Inflation and the Budget

by Dick Hall-Sizemore

In addition to conventional budget requests, the Youngkin administration is likely to receive requests from agencies in the fall budget development exercise for additional funding to enable them to cover additional costs resulting from higher inflation. (Yes, I realize that the 2022-2024 biennial budget has not even been agreed upon yet, but, once one round is out of the way, budget folks are always getting ready for the next round.)

With some exceptions, inflation is not normally built into budget bills. Budget development for a biennial budget starts with a base budget, which is the appropriation for the second year of the most recent biennium. Adjustments are made to the base, but rarely are those adjustments for inflation. As for the mid-biennium budget, agencies normally are not provided additional appropriations to cover inflationary costs.

The reason is simple, although not apparent to people unfamiliar with budget development. For many years, the administration and the legislature have followed a policy of “fully funding” agencies’ approved employment levels. That is, an agency’s appropriation is built upon the assumption that every approved position in the agency will be filled every day of the fiscal year. In reality, however, there is “turnover and vacancy” in each agency. Employees retire, change jobs, leave state employment, and, unfortunately, some die in office. As long as a position stays vacant, the appropriations for salary and fringe benefits for that position are not needed to pay for it. Furthermore, the replacement hired to fill the position is likely to be paid less than the previous holder of the position. All Department of Planning and Budget (DPB) analysts and money committee analysts are well aware that each agency will realize turnover and vacancy savings during a fiscal year. They reason that the agency can use these savings to cover increases in expenses resulting from inflation. In the vernacular, an agency can “eat” these increases in costs.

For some agencies, however, ordinary turnover and vacancy savings may not be enough to cover the cumulative effects of expense increases due to inflation. In such cases, the agencies may have to force additional turnover and vacancy savings by holding vacant positions open longer than normally would be the case.

The Department of Corrections (DOC) for many years requested large additional annual appropriations to cover funding shortfalls it had identified. For the 2016-2018 biennial budget, this projected annual shortfall amounted to approximately $32 million. Of that amount, DOC attributed $11 million, about one-third, to increases in electrical service charges, fuel costs, and building rentals. In its justification for its request, DOC said, “Increases in utilities, gasoline and P&P [probation and parole district office] lease costs must be paid. The Department has no other course of action but increase its vacancy rate for secure and nonsecure staff which could lead to a negative public safety impact.”

Likewise, the Department of State Police has reported that it has had to keep trooper positions vacant in order to generate enough savings to cover the rising cost of fuel. As described below, the administration and the General Assembly have taken steps to address inflation increases in both these agencies.


There are some exceptions to the general policy of not accounting for inflation in the budget.

Labor. One of the big factors in inflation is the cost of labor  (However, some economists will argue that it is inflation driving up labor costs, rather than the other way around.) The Commonwealth does provide agencies the funding to cover the costs of employee salary increases. Therefore, providing state employees with general raises in the pay scale drives up appropriations. However, as always, there is an exception. The employees of agencies funded with nongeneral funds (NGF), such as the Department of Motor Vehicles, are state employees and are covered by any general pay raise for state employees, but the agencies do not get general fund (GF) infusions to cover the costs of the increase in their employees’ salaries. Those agencies are expected to cover the additional costs out of their NGF revenue stream. If that stream does not increase sufficiently to cover the costs, the agency will need to reduce its other expenditures or increase its NGF revenue.

This was the situation that the Department of Wildlife Resources (formerly called Game and Inland Fisheries [DGIF]) found itself in several years ago.  In 1998, a special committee studying the finances of the agency reported that its traditional source of NGF revenue (hunting and fishing licenses) was insufficient to finance the agency’s activities. Accordingly, the tax code was amended to allot to DGIF the revenue derived from two percent of the sales tax levied on the sale of hunting and fishing equipment.

The same situation holds true for agencies that have both GF and NGF-supported employees or some that are split-funded, that is, partially supported by funds from both sources. The agencies will get an additional general fund appropriation (and cash) for their GF employees, but not for their NGF employees.

