EXECUTIVE SUMMARY

EXECUTIVE SUMMARY December 2012 Oregon Economic Forecast Current Conditions As 2012 winds down, Oregon’s economic expansion persists, but remains stuck in a low gear.

Growth continues to come in fits and starts – a strong quarter or two followed by a weak quarter or two – with the underlying trend remaining slow and steady. Real GDP has averaged just over 2 percent growth since the expansion started, with the nation adding approximately 150,000 jobs per month so far in 2012. The slowdown seen in recent months can largely be attributed to the global manufacturing cycle beginning to wane. Future orders and current shipments have softened across a wide range of Oregon’s products.

The good news is that the housing recovery is here to help drive economic growth. Even so, housing-related production is just now beginning to improve from its recessionary lows, and has a long way to go before the level of production approaches anything considered a normal year for housing.

Although sales growth has slowed, profitability remains near record highs for many businesses.

For households, signs are both encouraging and worrisome. Job growth has been weak, with the unemployment rate coming down very slowly. Wage growth has been even softer from a historical perspective. Average wages are growing at a 1.5 percent rate among production and non-supervisory employees and just under 2.0 percent for all employees overall. In good years, like the late 1990s or even mid-2000s, wage growth reached 4 percent per year.

Given such weak growth, consumers – like the economy as a whole – remain vulnerable to shocks. Encouragingly, inflation remains in check for now, and households are becoming more confident about their future prospects. Consumer sentiment recently hit levels not seen since before the Great Recession suggesting that recent gains in spending may be sustainable going forward.

Outlook Expectations call for growth in the coming few months to look like the growth we have been experiencing: slow. Although the fundamentals underlying economic growth remain strong, uncertainty continues to weigh on both businesses and households. Given weakness among our leading trading partners, and an uncertain federal policy environment, many firms are reluctant to take the risk of expanding their operations despite ample resources and profits. Similarly,

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households remain reluctant to make large purchases until their future job prospects become more certain.

The international slowdown is a drag on the U.S. economy. Historically, however, the U.S. has not fallen into recession due to global weakness alone. Of course, with increased globalization among U.S. businesses, ties to growth in Europe and Asia are now stronger than ever before.

The uncertainty of federal policy is weighing on both business and consumer decisions, delaying their investments and therefore slowing growth. The so-called fiscal cliff has the potential to derail the expansion and send the economy back into recession. The combination of planned spending cuts and allowing tax rates to rise amounts to between 3 and 4 percent of GDP according to most estimates. While these impacts are unlikely to hit simultaneously and in full force precisely on January 1st, 2013, their impact will be significant for an economy growing at just a 2 percent rate.

Although the recent national elections did little to change the composition of federal policymakers, there is a renewed sense of optimism that a budget deficit deal can be reached in the coming months. Should a deal in fact be reached by the middle of next year, the underlying economic conditions are primed for some acceleration in growth.

As one example, emergency unemployment insurance benefits are scheduled to expire January 1st, and will impact consumer spending. In Oregon, the average unemployment check for individuals on the extension programs is currently about $300 per week. Should these benefits expire, estimates are that 26,000 Oregonians will lose these payments at the end of the year. This amounts to a loss of over $30 million in January alone. While the best way forward would certainly be to increase the number of jobs, a short term loss of this magnitude would be a step backward.

Beyond these near-term issues, the stage is set for stronger growth should the economy manage to successfully navigate the next few months. The primary reason for optimism is the strength of balance sheets for businesses and consumers alike. With financing costs low and corporate profits high, a great deal of spending and investment stands to be unleashed as soon as some of the uncertainty that is obscuring the near-term outlook is cleared away. Although household net worth is not back to pre-recession levels, it has been increasing strongly. Home prices are again rising, and stock markets have regained much of their recessionary losses. Delinquencies on consumer debt are down across the board (auto loans, student loans, credit cards, etc.). Even rates of mortgages 1 or 2 payments behind have fallen to historically low levels. Only payments for mortgages 90+ days past due remain stubbornly high. All told, many businesses and consumers now have the resources with which to drive growth, and are lacking only the courage to do so.

The baseline (most likely) employment forecast remains essentially unchanged. Slow growth will continue to be the norm. Oregon is not expected to recover all of the jobs it has lost until the end of 2014—seven years after the recession began.

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Summary of Recent Trends Getting a handle on the health of Oregon’s labor market is being somewhat complicated by technical issues within the underlying payroll jobs data. Technical issues aside, employment in Oregon continues to increase at a slow, subdued pace so far in 2012, approximately in line with the gains seen at the U.S. level. After a strong start to the year, with employment increasing nearly 3 percent on an annual basis in the first quarter, employment gains have slowed the past two quarters in Oregon.

