By Vance Ginn and Talmadge Heflin

Texas faces multiple economic challenges. These headwinds have slowed what would be the world’s 12th largest economy and could slow it more, potentially contributing to the state’s first major recession in 30 years. Texas Comptroller Glenn Hegar also recently reported that state tax collections are on pace for a tight state budget during the 2017 Legislative Session.

Fortunately, Texas’ high level of economic freedom, diversified economy, and the forward-looking 2015 Legislature to spend wisely and cut taxes help weather these challenges. It’s a fiscally responsible course that provides an environment conducive for Texans to prosper that policymakers in others states and Washington, D.C. should follow.

Economic Challenges

During the Great Recession and since, Texas has been America’s jobs engine, creating 34 percent of all U.S. civilian jobs during the last eight years. Despite substantially lower oil prices since June 2014, Texas employed more net non-farm jobs in 11 consecutive months, had positive job creation in 64 of the last 65 months, and created 142,800 private sector jobs during the last twelve months through February 2016.

But that doesn’t necessarily mean smooth sailing ahead for the Lone Star State.

Texas and other states face challenges from slower global economic growth, particularly in China, and lower oil prices. There was also a combined 97,700 job losses in Texas’ mining industry, primarily oil and gas activity, and manufacturing industry during those last twelve months. More job firings and fewer openings were expected as annualized increases in real gross domestic product was only 0.5 percent in the second quarter and 0.1 percent in the third quarter of 2015—barely avoiding a technical recession.

These challenges would likely have caused a prolonged, severe recession in Texas if the economy looked like it did during the 1980s. But the state’s economy is much more diversified and better prepared to weather a potential downturn, despite what some doomsayers proclaim.

The mining industry is directly related to about 15 percent of the real private economy and less than three percent of the labor force today. This is substantially lower than in the 1980s when it was about 21 percent of the real private economy and five percent of the labor force. The combination of more economic diversification, enhanced private sector activity, the ratification of NAFTA, and pro-growth policies have supported a more resilient economy. Consequently, the sustained steep drop in oil prices hasn’t yet taken nearly as much of a toll on the Texas economy as it did in 1986 when Texas had its last major recession that lasted two years.

However, increased economic diversification also led to Texas being more dependent on the rest of the U.S. economy. Without growth in exports and the oil and gas sector, which fueled much of the U.S. economic expansion since 2009, there is a shaky foundation for the national economy to stand on. With the Federal Reserve having held interest rates too low for too long and now (rightly) tightening credit, slower economic growth and lower oil prices are likely as highly distorted markets correct. In addition to overbearing regulations, including those by Dodd-Frank and others promulgated by the Obama administration, the American Dream has been pushed further from the reach of too many Americans.

Collectively, the next U.S. recession could be much worse than the Great Recession because the national economy didn’t fully correct during that downturn as the government put the economy on life support filled with hot air instead of oxygen. This could send shockwaves through Texas’ economy.

Of course, the economic future is unknown, but so far, as Hegar recently noted, the sky is not falling in Texas. On the other hand, Texas has been blessed with a long business cycle contributing to great prosperity, but it won’t last forever. Texas will one day have another recession.

Fiscal Challenges

During the previous two recessions, legislators increased the total budget by far more than population growth plus inflation in both 2001 and 2009, which were both poor decisions in retrospect.

Excessive spending in 2001 was followed by a $10 billion revenue shortfall in 2003 that was met with steep spending cuts without raising taxes. The 2009 Legislature balanced its books by accepting a large short-term “stimulus” payment from the federal government. Two years later, it papered over a larger revenue shortfall with accounting gimmicks that were reversed in 2013.

In other words, previous spending excesses that substantially expanded the size and scope of government  hurt Texans by asking them to pay higher taxes and lose government benefits. This cyclical nature of excessive spending has been the way of doing business for too long in Austin.

The 2015 Legislative Session started with the state’s coffers overflowing with cash from a robust economy. Instead of discussing how much to spend, state officials discussed how much to cut taxes. This novel concept should be the starting point every legislative session.

Before the session started that January, Hegar gave his Biennial Revenue Estimate (BRE) to provide a guidepost of what was available to appropriate given the state’s requirement of a balanced budget. He then released the Certification Revenue Estimate (CRE) in October after session ended in June that certified the budget. But he noted that given slower economic growth and lower oil prices the estimated general revenue-related funds for 2016-17 were likely to decline.

Drop in expected economic growth and oil prices lower revenue projections but leave room to fund the budget if revenue falls further

Notes: Data are from the Texas Comptroller’s BRE and CRE. Revenue amounts are in thousands of dollars.