Rent. Some agencies are second-class citizens when it comes to rent increases.  The Department of General Services (DGS) is the “landlord” for agencies housed in downtown Richmond around Capitol Square. The Commonwealth owns most of the buildings and DGS pays their operating costs — electricity, water and sewer, janitorial services, repairs, etc. Rather than give DGS a big bag of money to cover these expenses, the state requires each agency to pay its proportional share of the costs via “rent” payments to DGS. Occasionally, DGS is authorized to adjust its rents based on costs. And, whenever that occurs, the agencies affected are provided an appropriation to cover these increased rent payments. For example, in the budget bill submitted for the 2014-2016 biennium, the Governor included a recommendation of $34,176 for DPB to cover “changes in the cost of rent charges at the seat of government. Overall rent rate changes are the result of additional costs to maintain facilities.” These types of adjustments are automatically included in the budget bill, without the agencies having to request them.

On the other hand, some agencies, such as the Department of Corrections (DOC), have operations in various parts of the state that are housed in leased private space. These agencies also face periodic rent increases, but they do not automatically get additional appropriations to cover these increased costs. Occasionally, the increases will have accumulated to such an extent that the agency can persuade DPB and the Governor’s office to include additional appropriation in the budget bill for these added costs. Such was the case in the 2014-2016 budget bill, in which an additional $800,000 per year was recommended for DOC “for a portion of the increase over the last ten years in the costs of leasing office space for probation and parole offices.”

Gasoline. The rising price of gasoline is probably the most prominent and talked-about element of inflation currently. Of all GF agencies, the Department of State Police (DSP) is the biggest user of gasoline. DOC is the second largest user. During previous periods of rising gas prices, both agencies have received additional appropriations to cover their rising fuel costs.

For the 2014-2016 budget bill, DSP requested an additional $2.9 million for increased fuel costs. The Governor’s budget included $1.6 million. For the 2016-2018 biennium, the General Assembly provided DOC $3 million in the second year to cover basic operating costs. That amount was essentially equal to the shortfall in fuel costs that DOC had identified

The Governor can expect requests this fall from both agencies, and perhaps others, for additional appropriations to cover their fuel costs. Expenditures for gasoline for all GF agencies over the past six years peaked in FY 2019, then declined in FY 2020 and FY 2021, as gas prices, as well as travel, declined during the pandemic. However, costs have increased in the current fiscal year, due to agencies returning to more normal operations and gas prices increasing significantly. In the five fiscal years prior to the current one, total GF expenditures for gasoline peaked in FY 2019 at $11.7 million. In the current fiscal year, agencies have spent to date $11.8 million in GF expenditures for gasoline, with five weeks of the fiscal year to go. DSP has already spent a little over $900,00 more for gas than it did in all of FY 2019.

Medical costs. Costs for medical services have long been notorious for increasing at rates higher than the overall inflation rate. Three state agencies have significant medical services costs and projected inflation is built into the appropriations for two of those agencies.

The Department of Medical Assistance Services (DMAS) administers the Commonwealth’s Medicaid program and is obviously highly vulnerable to cost increases. For the 2022-2024 biennium, the introduced budget provided an increase of $291.3 million in the first year for “Medicaid utilization and inflation.” The additional amount for the second year, $529.9 million, was almost double the increase provided for the first year. The detailed work papers are not available; therefore, it is not possible to determine the proportion of these increases attributable to inflation. However, it is clear that inflation is built into the recommendations

The provision of medical services to inmates accounts for approximately 18% of DOC’s $1.4 billion annual GF budget. (It amounts to approximately $258 million annually.) DOC generally requests annual increases in its appropriations for inmate medical services. As with DMAS and Medicaid, the increases result from changes in utilization and increased costs. In the work papers for its 2022-2024 biennium request, DOC set out several Consumer Price Index (CPI) rates that were included in the calculations. They ranged from a negative 4.5% for medical equipment and supplies to 3.4% for inpatient hospital services. Surprisingly, the CPI factor for prescription drugs was negative 2.7%.  It should be noted that the indexes are not projections. Rather, they reflect recent history, being for the period of August 2020-August 2021. To the extent that the cost increases in FY 2022 exceed the adjustment factors used, DOC will likely be asking for additional appropriations in its mid-biennium request.

