Speaking of State Credit Ratings & Income Tax Cuts . . . Part One

Please note that this important subject will be discussed here in several articles over the next few days.

As the House begins debating ways to increase revenue to fix our roads and whether our workers deserve an income tax reduction to offset those tax increases, a point will be made by those who oppose tax cuts that any meaningful reduction in our individual income tax rates will put our state’s credit rating at risk. Their point implies a recklessness on the part of those House members who advocate tax relief for South Carolina workers. This implication deserves further scrutiny.

South Carolina receives credit ratings from three organizations: Standard & Poor’s (S&P), Fitch, and Moody’s. Fitch and Moody’s has long rated our credit worthiness at AAA and Aaa, respectively. Our relationship with S&P has been more volatile. Historically, we enjoyed a AAA rating with them. After Hugo hit in 1989 they lowered our rating to AA+. We returned to AAA status in 1996. In 2005, they again lowered our rating to AA+ where it has remained.

Current income tax relief opponents claim that the 2005 ratings drop was primarily caused by the “Sanford Tax Cut” as they term it. That bill (sponsored by then Speaker David Wilkins and co-sponsored by many who oppose tax relief now) was similar to the relief being promoted by Gov. Haley in her current road funding bill which has been co-sponsored by 44 Republicans. The 2005 legislation passed the Republican controlled House but died in the Senate.

Gov. Haley’s opponents are employing some type of biased revisionism when they blame Gov. Sanford for our downgrade. If we review news reports from that time, our Democrat Treasurer Grady Patterson offered a different reason. After negotiating at length with S&P to maintain our AAA status, he said “the issue boils down to jobs, jobs, jobs”  – an issue that Gov. Haley has made the central theme of her time as Governor. Please see this  AP report from 2005 for more detail.

Our credit rating is a very important issue and we thank those who oppose income tax relief for bringing this to our attention. It raises several important questions:

How did a tax cut that did not actually become law lower our S&P credit rating to AA+?

Why have we been unable in the last decade to reclaim our AAA?

What methodology does S&P use to determine a state’s credit rating?

When did S&P last issue a report for South Carolina and what does it say?

The last question presents us with an excellent place to start. The latest S&P report was issued in 2014. It may be viewed at S&P SC Credit Rating 2014.

This 11 page document offers an independent analysis of our fiscal health. Though some will find the entire document fascinating, most will appreciate the following salient excerpts:

Page 1 – Rationale

S&P base their continued AA+ rating and stable outlook on our:

  • Growing economy, although growth has been historically cyclical in nature;
  • Positive revenue trends and financial operations;
  • Proactive budget adjustments to offset declining revenues in previous years
  • Maintenance of required budgetary reserves; and
  • Low to moderate debt levels.

The aforementioned strengths are partly offset by our view of South Carolina’s large unfunded pension and other post employment benefit (OPEB) liabilities.

Their rationale does not specifically mention tax policy but does note our positive revenue trends. It also counts our ability to proactively cut spending as a strength along with our low debt levels. Our unfunded pension liability continues to count against us.

Given their comments, a $500 billion bond offering might have proved more damaging to our credit rating than an income tax reduction. Also, anyone concerned about our credit rating should note that the Legislature’s pension “fix” passed a couple of years ago apparently did not impress.

Page 3 – Outlook

The stable outlook reflects what we consider South Carolina’s proactive management, contributing to improved financial performance in recent years. The outlook also reflects economic recovery after the recession, with an improved unemployment rate and state employment growth exceeding the national average. We believe South Carolina’s revenue performance has exceeded projections, and that its conservative revenue estimates will allow it to maintain or improve balances. We also view the state’s adopted long-term financial planning and forecasting strategies and moderate debt levels positively. We do not expect to change the ratings within the two-year outlook horizon.

Their outlook reads like an endorsement of our ability to recruit new employers – an ability that relies upon the cooperation of our Governor and Legislature. It also suggests that a meaningful income tax reduction could be achieved with that same cooperation. They also mention keeping our debt low again.

Page 7 – Budgetary Performance

In our view, South Carolina has constantly had well-defined financial management policies and a commitment to reserves despite budget challenges. In periods of economic decline, a focus on addressing budget imbalances include structural solutions, primarily from across-the-board budget cuts. There is a formal reserve set at 5% (up from 3%) that must be replenished within three years of being drawn upon. There is also a 2% capital reserve that is funded each year and can only be used for capital or to lower debt for the following year if it is not needed to cover any operating deficits. The state’s general and capital reserve funds are currently fully funded at the required amounts.

