Sunday, August 30, 2015

Record Borrowing Indicates Financial Instability

By Duane Goossen

What does the State of Kansas do when bills must be paid but the bank account is empty? Answer: Borrow. Get a payday loan and promise to repay when more revenue comes in.

On July 1, the first day of fiscal year 2016, Kansas took out a payday loan of $840 million. This record-high amount highlights the precariousness of the state’s financial situation.

During July, the state needed to pay out hundreds of millions to schools, Medicaid providers, universities, and state employees. (On average the state spends about $600 million per month from the general fund.) Yet Kansas only expected to receive a portion of the amount needed from tax revenue in July. In addition, the bank account (cash reserves) had been depleted to almost nothing as a result of unaffordable income tax cuts, so Kansas had no way to pay its bills in a timely manner without borrowing.

In Kansas, the payday loan has a fancy name—Certificate of Indebtedness. The Certificate allows the general fund to temporarily use money from other funds within state government. Bills must be paid from those other funds too, but the timing of the payments varies enough that when the cash from the other funds is pooled, enough is available to allow the general fund to temporarily use or borrow it.

This practice is not new. On the positive side, a Certificate allows the general fund enough cash flow to pay bills on time, but the FY 2016 amount is unprecedented. The more difficult the state’s financial position, the larger the Certificate. Previously the highest amount borrowed came during the Great Recession in FY 2009 when almost all states were experiencing significant financial stress. After that, the Certificate amount gradually decreased as the state started to recover financially. However, in FY 2013 the income tax cuts which have wreaked havoc on the state budget began to kick in, leading to a $675 million Certificate in FY 2015, and then the record $840 million in FY 2016.

That means that at the lowest cash flow point of the fiscal year, likely sometime in March, the state’s general fund bills will total $840 million more than the revenue received up to that point to cover them. The general fund must repay the Certificate before the end of the fiscal year using revenues from April, May, and June that are hopefully much greater than the bills that need to be paid in those months.

If Kansas were financially stable, it would have a large enough cash balance to avoid borrowing.

What if April/May/June revenue does not come in as estimated? The Certificate still needs to be repaid, so in that scenario, program cuts would have to be applied to keep the general fund solvent.

In FY 2016 Kansas expects total general fund revenue of $6.334 billion, which includes about $200 million in unusual one-time transfers from other funds, mostly the highway fund. Lawmakers approved spending of $6.322 billion, an amount that does not adequately cover schools and many other programs, but does barely fit within available revenue. (To cover cash flow issues within the fiscal year, the state borrowed and will have to repay $840 million.)

Everything must go perfectly in order to slide by with even this meager budget. But things usually don’t go perfectly. Unexpected costs appear, or revenue underperforms expectations. Recessions come as part of the business cycle. Kansas is not ready.

Kansas has little flexibility, and is operating on the financial margins. Lawmakers cut the state revenue stream too deeply and used up cash reserves to eke through the last two fiscal years.

This entry originally appeared on the Kansas Center for Economic Growth website.

Friday, August 21, 2015

Kansas Is Scraping By

By Duane Goossen

Three recent events provide further evidence that Kansas is just scraping by financially. July general fund revenue was below expectations, the governor cut $63 million out of the current budget, and the state’s pension bonds received a low rating.

July revenue fell $4 million below expectations. While $4 million does not represent a huge drop, the July loss is part of a long string of disappointing monthly revenue reports, and a trend that will likely continue. Individual income tax receipts tell the story. Dramatic income tax policy changes began to take effect in 2013, causing a sharp revenue decline, and now income tax receipts are staying down at that low level. Lawmakers raised the sales tax to try to make up for the diminished income tax stream. However, they have also depended heavily on transfers from the highway fund and other funds, leaving a structural budget imbalance in which ongoing expenses are still much higher than ongoing revenue.

The expenditure cuts announced by the governor were part of the final FY 2016 (July 1, 2015 to June 30, 2016) budget deal passed by the Legislature in June. To keep the general fund solvent, at least another $50 million had to be cut from the already conservative FY 2016 budget. The governor’s cuts transferred more money from the highway fund, and grabbed federal money that could have been used for children’s health programs. For the most part, the cuts were one-time transactions to save some general fund money in the current fiscal year but do not alter the longer-term imbalance between revenue and expenditures.

Kansas is preparing to sell $1 billion in bonds to shore up the state’s retirement system. Last year, Moody’s Investor Service lowered the state’s bond rating to Aa2 because of the expanding budget imbalance caused by falling revenue. This new pension bond issue has been rated one-notch lower at Aa3, and the rating analysis clearly outlines Kansas’ financial problems:

“The below-average rating also recognizes the structural imbalance in the state's budget and reliance on interfund borrowing, as well as an underfunded pension plan to which the state is not making actuarially determined contributions.”

In the 2015 record-long legislative session, lawmakers faced a budget crisis with general fund expenditures almost $800 million above revenue. They raised sales and cigarette taxes and dropped spending to a low level. That averted a full-blown financial disaster, but did not solve the state’s financial problems or put Kansas on a stable, forward-looking fiscal path. Rather Kansas has been left to live month-by-month scraping by with few reserves, a cramped budget, and little hope that the situation can improve in the future.

The root of Kansas’ financial problems is an unfair and unsustainable income tax policy that has garnered too few resources to adequately cover expenses. Lawmakers must reconsider that policy to get Kansas back to financial health.

This entry originally appeared on the Kansas Center for Economic Growth website.

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