Now it's official: A "mild" economic downturn, starting a year from now, will reduce tax collections for state coffers even as Oregon taxpayers prepare to receive a record $3.7 billion in kicker rebates in 2024.

But state economists told lawmakers that not much else has changed since their most recent quarterly forecast on Aug. 31. This forecast will be the starting point for the proposed state budget for the two years starting in July 2023, though incoming Gov. Tina Kotek has until Feb. 1 to offer changes — and the Legislature has two more forecasts before budgets become final by the end of June.

State Economist Mark McMullen said Wednesday, Nov. 16, that the latest projections by the Oregon Office of Economic Analysis call for $30.7 billion from the tax-supported general fund and Oregon Lottery proceeds for the 2023-25 cycle. Projections for the current cycle are for $33.9 billion. They are the most flexible sources for state spending, which includes billions more from federal grants and other restricted funds.

"You really would not know it if you are looking at the top line for state revenues," McMullen said of the likelihood of a downturn during a virtual presentation to lawmakers on the House and Senate revenue committees. "Available resources have remained roughly unchanged."

State government is highly dependent on personal and corporate income taxes, which make up more than 90% of the general fund, and some lottery proceeds. The state also collects money from a corporate activity tax and retail sales of marijuana, but proceeds from both are earmarked for specific purposes, such as targeted school improvements and mental health and addiction treatment.

McMullen and senior Josh Lehner already flagged the possibility of a downturn in their Aug. 31 report. They made it official this time after the consultant that Oregon relies on for national economic data forecast a downturn starting now, based on job losses.

But according to an Oregon Employment Department report released Wednesday, the private sector added 5,800 jobs in October, even though the statewide unemployment rate rose to 4.1%.

"We're really not seeing anything of that sort," he said, unlike the consultant's report.

McMullen said 10 of the 11 members of the Governor's Council of Economic Advisers now agree that a downturn should be considered likely, "though there was some disagreement about its timing and severity."

McMullen said his office is now projecting a short downturn starting in the third or fourth quarter of 2023, with 24,000 lost jobs — 1.2% of the state total, but far less than in recent downturns. The closest comparison, he said, was to a short downturn starting in mid-1990 and running through the first year Democrat Barbara Roberts was governor.

"It will be mild from a historical perspective," he said.

Kicker history

During the 1991 session, when legislative control was split between Democrats in the Senate and Republicans in the House, lawmakers did suspend the kicker for personal income taxes, then estimated at $186 million. The main reason was uncertainty caused by voter approval the previous year of a statewide property tax limit, which shifted the burden of public school operating costs from local districts to the state budget over five years.

It has been the only time, since the kicker became law in 1979, that a personal income tax rebate was suspended.

The corporate income tax kicker has been suspended twice, once in 2007 to create a permanent reserve fund. Voters in 2012 earmarked future excess amounts for the state school fund. The current estimate is for $1.3 billion.

Over the past decade in Oregon, corporate income tax collections have risen by an annual average of 14%.

Oregon's "kicker" occurs when actual tax collections exceed projected amounts by 2% or more during the state's two-year budget cycle, which currently ends June 30, 2023. The amounts are rebated to taxpayers as credits against taxes owed when 2023 tax returns are filed in 2024. The state discontinued direct mailing of checks in 2011.

The projected $3.7 billion in 2024 would set a record.

The exact amount to be rebated will be set after the September 2023 forecast, which is released after the close of the 2021-23 budget cycle.The record rebate so far was $1.9 billion from the 2019-21 cycle, paid in 2022, or 17.34% of tax liability. The rebate was a record 18.6% of tax liability in 2007, when checks for $1.1 billion were mailed just weeks before the start of the Great Recession.

The kicker was part of a 1979 law for property tax relief, which voters ratified in 1980 by 92%. The tax relief program is long gone, but the kicker remains.

The Legislature can suspend the kicker. But under a change that voters approved in 2000 when they made the kicker part of the Oregon Constitution, two-thirds majorities are required in both chambers to do so. Republicans, who held legislative majorities when the constitutional change went on the ballot, defend the kicker.

The Fed and inflation

McMullen said a downturn will hinge on the after-effects of the Federal Reserve's efforts to tame inflation by raising interest rates, which in turn increases lending costs.

