Budget cuts loom, taxes possible as Annapolis takes on shortfall

A gaping budget gap awaits Gov. Martin O'Malley and Maryland lawmakers when they return to Annapolis this month — a problem that persists even after three years of recession-driven trimming and now amplified by the evaporation of federal stimulus aid.

But fresh from re-election to four-year terms, officials have the political capital this year to make unpopular choices.

O'Malley, a Democrat who campaigned heavily on his commitment to education and secured the backing of the state's largest labor union, is considering cuts to schools and reductions to the state work force. And the Democratic-controlled legislature, emboldened by its immunity to November's national Republican tide, is weighing tax increases, including those on alcoholic beverages and gasoline.

"The general rule is, get the hard decisions out of the way early," said former Gov. Parris N. Glendening, a Democratic elected official for 31 years. "Even if there are budget-balancing gimmicks left, it's still better to just make the tough calls now so that voters can see the full benefits of what you've done by the next election."

Such was the case with O'Malley's first term. He called a special session of the legislature in 2007, pushed through a billion-dollar tax plan and laid the foundation for a slot machine gambling program.

Due largely to a national recession and a slow start for gambling, the state's budget remains awash in red, with as much as a $1.6 billion shortfall in the next fiscal year's $13 billion operating budget and a structural deficit — the persistent difference between state revenue and state spending — of about $2 billion, legislative analysts say.

A committee of top legislators recently recommended that the governor shrink the structural deficit by at least one-third this year, meaning that O'Malley would need to reduce spending by about $667 million, in addition to closing the gap in the operating budget.

The governor has said that his fiscal 2012 spending plan, to be unveiled this month, reflects the "new normal" of more than 7 percent unemployment and lower revenue from income taxes and other sources. He has pledged not to introduce new or increased taxes, though he has said that he would be open to revenue proposals approved by the General Assembly.

In recent memos and conversations with agency leaders and advocates, state officials have revealed some of O'Malley's options for cost savings.

For the first time since taking office in 2007, the governor is considering cuts to education spending. One plan calls for an across-the-board 5 percent cut to K-12 schools. He also is trying to reduce the state work force through buyouts — or layoffs, if necessary — and might merge some agencies.

And there's a movement to attack the unfunded pension liabilities, which could help drive down the structural deficit. O'Malley's budget advisers have presented him with plans to reduce benefits to new state workers, and renegotiate with existing employees. Local governments or school boards might be asked to shoulder some of the teacher pension burden — an option the former Baltimore mayor has bristled at in past years.

"This is going to be the most difficult budget that this governor has ever proposed," said Matt Gallagher, O'Malley's chief of staff. "No one will be happy, but we have to figure out the fairest and most sustainable path."

T. Eloise Foster, secretary of the Maryland Department of Budget and Taxation throughout O'Malley's tenure, said the next budget will be particularly ugly because "there are no easy choices left to make." In O'Malley's first term, she said, the state cut $5.6 billion in spending.

Annapolis has counted on Washington for federal Band-Aids for its budget the past two years. In the current fiscal year, which ends June 30, the state applied $1.3 billion in federal stimulus money to its operating budget. But with Republicans gaining control of the House of Representatives in the November elections and picking up seats in the U.S. Senate, a new round of stimulus dollars appears unlikely.

"Up until now, we've been on federal life support," said Minority Whip David Brinkley, a Republican representing Frederick and Carroll counties in the state Senate and a member of the Budget and Taxation Committee. "Everybody knew this was going to happen, but nobody wanted to acknowledge it."

As bad as Maryland's budget problems might appear, state leaders hasten to say they could be worse. States across the country face budget gaps, and some, including California and Illinois, are laying off teachers by the hundreds and defaulting on payments to contractors.

Nationally, state revenues have dropped an average of 12 percent since the recession began, said Elizabeth McNichol, a senior fellow at the Center on Budget and Policy Priorities in Washington. And it typically takes states two or three years longer than the rest of the economy to recover from a recession.

"Most states are going to have to look at both sides, revenue growth and cuts, this year," she said, adding that Maryland is "in the middle of the pack" when it comes to finances.

Maryland still has a AAA bond rating that enables it to borrow money cheaply and a rainy day fund of just under 5 percent of state revenues, about $630 million.

"We've muddled through," said Warren G. Deschenaux, the legislature's top fiscal analyst, crediting federal aid for propping up the state the past two years. "But adjustments need to be made in the funding structure for things like health care and education. We're at a point where we're not going to be able to maintain services."

In a recent letter to Prince George's County Superintendant William R. Hite, Foster laid out the possibility of reduced spending for education. "In addition to many other painful cuts — unthinkable only a few years ago — I have proposed for the governor's consideration a 5 percent across-the-board cut to K-12 education," she wrote.

