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Progress Report: Restoring the State’s Fiscal Health

June 28, 2018

MEMORANDUM

TO: Concerned Parties

FROM: Secretary of the Budget Randy Albright

DATE: June 27, 2018

SUBJECT: Progress Report: Restoring the State’s Fiscal Health

When Governor Wolf’s administration started in January 2015, the commonwealth’s fiscal position had been deteriorating dramatically since the Great Recession. Budgets were balanced by making deep cuts to school districts, higher education and county human service providers, among others. Stop-gap, short-term funding solutions were repeatedly deployed to balance state budgets. Chronic underfunding of the state’s pension obligations for the State Employee Retirement System (SERS) and the Public School Employee Retirement System (PSERS) allowed the unfunded pension liability to grow to more than twice the size of the state’s annual General Fund budget.

When Governor Corbett’s Budget Secretary gave his final Mid-Year Budget Briefing in December 2014, he reported the magnitude of the state’s structural budget deficit had grown to more than $2 billion. Bond rating agencies had previously lowered the state’s bond rating five times within the past few years. Many believed further downgrades were imminent.

GO-TIME was launched within the first month of the new administration to seek savings and efficiencies throughout all of the operations of state government. Procurement initiatives were initially the largest focus, realizing savings of more than $100 million annually. Steps to reduce the issuance of new debt, refocus and prioritize future debt commitments and refinance outstanding debt obligations combined to significantly reduce annual debt costs.

Medicaid expansion, implemented in 2015, along with further utilization of private managed care oversight for medical assistance programs, provided immediate cost savings for the state by leveraging significant, additional non-state resources. Similar steps, in concert with the hospital industry and research institutions, also provided additional new resources.

Fully funding pension obligations for SERS and PSERS required increases of more than $500 million annually. However, some costs were controlled within both systems through active steps to reduce management fees and administrative costs and now that these pension obligations have been fully funded, increases for future years will be reduced to $200 million. The transfer of responsibilities of the Public Employee Retirement Commission (PERC) to the Independent Fiscal Office and the Auditor General eliminated redundancies in program administration and oversight.

The Departments of Insurance and Labor & Industry worked with the Treasury Department to consolidate portfolio management for other special funds to reduce administrative costs and set an example for future restructuring opportunities.

Following the adoption of a budget for the 2015-16 fiscal year, the General Assembly began to work with the administration to restore the state’s fiscal health.

Unfortunately, progress from these collective efforts was subsumed by a steep revenue shortfall exceeding $1 billion during the 2016-17 fiscal year. While multiple factors may have contributed to this downturn, economic uncertainty immediately following President Trump’s election was the most likely cause of this slowdown in revenue collections.

Despite this short-term setback, prior budget progress set the stage for much more significant cost reductions and budget savings to reduce the cost of operations in the 2017-18 fiscal year. Governor Wolf’s proposed budget included initiatives to eliminate more than $2 billion in General Fund costs. These efforts focused on multiple areas, including complement management, debt reduction, facility downsizing, and procurement and operational controls to reduce costs.

Total Recurring Savings: $2.2 Billion

Complement Controls – $275 million

Since December 2016, complement has been reduced by over 1,700 positions (12/2/2016: 74,514; 6/4/2018: 72,777) to the lowest level in more than 40 years, reversing a trend of complement increases in prior years. Moreover, the administration achieved this reduction without the use of furloughs.

Complement reductions were accomplished through several administrative actions. Human resources and information technology services for all executive agencies have been consolidated within six service delivery centers, resulting in increased efficiencies to drive long-term savings. The commonwealth operationally created the Department of Criminal Justice by merging the Department of Corrections and the Pennsylvania Board of Probation and Parole to realize savings by reducing administrative costs and improving outcomes as individuals transition back to their local communities. Across all four human service agencies, fiscal and administrative oversight has been consolidated to reduce duplication and improve service delivery.

Upon retirement, vacancies are now critically reviewed for operational need and possible reallocation of responsibilities. Last year, there were 3,620 retirements across the commonwealth workforce.

Facility Downsizing – $125 million

Since January 2015, the state corrections population has declined from 50,904 to 48,341. This net reduction of nearly 2,600 individuals has allowed the commonwealth to reduce its footprint and reverse years of spending growth. As a result, SCI Pittsburgh, one of the commonwealth’s oldest and most functionally inefficient facilities, closed in 2017 with operations transferred to other institutions.

Similarly, the Department of Human Services closed the Hamburg State Center and continues to seek further opportunities to streamline the operation of other state residential facilities. In an effort to serve veterans closest to their communities, beds have been reassigned where appropriate.

In Harrisburg efforts have focused on consolidating agency operations within the capitol complex and adjoining properties. In many cases, where downsizing has already occurred, the commonwealth continues to carry significant annual costs until the property can be sold.