The employment data discussed in this report is adjusted for two important technical purposes: seasonality and the upcoming benchmark revisions 1. Given the relative strength of employment as measured by data collected through the unemployment insurance program, it is clear that preliminary payroll job counts will be revised upward significantly when benchmark adjustments are made next year. Such preliminary revisions to the payroll survey data are regularly published in some states, and are currently a topic of discussion at the Oregon Employment Department.

After adjustments, the data reveals a state that continues to expand slowly, adding approximately 25,000 jobs in the past year (1.5% through 2012q3). Unadjusted data suggest Oregon has been closer to stagnating, adding only 17,800 jobs in the past year (1.1%).

Over the past year, job growth has been widespread across industries, with only information and financial service firms seeing small declines in the private sector. Public sector employment has continued to fall. However, the losses are lessening in recent months. The largest gains have been in professional and business services, leisure and hospitality, and retail trade which increased by approximately 7,800, 3,200, and 3,600 jobs respectively, from 2011q3 to 2012q3.

Health services and construction each added between 2,000 and 3,000 jobs over the past year.

These five main industry groups account for approximately 60 percent of all private sector gains, with manufacturing accounting for another 16 percent, or 4,400 jobs. Within manufacturing, gains were led by durable goods, particularly metals and machinery.

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Each year the Oregon Employment Department and the U.S. Bureau of Labor Statistics revise the employment data – a process known as benchmarking. The current establishment survey (CES), also known as the monthly payroll survey, is benchmarked against the quarterly census of employment and wages (QCEW), a series that contains all employees covered by unemployment insurance. The monthly CES is based on a sample of firms, whereas the QCEW contains approximately 96 percent of all employees, or nearly a complete count of employment in Oregon. The greatest benefit of the CES is the timeliness – monthly employment estimates are available with only a one month lag – and these estimates are reasonably accurate. However the further removed from the latest benchmark, the larger the errors. The QCEW is less timely as the data is released publically approximately 3-4 months following the end of the quarter. The greatest benefit of the QCEW is that is a near 100 percent count of statewide employment. For these reasons, the CES is usually used to discuss recent monthly employment trends, however once a year the data is revised to match the historical QCEW employment trends.

The last month of official benchmark data is June 2011. The QCEW is currently available through June 2012, thus the preliminary benchmark used here covers the July 2011 – June 2012 period.

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Demographic Forecast Oregon’s population count on April 1, 2010 was 3,831,074. Oregon gained 409,550 persons between the years 2000 and 2010. The population growth during the decade of 2000 to 2010 was 12.0 percent, down from 20.4 percent growth from the previous decade. Oregon’s rankings in terms of decennial growth rate dropped from 11th between 1990-2000 to 18th between 2000 and 2010. Slow population growth during the most recent decade due to double recessions probably cost Oregon one additional seat in the U.S. House of Representatives. Actually, Oregon’s decennial population growth rate during the most recent decade was the second lowest since 1900. The slowest, actually negative, was during the 1980s when Oregon was hit hard by another recession. As a result of recent economic downturn and sluggish recovery, Oregon’s population is expected to continue a slow pace of growth in the near future. Based on the current forecast, Oregon’s population will reach 4.25 million in the year 2020 with an annual rate of growth of 1.03 percent between 2010 and 2020.

Oregon’s economic condition heavily influences the state’s population growth. Its economy determines the ability to retain local work force as well as attract job seekers from national and international labor market. As Oregon’s total fertility rate remains below the replacement level and deaths continue to rise due to ageing population, long-term growth comes mainly from net in-migration. Working-age adults come to Oregon as long as we have favorable economic and employment environments. During the 1980s, which included a major recession and a net loss of population, net migration contributed to 22 percent of the population change. On the other extreme, net migration accounted for 73 percent of the population change during the booming economy of 1990s. This share of migration to population change declined to 56 percent in 2002 and it was further down to 32 percent in 2010. As a sign of slow to modest economic gain, the ratio of net migration-to-population change will increase gradually and will reach 72 percent by the end of the forecast horizon. Although economy and employment situation in Oregon look stagnant at this time, migration situation is not expected to replicate the early 1980s pattern of negative net migration. Potential Oregon out-migrants have no better place to go since other states are also in the same boat in terms of economy and employment.

Age structure and its change affect employment, state revenue, and expenditure. Demographics are the major budget drivers, which are modified by policy choices on service coverage and delivery. Growth in many age groups will show the effects of the baby-boom and their echo generations during the period of 2010-2020. It will also reflect demographics impacted by the depression era birth cohort combined with diminished migration of the working age population and elderly retirees. After a period of slow growth during the 1990s and early 2000s, the elderly population (65+) has picked up a faster pace of growth and will surge as the baby-boom generation continue to enter this age group. The average annual growth of the elderly population will be 3.9 percent during the forecast period as the boomers continue to enter retirement age.