The Department of Behavioral Health and Developmental Services also incurs expenses for providing medical services to its patients. However, the agency has not, in the introduced budget, requested additional appropriation to cover any anticipated increase in these costs.

Capital Outlay. The area of the budget that will be affected the most by inflation is undoubtedly capital outlay. In fact, significant appropriation increases to cover inflation have already been proposed.

Because there is typically a time lag of two years or more between the initial development of a capital project for consideration by the Governor and the General Assembly and the beginning of construction if it is approved, capital outlay is another area of the budget in which projected inflation is built into the budget figures. Last fall, the Department of General Services (DGS) built an annual escalation factor of 4.5% into the forms it provided agencies to use in estimating the costs of their proposed projects. In previous years, it has been a smaller amount.

The execution of approved capital projects is a complex process. In simple terms, most GF-funded projects are placed in a “pool” for which there is an appropriation to cover the total estimated cost.(Estimated costs for individual projects in a pool are not identified in the budget bill.) At several points in the process of planning a project, DGS architects and engineers review the project documents and project the cost. DPB tracks these updated approved costs and is in a position to determine if the pool appropriation will be sufficient, and, if not, how much more appropriation will be needed. When it becomes apparent that there will not be enough appropriation in a pool, DPB recommends that the Governor include a request for additional pool funding in the next budget bill submitted to the General Assembly.

The capital projects approved by the General Assembly in recent years were reaching the point of being ready to go to bid in FY 2022 and early FY 2023, when the supply-chain shortages resulting from COVID shutdowns were playing havoc with construction costs. Many projects exceeded their original or even revised estimates and the Governor included requests for additional GF funding for pools, totaling $100 million.

In addition to recommending supplemental funding for existing pools in his introduced budget bills, then-Governor Northam included a special capital “project” in Central Accounts to address “material cost volatility.” The recommended GF appropriation for the project is $100 million. This “project” would essentially be a holding account from which DPB would be authorized to transfer appropriation to a project whose lowest bid exceeded the approved cost amount. Any transfer would be based on the producer price index’s special index for construction materials published by the Federal Reserve Bank of St. Louis in its Federal Reserve Economic Data online database using data from the U.S. Department of Labor’s Bureau of Labor Statistics.  (See Item C-69.50 of HB 29.)


Inflation affects state agencies, just as it does private businesses and households. To cover increases in ordinary operating costs, whether for printer paper and toner, other office supplies, rent, gas, electricity, tools, or equipment, agency budget directors will need to monitor expenditures more closely than usual and keep agency directors apprised of the levels of spending. Agency directors and managers may have to decide to curtail some activities or keep some vacant positions open longer than they would like.

One example illustrates the practical effect of inflation. The correctional facilities operated by DOC are in constant need of new equipment to replace equipment that has worn out or is in constant danger of breaking down. The DOC central budget office allocates money for new equipment to the three regional directors who, in turn, parcel it out among the institutions within their regions, based on priority need. The amount of funding that the central budget office will have in the next fiscal year for equipment replacement will be dependent on other needs in the agency. However, even if the amount is the same as it has been in recent years, inflationary price increases will mean that fewer old pieces of equipment will be replaced next year.

For some agencies, such as DOC, State Police, or the Department of Behavioral Health and Developmental Services, keeping vacancies unfilled longer may have a detrimental effect on public safety or patient well-being. In those cases, the Governor may have to decide whether to request additional appropriation from the General Assembly. Finally, all involved will need to keep in mind that any additional appropriation will not be available until after the 2023 Session and reconvened session of the General Assembly. That means that agencies will not be certain of receiving any additional appropriation until late February and the funding itself would not be actually available until sometime in April 2023.

Hat tip to James Sherlock for suggesting the topic for this article.