CLS Newsletter - December Economic & Revenue Forecast

COLORADO LEGISLATIVE STRATEGIES NEWSLETTER
December Economic & Revenue Forecast
December 21, 2022

​Introduction
 
The holiday season brings families together, shopping for presents, and of course the December Economic and Revenue Forecast! Yesterday, the Joint Budget Committee heard presentations from Legislative Council Staff (LCS, non-partisan economists) and the Office of State Planning and Budgeting (OSPB, Governor’s economists) about the economic outlook in Colorado and the US and about the general fund budget outlook for next year’s budget. 
 
The good news is that the forecast is not projecting that Santa will bring us a recession this holiday season. The forecast anticipates continued slow growth in Colorado and the
nation through 2023, and a return to a more moderate pace of expansion in 2024. Labor markets continue to have low levels of unemployment, plentiful job openings, and rising wages. However, high inflation remains present and the Federal Reserve’s aggressive steps to rein in inflation have become the primary risk to current economic expansion. 

​Santa will, on the other hand, be delivering large TABOR refunds to all the boys and girls in Colorado this year. Even though general fund revenue was revised down relative to the last forecast in September, that revenue will still greatly exceed the TABOR revenue cap. Moreover, even with the cap slated to rise due to recent high inflation, billions of dollars are still projected to need to be set aside in the budget to go out to taxpayers as refunds. 
 
Big factors driving next year’s budget will be the size of the set aside for TABOR refunds, the impact of recently passed ballot measures, and the continued impact from inflationary pressures. All of this will contribute to an extremely tight budget year. 
 
The following sections will dive into more detail on the economic and revenue forecasts. Selected charts from the LCS forecast will be included as illustrations. For more information, links to all of the forecast documents are included at the end. 
 
Lastly, keep in mind all of this data is a forecast (an educated guess based on currently available information) that is subject to change. The JBC will receive another forecast in March, which will be the final forecast before the JBC finalizes next year’s budget.
 
Economic Forecast
 
The post-pandemic economic recovery is projected to continue, albeit with a slow pace of growth. At least the forecast is not projecting a recession though! 

​The chart above shows that after the economy shrank by 3.4 percent in 2020, the economy is projected to grow by 2 percent in 2022 and 1.2 percent in 2023. However, different areas of the economy are exhibiting different degrees of strength and weakness. Labor markets continue to be a bright spot but rising interest rates are taking their toll on the housing market and stifling financial opportunities for business investment.
 
The primary risk to the economic expansion has been the Federal Reserve’s aggressive steps to rein in inflation by raising interest rates and reducing the money supply. The Fed’s approach risks both underreacting, in which case it would fail to contain inflation, and overreacting, in which case it would depress demand so severely as to trigger a downturn. At this point it appears that the Fed has not gone too far in either of those directions. However, the economy remains fragile and any number of unforeseen shocks could push the economy into a recession.

​The chart above shows that housing, food, and transportation costs have majorly contributed to inflation across the country. The good news is that housing costs have gone down 4.5% from its peak over the summer. The bad news is that the Federal Reserve has stepped in, using interest rates as a mechanism to reduce inflation. This means we are headed for more rate hikes in 2023, in addition to the seven we’ve already seen this year. That being said, there’s more to the story than just an increase in prices across industries. 
 
Although roughly 455,700 jobs were recovered in Colorado after the pandemic and wages have increased, unemployment concentrated in certain industries has contributed to inflation, as well as the difficulty of trying to keep up with inflation costs in general. Job losses were most common among low wage workers. Local government, mining, and food services have seen significantly more unemployment. Real estate has also seen a decrease in employment, due to an expensive housing market. High wage industries, on the other hand, have performed better than medium to low wage industries in employment recovery post pandemic, but hourly salaries have increased significantly in low wage industries. When adjusting for inflation, we’ve actually seen real wages decline by 2.8% over the last year.
 
Overall, the economic news is positive. We are not staring down the barrel of a recession and the forecast is projecting growth. Inflation is high but appears to have peaked and is coming down. The labor market remains tight and unemployment is down to 3.5 percent. The downside risks to the forecast include more aggressive monetary policy, a steeper housing market correction, and geopolitical uncertainty. The upside risks include possible drops in energy prices and a faster resolution to inflationary pressures, but risks are more weighted to the downside. 
 
