well for the state of Tennessee, which is expected to begin the next fiscal year with a revenue shortfall.
   Hipple, who attended a "Town Meeting" Wednesday night in Bristol to discuss the state financial situation, told a legislative delegation they could have a billion dollar hole in next year's budget.
   "We've got some problems here. We need a tax increase and to me one of the difficulties the governor has had in the past couple of years in selling an income tax is he's yakked about reform: 'We're reforming the tax.'
   "No we're not," Hipple said. "We're increasing the tax. And at the same time we're changing the tax structure because the income tax will grow the revenues more dependably than a sales tax, which is a consumption tax," Hipple said, and tends to fluctuate.
   "I think we'll probably have to go through another year of ad hockery and then a new governor will come in and put things to right. I also think some of the people in the Legislature who are stonewalling tax reform/tax increases will probably be gone," he said.
   While automotive incentives being offered by Detroit have had a very positive reaction, one thing must be pointed out, Hipple said: "These companies had inventory in the pipeline and they need to get rid of it. So you can sell it now for a small loss or hang on to it and sell it later for a big loss. So we sell it now. That has given a boost to retail activity in October, especially the auto sector, but the analysts that track the automobile industry are pointing out, No. 1, that there's more red ink than ever before and that the high levels of sales in the auto industry is really borrowing sales from future months.
   "At some point, probably in the winter, the market for new cars is going to be down, No. 1 because of recession and No. 2, it will be further down because they have borrowed sales from that period. So when they adjust production and employment to what will be a very weak market in the first part of next year, you're going to see really bad news coming out of Detroit," Hipple said.
   According to the professor, there have been some curious responses to having a catastrophic event on top of a recession.
   "Energy prices have declined dramatically, and that's a good thing."
   While the auto industry is aggressively promoting autos and losing money, future sales are also possibly being raided from consumer durable goods as companies push inventory to get it out the door, Hipple said.
   "When they get to that future it's going to mean a period where we have a lot of very low economic activity and it's really going to be a significant recession," he said.
   There are some people who have enough confidence about their jobs and future income that they are willing to assume additional debt today in order to take advantage of bargains on the market, according to Hipple.
   "Interest rates are very low (and by refinancing your home) that also can free up additional purchasing power. It's a very mixed picture if you start looking at the data; but overall, the trend of the economy is downward.
   "We are probably now in the second quarter of a recession and most analysts are not looking for any possibility of a recovery until the second half of next year. If you spend that much time in recession, then that means this will be a long recession and go up to the 1974-75, 1981-82 recessions for duration," Hipple said.
   The impact of a recession on shrinking state finances could leave Tennessee looking for creative ways to fill a $1 billion hole in the budget.
   "The state this year made an assumption of a $300 million growth in sales tax revenue," Hipple said. Though not an unreasonable assumption, it has not materialized and actually may decline, according to Hipple.
   "They raided a cookie jar, which is a one-time event, for $550 million in tobacco money, and they cut back on budgeted spending by about $400 million.
   "You start putting all of these pieces together and assume that there will be no growth in sales tax revenues next year and that the demand for state services will continue to expand ...," and the financial picture looks a little bleak.
   "A lot of our state spending is either controlled by federal statute or is under court order. The money they spend on K-12, the money they spend on TennCare, the money they spend on prisons -- which are major spending categories -- are either pass-through funds from the feds or there is a federal law telling them how much they have to spend, or there's a judge sitting there with a piece of paper saying, 'You guys need to do this.'
   "When the state does its budget it has to be a balanced budget. There's discussion that they may actually borrow funds short-term to cover the deficit," Hipple said, which means the state some day would have to pay that money back out of tax revenue.
   "It also means they have covered a hole this year but that there's going to be a larger hole next year. ... They've raided the $550 million tobacco settlement funds and there is a legal question that by doing that to cover state operating expenses, maybe we have to give that money back, too. The tobacco settlement money was not supposed to be used to fund the ongoing operation of state government," he said.
   Following Wednesday night's Town Meeting, Hipple said he believes that when the General Assembly meets in Nashville in January, "The Senate will refuse to do an income tax but the House will -- while the ship of state sinks."
   At the Town Meeting, Hipple said he brought up the prospect of the state seeking a loan to finance itself and received a curious response from Rep. Jason Mumpower.
   "He said he can say emphatically that the state would not borrow money to cover its deficit this fiscal year, that they will go to existing funds.
   "Tennessee has a special financing arrangement for the building and maintenance of roads. Every time you buy a gallon of gasoline, you pay a state tax on that. It's called a use tax. That is a designated tax. It does not go into the general revenues of the state but goes into the state highway fund which is to be used only for the construction and maintenance of highways and transportation infrastructure.
   "Apparently that fund is going to be tapped. They're going to go into the state highway funds because there is a balance in the fund that could be used to cover the state spending needs the rest of this fiscal year. The Legislature set that aside; so what the Legislature did, the Legislature can undo," he said.
   The state highway fund apparently has a couple billion dollars in it, "so you're looking at a fraction of the money that is in that fund," Hipple said. "You're robbing Peter to pay Paul ... (although) there may be some intention at some point to put it back.
   "There's also the state retirement fund that has a balance. You have the road fund and the state retirement funds that could be used for 'bridge' financing to get us through the rest of the fiscal year, and apparently that's where they're going to go."
   Asked about legislators passing a state income tax, Hipple said, "My personal feeling is that if some of these representatives feel that a state income tax is illegal, but we have a majority in the state House of Representatives for it, supposedly -- then the Senate should go ahead and pass a state income tax.
   "As soon as it is passed and signed by the governor, it will immediately be challenged in state court and because of its unique public interest, it will immediately go to the state Supreme Court, and I imagine that within two or three weeks after the governor signs the bill, the state Supreme Court will either say, 'Yes, it flies, and everything's fine,' or 'It does not fly. It is illegal.'
   "You're going to have to amend the state Constitution and that's a three to four year process and in the meantime you're going to need to find a lot more money. At that point, they will then go back and expand the number of transactions and the range of businesses that pay sales tax," Hipple said.