The paragraph continues on to describe the process of reducing spending should revenues fall.

The Legislature acted prudently to raise and fully fund our reserve accounts. That should always be the case before any tax cuts are considered.

Page 8 – Audited Fiscal 2013

On a generally accepted accounting principles basis, the state closed fiscal 2013 with $9.9 billion in revenues and $8.8 billion in expenditures. The state posted a $1 billion surplus before transfers and other sources and uses. After accounting for transfers and other sources and uses, the surplus is $915 million. The general fund closed fiscal 2013 with a $2.8 billion total general fund balance, up from $1.89 billion in fiscal 2012. The assigned general fund balance was recorded at $997 million, up from $495 million in fiscal 2012. The unassigned balance totaled $792 million, or 9% of expenditures, down from $945 million in fiscal 2012. Combined assigned and unassigned balances rose to 20% of expenditures, up from 17% in the previous year. In our view, general fund liquidity is good, with $3 billion in cash and cash equivalents as of fiscal year end 2013.

In other words, we seem to have a lot of cash on hand. That audited fact speaks for itself.

If nothing else, this report shows that House members looking for a meaningful income tax reduction to go with our roads revenue increase are not being reckless. Instead, we are forcing a prudent discussion about our revenue policy and this report suggests that meaningful income tax relief is long overdue.

Blue Ridge Roundabout Update

Many in the Blue Ridge community are concerned about the necessity and functionality of a proposed roundabout to be built at the junction of Highway 101 and North McElhaney Road. It would rest directly in front of Lake Cunningham Fire Department.

The $1 million project, paid for by the federal government and constructed by SCDOT, has been presented as a safety project to reduce the number of accidents at the junction even though we thought this was addressed when it was upgraded with traffic signals.

Several elected officials including Tom Corbin, Joe Dill and myself have met with SCDOT to express our concerns both about the proximity to the fire station and the necessity when compared with more urgent road needs on Highway 101.

At this point, SCDOT has promised a public hearing so that the community can ask questions and voice concerns.

One I receive the meeting date and time, I will let you know.

 

The Bond Defeat – Turning Bad Government Good

The South Carolina House voted last night to remove the $500 million bond section from the state appropriation act, also known as the state budget bill.

Though the vote delayed some needed capital improvement projects, the hard discussions within the House Republican Caucus about transparency, policy and procedure in our budgeting process were necessary . . . and long overdue.

State law defines certain duties for the Joint Bond Review Committee (JBRC) regarding the issuance of bonds. Duties include processing bonding requests from state agencies, gathering data determining need, maintaining priority lists and issuing an annual report to the General Assembly containing this information. Duties are even more refined for the Commission on Higher Education for the oversight of bond requests from colleges and also require disclosure.

As to be expected, this section of state law contains a caveat that allows the General Assembly to ignore these priority reports and determine bond needs as it sees fit. However, the caveat does not suspend the duties of the JBRC and CHE to annually report their findings. They should be required to follow state law – the rest of us have to.

When asked if the annual reports of JBRC and CHE were reviewed before the bond projects were inserted in the state budget bill, we learned that these duties were not being followed by either entity and that any such reports, if they exist at all, would be inaccurate. No priority lists of any kind were ever made available to House members.

We were just expected to vote yes to issue $500 million of government debt based on a list of projects created behind closed doors by a small group of legislators who waited until the last-minute to announce its existence.

Plainly put, this is bad government.

Thankfully, a group of House members stood firm this week and demanded that the citizenry deserves better.

 

The Bond Issue – More Barry than James

Part 3 of the current appropriations bill that the House is debating this week contains almost $500 million in capital improvement bonding projects.

A few random observations:

Bonds are debt. They aren’t appropriations of revenue as normally understood.

Bonds, though they are instruments that allow people to loan money to the state for interest, do incur issuance costs – much like closing costs when you mortgage your house. None of the issuance costs or parties involved have been disclosed.

None of the project details have been disclosed.

The current budget contains recurring revenue that was dedicated to the payment off old bonds that are now being paid off.

Between now and 2030, the accumulated recurring revenue from these paid off bonds will reach almost $2 billion.

The bond projects listed in Part 3 of the budget were compiled by a small group of legislators. The list had no input from the larger body of members.

No one has produced the overall priority list where these projects were drawn from – if such a list exists.

Questions:

Though interest rates are low, should we issue debt this particular year when we have much more pressing problems to address – like that road crisis thing?

