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State Revenues on Target in April Amid Signs of Economic Cooling

Secretary of Finance Stephen E. Cummings presented an update on the “better than expected” performance of state revenues in April to the Senate Finance and Appropriations Committee on May 16.  Although Secretary Cummings expressed confidence that overall state General Fund revenues will meet the December 2022 forecast, he pointed to several areas of softening, notably withholding and sales tax collections.  A contraction in the national economy is still widely expected, but possibly later than anticipated in the December forecast; this delay into the third quarter of the calendar year may bolster FY 2023 revenues at the expense of FY 2024.  Budget negotiators have cited uncertainty regarding a potential slowdown, magnified by concern about the progress of negotiations at the federal level regarding the nation’s debt ceiling, in their decision to pause negotiations on a full rewrite of the biennium budget.  (Committee staff provided an overview of potential impacts on Virginia of a debt ceiling breach, stressing that such scenarios are theoretical at this time.)

As reported by Secretary Cummings, total General Fund revenues declined by 8.2 percent in April relative to last year, and are down 0.9 percent on a fiscal year-to-date basis.  However, collections are $497.4 million ahead of the December forecast (which assumes an 8.8 percent decline).  Nonwithholding collections outperformed expectations, but this revenue source historically has been volatile, and the effect of the new pass-through entity tax on FY 2024 revenues is unclear (this tax allows certain business entities to pay Virginia income taxes in a way that allows for potential federal income tax savings, in response to the cap placed on the federal income tax deduction for state and local taxes).

Withholding collections are trailing projections by $71.3 million through April, representing 4.3 percent growth on a fiscal year-to-date basis and lagging the December projection of 4.8 percent growth, although the Secretary’s memorandum points out that “the higher than anticipated decline is still within a margin of error to meet the year-end Forecast.”  Sales tax collections have underperformed more consistently, and now trail projections by $116.9 million.  The Secretary’s memorandum notes, “The continuing shift in consumption from taxable goods to non-taxable services is likely dampening sales tax revenue growth more than anticipated,” and the Secretary pointed out in his presentation that Virginia is more affected by this national trend than other states with broader sales tax bases.

Secretary Cummings explained that the consensus expectation among economists is a mild economic contraction in the third quarter of calendar year 2023, later than the assumption in the December forecast, which expected a contraction beginning in the second quarter of calendar year 2023.  The delayed onset of the slowdown may be reflected in the stronger-than-anticipated FY 2023 collections, with implications for FY 2024; the Secretary’s presentation notes, “While we anticipate that collections for FY 2023 will be above forecast, much of the higher collections are the result of our assumption of when a recession will begin.  The resulting shift of revenues into FY 2023 may largely be reversed in FY 2024.”

Predicting the timing of a potential economic slowdown is an ongoing challenge for the Federal Reserve’s Federal Open Market Committee, which took action on May 3 to increase the federal funds rate by another one-quarter percentage point, but signaled a potential pause in rate hikes in subsequent meetings, stating, “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”  A key factor may be the effect of tightened lending standards resulting from concerns about the recent failures of several regional banks, which may play a role similar to an interest rate increase in cooling the economy.

Updated Consumer Price Index data released on May 10 suggest that inflation appears to be moderating, but is still considerably higher than the Federal Reserve’s 2 percent target.  The CPI-U rose 0.4 percent in April, driven by increases in costs for shelter, used cars and trucks, and gasoline, but the increase for the 12 months ending in April (4.9 percent) was the smallest 12-month increase since the period ending in April 2021.  The index for food at home fell 0.2 percent in April, following a drop of 0.3 percent in March, suggesting a moderation in grocery prices.

VACo Contact:  Katie Boyle

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