The CRE shows that compared with previous estimates, the 2016-17 budget had a higher beginning balance, lower tax collections, and less funds available for transfers from lower oil and natural gas prices. In addition, there were $6.9 billion less in all state funds of $214 billion and $2.6 billion less in general-related funds of $110.4 billion. According to this estimate, general revenue-related funds provides a buffer of $4.2 billion above expected spending of $106.2 billion.

Today, the taxable oil price in the CRE looks overestimated as the Energy Information Administration recently lowered their forecast of the average oil price to $34 per barrel in 2016 and $40 per barrel in 2017. These $16 per barrel lower oil prices in each year compared with the CRE would likely be associated with slower economic growth and job creation, leading to a legitimate concern of whether there will be sufficient revenue to fund the budget.

Hegar recently reported that sales tax collections increased by 2.1 percent in March compared with the March 2015. However, through the first seven months of fiscal year (FY) 2016, which is from September 1 through August 31, sales tax collections are down 2.6 percent. Hegar noted, "The modest growth in sales tax collections for March was in line with expectations and comes after five consecutive months of declining sales tax revenues." In addition, he highlighted the diversity of the state’s economy by noting that there was “stronger growth in receipts from the retail trade, restaurant and construction sectors” that offset lower tax collections from oil and gas-related sectors.

From September through March, here’s how the current trend of tax collections compares with the CRE:

  • Sales Tax Revenue: $16.4 billion so far through the first seven months compared with an average of $17.1 billion in the CRE for six months, equaling a $693 million shortfall.
  • Franchise Tax Revenue: Below CRE by $2 billion through first seven months, but historically this tax is primarily collected monthly starting in March through the rest of the fiscal year, so this doesn’t provide a complete picture. For example, there was $249 million net tax collected in March after six months of negative net collections.
  • Oil Production Tax Revenue: Below CRE by $102 million as oil production per day is 8 percent below its peak in March 2015 of 3.6 million barrels per day through the latest data available in January 2016.
  • Natural Gas Production Tax Revenue: Below CRE by $113 million.
  • Total Tax Collections: Below CRE by $3.2 billion, but a major portion of that is the franchise tax discrepancy noted above. If you exclude the franchise tax discrepancy, total tax collections would be about $1.2 billion below the CRE for FY 2016.

Again, the CRE noted a 2016-17 excess fund balance of about $4.2 billion after dropping its oil price forecast by about $15 per barrel. With oil prices potentially averaging another $16 lower this year and with about a $1.2 billion decrease in revenue projected in FY 2016, that would translate to $2.1 billion less for the full year. If this pace of total tax collections continues, which things could change drastically during the full two-year budget cycle, there may be little to no available excess fund balance going into the 2017 Legislative Session.

Legislature Helps Weather an Economic Downturn

The 84th Texas Legislature made great strides last session to weather an economic downturn by passing a total budget that increased by less than population growth plus inflation, $4 billion in tax and fee relief, and billions of dollars left unspent, including almost $10 billion in the state’s rainy day fund.

These prudent fiscal decisions helped keep the size and scope of government from crowding out the productive private sector during a slowing economy—the best economic stimulus.

Texas faces real, and potentially major, economic and fiscal challenges. However, the proven recipe of a diversified economy and limited government philosophy must be enhanced to continue meeting these challenges and propel Texas towards greater economic prosperity.

Advancing the Texas Model

The 85th Texas Legislature should advance the Texas model to provide the best economic environment for Texans to succeed and further cushion the effects of natural business cycles by the following: pass another conservative Texas budget, eliminate the business franchise tax, reform the state’s weak spending limit, adopt a mechanism to reduce the budget, stop excessive growth in property taxes, and provide a 21st century-level of budget transparency. This is what the 13 members comprised of grassroots, statewide, and national organizations of the Conservative Texas Budget Coalition support.

By advancing economic freedom and individual liberty in the Lone Star State, Texas will better deal with potentially deep downturns and other economic circumstances. This provides Texas with the best opportunity to remain a free market bastion for Texans to achieve their hopes and dreams and a model for others to follow.

Vance Ginn, Ph.D., is an Economist at the Texas Public Policy Foundation, a non-profit, free-market research institute based in Austin. He may be reached at vginn@texaspolicy.com.

The Honorable Talmadge Heflin is Director of the Center for Fiscal Policy at the Texas Public Policy Foundation, a non-profit, free-market research institute based in Austin. In the 78th Session, Heflin served as chairman of the House Committee on Appropriations and navigated a $10 billion state budget shortfall through targeted spending cuts that allowed Texans to avoid a tax increase. He may be reached at theflin@texaspolicy.com