Four years of accelerating growth in public construction spending is terminating at the end of 2007, at the same time that the steep two-year plunge in private construction spending is reversing. The precipitating event in the public sector is the very cautious state and local government budgets for the 2007-08 fiscal year. The turnabout in the private sector results from new home construction hitting the low point for this cycle (or at least close to it). The outlook for resumed growth of private sector construction has been set out previously at buildingteamforecast.com.

Public Construction has Increased 40% since March 2003
Public construction spending increased 40% since the bottom of the last public construction cycle in March 2003. Public facility managers had to severely cut back on new construction funds in 2002-03. Many projects were cancelled or delayed. In the fiscal year that ended in June 2003, state governments cut the real value of spending after inflation by 3.1%, even after boosting taxes nearly $10 billion and drawing budget reserves down to 3.2% of expenditures, about the level hit in the deep recessions in the early 1980s and 1990s.

Big Lag between State Revenues and State Spending Trends
Then the financial position of state and local governments began to improve quickly as the long period of above-average economic growth began in the middle of 2003. In the first year, state budget balances improved to 5.1% of annual expenditures and after-inflation spending by all states dipped only 0.4%. There is a considerable lag in the response of state spending trends to a change in state budget financial conditions. The lag is much longer than in the private construction sector.

By the end of the 2005-06 fiscal year in June 2006, state budget reserves, including budget stabilization funds, rose to a record high 10.9% of expenditures, according to the National Association of State Budget Officers. Real state spending increased 5.4%, the highest year-to-year change in more than three decades. Public construction spending increased 8.4% over the same period. With the usual delay in appropriating tax receipts for capital projects, public construction spending jumped 9.9% in the 2006-07 fiscal year ended last June.

“Surprise” Tax Receipts now Available to Fund Spending
The delay in getting tax receipts to the job site or any other public spending program is partly due to the lengthy bureaucratic process. However, a large part of the delay is also the typically huge errors made in estimating tax receipts. In the fiscal year just ended last June, the aggregate underestimate of the growth in tax receipts was about 50% across all states. 27 states underestimated tax receipts. The “surprise” tax receipts are now available to fund spending, including construction, in the 2007-08 fiscal year ending next June.

Growth of Public Construction will Peak at 12.2% in 2007
The growth of public construction spending will peak at 12.2% in the 2007 calendar year, slip to 8.2% in 2008 and slip further to 7.3% in 2009. This projected gradual slowdown looks very optimistic compared to state budgets approved for the current fiscal year. Taken together, all states budgeted for only a 1.0% expansion in after-inflation spending, down sharply from the 5.3% gain in the previous year. The budget assumptions include drawing down budget reserves to 6.0% of annual expenditures from 8.2% in the prior year.

Expect State Revenues to Exceed Budget Assumptions in 2007-08
Expect state revenues to exceed budget assumptions again in 2007-08 so that spending appropriations are raised later in the budget year. This will permit the expected gradual slowdown in the growth of public construction spending rather than the abrupt slowdown implied by the approved budgets. Furthermore, the “surprise” discovered next spring will be available for the 2008-09 fiscal year.

Don’t state legislators and governors ever learn from their mistakes? (The author of this report, Mr. Haughey, made the revenue projections for the state of Michigan in the early 1970s and learned that the mistake that legislators and governors most want to avoid is promising something that they cannot deliver. Therefore, they estimate low and then have a bonus to take credit for later.)

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