SD24 - Proposal for a Revenue Stabilization Fund in Virginia

  • Published: 1991
  • Author: Joint Legislative Audit and Review Commission
  • Enabling Authority: Appropriation Act - Item 13 (Regular Session, 1990)

Executive Summary:
Revenue forecasting is not an exact science. As noted in the Joint Legislative Audit and Review Commission (JLARC) Interim Report "Revenue Forecasting in the Executive Branch: Process and Models," while an increased role for the legislature and other improvements to the revenue forecasting process may improve accuracy and would enhance accountability, there will still be normally-occurring forecast error. Shortfalls and surpluses are both inevitable. But forecast error is most problematic when it results in revenue shortfalls. Given the inevitability of forecast error, Virginia needs a strategy to cope with shortfalls which periodically result.

The Revenue Stabilization Fund, or rainy day fund proposed in this report, would be such a mechanism. The fund would provide a cushion for the State during unforeseen downturns in the economy. Further, the fund would provide a mechanism for building up the fund when above-average revenue growth occurred. This feature would discourage building high revenue growth into the permanent spending base of the State.

The provisions of the proposed Revenue Stabilization Fund are contained in Senate Joint Resolution No. 159, which was pre-filed by the subcommittee in December 1990. The resolution proposed amending the Constitution of Virginia to establish the fund.

The proposed constitutional amendment addresses a maximum fund size, a deposit mechanism, and a withdrawal mechanism. The summary exhibit on page II highlights the key proposals.

The Fund Should be Constitutionally-Based

A constitutional amendment would ensure that the fund would be a permanent part of the fiscal process. A constitutionally-based fund would be more permanent than one contained in statute, since the former could not be overridden by the Appropriation Act. In addition, a constitutional amendment would avoid potential constitutional problems which could confront a statutory fund.

The Fund Should Have a Maximum Allowable Fund Size

Establishing the maximum size or the fund annually, by formula, is important if the fund is to keep pace with inflation and the increasing responsibilities of government. The proposed formula bases the fund size on ten percent of the State's average income (individual and corporate) and retail sales tax revenues for the prior three years. At the current time, the maximum fund size would be $459.5 million. The maximum fund size is to be computed by the Auditor of Public Accounts and reported to the General Assembly.

Both Mandatory and Discretionary Deposits Would Be Made By the General Assembly

There are two basic deposit provisions: deposits guided by a formula and discretionary deposits. All deposits are to be made by legislative appropriation. The proposed formula requires the deposit of 75 percent of the above-average revenue growth from income (individual and corporate) and retail sales taxes. The proposed mandatory deposit mechanism is designed to be a slow-growing one. The maximum fund size could be reached more quickly through the use of additional discretionary deposits.

Withdrawals by the Legislature Would Address Major Shortfalls

Under the proposal, a withdrawal may be made only by legislative appropriation. An appropriation may be made only in the event of a shortfall that exceeds two per cent of certified tax revenues. (At the present time, a shortfall would have to be in excess of $95million.) In addition, no more than one-half of the fund may be withdrawn in any fiscal year. Further, a withdrawal cannot exceed one-half of the projected shortfall.

Several objectives are achieved using the proposed withdrawal policy. First, the entire fund cannot be depleted in the first year. In fact, there would never be a zero balance in the fund. Second, the fund would not be used to address all of a projected shortfall. Spending cuts or other measures would also have to be employed. Finally, the two percent threshold would ensure that the fund is not used to compensate for relatively minor shortfalls.

Recommendation. The General Assembly may wish to establish, by constitutional amendment, a Revenue Stabilization Fund for Virginia containing the following general characteristics: (a) a maximum fund size that is ten percent of income and retail sales taxes for the three immediately preceding fiscal years; (b) funds may be deposited by a discretionary appropriation or by a mandatory appropriation determined by a formula; (c) funds may be withdrawn by appropriation of the General Assembly during years in which there is a projected revenue shortfall; (d) a projected revenue shortfall must exceed a threshold amount of two percent of the prior fiscal year's certified tax revenues in order for a withdrawal to be made; (e) funds may be applied to no more than one-half of a shortfall; and (f) no more than one-half of the fund balance may be withdrawn in anyone fiscal year.

** NOTE: As this document went to press, the Senate Finance Committee reported an amendment in the nature of a substitute for SJR 159 - the JLARC subcommittee proposal for a Revenue Stabilization Fund. The committee substitute lowered mandatory deposits from 75 percent to 50 percent of above-average revenue growth. The substitute also provided a mechanism for exempting revenues from tax increases for up to six years. The other provisions of the fund remain as described in this report. A copy of the committee substitute is included in Appendix A of this report and several references to the substitute have been added to the report. No subsequent actions on the proposal are reflected in this report.