October 30, 2017

New Mexico isn’t ready for the next recession

The seal of the state of New Mexico in the House

The question isn’t if there will be another recession, it’s when the next recession will hit. And a new report finds that New Mexico is among the most ill-prepared states for an economic downturn.

Moody’s Analytics analyzed all 50 states to find out which are best- and least-prepared for the next recession. Performing “stress tests” on each of the states’ budgets, the risk management company looked at how drops in tax revenue and increases in Medicaid spending from a recession would impact state spending—and if states had enough reserves to weather a moderate or severe recession without raising taxes or cutting spending.

Senate Finance Committee Chairman John Arthur Smith said one clear indicator that New Mexico isn’t ready is the state has “never fully recovered from the recession when the rest of the nation has.”

The inability to recover from the Great Recession shows that the next recession “should be around the corner” according to Moody’s Analytics.

The company is not predicting a recession will start that soon, but used that as a way to look at states’ current preparedness.

New Mexico’s reserves are virtually nothing right now—Moody’s Analytics lists them as -1.1 percent.

If a moderate recession hit New Mexico starting in 2018, for example, that would mean 8.9 percent less tax revenue than projections without a recession. In addition, Medicaid costs would increase 1.1 percent. That would mean New Mexico’s reserves would need to be 10 percent—more than $620 million—to cover the gap.

A severe recession, like the one that hit the country almost a decade ago, would hurt even more. The state would lose 14.3 percent of its tax revenue and Medicaid spending would increase 1.8 percent. That means the state would need 17.1 percent reserves—or over $1 billion—to make up for it.

Historically, Smith said, policymakers liked to have 10 to 12 percent in reserves.

The report isn’t the only harbinger to policymakers looking at balancing the budget.

Not enough revenue

A report released last week by The Pew Charitable Trusts also highlighted warning signs. The Pew report analyzed revenue collection of all 50 states over 14 years.

A total of 11 states did not collect enough revenue, through taxes and fees, to cover the amount they spent from 2002 to 2016.

New Mexico was one of these 11 states, which, the report says, show “symptoms of structural deficits.” States must balance their budgets each fiscal year, and so cannot go into debt. This means to cover a deficit, states must either use money they have in reserves, cut spending to the level of revenue or raise taxes.

In New Mexico, revenues from gross receipts taxes, severance taxes and other taxes made up just 95.5 percent of the revenue needed to cover expenses in that time period, below the 102.2 percent median of all states.

The Pew report also showed that New Mexico was the only state whose fiscal balance moved from positive to negative territory in Fiscal Year 2016.

Empty reserves, volatile tax revenue streams

One reason New Mexico is in such a bad position is its tax revenue volatility. These are revenue streams that can have large swings in how much they bring in from year to year. New Mexico relies on oil and gas revenues to fund a sizeable portion of the budget. Those revenues fluctuate depending on global markets and supply, the use of new technologies and changes in demand. Currently, prices are far lower than the pre-recession peak when crude oil was at $140 per barrel or even the post-recession levels when prices exceeded $100 a barrel.

“Principally oil and gas is responsible or indirectly for one-third of our general fund,” Smith said. This comes from not only taxes directly on oil and gas, but gross receipts taxes from related industries and areas.

“The area that I’ve been speaking to, because it’s a no-no for politicians to talk about tax increases, I’ve been talking about tax stability,” Smith said. “New Mexico does not have tax stability at this stage.”

Tax exemptions and carveouts also cause problems. These “can make life extremely difficult for economists and revenue estimators trying to project future revenue collections,” according to the Moody’s Analytics report. When exemptions and special favors for certain industries or companies are not tracked closely, they can exacerbate this problem—something New Mexico has struggled with as legislators have grappled with balancing tax incentives to create economic activity with the loss of revenue those tax incentives bring in.

While the state Legislature passed bills requiring a tax expenditure budget multiple times, Governors Bill Richardson and Susana Martinez have vetoed those efforts. The Martinez administration has released annual, stripped-down version of a tax expenditure budget, but it has been criticized for not providing enough information. State Auditor Tim Keller, who sponsored tax expenditure budget language as a state senator, also released a report this year showing the impact of tax credits and other exemptions on the state’s budget.

Keller told the Legislative Finance Committee in September that the state lost nearly $1 billion in revenue from tax carveouts last year.

After an unsuccessful attempt to overhaul a key part of the state’s tax code in last year’s legislative session, lawmakers are hoping to reform the state’s gross receipts tax structure in next year’s 30-day session. The plans would likely include removing many tax credits and exemptions.

Another reason to be concerned about the state’s preparedness for the next economic downturn is the lack of current reserves.

The states that rank below New Mexico of the Moody’s Analytics state preparedness list have similar profiles when it comes to energy reliance: Louisiana, North Dakota and Oklahoma.

These are also three of the five states that would require reserves of 15 percent or more to weather a moderate recession (Colorado is sixth-worst, while Alaska, thanks to massive reserves, is most well-prepared).

Still, the report acknowledges no two states are identical. There is no “average state”—all have wildly varying differences.

“As a result, when asked, ‘How much should a state put away for a rainy day?’ the answer, as to so many other good economic questions, is that ‘it depends,’” the report says. “Each state’s target is unique to its volatility and, ultimately, risk tolerance.”

New Mexico ranks among the states with the lowest level of reserves in the nation.

The Legislature attempted to fix this by expanding the state’s existing tax stabilization fund. Legislation passed in the most recent special legislative session will put any money from oil and gas taxes that are over the five-year average of those revenues into the tax stabilization fund to prepare for the next shortfall. Currently, all of those funds go into the state’s general fund, which is spent each year.

Smith said this is helpful, but could lead to complacency and that some would want smaller overall reserves while leaving the rest to the tax stabilization fund, which he fears would not be adequate.