Revenue Forecast
 
General fund revenue was revised down relative to the last revenue forecast. The biggest changes from the September forecast are the adjustments made for statewide ballot measures passed by voters in this year’s election. Five of the eight ballot measures passed this year will require an adjustment to the budget, especially 121, 123, and FF. Proposition 121 cut the state income tax rate, meaning the amount of revenue coming into the state is reduced. Relative to the September forecast, it’s now projected there will be $707 million less in general fund revenue for FY 2022-2023 as a result of Proposition 121. Additionally, Proposition 123 allocated income tax revenue to affordable housing programs. Because this was already being collected, the funding will be allocated to another fund, rather than the discretionary general fund. 

​The chart above shows that general fund revenue grew by an astonishing 23.7 percent in 2021-22. After that historic increase, general fund revenue is projected to shrink by 3.8 percent in 2022-23 and then grow by 3.7 percent in 2023-24 and 4.9 percent in 2024-25. Only when we get to 2024-25 will we again see general fund revenue as high as it was in 2021-22. The chart also shows the decreases in revenue projections relative to the September forecast, which are down primarily due to the impacts of the recently passed ballot measures. 
 
However, the drops in general fund revenue projections will not constrain the budget, instead they will be absorbed by TABOR surpluses, which are forecasted to be in the billions of dollars in each of the forecasted years. Santa will certainly be giving out big refunds, but the ways those billions go out to taxpayers could change. 

The chart above shows that for 2021-22 the state will be refunding $3.73 billion, for 2022-23 the refunds will be $2.47 billion, for 2023-24 the refunds will be $1.53 billion, and finally in 2024-25 the refunds will be $1.37 billion. Those are massive TABOR refunds and we will be that far over the TABOR cap even with the cap rising due to high inflation, which is illustrated by the red circles on the chart. Since we are over the cap, it’s important to remember any additional dollar of general fund coming in will just have to go back out as a refund. Moreover, any additional dollar or cash fund revenue that comes in will result in a dollar of the general fund going out. 
 
One thing to watch out for going forward is how all of this money goes out to taxpayers, which are called TABOR refund mechanisms. The first refund mechanism is reimbursing counties for lost revenue from property tax exemptions. The second refund mechanism used to be a temporary income tax cut, but the state income tax rate is now lower than what is permitted in law for the temporary cut, so that mechanism is not applicable now. The final refund mechanism is what is known as the six-tier sales tax refund, which provides bigger refunds to higher income earners. Last year, Senate Bill 233 added one-time flat payments to every taxpayer as a refund mechanism, but that bill was for one year only. Stay tuned this legislative session for the majority to potentially change around the refund mechanisms again. 
 
Finally, the budget this year will be extremely constrained. If all of the Governor’s budget requests were approved then there wouldn’t be enough money left to sufficiently fund the required statutory reserve amount. And that doesn’t even account for the costs of all of the bills that will pass this upcoming legislative session that weren’t included in the Governor’s request. So a major theme of the legislative session will be how legislators grapple with what bills are a high enough priority to get funded and what happens to all the other bills. 
 
Conclusion
 
Overall, this holiday season brought a December Economic and Revenue Forecast with a lot of presents. There is still a risk of recession but the forecast is projecting positive economic growth. The Colorado economy continues to rebound and has a tight labor market with low unemployment. General fund revenue was revised down, largely due to ballot measures, but revenue continues to be well above the TABOR cap and there will be very large refunds forecasted for the next several years. Lastly, given the set-asides for those refunds and continued inflationary pressures, the budget this year is going to be extremely constrained. Stay tuned for all the budget fun this legislative session!
 
Links to All Forecast Documents
 
Legislative Council Staff (LCS)

• LCS Presentation
• LCS Full Report
• Consumer Price Index

 
Office of State Planning and Budgeting (OSPB)

• OSPB Presentation 
• OSPB Full Report
• OSPB Supplemental ​

---

​NEWS: Representative Adrienne Benavidez Resigns
 
Lastly, we wanted to make sure you saw the recent news that Representative Adrienne Benavidez announced on Tuesday she will resign. Representative Benavidez represents House District 32, which includes Commerce City and parts of unincorporated Adams County. Her official resignation date has not been made public yet, and a date for the vacancy process is currently unclear. Her resignation will leave an opening on both the House Finance committee and the House Judiciary committee. Representative Benavidez was heavily involved in tax issues, as well as environmental and air pollution issues. While Representative Benavidez has not yet shared what her next chapter might hold, Speaker Garnett, Senator Gonzales, and Speaker-designate McCluskie have released a statement expressing support and wishing her well. Candidates are already lining up for the vacancy appointment, including Lorena Garcia, who most recently ran for the Democratic nomination in the 2020 election for U.S. Senate.