A mild recession and a holiday spending hangover. That’s what economic forecasters predict for 2023 as lawmakers head to the state Capitol in January.
Rising interest rates and persistent inflation will push the economy into a downturn, experts say, and those economic clouds could also cause the 94th General Assembly to consider any robust spending programs in light of a possible nationwide slowdown.
As Gov. Asa Hutchinson winds down his administration, he recently reported to lawmakers that Arkansas’ budget coffers are overflowing with $2.78 billion of reserve funding.
In his final meeting before the Joint Budget Committee on Nov. 10, Hutchinson noted that the state’s financial position is the best it’s ever been.
“We have lowered taxes; we’ve created a more efficient state government with a 14% reduction in the number of state employees. We’ve invested in education, funded highways and set aside over $2.5 billion in reserve accounts,” Hutchinson told lawmakers on the joint budget panel. “Today, I can say with confidence that the state has never been in better financial condition.”
Concerning that $2.5 billion reserve, over $1.2 billion has been set aside for the so-called “catastrophic reserve fund.” The governor and General Assembly created that fund in the 2021 session to plug any holes in the state budget if gross revenue collections fall below 3%.
Another $224 million of the rainy day provisions goes into the state’s restricted reserve fund. Under the state’s balanced budget law, that fund can only be accessed with the approval of three-fifths of the legislature to shore up budget shortfalls at state agencies.
Jeremy Horpedahl, associate professor of economics and director of the University of Central Arkansas’s Center for Research in Economics (ACRE), said the Hutchinson-gifted long-term fund would provide some leeway for lawmakers during the legislative session if the economy turns south.
“They should be thankful they have that long-term reserve fund in place,” said Horpedahl.
The UCA economic and tax policy expert also said that if Arkansas enters a recession in the first quarter of 2023, the Legislature and Gov.-elect Sarah Huckabee Sanders also have time to alter any spending bills before the Joint Budget panel at the end of the session.
Horpedahl said he plans to closely monitor how the Republican supermajority at the state Capitol will handle the record surplus, especially if inflation pressures cause any hiccups in consumer spending, job growth, home sales, or other key economic indicators.
“For right now, we are not in a situation where a recession is going to be really bad,” he said. “We won’t know until we are well into 2023. I think the legislature will have this challenge of trying to budget for an uncertain year.
“The DFA (Department of Finance & Administration) will also keep an eye on those numbers as they come in and watch how much people are spending because that drives the economy and state tax revenue,” Horpedahl said.
Delayed effects
John Shelnutt, the administrator of economic and tax research at the DFA, said the state entered fiscal years 2021 and 2022, respectively, with budget surpluses of $945.7 million and $1.628 billion.
Going into fiscal 2023, which began July 1, 2022, Hutchinson’s $6.04 billion budget proposal left the state with a $175 million surplus and a 3.3%, or $195 million, increase over the prior fiscal year.
In his fiscal 2024 budget proposal before the joint committee two days after the Nov. 8 election, Hutchinson laid out a $6.33 billion budget request that increased spending by 5.21%, or $314 million.
According to Shelnutt, Hutchinson’s earlier projected $555 million surplus was recently revised upward 7.7% to $598 million. The updated finance department surplus included $500 million in tax cuts from the special session of 2022 and other updates such as higher inflation estimates and faster growth.
Asked if DFA would make any additional revisions going into the 2023 session on Jan. 9, Shelnutt said any future revision would likely occur in the next fiscal year because state revenue forecasts tend to lag U.S. and state economic conditions and predictions because of the annual delay in tax year filings.
“Before those required filing months, we still have potentially high growth (above forecast levels) coming this January from the final estimated payment for fiscal 2022 and the same potential contribution in December from corporate estimated payments from a large group of those accounts having calendar year tax years,” Shelnutt explained.
“A hit to individual incomes and corporate profits in a shallow recession during the first half of 2023 would play out over a lagged period of tax filings that stretch into fiscal ’24.”
Recession signs
Despite state government’s rosy fiscal forecast going into the 2023 session, several recent economic reports point to a mild recession or contraction in early 2023 that could undermine consumer confidence and business growth.
At the annual Arkansas Economic Forecast Conference on Nov. 10, economists from the St. Louis Federal Reserve and the University of Arkansas at Little Rock predicted a mild recession for the U.S. and Arkansas heading into next year. Michael Pakko, chief economist and director of UA Little Rock’s Economic Development Institute (AEDI), said the state’s economic picture could dim somewhat if Arkansas consumers ease their spending after Christmas.
“Compared to the slowdown in 2020, what we expect to see in 2023 will be nothing,” said Pakko. “But with consumer spending slowing down after the holiday season, what we will see represents a mild recession.”
Despite stubborn inflation, rising interest rates and higher energy prices, Pakko said consumer spending has not waned in 2022 as pandemic relief and funding increased personal income and purchasing power. According to economic data from the U.S. Bureau of Economic Analysis and UA Little Rock’s financial institute, personal spending in Arkansas grew by 12.8% in 2022, compared to only 0.6% and -0.9% in the prior two years.
“What is driving the Arkansas economic outlook is the overhang of consumer spending,” said Pakko.
Ernie Goss, chief economist and director of Creighton University’s Economic Forecasting Group, also expects a significant correction after the holidays. Creighton University publishes the Mid-America Business Conditions Index, a leading economic indicator for the nine-state region stretching from Minnesota to Arkansas.
Goss points to weakness across the regional economy due to declining manufacturing activity, which is one of Arkansas’ strongest business sectors. Despite healthy growth in monthly economic activity for almost two years, regional manufacturers have added jobs at a modest pace. Business confidence at the end of the year is also at its lowest level in several years, he said.
“Our Business Confidence Index fell to its lowest level since March 2020, the first month of the pandemic,” said Goss. “Confidence indices for each month in 2022 … are the worst string of readings since the 2008-09 recession.”
In a recent forecast for the upcoming legislative session in January, Erika MacKellar with the National Conference of State Legislatures (NCSL)said many states have seen their fiscal situations continue to rebound in the wake of the pandemic and the resulting recession in early 2020. However, MacKellar told the Arkansas Advocate that while revenue overflows for many states will continue in 2023, budget forecasters should not expect collections to be as robust as the previous year.
“While overall state revenue growth is expected to be modest, state fiscal situations for (fiscal) 2023 are expected to stay strong,” said MacKellar. “However, a sense exists among many states that robust revenue growth may not continue in future years, and states are making large deposits to rainy day funds to mitigate the effects of a potential economic downturn.”
MacKellar, who guides NCSL’s fiscal affairs program, covers state budget conditions and procedures. She said NCLS, which represents state legislatures, territories, and commonwealths of the U.S., will issue another fiscal report in January as more annual revenue data is collected.
