A number of state commissioners entered the State House hearing room late last month, each with their own mission. For three days, Governor Chris Sununu and his budget director held budget hearings. Administration officials detailed progress in their departments and outlined their financial needs to plead for more funding when Sununu prepares its budget next year.
But before the proceedings began, Sununu issued a warning.
“I think there are certainly a lot of possibilities, but we also have to be careful about where the economy as a whole might go,” he said.
He continued, “There’s really no way to avoid any form of national recession. it’s real It’s coming.”
Sununu is not alone in this concern: A September report by Moody’s Analytics highlighted what its authors called “a crucial issue” for state governments. Buoyed by two years of record flows of COVID-19 federal stimulus funds, state governments are on the verge of seeing much of that funding phase out. And with inflation rising and interest rates rising to curb that inflation, the risk of an economic downturn is real.
Preparing for this downturn, according to the Moody’s report, will be critical for state legislators over the next few years. The New Hampshire Legislature must pass its next biennial budget by July 2023; Traditionally, Sununu will present its budget proposal to lawmakers in February.
But New Hampshire is among the five states least prepared for a recession, according to the analysis; Should the state face a moderate recession, it could see an 18.1 percent tax cut, one of the largest in the country.
New Hampshire economic analysts say the state has a lot to offer financially. Business tax receipts remain strong, the state ended last fiscal year with a $430 million surplus, and lawmakers poured hundreds of millions into the Rainy Day Fund, they note.
But in a moderate recession, even this rainy-day fund wouldn’t make up for lost revenue, Moody’s warned. New Hampshire, the report said, would still need to cut 10 percent of its spending to make it.
With growing nervousness, New Hampshire observers say lawmakers need to be smart when moving forward with a budget.
“You just don’t want to get into a situation where you have to raise taxes or cut 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 tax base
One reason New Hampshire is vulnerable to the effects of a recession is the state’s reliance on corporate taxes, notes Phil Sletten, research director at the New Hampshire Fiscal Policy Institute. The state receives about a third of its general fund income from trade income tax and trade tax. Much of those corporate profits are paid by large, multinational corporations: Of the nearly 80,000 companies that filed taxes in New Hampshire in 2019, 80 accounted for nearly half of total revenue, according to an NHFPI analysis. Sixty percent of applicants that year were multinationals, the NHFPI said.
This dynamism means that much of New Hampshire’s revenue depends on how the national and global economy performs. And it puts New Hampshire at a disadvantage compared to states that rely on broad income taxes to weather a recession.
Sletten said taxes on corporate profits “are generally viewed as more volatile” than broad-based income taxes. The reason is simple, he added: In a recession, “earnings move faster than compensation.”
However, Sletten noted that New Hampshire still has a variety of revenue streams, and some are more recession-prone than others.
Some taxes are resilient. The statewide education property tax levied and withheld by cities depends on the property values, which do not change from month to month. This tax does not technically go to the state coffers, but it does help offset any amount of money that may be left over from the Education Trust Fund to pay school adequacy grants.
Revenues from alcohol and tobacco sales tend to survive economic downturns. Those revenues are significant: Profits from the state alcohol commission accounted for 5 percent of state revenue in fiscal 2021, and the tobacco tax brought in 8.5 percent that fiscal year.
But many other New Hampshire taxes would suffer if the economy changed. Food and rent taxes would be doubled, Sletten noted. People living in New Hampshire would probably go to restaurants less. People who don’t live in New Hampshire would likely visit the state less, which means less revenue from hotels, Airbnbs, and rental car agencies.
And because the state doesn’t have a broad sales tax, switching habits from eating out to grocery shopping wouldn’t generate additional revenue.
Meanwhile, the real estate transfer tax, which brought in 7 percent of the state’s general revenue in 2021, could suffer if home buying falls, Sletten noted. This tax has been successful in recent years, helped by a record-breaking increase in median selling prices in the state, even as overall home sales have declined. But as Federal Reserve interest rates rise, that demand is likely to cool in the coming years, Sletten noted. And if sales prices fall, the state’s low housing stock is likely to catch up, reducing property transfer tax revenues.
A New Hampshire tax directly related to the stock market is the interest and dividend tax. While rising interest rates could bring higher yields to some New Hampshire investors, most taxpayers are likely holding assets that could be hurt by a struggling market.
Additionally, 2023 marks the first year in the state’s five-year plan to phase out interest and dividend taxes. The tax will decrease from 5 percent to 4 percent for the 2023 tax year and will continue to decrease by 1 percent per year until 2027, when it ends. Regardless of a recession, this will bring less revenue, Sletten noted.
Predictions are difficult
It’s difficult to determine just how much New Hampshire’s revenue could fall as a result of a recession. Ledges are slippery. However, observers note that there are four key milestones to watch as the governor and legislature prepare the budget over the next seven months.
The first will come in February, when Sununu will present its budget proposal in an address to lawmakers. This budget will include revenue projections for the next two government fiscal years, fiscal years 2024 and 2025, which will span July 2023 through June 2025.
When the House of Representatives is expected to present and vote on its budget by the end of March, the House Finance Committee will come up with its own revenue projections. Two months later, in May, the Senate will make a third attempt to estimate the revenue. Then in June, when the House of Representatives and lawmakers are discussing bringing their proposals together in one budget, lawmakers will issue another revenue forecast.
Traditionally, the first two passes of the budget — by both the governor and the House of Representatives — are less accurate because they come before the collection and processing of corporate tax returns in April. The draft budgets for May and June can take these returns into account.
But if a recession looms, even current sales forecasts late next spring won’t capture the potential losses. To do this, the legislature must build in its own uncertainty.
New Hampshire’s strong earnings heading into a potential downturn present both opportunities and pitfalls, argues Cline.
“In general, if you have some money in the bank and it’s sitting in the general fund, it’s a good idea to just hold it until we get through this event,” he said.
If lawmakers don’t and revenue falls during a recession, the alternatives aren’t as pleasant, he said.
“You can raise taxes, cut spending, or deplete your reserves,” he said. “And those are three ways you can adapt to declining revenue.”
The Moody’s report agreed. “States that have channeled excess tax revenue into emergency reserves and avoided spending one-time stimulus money on recurrent spending will be better able to weather such a downturn,” wrote authors Emily Mandel, Haley Curtin and Bridget Ryan.
But lawmakers have not traditionally been a paragon of restraint when it comes to spending, especially when they have money to gamble, Cline said. Even the Republican-led Legislature has spent a significant portion of the state surplus on non-budgetary spending over the past two years. During the biennium, the Legislature passed bills authorizing spending of $272 million over the budget passed in 2021, according to a list from the state’s Legislative Budget Assistant.
Many lawmakers and advocates would argue that these expenses were important: $5.7 million went to sanitation projects; $11.8 million was spent on a one-time grant to state retirees; $25 million spent on a PFAS contamination clean-up loan fund; and $15.3 million was spent building a new government parking garage in Concord, to name a few.
But for Cline, that kind of spending should be prudent when the state faces a recession.
“Unfortunately, by the end of last fiscal year, the Legislature had spent almost 70 percent of the surplus,” he said.
Democrats have criticized New Hampshire’s tax structure in recent years, pointing to high property tax burdens resulting from the state’s thrifty use of local schools. But they have generally avoided the idea of broad taxes.
Cline, like other conservatives in the state, is satisfied with the state’s revenue structure, which he says is designed to fund the state while creating a low tax burden on individuals in terms of state taxes. The key to surviving with such a reliance on corporate taxes is knowing the state’s financial constraints and planning for them, he said.
“It’s entirely doable as long as we don’t act like a (tax) diversified state,” he argued.