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State faces $900 million budget gap, watchdog warns

The state could be facing a nearly $900 million budget gap next fiscal year thanks to slowing tax revenue and growing costs, including those under Massachusetts’ sweeping new K-12 education law, a Beacon Hill watchdog is warning.

The analysis by the Massachusetts Taxpayers Foundation suggests that lawmakers may have to consider “tax increases or spending cuts” to balance the state’s $43 billion-plus budget. It would mark a stark reversal from recent years when officials’ primary money problem was jostling over ways to spend an unexpected windfall amid back-to-back years with a $1 billion surplus.

But as Governor Charlie Baker readies his annual budget proposal — and House lawmakers a transportation financing bill that could raise taxes — the nonpartisan foundation suggests policy makers will face “tough choices.” That includes finding an estimated $428 million in new money for local schools and closing a gap of $880 million between estimated revenue and the state’s obligatory spending for the fiscal year that starts in July.

“I try to err on the side of being conservative in my assumptions. I wouldn’t be surprised if people actually doing the budget writing are looking at a gap that’s bigger,” said Heath Fahle, the foundation’s policy director and the author of the 20-page report.

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The analysis acknowledges that the gap may not appear in public-facing budget documents released by the governor or lawmakers, making it difficult to compare to past years. But one legislative leader recognized this year’s budget will be “tighter.”

The business-backed foundation has warned of similar gaps before, including in its forecast for fiscal year 2017 when it pegged it at between $800 million and $1 billion. That year proved a fiscal struggle: Tax revenues lagged the state’s optimistic projections, and lawmakers ultimately trimmed their next spending plan so much that one lawmaker called it “the harshest state budget since the last recession.”

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State budget writers have since leaned on relatively modest projections, including this year. Baker’s finance secretary and the Legislature’s two top budget writers said this week they’re estimating tax revenue to grow 2.8 percent in fiscal year 2021. That’s well below the 6.9 percent revenue jumped in 2019, and halfway through the current fiscal year, tax collections are up 4.7 percent, according to the Department of Revenue.

The consensus estimate provides a starting point for Baker in crafting his budget proposal due on Jan. 22, a day after the Republican delivers his State of the Commonwealth speech. Representative Aaron Michlewitz, the House budget chairman, called the 2.8 percent projection “responsible and fiscally sustainable.”

In building its own estimates, the Taxpayers Foundation relied on a more conservative growth forecast, at 1.7 percent. It underlines the feeling among some economists that the state’s flush revenue stream may soon ebb.

The foundation report notes that the state’s workforce is aging, which could drive down income and sales tax collections. And the better-than-expected tax collections of recent years leaned, in part, on changes under the 2017 GOP-led federal tax overhaul. The cash bonanza also relied on surging revenues from capital gains taxes — levies on investment profits — which tend to be volatile.

“The swings in capital gains becomes a margin of error,” Fahle said, calling those collections the difference “between a good year, an average year, and a bad year.”

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Michlewitz, a North End Democrat, said in a statement that he can’t comment on whether there will be a budget gap as the foundation describes until Baker files his proposal. But he didn’t dispute the state could be entering leaner times.

“We respect the work MTF does, and agree that it will be a tighter budget than we’ve seen in previous years,” Michlewitz said. “Once the governor files his budget and the committee begins talking directly with agencies and stakeholders about their detailed budgetary needs, we will be in a better position to answer those questions.”

A spokesman for Michael J. Heffernan, the state’s secretary of administration and finance, did not directly address the report, but in a statement said the Baker administration has “focused on returning structural balance to the budget” since facing a yawning deficit early in Baker’s first term.

Senator Michael J. Rodrigues, a Westport Democrat and the Senate’s budget chair, did not respond to requests for comment. The House and Senate typically release their spending proposals in the spring, and will have to reconcile any differences before sending a final budget to Baker’s desk this summer.

The potential budget gap is driven, in part, by increasing costs, especially in education.

Lawmakers last year passed a long-awaited bill that reshapes the state’s school funding formula while promising $1.4 billion in extra direct local aid.

But the new law doesn’t include its own dedicated funding source, meaning the costs — which lawmakers estimated at roughly $300 million annually, including inflation, over seven years — will have to be carved out from existing tax revenue.

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The Taxpayers Foundation projects the added spending will be closer to $428 million for the coming fiscal year, given that “the bulk of the changes” under the new law are “front loaded,” according to its report.

Put another way, more than 80 percent of the $521 million in new money the foundation is projecting for the state’s coffers would go toward K-12 education, squeezing the resources available for transportation, health care, or other priorities.

The foundation also projected added spending in the state’s Medicaid program, known as MassHealth, and a $273 million increase in the state’s contributions toward its pension fund.

On the other side, Baker and lawmakers are also accounting for drops in revenue, including a cut to the state’s income tax rate, which dipped to 5 percent on Jan. 1, and the return of taxpayers’ claiming charitable deductions on state tax returns in January 2021. Over a full fiscal year, those deductions could cost the state $300 million in revenue.

Baker has opposed raising taxes or fees to balance the budget, even though he’s signed a variety of increases into law.

Meanwhile, every seat in the state Legislature is up for reelection in November.


Matt Stout can be reached at matt.stout@globe.com. Follow him on Twitter @mattpstout.

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