HD30 - Interim Report: Review of State Spending

Executive Summary:
State spending grew from $5.7 billion in FY 1981 to $21.4 billion per year in FY 2000, an overall increase of 274 percent. The average annual growth rate for Virginia appropriations was 7.3 percent. These upward trends led to the concerns addressed in this report: Why did spending grow so much? Which spending components grew fastest, and why? How accurate were the forecasts of revenue growth that were used to build budgets? Has State government's performance improved along with the increased spending? These are some of the concerns addressed in this report, the first in a series of JLARC reports on State spending.

The 2001 General Assembly adopted two mandates directing JLARC to review expenditure growth and related concerns. House Joint Resolution 773 calls for JLARC to analyze six topics related to expenditure growth and improving the efficiency of State government. House Bill 2865 added § 30-58.3 to the Code of Virginia, requiring JLARC to develop an annual report on State expenditure growth and efficiency in Virginia government. Both mandates are included in Appendix A.

Change in Virginia, 1981·2000

State spending grew along with many other indicators of life in Virginia. Virginia became a more populous and richer State between 1981 and 2000. State spending grew in response to substantial growth in almost every category of persons served by State programs, whether Medicaid recipients, child support recipients, college students, State park visitors, or prison inmates.

Virginia's population increased 32 percent between 1980 and 2000, growing from 5.3 million to 7.1 million persons. State government had the resources to respond to this increasing population due to growth in other key aspects of Virginia's economy. Total employment in the State, for example, increased 60 percent between 1981 and 2000, from 2.2 million to 3.5 million persons employed. Total personal income, such as wages, salaries, dividend and interest income, and transfer payments, grew 176 percent over this period.

Inflation was a major factor during the 20-year period of this review, going up 90 percent. Adjusting for the effects of inflation shows spending grew 107 percent over the period. Placing inflation-adjusted spending on a per-capita basis to adjust for the population increase, Virginia spending increased 56 percent, from approximately $2,000 to $3,100 per-capita (in constant dollars), an average annual increase of 2.8 percent.

Spending on State services grew not only in response to inflation and the needs of an increased population, but also due to federal and State decisions to meet increased citizen demands for services and to provide higher levels of services and benefits to more persons. Federal requirements for programs such as Medicaid, child support enforcement, and transportation caused State spending to increase. Major State initiatives to improve elementary and secondary education, higher education, transportation, public safety, and the environment took place during the 20-year period examined in this study, all of which had the effect of increasing costs to the State. Changes in tax policy also affected State spending, as by the close of this period Virginia began phasing out the personal property tax, an initiative which quickly became a significant State outlay.

Although Virginia spent substantially more in FY 2000 than in FY 1981, the Commonwealth's ranking among the 50 states actually declined in terms of per capita state spending. Virginia's rank decreased one position, from 36th to 37th on this measure between FY 1981 and FY 1998, the most recent year for which data were available. Substantial increases in spending appear to have been the norm in the other states over this period.

Revenue Forecasting

An outgrowth of this JLARC staff review was a request by Commission members for staff to assess the accuracy of Virginia's general fund revenue forecasting. This effort updates a 1991 JLARC report on the State's revenue forecasting process.

Revenues are forecasted through a multi-step process, involving a variety of agencies and personnel. The Department of Taxation takes the lead in forecasting general fund revenues, using information from various State agencies and from two consulting firms to forecast the performance of the State economy as well as the general fund. Statutes require a six-year forecast of general funds, and outline a process requiring a review of the forecast by two groups: the Governor's Advisory Board of Economists (GABE) and the Governor's Advisory Council on Revenue Estimates (GACRE). Legislative involvement in the revenue forecast is limited to participation on GACRE by certain members of the legislative leadership.

Two findings from the 1991 JLARC report remain valid: there is always some difference between the forecast and actual collections, and the further out a forecast is from the end of the fiscal year being predicted, the less accurate the forecast tends to be. Forecasting error is also correlated with the business cycle - forecasts tend to call for too much revenue during economic slowdowns, and to predict too little revenue during economic expansions.

During the period from FY 1981 to FY 2000, the absolute error for the forecasts made about 24 to 26 months from the end of a year (the accuracy of the second year estimate used in the first Appropriation Act of a biennium) was 6.5 percent. The absolute error for the forecasts made 12 to 14 months from the end of a year (the accuracy of the first year estimate used in the first Appropriation Act of a biennium, and the second year estimate in the second Appropriation Act of the biennium) was 3.8 percent. The absolute error for the one-quarter out forecasts (forecasts of the current year of the biennium) was still less, at 1.0 percent.

The State has some safeguards against revenue shortfalls. For example, the General Assembly may amend and adjust any year's appropriations at least twice - through second year and "caboose" or final Appropriation Acts. Second, the Governor may adjust expenditures, within certain limits, as revised forecasts become available. A third important means of coping with a revenue shortfall is the revenue stabilization fund. To some extent, this fund operates as a hedge against "downside" forecast error, because if the forecast calls for substantially more revenue than actually becomes available, the stabilization fund may be tapped to provide some funds, subject to various conditions.

Components of Spending Growth

Not every State agency and program experienced as much growth as suggested by the overall growth in State spending. Some grew faster, others grew much more slowly or were level-funded (received no budget increases) for several years, and others experienced both reductions and increases during the period. Numerous agencies and programs were abolished, consolidated, and reorganized, making it difficult to track longer-term trends. There were also specific initiatives undertaken during this 20-year period that helped shape the State's overall spending pattern.

