THE      PARCA REPORT

A Publication of the Public Affairs Research Council of Alabama / Number 43 / Spring 2002

 

SHOULD THE ALABAMA TRUST FUND BE SPENT

FOR SHORT-TERM BUDGET RELIEF?

Large-scale production of natural gas and oil from Alabama’s offshore waters began in the 1980s. Since that time, sales of drilling rights and royalties from oil and gas production have created over $2.1 billion in state revenues. These revenues will not continue to grow forever – some experts predict the oil and gas may be depleted within the next 20 years. As a result, this large windfall has been placed in a constitutional trust named the Alabama Trust Fund (ATF), with restrictions that aim to preserve it for the continuing benefit of the state and its people. 

Proposed Amendment No. 1 on the June 4, 2002 primary ballot would take more than 12% of this money and use it as a “rainy day” account for the education budget, to fill in the gap when actual revenues fall short of official estimates. A similar proposal for a General Fund rainy day account will be on the November ballot, and it would take another 3% of the ATF. Together, these proposals would set aside $325 million or 15% of the ATF in two rainy day accounts to be spent as early as the current fiscal year, if revenues fall short of expectations.

Voters should consider three questions in deciding whether to approve this proposal.

1.  HOW WOULD THE MONEY BE REPAID?

Repayment of the ATF in future years would be uncertain. The proposal requires repayment within 5 years but does not set aside any money for that purpose. In 2001, the Legislature passed and the Governor signed an act to repay the ATF from sales and use taxes on items bought over the internet or by phone or mail order – if Congress removes federal restrictions on collecting such taxes. However, an act signed into law in 2002 has different earmarking.[1] Thus it is not clear whether money has been set aside or whether it will be collected. Nor is there a require-ment to pay interest, which means the ATF would lose money it could have earned. The biggest loser would be the state’s General Fund, which depends on ATF income as one of its largest revenue sources. Agencies affected would include prisons, mental health, medical assistance, state police, and courts.

Most states have a rainy day account.[2] A common way to create one is by transferring money from year-end balances. The ATF is a good foundation for Alabama’s rainy day accounts, because there is a large fund already available to draw on in a downturn; but the terms of the account should guarantee repayment from real revenues, within a reasonable time, and in full, so that the ATF does not lose money.

South Carolina’s rainy day account is a good example of how this can be done. The South Carolina Constitution (Article III, Section 36) requires that:

“The [Legislature] shall provide for a General Reserve Fund of three percent of the general fund revenue of the latest completed fiscal year. Funds may be withdrawn from the reserve only for the purpose of covering operating deficits of state government….

“[T]he amount must be restored to the reserve fund within three fiscal years out of future revenues until the three percent General Reserve Fund is again reached and maintained…. [A] minimum of one percent of the general fund revenue of the latest completed fiscal year, if so much is necessary, must be restored to the reserve fund each year following the deficit….”

If Alabama followed the South Carolina model, here’s what would happen after withdrawing money from the rainy day account:

·   repayment would be required out of the future revenues of the Education Trust Fund,

·   in an amount equal to one percent of the Education Trust Fund’s current revenue each year,

·   until the rainy day account was restored to its original percentage of the Education Trust Fund’s revenue, in the year of restoration.

Under these terms, the rainy day account would grow at the same rate as the Education Trust Fund, because the 1% repayment percentage each year would be based on a growing revenue base. This would ensure that the rainy day account remains large enough to serve its purpose, and it would provide a fair return to the ATF as well. The Legislature could earmark any new revenue sources such as sales taxes on electronic commerce directly to the Education Trust Fund, which would be responsible for repayment.

Unfortunately, none of these provisions is included in the proposal before the voters.

2.  COULD THE STATE MAKE IT “RAIN” TOO OFTEN?

Accurate revenue forecasting is crucial to a workable rainy day account. If anticipated revenues are over-estimated, appropriations will be too high, and the rainy day account can be triggered in mid-year to meet the “shortfall.” The ability to fall back on a rainy day account therefore could lead to a loss of fiscal discipline.

An Alabama law adopted two years ago creates upward pressure on revenue estimates. The law commits much of the growth of the Education Trust Fund to achieving national average pay for public school teachers. If the fund’s revenue base grows by 3.5% or more, a major part of the growth is allocated to teacher salary increases; if growth is below 3.5%, this allocation is suspended. The pay-raise decision is based on revenue estimates of the State Finance Director and the Legislative Fiscal Officer made at the beginning of each regular legislative session.

In the two years since the law was enacted, the growth estimates have been under 3.5%; but the creation of a rainy day account would add to the pressure on those who estimate revenue, especially if the rainy day account did not have to be repaid with certainty and timeliness. Proposed Amendment No. 1 uses the same revenue estimates as the basis for withdrawing money from the rainy day account.

Because of the importance of accuracy and objectivity, the State of Florida requires revenue estimating to be done by consensus, through semi-annual conferences that involve legislative and executive staffs and are open to the public. A fall conference creates estimates for budget planning; appropriations for the next fiscal year are based on a spring conference so that the numbers are more accurate than those done earlier. A monthly report on the internet tracks the accuracy of forecasts during the year, for all to see.  Adding openness, visibility, and frequency to Alabama’s revenue estimation process would be healthy as well, particularly since important policy decisions depend on the results.

