Address to the Joint Money Committees on the Proposed Executive Budget 2004-2006

Mr. Speaker, Chairman Chichester, Chairman Callahan, Chairman Parrish, and Members of the General Assembly:

Good morning.

I have come before you this morning to report on the state of our economy and to share with you the substance of the budget I will propose for the 2004-2006 biennium, which will be introduced as House and Senate Bill 30, as well as the amended budget for the rest of the current biennium, which will be introduced as House and Senate Bill 29.

These bills meet our responsibility to balance our budget - in a fiscally conservative manner that protects not only our core priorities - but that also restores our commitment to fiscal integrity, with the specific aim of preserving Virginia 's AAA bond rating.

I present this budget to you this morning mindful of all that we have accomplished together in our mutual effort to restore the Commonwealth to sound financial footing.

Accomplishments Thus Far

In the first 23 months of this administration, we have worked to restore the fiscal integrity of Virginia , to make government more efficient, and to promote new economic opportunities for our people.

These would be ambitious goals in the best of times - but these have not been the best of times. I took office less than twelve months after Virginia had failed to pass a budget for the first time in history. Over the past two years, we have faced a continuing series of natural disasters, from droughts, to floods, to a major hurricane, and last week - even an earthquake.

Throughout all of these challenges, we have tried to put partisanship aside for the good of Virginia . And working together, we have made substantial progress. Together, we have successfully addressed a $6 billion budget shortfall - the most serious fiscal crisis facing Virginia in at least two decades. We did that while protecting our investments in public education, and thus far, we have preserved Virginia 's long-standing AAA bond rating.

Having a AAA bond rating saves our taxpayers millions of dollars in borrowing costs. But a AAA bond rating also announces to prospective businesses and financial experts that Virginia stands on the very top tier among the states.

We must preserve Virginia 's AAA bond rating. I daresay there is not a single person in this room who does not realize the financial significance of this credential.

When we encountered budget shortfalls, our first response was to cut spending. Indeed, together, you and I have shrunk the size of government - eliminating more than 50 agencies, boards, and commissions. Working together, we have reduced the size of the state workforce by almost 5,000 positions. And we have reduced the budget of most state agencies by an average of 20 percent - while protecting public education.

Our administration has also brought sound business practices to state government. For example, we now do a much better job of collectively leveraging the state's buying power, and we have plans to extend that capacity to local governments.

We are in the midst of consolidating information technology activities, based on legislation adopted last session, and we have begun re-examining other fundamental business operations, such as management of real estate and our vehicle fleet.

We have significantly improved our ability to collect money owed the Commonwealth. We have done this through streamlined collections practices, through additional audit positions, and through a tax amnesty program. In that regard, I am pleased to announce this morning that the recently completed Tax Amnesty program which you enacted collected a total of $98.3 million in back taxes and interest.

This provides a one-time, net increase of $33.7 million - over and above original projections. Local governments and the Transportation Trust Fund will also benefit from the success of this initiative.

These and other reforms will yield millions of dollars in savings while giving the people of Virginia a better return on their investment, as well as better value for their tax dollar.

But these are not all of our accomplishments.

We have restored professional and accountable leadership at our most troubled agencies, like the Department of Transportation. While it has not always been easy, we are showing important progress in turning this and other agencies around.

We have renewed our commitment to cost-effective investments in children's health care. Since January of 2002, more than 77,800 children have been enrolled in FAMIS or the Medicaid-based health insurance programs for children.

We have worked hard to recruit new employers to Virginia , and also to help existing businesses expand. In the 23 months that I have been in office - in a difficult economy - we have announced over 48,600 new jobs and $6.3 billion in new capital investment, including more than 10,500 jobs and $1.4 billion in investment in Southside and Southwest Virginia.

Working with you and business leaders, we have created the Council on Virginia 's Future, to help set out long-term goals for Virginia - and identify benchmarks by which we can hold ourselves accountable.

Over the past several months, recognizing that resources remain limited as never before, I launched a series of affordable, cost-effective reforms in public education, which we called Education for a Lifetime. These reforms are based on accountability and are targeted at making better use of our education resources.

The Education for a Lifetime plan, for example, will deploy auditors to streamline administration of public schools and direct more dollars to the classroom. It will send highly-trained turn-around specialists to schools needing extra help to meet Virginia 's high academic standards.

