Facing potential recession, NH lawmakers urged to exercise budget restraint

A string of state commissioners filed into the State House hearing room late last month, each with their own mission. For three days, Gov. Chris Sununu and his budget director would hold budget hearings. Administration officials detailed the progress within their departments and outlined their financial needs, making the case for more funding when Sununu crafts his budget next year.

But before the proceedings began, Sununu gave a warning.

“I think there’s a lot of opportunity on the table to be sure, but we also have to be cautious with where the economy as a whole could be going,” he said.

He continued: “There’s really no way to avoid some form of a national recession. It is real. It is coming.”

Sununu isn’t alone in that concern: A report by Moody’s Analytics in September highlighted what its authors called “a crucial juncture” for state governments. Propped up for two years with record flows of federal COVID-19 stimulus funds, state governments are about to see much of that funding expire. And with rising inflation and climbing interest rates intended to curb that inflation, the risk of an economic downturn is real.

Preparing for that downturn, the Moody’s report said, will be critical for state lawmakers in the next few years. The New Hampshire Legislature must pass its next two-year budget by July 2023; by tradition, Sununu will present his draft budget to lawmakers in February.

But New Hampshire is among the five least-prepared states for a recession, the analysis concluded; if the state were to face a moderate recession, it could see an 18.1% tax revenue shortfall, one of the biggest in the country.

New Hampshire economic analysts say the state has plenty going for it financially. Business tax revenues continue to come in strong, the state ended the last fiscal year with a $430 million surplus, and lawmakers have put away hundreds of millions into the rainy day fund, they note.

But in a moderate recession, even that rainy day fund would not offset revenue losses, Moody’s warned. New Hampshire, the report found, would still need to cut 10% of its spending in order to make it out.

With jitters growing, New Hampshire observers say lawmakers will have to be savvy as they move forward with a budget.

“You just don’t want to be in a situation of having to raise taxes or slash services to deal with the effects of a recession, if you can avoid it,” said Drew Cline, president of the Josiah Bartlett Center for Public Policy, a fiscally conservative think-tank.

A diverse base of taxes

One reason for New Hampshire’s vulnerability to the effects of a recession is the state’s dependence on business taxes, notes Phil Sletten, research director at the New Hampshire Fiscal Policy Institute.

The state receives about a third of its general fund revenues from the business profits tax and the business enterprise tax. Much of those business profits are paid by large, multinational corporations: Of the nearly 80,000 businesses that filed taxes in New Hampshire in 2019, 80 accounted for nearly half of the total revenues, according to an NHFPI analysis. Sixty percent of the filers that year were multinational corporations, the NHFPI said.

That dynamic means a major part of New Hampshire’s revenue stream is dependent on how the national and global economies are doing. And it puts New Hampshire at a potential disadvantage over states that rely on broad-based income taxes when it comes to weathering a recession.

Sletten said taxes on corporate profits “are generally considered more volatile” than broad-based income taxes. The reason is simple, he added: In a recession, “profits move more substantially than compensation.”

But Sletten noted that New Hampshire still has a diverse array of revenue sources, and some are more susceptible to recessions than others.

Some taxes are resilient.

• The statewide education property tax, which is collected and retained by towns, is dependent on property values, which don’t change from month to month. That tax doesn’t technically go into the state’s coffers but it does help offset the amount of money that might have left the Education Trust Fund to pay for school adequacy grants.
• Revenue from alcohol and tobacco sales also tend to weather economic downturns. Those collections are substantial: Profits made from the state-run Liquor Commission made up 5% of the state’s revenue in fiscal year 2021, and the tobacco tax brought in 8.5% that fiscal year.

But many other New Hampshire taxes would take a hit if the economy changed.

• The meals and rentals tax would be hit twofold, Sletten noted. People who live in New Hampshire would likely go out to restaurants less. People who don’t live in New Hampshire would be less likely to visit the state, meaning less in revenue from hotels, Airbnbs, and rental car agencies. And because the state does not have a broad sales tax, a shift in habits from eating out to grocery store purchases would not bring in additional revenue.
• Meanwhile, the real estate transfer tax, which brought in 7% of the state’s general revenue in 2021, could suffer if homebuying takes a dip, Sletten noted. That tax has been successful in recent years, bolstered by a record-setting surge in median sales prices in the state, even as the overall number of home sales has dropped. But with rising interest rates from the Federal Reserve, that demand will likely cool off in coming years, Sletten noted. And if sales prices fall, the state’s low housing stock will likely catch up to it, bringing the transfer tax revenues down.