Hite had told reporters days earlier that he wanted $139 million more from the state this coming year, an idea that Foster, in her letter, said "suggests that you believe that the governor's winning re-election is the equivalent to winning the lottery."

Budget advisers are recommending that the state charge hospitals a higher "assessment fee" to help pay for Medicaid. Two plans under consideration would raise up to $254 million to support the health care plan for the poor.

O'Malley has turned his attention to the state work force of about 79,000 as a potential source of savings. In December, he introduced a buyout program — a lump sum of $15,000 plus $200 for each year of service — in hopes of eliminating 1,500 employees by the end of January.

A spokesman for the governor said more than 1,000 workers have submitted applications, though some will be rejected to ensure that the reductions are spread sensibly throughout the agencies. O'Malley will turn to layoffs if the target is not met.

State employees have been through several years of furloughs — unpaid days off — amid budget-balancing efforts. O'Malley has eliminated about 3,200 positions, said Patrick Moran, director of the Maryland chapter of the American Federation of State, County and Municipal Employees, which has 30,000 members.

"I don't know who they would lay off," Moran said. "They've already cut to the bone, and now I guess they're going to attempt to cut into the marrow."

Aides say the governor is considering merging agencies to reduce the work force. Proposals include combining the Maryland Department of Natural Resources with the Department of the Environment and moving the Maryland Higher Education Commission under the Department of Education.

State workers are being eyed for other savings: cuts to pensions and retiree health care. Taxpayers are on the hook for $25 billion in unfunded benefits, reports show.

Brinkley said this will likely be Year One of a "long-term discussion about what we provide to retirees."

"We can't continue to pay the rates that we do," he said. "At the same time, we have to find a way to keep promises that we made. It's going to take a lot of work to find the middle ground."

One short-term solution, he and other lawmakers said, is to freeze out new state employees from the current system and look for a fair way to change the retirement plans of existing employees.

Documents prepared by the state budget office propose two options for retirement plans for new employees, both of which would require them to contribute more of their salary than current workers do.

Moran called the proposals "an assault on working people. They want employees to pay more and get less." He said labor groups will "fight tooth and nail" against such changes this coming session.

The state might also try to offload another pension burden. It now pays $900 million per year for teacher pensions, even though local school boards make hiring and salary decisions. The governor has said he does not believe that Baltimore and the counties can withstand transferring those costs.

But his aides have presented him with two proposals. Under one scenario, all counties and Baltimore would pick up 40 percent of the costs. A separate, "wealth-adjusted" plan would shift more of the burden to wealthier counties and less to poorer jurisdictions.

Baltimore Mayor Stephanie Rawlings-Blake said she is particularly worried about a teacher pension shift —which could force the city to pay as much as $22 million per year. "It would be devastating to our school budget even if it's phased in over several years."

Interest groups such as Progressive Maryland and the Maryland Budget and Tax Policy Institute, and some lawmakers, say it is impractical to think the budget can be righted without higher taxes.

In a state of the work force report out last week, those two organizations called for an array of new revenue, including raising taxes on alcoholic beverages, gasoline, services and millionaires.

"We're concerned about trying to balance the budget on cuts alone," said Neil Bergsman, head of the tax policy institute.

Taxes were the go-to solution in the 2007 special session. The package of increases, including a penny-per-dollar rise in the sales tax and adding a higher tax bracket for millionaires, was designed to raise $4.7 billion in revenue over four years, according to an estimate at the time.

Meanwhile, legislators asked voters to consider allowing the state to develop a slot machine gambling program that was projected to generate $600 million in tax revenue. Voters approved slots in 2008, but two years later, just one of five planned casinos is up and running; another is scheduled to open this week.

In spite of O'Malley's tax-increase-free budget, lawmakers say they are likely to propose new measures anyway.

"There is a lot of interest among my colleagues at looking at revenue enhancements," said Del. Thomas Hucker, a Montgomery County Democrat. "We can't just cut our way out. We've been cutting for years."

Baltimore Sun reporter Julie Scharper contributed to this article.

Expense comparison

The General Assembly's spending affordability committee recommended reducing the structural deficit by one-third this year. That would translate to about $667 million in general fund spending. For perspective, here are some expenses in that ballpark.

•Terminate all state employees making $105,000 or more (4,400 people): Save $688 million

•Eliminate all Medicaid and medical benefits for poor children: Save $680 million

•Close University of Maryland, College Park; University of Maryland, Baltimore County and Towson University: Save $671 million

•Shutter adult state prisons: Save about $650 million

•Eliminate spending on health and mental hygiene: Save about $632 million

•Disband state social services and juvenile services: Save about $600 million

Cost estimates are based on current state operating budget.