It builds on the success we have achieved in PASS (the Partnership for Achieving Successful Schools), and in Project Graduation.

Education for a Lifetime also places a renewed focus on effectively using the senior year of high school for real learning and for preparing students for life after high school - whether in work or in higher education. The "Senior Year Plus" proposal was recently described in the Chronicle of Higher Education as "one of the first .[efforts] to push a broad plan focused on restructuring the senior year of high school."

And, Education for a Lifetime will increase research and development investments and expand the number of graduates at our institutions of higher education. I look forward to working with you to making sure that these common sense reforms produce measurable benefits in all our schools.

Now, let us turn to the work at hand.

The Need for Tax Reform

This past spring, I announced that tax reform would be a top priority for the 2004 session. I was not alone in setting that objective. Two executive and two legislative commissions concluded in prior years that Virginia 's tax code was in need of an overhaul. You and your colleagues charged your legislative commission with bringing forward a set of recommendations prior to the 2004 session.

You know the reasons as well as I do. They have been regularly documented and frequently cited.
Key features of the individual income tax have been unchanged for almost 20 years. In fact, the bottom two income tax brackets have remained unchanged since 1926.

Virginia 's top marginal income tax rate of 5.75% begins at $17,000 - below the poverty level for a family of four.

Analysis of the income tax shows that Virginia places higher tax burdens on low- and middle-income working families than most other states do, and Virginia places lower-income tax burdens on upper-income families.

Virginia is one of just 14 states that tax food for home consumption.

Through effective use of tax planning strategies - sometimes called tax loopholes - many large multi-state corporations have avoided paying Virginia corporate income taxes, even though they earned substantial profits on business in Virginia.

In 1999, for example - one of the peak years of the economic boom - 21 of the top 50 corporate employers subject to the corporate income tax paid no corporate income tax in Virginia. The problem is not confined to the tax code alone.

Two years ago, we proposed legislation that required all governors to prepare and present a six-year financial plan. I think of it as a business plan - for state government. You agreed and adopted the law unanimously, and I again want to thank Senator Chichester and Delegate Callahan for sponsoring this legislation.

The baseline projection for the six-year plan is sobering. On the revenue side, it shows clearly that even with an economic recovery, and even with no economic slowdown for the next six years - Virginia still faces substantial budget shortfalls through at least the end of the decade.

At the same time, on the spending side, the six-year projection shows that shortfalls persist:
even without moving the car tax to 100 percent or any additional food tax reductions
with no major new funding for higher education or transportation, and with no new programs or commitments.

Your staffs confirmed the budget outlook in the near term, by publishing their own assessments that a shortfall of over $1.0 billion was looming for the 2004-06 biennium. In numerous meetings, many of you and your colleagues have expressed to me your recognition that Virginia 's fiscal condition is serious. And you have acknowledged that we can no longer afford to defer the tough choices that we all know we must face.

The reasons are also well known.

Medicaid growth is now projected to exceed 8 percent per year, even though Virginia is already one of the lowest Medicaid reimbursement states in the country.

In education, in addition to re-benchmarking our Standards of Quality, we know that more than 100,000 new students will enroll in public schools by the end of the decade.

Our prisons and jails already are seriously crowded, and longer sentences and an increasing number of inmates will outstrip available prison capacity.

Continuing growth in the number of vehicles and the value of cars grow the cost of car tax relief, even if the reimbursement level remains at 70 percent.

After years of dramatically increasing investment returns during the stock market boom of the 1990s, our retirement system is now feeling the effects of investment losses, and state contributions must now increase to make up the difference.

Our aging roadways require increasing maintenance, meaning that in the current Six-year Transportation Plan more than $400 million in funds originally intended for construction must be used for ordinary maintenance instead.

This is a situation we cannot continue to ignore.

Given these realities, I have proposed a tax and budget reform plan with three fundamental objectives:

First - we should make Virginia 's tax code fairer;

Second - we must keep Virginia 's commitment to education; and

Third - we must act to preserve Virginia 's fiscal integrity.

The tax and budget reform plan I have proposed meets these objectives.

The plan lowers the income tax for the overwhelming majority of Virginians.

It reduces the food tax by 1.5 cents and adds 1 cent to the sales tax.

It closes some corporate loopholes.

It increases Virginia 's state cigarette tax, with proceeds from the entire cigarette tax to be dedicated for health care. It will also give counties the ability to levy a cigarette tax, up to a cap.