Two of the broad functions of State government accounted for nearly three-fifths of the overall budget increase (in dollar terms, unadjusted for either population growth or inflation). The figure on page IV indicates that education (including elementary and secondary education as well as the institutions of higher education) accounted for $5.1 billion or 31 percent of the total State spending growth. Second largest in terms of dollar growth was the broad function of individual and family services, accounting for $4.5 billion of the growth, or 28 percent. This function includes Medicaid, welfare, child support enforcement, mental health programs, and related activities.

Looking at individual agencies with the largest increases (in terms of total appropriation dollars) shows a similar finding. The Department of Education had the largest dollar increase, followed in order by the colleges and universities (taken together due to the similarity of their missions), the Department of Medical Assistance Services (the State's Medicaid agency), the Virginia Department of Transportation, and the Department of Social Services.

This review also identified budget programs which grew the most and which are not conventional State agencies with employees and offices, but instead are related activities grouped together in the State budgeting and accounting system. Some budget programs are common to more than one agency (such as the budget program called "administrative and support services"), but many of the fastest growing programs are administered by only one agency.

Appropriations for the broad function of education, which includes elementary and secondary education, the State's colleges and universities, and other post-secondary education programs, grew the most between FY 1981 and FY 2000. Two education budget programs accounted for most of the growth in this broad function: financial assistance for public education, which includes funding for the standards of quality (SOQ) required by the Constitution of Virginia, and the education and general programs in higher education, which includes funding for a variety of higher education instruction-related activities.

Medical assistance services - the core Medicaid budget program - was the program with the most growth in spending, measured on a percentage basis, within the broad function of individual and family services over the 20-year period under review. Second within this broad function was child support enforcement in the Department of Social Services; most of this appropriation consists of payments by non-custodial parents for their children's court-ordered support. The third largest budget growth in this function was in State health services, which includes in-patient medical and mental health services in State supported hospitals, such as those operated by the University of Virginia and the Department of Mental Health, Mental Retardation, and Substance Abuse Services.

Four programs - highway system acquisition and construction; highway system maintenance; crime detection, apprehension and investigation; and secure confinement - were the fastest growing budget programs within the broad functions of transportation and administration of justice.

Several initiatives were undertaken between 1981 and 2000 that also had the effect of increasing State spending. Some of these initiatives are profiled in this report, including the "HB 599" program, the revenue stabilization fund, and the personal property tax relief program. Together with the 1986 transportation initiative, these four initiatives accounted for $1.4 billion, or seven percent of the FY 2000 budget.

The Development of Performance Measures in Virginia

One of the mandates for this review (HJR 773) focuses on whether performance measurement can be used effectively to guide program improvement. Although Virginia has, in many ways, a model system of strategic planning and performance management and has been recognized nationally, it is a system still in a developmental stage. The overall system of performance management is under the general supervision of the Department of Planning and Budget (DPB), which has provided agencies with training, guidance, and a web site posting agency measures and other performance information.

Only limited use is made of State-level performance information in decision making, oversight, management, or planning. At the agency level, use of performance information varies widely. Some agencies make little use of the system at any level. Others effectively use the information as part of their day-to-day operations. Several agencies have been recognized nationally for their internal use of performance information, including the Virginia Retirement System, the Department of Motor Vehicles, the Department of Mines, Minerals, and Energy, and the Department of Taxation.

Performance measures have been developed for all Virginia executive branch agencies. These measures are posted on Virginia Results, the internet-based planning and performance site maintained by DPB. During FY 2000 audits, the Auditor of Public Accounts (APA) tested 89 out of about 700 agency measures, focusing on those that were relevant to financial management. These audits found the information provided in the 89 measures to be 99 percent accurate. The APA found that agencies met or exceeded targeted performance levels in 51 percent of the measures, and did not meet the targeted performance level in 45 percent of the measures. The APA also identified an instance where an agency dropped a performance measure because performance was declining. Agencies should be required to provide a period of notice prior to dropping a performance measure or removing one from Virginia Results.

JLARC staff reviewed performance measures for two agencies (the Department of Motor Vehicles and the Department of Medical Assistance Services) and found the measures to generally reflect some important agency objectives, while not addressing other important areas. While this is consistent with a system under development, consideration should be given in the future to developing measures that address all of an agency's key missions.

As scrutiny of performance measures increases, through posting on a public web site, through regular audits by the Auditor of Public Accounts, and through JLARC reviews, it is possible that agency management will devote more time to the function and attempt to more fully integrate the development of State-level performance measures into their managerial and budgetary practices.

Agency Profiles

This report includes a series of agency profiles intended to provide additional detail about how and why the State budget grew over the 20 years since FY 1981. JLARC staff identified the largest agencies in terms of their FY 2000 total appropriation, and collected extensive data from them during the course of this review. A key goal was for each agency to explain the growth in its budget since FY 1981. Additional information was requested in order to provide a more complete profile of each agency's activities.

The profiles recap the agency's history and organization, an overview of its budget, a comparison of how key agency characteristics changed over time, the appropriation history of the agency, and explanations for the principal changes in the agency's budget. Each profile also presents pie charts of the agency's FY 2000 revenues and expenditures, along with a discussion of the major programs in the agency and a summary of its performance measures.

Profiles of nine of the largest agencies, in terms of total appropriations, are included in this report. Additional information on these and other agencies will be provided in a later JLARC report.