March 13, 2004

State revenue this fiscal year will come in at least 9% higher than last, but two components traditionally regarded as bulwarks of the General Fund budget are lagging, the Delaware Economic & Financial Advisory Council will report when it meets on Mar. 15.

The official forecasting panel will add $37.7 million to its December, 2003, prediction, reflecting continued improvement in both the national and state economics. But it will knock off $5 million from what it said will happen in fiscal 2005, leaving an expected growth rate of just over 3% then.

Because the General Assembly is required to use the forecast as the basis for the operating budget it will adopt in June for the year which begins July 1, the latter forecast is the more significant of the two. The coming meeting is the first of four to be held monthly before the Assembly acts, leaving open the possibility -- some observers would say likelihood -- of some upward revision before legislators act.

While all that is in sharp contrast with the situation a year ago, before the recovery from recession took hold and before the Assembly agreed to the so-called 'structural changes' in the state's revenue stream requested by Governor Ruth Ann Minner, there are glitches:

• Corporate franchise tax proceeds would be running well behind a year ago if the 19% boost in fees had not been enacted and the rate at which new corporations are being added to the roster is just keeping pace with normal attrition.

• The bank franchise tax is lagging more than 4% behind a year ago and current developments in the banking business are raising questions about that important revenue stream.

As a result, the advisory panel will reduce, by $13.3 million and $16.3 million, respectively, its December forecast of what those two taxes are expected to bring in during fiscal 2005.

As regards the economic outlook, the determinant in a state which holds tight rein on its public spending, an otherwise buoyant recovery from recession is clouded by an historically unusual lag in the rate at which new jobs are being added. More than a curiosity, that has everyone from top policy makers to folks with modest mutual fund holdings worried.

"If we don't get the jobs, what kind of growth rate can you sustain?" Fred Dixon, a former corporate economist now in private consulting work, asked rhetorically at a meeting of the advisory council's revenue subcommittee. "I don't think we can get consistent G.D.P. growth without job growth." 'G.D.P' stands for 'gross domestic product', which is considered the fundamental measure of economic performance.

The state Department of Finance is now looking for a sixth-tenths of 1% growth in employment in Delaware this fiscal year and 1.5% growth in the coming one. The latter figure is down from the 2.5% growth it forecast in December.

Nevertheless, the advisory committee is bullish on personal income tax, which is far and away the largest component of state revenue. It has upped its December forecast for this year's revenue by $3.7 million and will predict 6.2% growth next year.

"It's a great year if you have a job," said Kenneth Lewis, the University of Delaware professor who chairs the revenue committee.

Given the pace of improvement in other components of the economy, "we should be seeing 2% to 3% growth in employment" but it was "virtually nil" in the first two months of 2004, finance department economist James Craig said.

Dixon told the committee that so-called 'outsourcing' of work by businesses is "a scapegoat." The real cause of the job lag, he said, is a fundamental change in business-management philosphy. "They're using their employees the way they do their inventory," he said, explaining that involves taking on temporary help rather than permanent employees for as long as possible akin to the way manufacturers arrange 'just-in-time' delivery of supplies. "Why go out and hire new workers when health care [cost] is rising faster than wages?" he said.

The committee was told there has been a decline of between 4% and 4.5% since 2000 in the number of corporations hosted in Delaware, largely as a result of a dearth of new public stock offerings. In all of 2003, there were only 75, less than a quarter of the average number during the 1990s. Richard Geisenberger, assistant secretary of state, said Delaware chartered 51 of those companies.

Overall, he said, the number of companies delisted as a result of mergers, dissolutions and other causes continues to more than offset the number of new ones being signed up. As a result, net franchise tax revenue this fiscal year is expected to be only 16% higher than a year ago despite the 19% increase in fees. The advisory council will forecast a 1.6% decline from this year in fiscal 2005.

On the other hand, Geidenberger reported, formation of limited-liability partnerships and corporations is booming. Revenue from that source is now expected to double this fiscal year, compared to last and the advisory council will predict nearly 10% growth in the coming year.

Those business organizations, however, are much smaller than traditional companies and the revenue they generate this year is expected to be in the range of $50 million, a tenth of what corporate franchising is expected to bring in.

Bank commissioner Robert Glen told the committee that Delaware has not yet felt an impact from the acquisition by J.P. Morgan Chase of Bank One and does not look for a significant one in the immediate future. Both of those banks have major credit-card business based in the state which is likely to eventually be consolidated.

However, Glen said, there currently are tax disputes "with three [banks] and they are significant."

The disputes involve how they allocate income for tax purposes among states in which they do business, specifically in those cases Delaware and New York. He declined to identify the banks, saying, "I don't think I ought to say who we are having problems with" or to go into detail about the disputes.

The advisory council will forecast that this year's 4% decline in bank franchise revenue will be followed by a similar one next year.

On the plus side of the ledger, abandoned property coming to the state as the result of enforcement and voluntary compliance with escheat laws continues to run strong. That is now expected to bring in $265 million this year, up from $231.5 million in fiscal 2003. Playing it cautiously, the advisory council will estimate that there will be no change in the amount of that revenue next year.

Legislation now pending in the Assembly would consign any increase over the current level of 'abandoned property' -- everything from unclaimed bank accounts to unredeemed gift certificates -- reverting to the state be put into a 'video lottery transition fund' to offset the loss of revenue when Maryland and Pennsylvania institute slot machine gambling.

The advisory council will lower its estimate of lottery revenue, from both slots and traditional games, from its December forecast by $3.6 million, but forecast 3.3% growth next year. The council's policy is to base all forecasts on existing conditions and not anticipate future developments no matter how certain they may appear.

On the other hand, action by Pennsylvania in raising its tobacco tax is given as a major reason for an expected doubling of revenue from the cigarette tax this year and a further increase of nearly 14% in fiscal 2005.

There also is notable growth in revenue from the real estate transfer tax as a result of what is described as a booming housing market. The advisory council is now looking for 27% revenue growth from that source this year, but a 3.6% pull back next year.

© 2004. All rights reserved.

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