It finishes the promise to end the car tax over the next four years, subject to the existing conditions on revenue growth.

It eliminates estate tax for working farms and family-owned businesses, and for all estates valued at $10 million or less.
It ends the unfair accelerated sales tax collection for retailers.

It provides incentives for small and mid-size businesses to invest.

It eases the tax burden on the military, reservists, and National Guard families.

It streamlines collection of the state sales tax.

Sixty-five percent of Virginians will pay less under this plan in 2006 - the first full year of implementation - than they do now. Our estimates are based on conservative methods, using the best available data, and only count as winners those who would pay at least $50 less in 2006 than they do in 2003.

Moreover, our methods on the income tax, sales tax, and car tax have been carefully reviewed and judged to be sound by economists you all know and respect:

Dr. Al Broaddus, President of the Federal Reserve Bank of Richmond , who had economists from his staff at the Federal Reserve Bank conduct an independent assessment of our methods;

Dr. Roy Pearson, Professor of Business at the College of William & Mary, former director of the College's Bureau of Business Research and past president of the Virginia Association of Economists;

Dr. Steven Fuller, Dwight Schar Faculty Chair and University Professor, and the Director of the Center for Regional Analysis at George Mason University ; and

Dr. Christine Chmura, President and Chief Economist of Chmura Economics and Analytics.

All four of these economists are well respected and have provided sound economic advice and expertise to governors and legislators from both parties. Their comments and validation should give comfort to anyone who has been skeptical thus far.

Nevertheless, I am fully aware that some people may still have questions about what they regard as complex calculations involving comprehensive methodologies.

For that reason, the Department of Taxation developed a Web site where every person can assess the impact of the tax reform plan for him or herself. The Web site went live Monday morning, and as of this morning, more than 8700 individuals have calculated for themselves how they would fare. We welcome that inquiry. Test it for yourself.

The site can be accessed at taxreform.governor.virginia.gov.

Every exercise in tax reform requires balancing competing interests and priorities. This plan is no different. Nevertheless, I am convinced that the tax and budget reform plan I have proposed meets the test of fairness for all Virginians. I ask that you study it carefully - and with an open mind.

Let me hasten to add that I am confident this plan is the right medicine for Virginia 's economy. By lowering the tax burden for low- and middle-income families, we will stimulate consumer spending and job creation. Investments in education, both at the K-12 level and in higher education, will help attract the kind of good jobs our people deserve.

In fact, as President Bush's own Assistant Secretary of Commerce for Economic Development has pointed out, "The essential quality of a modern, growing, prospering economy is a well-educated, versatile workforce . To an unprecedented degree, intellectual capital drives economic prosperity."

And again, by preserving our AAA bond rating, we will send the right signal to investors about our adherence to conservative financial management.

I welcome any independent analysis, and I'm confident of the results.

The revenue from the tax and budget reform plan I have proposed creates no new entitlements. Indeed, if you look closely at the budget I am proposing, you will see more than $180 million in additional budget savings and reductions.

We must continue to find ways to streamline government. The tax and budget reform plan I have recommended restores Virginia to responsible budgeting practices, allowing us to meet our most basic commitments.

To that end, I am proposing to make two deposits to the Revenue Stabilization Fund, also known as the "rainy day fund." In FY 2004, I am recommending a special deposit of $128.5 million - in effect canceling the planned withdrawal from the Fund for FY 2004. This action, which I initially announced in September along with Delegate Callahan and Senator Chichester, will double the projected balance for the Fund by the end of FY 2004.

The second deposit totals $87.0 million, and will be required in FY 2006, based on projected revenues for FY 2004. Together, they demonstrate to the rating agencies a first step toward putting our fiscal house in order.

Let me take a few minutes to lay out for you what I consider to be the other key elements of the budget I will submit today.

Public Education

One of the three objectives I laid out for tax and budget reform was keeping the Commonwealth's commitment to public education.

Every CEO that considers locating in Virginia asks first about the quality of our workforce, and our education system. I have said before that public education is the key to Virginia 's long-term economic prosperity, and is the backbone of our democratic society.

The local elected and appointed officials we met with in preparing for tax reform sent a single, unambiguous message - "if you really want to take the pressure off local property taxes, then meet your commitment to public education."

The budget I am submitting keeps that fundamental commitment by providing $761.5 million in new funding for elementary and public education.

