A new war in Ukraine, mounting inflation and lingering uncertainty about the coronavirus point to an elevated risk for possible economic downturn in Colorado this year, state economists told the legislature’s Joint Budget Committee on Thursday.
Strong growth in state revenue is expected to flatten in the next two fiscal years, in part due to higher interest rates.
The new uncertainty is moderated by growth across most sectors, the lowest unemployment rate since February 2020, and flush state coffers.
Colorado refunds taxpayers in strong budget years, when the state exceeds a set limit on government spending. Those refunds will be higher in the coming fiscal years, according to economists in the Governor’s Office of State Planning and Budgeting.
“There’s a lot to celebrate,” said Kate Watkins, chief economist of the state’s nonpartisan legislative council. “There are also kind of big clouds on the horizon that could rain quite a bit on the recovery that we’ve seen so far.”
JBC Chairwoman Julie McCluskie, a Dillon Democrat, agreed the budget pressure could be significant in the next two years.
“When you add inflationary growth, like what we are seeing here today, it adds to that constrained environment and certainly makes it tougher to deliver all of the services and programs that Coloradans expect of state government,” she said.
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Still, the forecast is relatively optimistic compared with the coronavirus-driven recession that hit Colorado and the rest of the nation in 2020.
Lawmakers are expected to have $3.2 billion more to spend than last year, when a $34.1 billion budget restored cuts made at the start of the coronavirus pandemic in 2020. Legislative economists suggested three alternatives for the next budget year: holding on to the extra money; spending $1.2 billion on one-time spending; or spreading the spending out over two years.
The forecast is also expected to have little impact on the state budget. Colorado is expected to exceed its cap on government spending, meaning any reduction in revenue will just shrink the size of tax refunds headed to residents.
“Colorado is recovering faster, stronger and ahead of other states,” Gov. Jared Polis, a Democrat, said in a statement. “While Colorado’s unemployment rate continues to rapidly fall and job growth continues to soar, we are seeing pandemic-induced inflation nationwide, and gas prices rising as a result of Putin’s extreme aggression in Ukraine.”
Impact to the state budget and taxpayers
Colorado’s Taxpayer’s Bill of Rights , known as TABOR, caps government spending based on population growth and inflation. Additional money that flows into state coffers must be refunded to taxpayers, unless lawmakers ask — and voters allow — the legislature to keep it.
If revenue projections hold, taxpayers will see an income tax rate reduction and sales tax refunds in each of the next three fiscal years.
Any decrease in revenue is expected to be absorbed by those refunds, meaning the size of the state budget would be unaffected.
That assumes the state doesn’t sink into a recession. If that happens, “all bets are off,” Watkins said.
Still, there could be belt-tightening ahead. Taxpayers could see smaller refunds in future years due to soaring inflation rates now.
A 0.1% increase in inflation leads to a roughly $16 million increase in the TABOR cap, according to a report from the Governor’s Office of State Planning and Budgeting.
Inflation rates could also increase state expenses in the short-term, particularly for construction, fuel, state employee wages and required increases to the school funding formulas.
Nonpartisan legislative staff expect a $2 billion surplus over the TABOR cap this year, and a $1.56 billion surplus next year. The Governor’s Office of State Planning and Budgeting predicts a TABOR excess of $2.2 billion this year, and $2 billion and $1.3 billion in the next two years.
Those predictions are smaller than in December, when state economists anticipated around $2 billion of annual TABOR surplus revenue for the next three fiscal years.
Inflation versus recession worries
The forecast comes amid soaring inflation and fuel prices, and fresh worries about supply-chain disruptions as Chinese manufacturing hubs face a new surge in coronavirus cases.
“Economic growth is facing larger headwinds from inflationary pressures,” said Bryce Cooke, chief economist for the governor’s office.
The national Consumer Price Index rose nearly 8% through February, the highest annual increase in 40 years. In the Denver area, inflation is expected to rise 7.2% in 2022, before decreasing to 3% in 2023 and by 2.7% in 2024, according to the governor’s office report.
While unemployment is low, at 4.1%, “the labor market is considered to be very tight,” Cooke said. “The demand for workers far exceeds the supply.”
That’s driving higher wages, which leads to higher costs for goods. At the same time, the housing market in Colorado faces high demand with limited supply.
The price of construction materials rose 34% in the past year, driving up the cost of capital projects, and in March, gas prices were up 35% from March 2021.
It’s unclear when supply-chain disruptions that have hamstrung the production of goods from cars to tractors will ease. Economists said the timing was uncertain but expected it to be later than anticipated.
Meanwhile, war in Ukraine also threatens the post-pandemic recovery.
“The war is expected to weigh heavily in the first and second quarters,” said David Hansen, senior economist for Legislative Council Staff. “The war really promises to exacerbate many of the challenges” stemming from inflation, supply chain issues and more.