However, the youngest elderly (aged 65-74) will grow at an extremely fast pace during the forecast period, averaging 4.9 percent annual rate of growth due to the direct impact of the baby9

boom generation entering the retirement age. Reversing several years of shrinking population, the elderly aged 75-84 will start a positive growth as the effect of depression era birth-cohort will dissipate. A faster pace of growth of population in this age group will begin once the baby-boom generation starts to mature. The oldest elderly (aged 85+) will continue to grow at a moderately but steady rate due to the combination of cohort change, continued positive net migration, and improving longevity. The average annual rate of growth for this oldest elderly over the forecast horizon will be 1.4 percent.

As the baby-boom generation matures out of oldest working-age cohort combined with slowing net migration, the once fast-paced growth of population aged 45-64 will gradually taper off to below zero percent rate of growth by 2012 and will remain at slow or below zero growth phase for several years. The size of this older working-age population will remain virtually unchanged at the beginning to the end of the decade. The 25-44 age group population is recovering from several years of declining and slow growing trend. The decline was mainly due to the exiting baby-boom cohort. This age group has seen positive growth starting in the year 2004 and will increase by 1.2 percent annual average rate during the forecast horizon. The young adult population (aged 18-24) will change only a little over the forecast period and remain virtually unchanged for most of the years into the future. Although the slow or stagnant growth of collegeage population (age 18-24), in general, tend to ease the pressure on public spending on higher education, college enrollment typically goes up during the time of high unemployment and scarcity of well-paying jobs when even the older people flock back to college to better position themselves in a tough job market. The growth in K-12 population (aged 5-17) will remain low which will translate into slow growth in school enrollments. This school-age population has actually declined in size in recent years and will grow in the future at well below the state average. The growth rate for children under the age of five will remain below zero percent in the near future and will see positive growth only after 2013. Although the number of children under the age of five will decline slightly in the near future, the demand for child care services and preKindergarten program will be additionally determined by the labor force participation and poverty rates of the parents. Overall, elderly population over age 65 will increase rapidly whereas population groups under age 65 will experience slow growth in the coming decade.

Hence, based solely on demographics of Oregon, demand for public services geared towards children and young adults will likely to increase at a slower pace, whereas demand for elderly care and services will increase rapidly.

Revenue Forecast The filing season for personal income taxpayers who requested extensions came and went this year without any major revenue surprises on either the upside or downside. With most tax returns now having been received, the slow-growth year that was expected has largely come to pass.

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Although growth in taxes collected out of wages and salaries will likely remain slow for several months, taxes on investment income are expected to post healthy gains in the near term. Should stock prices and other investments be able to hold their value through the end of December, Oregon can expect to see significant growth in tax payments when 2012 returns are filed in April. Not only have many investments been profitable this year, but many investors are being advised to cash in their gains for tax purposes before the end of the year in anticipation of possible tax increases at the federal level in 2013.

The outlook for the 2013-15 biennium calls for some modest improvement in revenue growth.

However, state revenue collections will still likely fail to keep pace with the growing cost of providing public services. Along with underlying economic conditions, tax revenue growth in Oregon is expected to fall in between what we have become accustomed to during past periods of economic expansion, and the slow gains we have seen in recent years.

The primary risk facing the near-term revenue forecast is the uncertain future of the nationwide economic expansion. Should federal government austerity or the slowdown in Europe and Asia derail the U.S. economy, Oregon tax collections will come in far below the forecast.

Revenue growth in Oregon and other states will face considerable downward pressure over the 10-year extended forecast horizon. As the baby boom population cohort works less and spends less, traditional state tax instruments such as personal income taxes and general sales taxes will become less effective, and revenue growth will fail to match the pace seen in the past.

2011-13 General Fund Revenue Growth in general fund revenues has been slow in recent months. Personal income taxes are growing due to a mix of both labor and investment income. However, gains from labor income slowed in the fall as the job market cooled off. Corporate excise taxes remain stable after dropping sharply early in the biennium.

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Table R.1 2011-13 General Fund Forecast Summary (Millions)

2011 COS September 2012 Forecast Forecast

Structural Revenues Personal Income Tax

$12,193.6

$11,956.6

$11,974.8

$18.2

-$218.7

Corporate Income Tax

$894.2

$842.6

$855.9

$13.3

-$38.4

All Other Revenues

$944.2

$1,121.8

$1,130.4

$8.6

$186.2

$14,032.0

$13,921.0

$13,961.1

$40.1

-$70.9

$0.0

-$2.3

-$12.0

-$9.7

-$12.0

-$23.1

-$4.4

-$4.4

$0.0

$18.7

$0.0

$0.0

$0.0

$0.0

$0.0

$14,008.9

$13,914.3

$13,944.7

$30.4

-$64.2

Gross GF Revenues Offsets and Transfers Administrative Actions1 Legislative Actions Net Available Resources Confidence Intervals 67% Confidence 95% Confidence

+/- 3.3% +/- 6.5%

December 2012 Forecast

$455.1 $910.3

Change from Change from Prior Forecast COS Forecast

$13.51B to $14.42B $13.05B to $14.87B

1 Reflects cost of cashflow management actions, ex clusiv e of internal borrow ing.

Collections of most major revenue types have closely matched expectations in recent months.