Included in this total is funding for the 31,000 new students that will enroll in our schools next biennium, as well as funding for updating the cost of the state share of meeting the Standards of Quality.

Providing this funding is the right thing to do for Virginia 's children - and it will help to ease the pressure on property taxes at the local level. The budget also includes the appropriations necessary to fund teacher retirement contributions on a pooled basis with retirement contributions for state employees.

This will save our localities over $20 million a year - something I know you have heard a great deal about in recent weeks.

I am also recommending that we provide the funding necessary to implement the Board of Education's prevention, intervention and remediation program - addressing the perverse incentive that penalizes school divisions that perform well. This action is one of the Board of Education's central recommendations to bring the Standards of Quality up to date.

The budget also provides funding to continue technology improvements in our schools through Literary Fund equipment notes ($118.1 million NGF). It supports the final phase of the "cost of competing" adjustment for localities in Planning District 8.

It recognizes prevailing practice for English as a Second Language programs statewide, and it begins to allow localities to deduct a portion of the Title I funds being used to support programs for four-year-old children.

With this budget, we provide substantial new resources to meet the basic needs of our public schools. In the process, we renew the state's partnership with our local governments - and take important steps to strengthen our children's future.

Higher Education

In higher education, we have known for some time that enrollment demand is projected to grow substantially over the remainder of the decade. At the same time, your own legislative studies have shown that we are under-funding our colleges and universities by almost $400 million a year.

Last session, the substantial budget shortfall we faced required us to reduce state support for higher education - much as we did for all state agencies - and students saw tuition increases averaging 20 percent.

Many of our schools now find that they are losing their best faculty to colleges which five years ago could not have lured them away. Students are finding it more difficult to get the courses they need to graduate in four years. We are in effect charging more to attend state colleges, but delivering less. It is imperative that we reverse that trend.

The budget I am proposing adds a total of $144 million GF in new funding to our colleges and universities. The budget provides funds to address a portion of the base operating guidelines that your Joint Subcommittee has put forward.
It includes funds to recognize actual enrollment growth in our colleges and universities - as well as to increase the number of degrees granted by 10,000. It also provides additional student financial assistance to offset higher tuition.

I am recommending limited funding to strengthen outstanding research programs in our colleges and universities - a key step toward the goal of reaching $1 billion in sponsored research by 2010. Numerous studies have shown that research activity has a clear and positive effect on economic growth.

In addition, I am recommending funds to support the Commonwealth's obligation to our historically black colleges and universities.

I propose funds to equip and operate the Institute for Advanced Learning and Research in Danville.

I propose funds to operate and maintain buildings that are coming on line in the next biennium.

I am proposing increased support for the Tuition Assistance Grant for students who attend private colleges and universities - as well as funding to provide in-state tuition for spouses and dependents of military personnel stationed in Virginia.

Public Safety

Preserving public safety is one of government's most basic functions. That means providing adequate funding for state and local police and sheriffs, and providing the resources to keep criminals off our streets.

In the next biennium, the number of state-responsible inmates is projected to increase by about 1,400 per year. At the same time, many of our already crowded local jails will face further crowding unless we take steps to expand our prison capacity.

This budget provides a total of $97.0 million in new funds to address security in our prisons. Central to these efforts is a decision to end the housing of out-of-state inmates when current contracts expire. We will also re-open the Nottoway Work Center - expand jail bed contracts - and expand some treatment programs that have a direct impact on limiting the growth in inmate populations.

The capital budget I am proposing authorizes additions at two existing facilities and construction of a new medium security facility, to ensure that we are prepared for the growth in inmates that continues to occur.

After the attacks of September 11 and our experience with Hurricane Isabel, I am also recommending funding to begin building the State Agency Radio System (called STARS), a project that is long overdue.

If you take time to listen to the muddled audio tape of a state trooper about to go in harm's way compared to a digital version of an audio recording, you will ask yourself why we have waited so long to start this project.

The budget also funds additional law enforcement deputies at the required 1:1,500 ratio. It provides matching funds for the SAFER program for local firefighters, and strengthens training programs for our Commonwealth's Attorneys. It also includes funds to ensure that the State Police are able to retain experienced troopers. Finally, the budget fully funds the state's obligation to localities with police departments under HB 599.Health and Human Resources

In health and human resources, we face the continuing challenge of meeting the basic needs of our most vulnerable citizens. Many of these programs are defined by federal mandate and regulations. Nevertheless, we must recognize that these programs and services respond to real human needs and compelling personal situations.