"As interest rates go up, some industries are hit harder than others," he said.

Housing and finance already are affected by rising interest rates, and McMullen said he expects the effects to spread to construction, manufacturing, and transportation/warehousing. He said there will be secondary effects on health care and leisure and hospitality sectors.

In turn, his office has projected that Washington and Clackamas counties, Columbia County, and Deschutes and Crook counties, will be among those with higher exposure to those sectors and higher volatility for job losses. Multnomah, Marion, Yamhill and Jefferson counties are among those facing less exposure and less risk.

"The path to the 'soft landing' has narrowed," Lehner said. "It is challenging to raise interest rates high enough to bring inflation down, but not high enough to send us into recession."

The Fed policies tamed inflation in the 1980s — and it largely stayed that way until last year — but not until record-high interest rates triggered a severe economic downturn that lingered well into the 1980s. It took Oregon seven years to recover the lost jobs.

But McMullen and Lehner said there are signs that offer optimism that a downturn will be short-lived or might not happen at all:

• Moderating inflation. The Bureau of Labor Statistics reported that the year-over-year inflation rate in October was 7.7%, less than had been expected. Lehner said if the trend continues, the Fed still might continue to push up interest rates, but not as aggressively as in recent months, until the annual rate drops to 2%.

"But one data point is not a trend," Lehner said. "The Federal Reserve is looking for convincing evidence of a slowdown in inflation. We are not there yet."

• Unfilled jobs. According to a third-quarter report by the Employment Department, based on inquiries to employers, Oregon's economy still had 94,000 unfilled jobs, though the total was slightly down from the 100,000-plus in earlier reports. "Labor hoarding" was present even before the coronavirus pandemic, when unemployment was at record lows of 3.4% before business shutdowns and curtailments prompted mass layoffs.

"At the first sign of weakening demand, a business is not going to send those people away," Lehner said.

• Consumer spending: It remains strong even as households spend down the savings they accumulated during the pandemic. McMullen conceded that was probably not true for low-income households living from paycheck to paycheck.

"There's still a bit of a cushion here. but it does not work evenly across the income spectrum," he said. "Most of this wealth and income comes from the upper end of the spectrum."

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(NOTE: Comments from state leaders will be posted separately)

Reserves could ease spending cuts

Record budget reserves could cushion state spending cuts if an economic downturn does happen.

Unlike in previous downturns, Oregon now has healthy amounts in its main reserve funds — one earmarked for education, the other for general purposes — plus the ending balance in the budget. According to the Legislative Revenue Office, the current total from all three sources is $5.9 billion, which will rise to a projected $6.2 billion by the end of the two-year budget cycle in mid-2023.

For education, the fund is projected at $700 million; for the general reserve, $1.3 billion, and the ending balance, $4.1 billion, part of which has to be carried over into the next budget cycle. The ending balance includes nearly $500 million that Oregon got in federal aid during the coronavirus pandemic and is intended to offset some of the other one-time federal funds spent in the current state budget. State government got an estimated $2.6 billion from the 2021 American Rescue Plan Act.

The Legislature can withdraw money from the reserve funds by 60% majority votes, though such action must be preceded by one of two economic triggers. State Economist Mark McMullen said one has already been met, because projected tax collections for the next two-year budget cycle are 10% less than approved spending for the current cycle. (The actual trigger is 3%.) The other trigger is reduced job growth in two consecutive quarters, a mark that has not been reached.

But lawmakers are limited as to how much they can take from reserves in a single budget cycle.

The Legislature did withdraw $400 million from the education stability fund in 2020 to balance the state budget in the immediate aftermath of the downturn triggered by the coronavirus pandemic.

The kicker for corporate income taxes was suspended twice, in 1993 and 2007. In the latter case, business interests agreed to forego the amount, which was converted into a general reserve now known as the rainy-day fund. (Voters in 2002 approved the conversion of an existing fund to create the education stability fund, which is fed by excess proceeds from the Oregon Lottery.)

The amounts are capped at 5% of previous general-fund spending for the education reserve and 7.5% for the general reserve.

Excess corporate income taxes now go into the state school fund, instead of going back to businesses, under a 2012 measure approved by voters. That amount is excluded from the base for the following two-year budget.

— Peter Wong