With the economic forecast tracking closely as well, the revenue outlook for the 2011-13 biennium remains largely unchanged from the September 2012 forecast. The forecast for General Fund revenues for 2011-13 is now $13,961 million. This represents an increase of $40 million (0.3%) from the September 2012 forecast.

The forecast for the 2011-13 biennium is now $71 million below the Close of Session forecast.

Given the strong employment gains seen in early 2011, the Close of Session forecast is more optimistic than other versions produced before or since. Nevertheless, a strong April 2013 of tax collections would put us back on track with the Close of Session’s relatively optimistic outlook.

In the unlikely event we see a revenue surge similar to what occurred at the peak of the technology and housing booms, the personal income tax kicker may yet come into play.

Personal Income Tax Personal income tax collections were $1,488 million for the first quarter of fiscal year 2013, $7.5 million (-0.5%) below the latest forecast. Compared to the year-ago level, total personal income tax collections grew by 2.5% relative to a forecast that called for 3.1% growth. More recently, personal income tax collections have come in higher than forecast during the current quarter, bringing them back in line with the September outlook.

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Personal income tax collections are expected to remain weak until the April 2013 filing season when the gains seen in stock markets this year are realized for tax purposes. Further taxable capital gains realizations will be generated by taxpayers attempting to move their assets ahead of potential federal tax increases in 2013.

Corporate Excise Tax Corporate excise tax collections equaled $113.5 million for the first quarter of fiscal year 2013, $13.2 million above the September forecast. Compared to one year ago, net corporate receipts were up 8.2% with the forecast calling for an 4.4% decline.

Corporate tax collections are expected to continue to decline throughout fiscal year 2013, as they remain very large from an historical perspective. Very strong growth is expected during the 2013-15 biennium, since corporate tax collections are prone to boom-bust cycles. However, growth rates, while large, will remain less than half of what has been seen during recent profit booms.

Other Sources of Revenue All other General Fund revenues are expected to total $1,130.4 million for the 2011-13 biennium, an increase of $8.6 million (0.8%) relative to the September forecast. Most revenue sources are tracking ahead of the previous forecast, including large contributions from estate taxes, judicial-related revenues and liquor apportionment. Tobacco taxes have been lowered slightly to match recent collections.

Extended General Fund Revenue Outlook Table R.2 exhibits the long-run forecast for General Fund revenues through the 2019-21 biennium. Users should note that the potential for error in the forecast increases substantially the further ahead we look.

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Table R.2 General Fund Revenue Forecast Summary (Millions of Dollars, Current Law) Forecast Revenue Source Personal Income Taxes Corporate Income Taxes All Others Gross General Fund Offsets and Transfers Net Revenue

Forecast

2009-11

%

Biennium

Chg

10,467.2

2011-13

Forecast %

Biennium Chg

3.7% 11,974.8 20.9%

855.9

3.4%

1,226.6

29.8%

1,130.4

-7.8%

12,521.4 12,521.4

%

Biennium

Chg

14.4% 13,506.8

827.6

Forecast

2013-15

1,052.9

2015-17

Forecast %

2017-19

Forecast %

2019-21

%

Biennium Chg Biennium Chg Biennium Chg

12.8% 15,134.8 12.1% 16,642.5 10.0% 18,406.9

10.6%

23.0%

1,071.1

1.7%

1,036.0 -3.3%

1,050.3

1.4%

957.4 -15.3%

1,015.7

6.1%

1,083.2

1,167.4

7.8%

8.9% 20,624.6

9.9%

6.8% 13,961.1

11.5% 15,517.1

(12.0)

(105.0)

-2.2% 13,949.1

11.4% 15,412.0

11.1% 17,221.6 11.0% 18,761.6 (120.9)

6.6%

(128.8)

(136.9)

10.5% 17,100.6 11.0% 18,632.8

9.0% 20,487.7

10.0%

Other tax es include General Fund portions of the Eastern Oregon Sev erance Tax , Western Oregon Sev erance Tax and Amusement Dev ice Tax .

Commercial Fish Licenses & Fees and Pari-mutual Receipts are included in Other Rev enues

General Fund revenues will total $15,517 million in 2013-15, an increase of 11.1% percent from the prior period, and $62 million (0.4%) above the September forecast. In 2015-17, revenue growth is expected to remain stable at 11.0%, followed by slower rates of 9% to 10% in subsequent biennia. The slowdown in long-run revenue growth is largely due to the impact of demographic changes.

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