Should not we know more about how the bond project list was created or what projects were not included before we send something of a blank check over to the Senate?

Or should we not just take advantage of the freed up recurring revenue from old bond payments and direct that toward DOT’s approved 6-year rolling priority project list – like the safety program or the bridge program?

Just imagine – we could use the money on those pesky safety projects that endanger peoples lives.

At least we would know what the money was spent on.

Killing Tillman – Part Three: Our State Budget

Note: This is the last installment in a series of short articles about Ben Tillman’s imprint on South Carolina.

The South Carolina House will debate Tillman’s legacy this week. No, the debate will not be about renaming Tillman Hall at Clemson University. Instead, we will debate the state budget and we will stumble over Tillman every time we consider a revenue transfer to local government, a proviso for a special purpose district or consider $500 million worth of capital improvement bonds for local projects.

Most people today remember Tillman as a rabid segregationist and for good reason. After leaving the Governor’s mansion for the US Senate, Tillman pushed for a constitutional convention in 1895 to reshape South Carolina’s government into one deliberately removed from the people.

The resulting constitution codified a miserable and life threatening existence for our black citizens. An existence that forced many to flee North and left those remaining at the bottom of a very narrow class system. His artificial and petty control of life’s daily interactions between white and black South Carolinians suppressed the remaining vestiges of manners left over from the ante-bellum days. Though much altered, his constitution remains in effect to this day.

Beyond controlling the daily activities of black citizens, Tillman’s constitution was designed to defeat any populist uprising by ordinary South Carolinians, regardless of color. He established these barriers by drastically weakening the authority of our counties and our Governor.

The General Assembly, not the people, became the authority to control the trickle of power and money down to local government. Tillman limited the power of counties to tax and narrowly defined what services they could provide. His limitations led to the existence of special purpose districts, controlled by the state, that tax and spend on their own. These special purpose districts add another layer of illogical complexity to local government.

Tillman’s constitution also limited the power of the Governor by requiring each of the Governor’s cabinet members to be elected separately. A new Governor could be given a mandate to change the direction of the state through a landslide victory, but this mandate might not extend to the other cabinet members. Even in recent memory, we have seen a Governor and Superintendent of Education elected at the same time from different political parties.

Seventy-five years passed before the Civil Rights Act of 1964 overturned the segregation laws enabled by Tillman’s constitution. During those 75 years, blood was shed and lives were lost to bring about those changes. Over 50 years have passed since codified segregation ended and we are still paying the price for Tillman’s prejudices. We should have tossed out his constitution years ago, yet we continue on with his system of government whose core remains an all-powerful General Assembly whose leaders remain even further removed from the majority of the citizenry.

South Carolina competes in a 21st century global economy with a 19th century state government structure chained to our ankles. Last year we elected our Governor to a second term with 56% of the vote. She received a clear mandate to continue her pro-economic growth policies, including improving our roads, yet has no power other than her veto to deliver her vision of South Carolina.

Just this past week, the SC House passed a compromise bill adjusting the formulas used in the Local Government Fund to redistribute local revenue to local governments. These formulas were last adjusted 24 years ago. The current adjustment was required because the formulas left a deficit owed to local government each year that state government refused to pay. In effect, the compromise bill put into law that the state really does not owe the counties or municipalities the accumulated funds that have not been paid. Or so we think.

Last week The Greenville News reported that Act 388 has accumulated an $866 million shortfall since 2007. It was a tax swap that raised sales tax revenue and lowered property tax revenue used to support local school districts. Unlike the local government fund, the state has been dutifully paying this bailout to the school districts each year. Yet again, a formula miscalculation has resulted in an almost billion dollar opportunity cost.

Both of these miscalculations trace their ancestry to Tillman’s belief that local government cannot be trusted – or more to the point – our citizens cannot be trusted to elect effective local officials. Maybe South Carolina should issue a special dollar to be used in these bailouts. It could have Tillman’s picture on the front and a shackled citizenry on the back.

As the House debates the budget this week, take a good look at the process. Think about how few members of the General Assembly actually control the amounts that we debate then dole out. Consider the blinding speed in which the $500 million bonding portion of the budget was revealed and debated in committee. Ask yourself what projects were left off.

Think on these things if you are tired of the inertia, backwardness and lack of problem solving ability that we find today in the General Assembly. The inertia exists by design. That design may have been just the thing to suppress our citizenry in 1900, but it drastically hurts opportunity for all of us in 2015.

Tommy Stringer