Consequently, I am recommending more than $870 million in new money for health and human resources. This will allow us to meet our existing obligations and caseloads in Medicaid, foster care, special needs adoptions, Comprehensive Services Act, TANF, and commitment of sexually violent predators - as well as to cover revenue shortfalls in our mental health facilities, and rising caseloads in our two children's health insurance programs (FAMIS and S-CHIP).

In addition to these required costs, the budget proposes $27 million to provide community mental health and mental retardation services consistent with the recent U.S. Supreme Court's Olmstead decision.

Finally, we must recognize that the heart of the Medicaid program is a network of private providers who agree to serve Medicaid clients at the rate the state prescribes. Without these providers, the state would be forced to serve these clients in higher cost settings farther from their homes.

Nursing homes and hospitals have consistently demonstrated that state reimbursement is exceptionally lean, compared to national standards. This budget recommends modest rate increase for these providers, to reflect our obligation to recognize their costs.

Transportation

In transportation, we face daunting challenges. We have initiated reforms to ensure greater accountability and stronger financial management of our transportation dollars. But at some level, we all recognize that additional resources are necessary. Without adequate investment in our transportation system, we risk a reduction in our economic productivity and the ability to attract new businesses.

The budget I am proposing provides over $392 million in new state support for transportation - more than the equivalent of a 4-cent annual increase in the gas tax. Over the next six years, this additional funding will allow us to expand construction by more than 20 percent.

That additional funding comes through dedication of one-third of the insurance premiums for transportation - a commitment that was passed in the 2000 session but has not yet been funded. It also continues general fund support to pay debt service on FRANs that were issued when the budget took from the Transportation Trust Fund the half-cent sales tax dedicated for transportation.

The $392 million also includes the benefit that the TTF receives from eliminating the accelerated sales tax - one of the elements of the tax reform plan. During the current biennium, about $87 million in VDOT operating funds were transferred to the general fund to address the substantial budget shortfall we faced.

I am pleased to say that none of that funding will be transferred in either FY 2005 or FY 2006. It remains in Transportation, where it can be used for our most pressing priorities.

Natural Resources

Our Constitution cites conservation of our natural resources as a basic obligation. Nevertheless, like most programs, programs and agencies in natural resources are severely constrained.

To partially address that situation, we are proposing that the revenue from the current $10 fee on deed recordation be dedicated for water quality and land conservation, through a new Virginia Natural and Historic Resources Fund.

This will provide about $30 million over the biennium to reinforce our efforts in these areas. The budget also appropriates $7.7 million to the Water Quality Improvement Fund, which was designated from the year-end surplus for FY 2003.

Employee Compensation
As I approach the end of my comments, let me take a moment to focus on a group of people who are very important to all of us - our state employees. Virginia's state government functions as well as it does because our employees routinely go the extra mile.

As I visit agencies, I am constantly impressed with the knowledge, dedication, and commitment that state employees display. The same can be said about teachers in our public schools, sheriff's deputies, and other state-supported local employees.

In difficult budget times, we have asked employees to take on additional duties, to adopt new business practices, and to embrace changes in how they operate. In my view, it is incumbent upon us to recognize their contributions.

For that reason, the budget I am proposing provides $103.6 million to support a three percent salary increase for state employees, faculty, teachers, and state-supported local employees, effective November 25, 2005.

In addition, the budget proposes sufficient funding to support the state share of the increased cost of health insurance, based on our health actuary's latest analysis.

In Conclusion

Ladies and gentlemen, we have much work to do in the weeks to come. The issues we must face include many we might prefer to ignore. But they have been ignored for too long.

The policies we must craft will shape Virginia's future for years to come. It would be wrong to deny our responsibility to our children and grandchildren by taking the easy way out and continuing to ignore the problem.

Everyone in this room knows the financial problems facing Virginia, and we all have a responsibility to address them in a serious manner.

I know some skeptics will say that these financial reforms cannot be accomplished, and that we will revert to the same old political divisions. Together, I know we can prove the skeptics wrong.

You know - some said the earth would quake before Virginia seriously confronted its financial challenges. That happened last week. Now let's get to work.

Thank you all - God bless you - and I wish you the very best of holiday seasons.

Governor of Virginia - Mark R. Warner

Copyright 2004