Joseph Krist

Municipal Credit Consultant

The month of June is crunch time for state budget makers and this year there is no shortage of contentious budget action. We focus on four significant state budgets and the increasingly poor outlook for favorable resolutions, at least from the perspective of bondholders.

ILLINOIS

It was not unexpected but the Illinois budget process has turned into a major battle. House Republican Minority Leader Rep. Jim Durkin  called it “a Greek tragedy.” The likelihood is that the actual budget may not be finally adopted until later this summer. While we do not expect this spectacle to impair the payment of debt service on state debt, we do expect that the various twists and turns of the soap opera will continue to pressure prices and ratings on the state’s bonds.

Illinois Democrats have offered a series of budget bills designed to restore social service cuts proposed by Gov. Bruce Rauner. Republicans have criticized the House Speaker’s budget as being irresponsibly out of balance, while Democrats retorted that the Governor’s February budget proposal counted on more than $3 billion in false savings. The Governor has said he would consider raising taxes — but only after lawmakers agreed to a series of his proposals including term limits on lawmakers, a property tax freeze and reforms to workers compensation laws. He has threatened to keep the legislature all summer if they fail to pass those measures.

Debate was focused by the introduction of a bill to restore deep cuts to human services. It included programs that the Governor’s plan had slashed or zeroed out including restoring immigrant and refugee funding as well as money for autism, epilepsy, Alzheimer’s, Boys and Girls Clubs, YWCA and YMCA programs. The bill’s sponsor said it included $134 million in cuts in all and held Medicaid spending to fiscal year 2015 levels.

House Democrats contend that the $36.3 billion spending plan would reflect “what the state of Illinois should do for Illinoisans who need the government to be helpful to them.” according to the House Speaker. He did however, acknowledge that  “we don’t have the money to pay for this budget” — in fact they’ll be about $3 billion short — but he said he’s prepared to work with Rauner to find “new money.” All the while, the State’s biggest issue – pensions – remains unresolved.

FLORIDA

The Florida legislature has one constitutionally established responsibility – the passage of a budget. Not since 1992 has the state flirted with budgetary disaster so close to the end of the fiscal year on June 30. Hoping to break the Legislature’s budget stalemate, the Senate tweaked its Medicaid expansion plan Tuesday in the face of continued opposition from the House and Gov. Rick Scott.

The House did not have a categorically negative response , but Gov. Rick Scott stepped up his criticism of what he called the Senate’s “Obamacare Expansion Plan” and accused his fellow Republicans of trying to impose higher taxes on Floridians. Gov. Scott claims that the Senate’s plan to expand Medicaid under Obamacare will cost Florida taxpayers $5 billion over 10 years. His two priorities in the special session are a package of tax cuts and more money for public schools. Scott has ordered agencies to make contingency plans to provide critical services in case of what he has called a possible “government shutdown,” and has issued dire warnings of teachers not being paid and child abuse complaints being ignored.

The Senate changes, if adopted in committee and floor votes in next week’s special session, would drop the requirement that people would first have to be enrolled in a Medicaid HMO for six months. Instead, they could use federal money to buy subsidized insurance on the private market, in an effort to head off House criticism of Medicaid as a “broken system.”

A job-seeking provision for people in the revamped Senate plan would require them to seek work by using the state workforce portal, Career Source. Patients also could enroll in insurance plans through a federal health exchange, rather than using the state-run option, and the Legislature would have to approve any major changes in the plan ordered by the federal government.

Senate President Andy Gardiner, for the first time, said that approval of a health care plan is not directly linked to passage of a state budget. “We fully intend to pass a budget,” he said. “You could have a scenario where no health care bills get done and we pass a budget and go home.”

The House’s chief budget-writer, Rep. Richard Corcoran called the revised Senate plan “exciting,” but said the House wants guarantees that the Senate will take up several unrelated House proposals. These include plans to expand ambulatory surgical centers, a requirement that hospitals to publish price lists, and an end to approval of new hospital beds through the certificate of need process.

The Legislature will reconvene on June 1, for a three-week special session to finish work on the budget. The session is scheduled to end June 20, but the state Constitution requires a three-day “cooling off” period before lawmakers can vote on the budget. To stay on schedule, they would have to finish all work on the budget by Wednesday, June 17.

 PUERTO RICO

The P.R. House of Representatives approved a tax bill that calls for the implementation of an 11.5% sales tax at cash registers, up from the current 7% paid under the sales & use tax (IVU by its Spanish acronym), after introducing several amendments on the floor. The Senate approved the tax bill after amendments were introduced by the Senate before voting on it. If the House decides not to concur with the Senate’s version, a conference committee will be needed to address the impasse, something that could further delay the legislative process.

Among the amendments is one that would establish a commission which would submit a report on the different tax models within 60 days of the law’s final approval. The commission would be created to evaluate the different alternatives to change the consumption tax, including a return to the tax at the ports. The Consumption Tax Transformation Alternatives Commission (CATIC by its Spanish acronym) would comprise the Treasury secretary as its president, the Justice secretary, the Office of Management & Budget director, the Ports Authority director, members from the Senate and the House, as well as representatives from the private and labor sectors.

If it includes findings or recommendations favoring a move toward the tax at the ports, legislation would have to be presented within 10 days of the report’s presentation to address the findings.

A last-minute amendment to the bill calls for applying the 11.5% sales tax on frozen, refrigerated, canned, packaged “or in some other way preserved or packaged” food items. It is argued that the amendment levels the playing field for all involved in the food industry. Prior to the vote, some had been pushing to exclude from the proposed sales tax prepared food items served at restaurants, which have been taxed since the implementation of the sales tax.

The tax plan calls for a nine-month transition from the sales tax to a VAT, a process that is expected to be completed by April 1, 2016. A 4% tax on business-to-business services, as well as professional services, was also included, and is slated to kick in Oct. 1. These services are exempt under the current tax system.

PENNSYLVANIA

The Commonwealth is no stranger to prolonged budget battles and this year is no exception. The new Governor, a Democrat, faces a legislature where Republicans hold significant majorities. The legislature sees pension reform as its top priority through a bill to scale back pension benefits for future and current public school and state government employees. The governor has made education funding his top priority and released an open letter last week that showed how little headway he has made in winning over opponents to a tax increase on Pennsylvania’s natural gas industry, a source of money Wolf is counting on to put more money into public schools. Overhanging all of this is a projected $2 billion deficit in the fiscal year starting July 1

The Governor’s plan requires over $4 billion annually in higher taxes, according to an Independent Fiscal Office analysis, and Republicans oppose nearly all of it. The House has passed a bill to increase state sales and income taxes as a way to reduce the school-funding burden currently funded primarily by local property taxpayers. Senate leaders are skeptical.  The House also passed a bill to privatize much of the state-controlled wine and liquor store system, but it has not been acted on in the Senate for three months and it is opposed by the Governor. As for the pension situation, the Governor supports the issuance of pension bonds – a red flag for any market observer – as a stopgap measure.

We would not be surprised to see a late budget, a failure to address the Commonwealth’s pension situation, and a greatly compromised effort to address school funding. There is simply no consensus in the Commonwealth around any of the proposed resolutions and there is a deep sense of cynicism on the part of the electorate about efforts to reform school property taxes. This discussion has colored state politics in Pennsylvania for at least a quarter century with no successful resolution achieved regardless of which party has been in power. The net result is likely additional pressure on the Commonwealth’s ratings as well as those of many localities.
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