Revenue forecasts in Alabama also are affected by the way the state government handles income tax refunds. No reserve for refunds is set aside as taxpayers make their monthly or quarterly income tax withholding payments; rather, the state pays refunds out of tax collections received later, in the months following the filing of annual income tax forms. This means that refunds for tax year 2000 normally would be paid in fiscal year 2001. In the past, the time lag mattered little because tax refunds were paid along with other obligations in a routine manner. This is how a well-run government should operate.

However, deciding when to pay these refunds apparently has become a policy decision. As of May 8, 2002, the state had not paid over $83 million of corporate income tax refunds from tax year 2000.[3] These refund obligations are drawing interest at a rate of 6%, costing the state about $5 million per year. When the refunds are paid, they will reduce the revenue flowing into the Education Trust Fund, which then will drop substantially. The outstanding refunds have not been fully taken into account in revenue estimates made thus far.[4] Paying all or a substantial percentage of them could trigger a “rainy day” in 2002 that has nothing to do with economic conditions.

 The revenue flowing into the Education Trust Fund also is affected by debt service requirements of the Alabama Public School and College Authority (APSCA), which finances capital improvements for the state’s educational institutions. Debt service on APSCA bonds is paid from tax collections before they flow into the Education Trust Fund. Decisions to issue or repay debt, as well as the structure of debt repayment, directly affect Education Trust Fund revenue.

      It would not be appropriate to build a rainy day account on revenue definitions that could easily be influenced by policy decisions. An Alabama rainy day account should be built on objective, accurate revenue estimates and stable accounting rules so that “rainy days” cannot be manipulated.

3.  WOULD THE RAINY DAY ACCOUNT BECOME ANOTHER ONE-TIME REVENUE SUBSTITUTE?

      Per-capita state and local tax collections in Alabama are far below those in any other state.[5] Often this means that Alabama agencies are trying to accomplish the same results as their peers in other states, but with inadequate resources. Alabama’s state government is fortunate to have dedicated professionals in the Legislative Fiscal Office, the Finance and Revenue Departments, and operating agencies. Unfortunately, Alabama’s policy makers over a number of years have chosen to create patchwork solutions to chronic financial problems, rather than face the state’s financial condition forthrightly.

      Ironically, the results of operating in this way often turn out to be more costly than providing adequate funding upfront and then expecting efficient performance.

      For example, choosing not to pay $83 million of corporate tax refunds in fiscal 2001 and thus far in 2002, as discussed above, resulted in a one-time increase in education revenues. This created a short-term benefit to educational agencies, but at the expense of revenues in future years and at a cost of $5 million or more in interest that must be paid – to say nothing of the loss of taxpayer confidence in the tax system of the state.

      Another short-term “solution” that has long-term consequences is the use of borrowed money to pay operating expenses. In fiscal 2001, appropriations from the Education Trust Fund were “prorated” (reduced across-the-board in mid-year) by 6.2% or $264 million. Revenue estimates had assumed growth of about 3.5%, but in actuality revenues turned out to be 2.7% lower than in the prior year.  The Legislature authorized local school systems to use state capital outlay appropriations to shore up their operating accounts, in order to minimize layoffs. Money from a $97.5 million bond issue of the Alabama Public School and College Authority was then allocated to public schools, colleges, and universities to replace in part the capital funds they had used for operating purposes. The interest on these APSCA bonds, if held to maturity, will add $44 million to the cost of this subsidy for 2001 operating expenditures.[6]

      Once the Alabama Capital Improvement Trust Fund (ACITF) became available, it too was soon employed as a source of short-term budget relief. To assist the fiscal 2002 budget, the Legislature appropriated $31 million from the ACITF to underwrite part of the debt service on general obligation bonds and the bonds of the Alabama Public School and College Authority.[7] These appropriations are simply a substitute for the normal funding of certain capital improvements. Their real purpose is to make more money available for operations in the General Fund and Education Trust Fund.

      The ACITF was created by Constitutional Amendment No. 666 (also known as “Amendment One” when approved in November 2000) to fund capital investments in Alabama’s infrastructure, not to subsidize state operating revenues. Some ACITF appropriations do finance infrastructure investments, as they should. Examples are county roads and bridges, the state docks, and the UAB biotechnology research facility. Perhaps the Legislature should provide for an independent board to screen and rate proposals for the investment of ACITF funds, and publish its recommendations for all to see.

      Clearly the temptation will exist under current circumstances to make use of any rainy day account as another one-time revenue substitute. To make a rainy day account function as intended, the state must have a financial plan that provides stable, continuous funding for its operations, overcoming the chronic financial difficulties that Alabama’s operating funds face today. Such a financial plan ought to be built on a fair, efficient, and adequate tax system.        

A rainy day account is a sound and sensible idea, and a necessity for good financial management of the State of Alabama. The ATF is a good foundation for Alabama’s rainy day accounts, because it provides a large fund already available to draw on in a downturn. However, the terms of the account should guarantee repayment from real revenues, within a reasonable time, and in full, so that the ATF does not lose money.