The recent sale agreement for the Harrisburg Annex will eliminate more than $5 million in annual maintenance costs. The former grounds of the Allentown State Hospital still carries an annual operating budget of more than $3 million. In this case, the commonwealth is making proactive capital investments to dispose of the property more expeditiously, to eliminate continuing maintenance costs.

More than half of commonwealth office space is leased, not owned. Prudently managing these lease costs, through the creation of a consolidated database and long-term space management strategy, provides operational savings and the potential for future efficiencies.

Procurement and Operational Controls – $1.3 billion

The Department of General Services (DGS) has realized more than $100 million in annual savings through strategic sourcing initiatives for the procurement of goods and services. They continue to focus on additional efficiencies through other mechanisms, including reverse auctions and competitive procurement tools, to reduce costs.

Lean practices have been employed to address backlogs, improve workflow, increase quality, empower employees and better meet the needs of customers. GO-TIME, in collaboration with state agencies, has pursued continuous process improvement opportunities using these approaches. In February 2018, the Office of Performance through Excellence was established to spearhead these efforts. To date, GO-TIME has identified more than 300 projects generating nearly $400 million in cumulative budget savings.

Pennsylvania was one of the first states to use private managers to deliver Medicaid services to ensure affordability while maintaining access to quality care. For more than two decades, managed care organizations (MCOs) have served a crucial role in controlling Medical Assistance costs. Since 2015, Medicaid Expansion has provided health care to more than 700,000 people, while saving the commonwealth more than $700 million annually. Assessments on MCOs and hospitals have generated significant additional resources. Likewise, academic medical center appropriations have also provided an effective tool to leverage non-state resources.

Debt Reduction – $200 million

Over the last three years, the commonwealth has taken multiple steps to prudently manage debt through proactive refinancing of outstanding obligations, active oversight of new issuances and stricter controls for future debt commitments.

Taking advantage of historically low long-term interest rates, the commonwealth has been able to refinance nearly $3 billion in existing obligations, eliminating more than $316 million in future payments.

DGS has streamlined and prioritized public improvement projects throughout the commonwealth to focus on better addressing agency needs. Targeting projects in this manner allowed for lower total annual allocations. To ensure these reforms are lasting, statutory limitations have been enacted to further limit the issuance of new debt in future fiscal years.

Debt service costs nearly tripled in the prior decade. For the third consecutive year, the steps outlined above have allowed the commonwealth to maintain debt service costs below the 2015-16 fiscal year.

Pension Reform – $300 million

For the first time in nearly two decades, the 2017-18 budget fully funded the actuarially required contributions for SERS and PSERS. While funding levels will remain high for many years until the unfunded liability has been fully repaid, annual increases in these payments have been significantly reduced.

Act 5 of 2017 enacted historic reforms to reduce employer risk and outline steps to further lower management fees and administrative costs for the operation of both pension systems. New hybrid benefit plans, incorporating a defined contribution component, will be implemented for new hires in 2019. A new commission will issue final recommendations later this year to provide a roadmap for both systems to reduce management fees by a combined $3 billion or more.

Base Revenue Growth – $1.1 Billion

Revenue bills enacted in both 2016 and 2017 will provide more than $1.1 billion in recurring revenue for future fiscal years. Detailed below are the components of these adopted changes.

The state’s sales tax base has been expanded to include digital downloads and marketplace sellers, positioning the commonwealth to take maximum advantage of the emerging digital economy ($150 million). These tax changes will also create a fairer playing field for brick-and mortar-retailers. Increases in cigarette and other tobacco products taxes will generate an estimated $500 million annually. Pennsylvania will now join most states by taxing Lottery winnings ($30 million).

Tightening net operating loss allowances for corporate net income tax payments will grow annual collections significantly ($250 million). An increased tax rate, base expansion, and other technical clarifications will increase bank shares tax revenue by $25 million annually.

Gaming expansion, including new Lottery games, sports betting, internet gaming, and authorizing casino operations to serve additional markets, will provide more than $100 million annually. The sale of wine and spirits in the commonwealth now generates more than $700 million annually in tax revenue and profits from the liquor system. Act 39 of 2016 increased these annual revenues by more than $100 million from the sale of wine and spirits. These improvements enhanced customer convenience and consumer choice by expanding sales to new retail outlets.

Ending 2017-18 in Balance

Together, these budget cutting, cost saving, and revenue generating initiatives have enabled the commonwealth to end the 2017-18 fiscal year with a modest budget surplus. Total expenditures were maintained below budgeted amounts throughout the fiscal year, ending less than $7 million above prior-year amounts. Meanwhile, base revenue collections increased by more than 4.4 percent above the prior-year. While modest, this surplus will allow the state to make its first meaningful contribution into the Rainy Day Fund in more than a decade.

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