One New Hampshire tax directly tied to the stock market is the interest and dividends tax. While the climbing interest rates could bring in higher yields for some New Hampshire investors, most people paying the tax are likely holding investments that could be hurt by a struggling market.

Additionally, 2023 is the first year in the state’s five year plan to phase out the interest and dividends tax. The tax will drop from 5% to 4% for the 2023 tax year, and will continue to drop by 1% a year until 2027, when it will end. Regardless of a recession, that will bring in less revenue, Sletten noted.

Predictions are tricky

Precisely how much New Hampshire’s revenues might fall as a result of a recession is difficult to nail down; projections are slippery. But there are four major milestones to watch as the governor and Legislature craft the budget over the next seven months, observers note.

The first will come in February, when Sununu will submit his proposed budget in an address to lawmakers. That budget will contain revenue projections for the next two state fiscal years, fiscal years 2024 and 2025, which span from July 2023 to June 2025.

When the House presents and votes on its budget, likely by the end of March, the House Finance Committee will arrive at its own revenue projections. Two months later, in May, the Senate will take a third crack at estimating revenues. Then in June, when House and lawmakers negotiate to bring their proposals together into one budget, lawmakers will issue one more projection of revenue.

Traditionally, the first two passes at the budget – from both the governor and the House – are less accurate because they come before business tax returns are collected and processed in April. The May and June budget drafts can factor in those returns.

But if a recession is looming, even the up-to-date revenue projections in late spring next year won’t capture the potential losses to come. For that, lawmakers will have to build in their own uncertainty.

A need for caution

New Hampshire’s strong revenue heading into a potential downturn presents both opportunities and pitfalls, argues Cline.

“Generally it’s a good idea if you have some money in the bank and it’s sitting in the general fund, to just hold on to it till we weather this event,” he said.

If lawmakers don’t do this and revenues drop during a recession, the alternatives are not as pleasant, he said.

“You can raise taxes, reduce spending or drain your reserves,” he said. “And those are three ways you can adjust to declining revenue.”

The Moody’s report agreed. “States that shuttled surplus tax revenues into rainy-day reserves and avoided spending onetime stimulus funds on recurring expenses will be better able to weather any such downturn,” authors Emily Mandel, Haley Curtin, and Bridget Ryan wrote.

But lawmakers are not traditionally exemplars of restraint when it comes to spending, especially when they have money to play with, Cline said. Even the Republican-led Legislature spent a significant amount of the state’s surplus in non-budget spending over the past two years. During the biennium, the Legislature passed bills that appropriated $272 million in spending beyond the budget passed in 2021, according to a list from state’s Legislative Budget Assistant.

Many lawmakers and advocates would argue that those expenses were important: $5.7 million went to wastewater projects; $11.8 million was spent on a one-time allowance to state retirees; $25 million was spent to a remediation loan fund for PFAS contamination; and $15.3 million was spent to build a new legislative parking garage in Concord, to name several.

But to Cline, that kind of spending should be restrained when the state is facing a recession.

“Unfortunately, the Legislature spent almost 70% of the surplus by the end of the last fiscal year,” he said.

Democrats have criticized New Hampshire’s tax structure in recent years, noting high property tax burdens that come from the state’s frugal approach to local schools. But they have generally eschewed the idea of broad-based taxes.

You just don't want to be in a situation of having to raise taxes or slash services to deal with the effects of a recession, if you can avoid it.

Cline, like other conservatives in the state, is happy with the state’s revenue structure, which he says is designed to fund the state while creating a low tax burden on individuals with respect to state taxes. The key to surviving with such a reliance on business taxes is to know the state’s financial limitations and plan for them, he said.

“It’s perfectly manageable, as long as we don’t act like a state that has a broad (tax) base,” he argued.

This story was produced by the editorially independent New Hampshire Bulletin, which is part of States Newsroom. Contact Editor Dana Wormald for questions: info@newhampshirebulletin.com.