Joseph Krist

Publisher

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UNLIKELY ALLY IN THE MOVEMENT AGAINST TAX INCENTIVES

The World Trade Organization concluded last year that Boeing benefited from unfair subsidies in the form of tax incentives from the State of Washington worth roughly $100 million a year. The decision was made over a complaint from the Trump Administration against Airbus, Boeing’s European rival.

In its case, the U.S. cited the fact that Airbus received billions in so-called launch aid from European countries as it developed new aircraft. In its defense, Airbus cited the receipt by Boeing of tax incentives for its Washington State and South Carolina manufacturing facilities. After the WTO decided in favor of Boeing, the company remained concerned that the tax breaks could be used to justify the imposition of tariffs by the EU in retaliation for those imposed by the U.S. after the WTO decision.

In reflection of those fears, Boeing is now seeking to end those tax incentives at least in Washington State. Legislation has been introduced on behalf of Boeing to do so. A sponsor of the bill, said the proposal had come from Boeing itself. It is under current consideration by the Washington legislature. Doing away with the state tax breaks eliminates a target for European Union trade representatives.

This response from the State and Boeing is reflective of the changing landscape over which these entities approach economic development. Tax incentive schemes in the U.S. reflect 20th century rules and thinking. The globalization of not only production but also supply chains means that incentives are no longer an intramural fight between U.S. entities. They have global trade implications which could seriously impact local economies.

There are many sound arguments against the use of these incentives. The potential impact on trade  and the economies reliant on it have just created more of those arguments.

THE FUTURE OF TRANSPORTATION REVENUES

New research for The Pew Charitable Trusts shows that even moderate use of  autonomous vehicles (AV) could affect the fiscal outlook of states that collect substantial taxes and fees from cars and trucks through a range of revenue streams that would diminish.  The research, conducted by a professor at the University of Tennessee at Knoxville, and published by Pew, examines the effect of the adoption of AVs on tax revenue in California, New Hampshire, New York, Ohio, Tennessee and Texas. The research focused only on transportation-related taxes and fees, assumed that AVs will be largely electric-powered, and modeled the direct fiscal changes using each state’s current tax structure.

First, the data.  States currently collect about 8 % of their total revenues from vehicle-related taxes and fees on sales, licensing, registration, and fuel.  That percentage involves a range of outcomes. Transportation-related revenues in Texas would drop by nearly a third over a 15-year period, from 18.4 % of total state revenue in 2025 to 12.7 % in 2040. New York’s vehicle-related revenues are already less than 5% of total state revenue. Although vehicle-related revenues would drop by more than half in the Empire State, the projected decrease in overall revenues is still only from 4.6% in 2025 to 2.1% in 2040.

Now the caveats. The study only covered six states. Importantly,  it assumes that current tax regimes remain as they are. While the difficulties to date in establishing vehicle mileage taxes to replace gas taxes are clear,  a consensus is forming around the issue and it currently has bipartisan committee leadership support in the U.S. House. The other is the analysis assumes that AVs eventually replace person-driven vehicles entirely.

What does this tell us? The concentration by advocates on transportation without taking into effect the overall economic impacts of full AV adoption is a major flaw in approach. Eight percent, while significant,  is a manageable revenue drop.  The real costs come when one looks at the implications for employment especially among lower skilled workers. The revenue drop would occur in the context of massive employment disruptions which would have a greater impact on state revenue bases. At the same time, at least initially, a significant social service funding impact would have to be absorbed by the states.

PRIVATE COLLEGES CONTINUED HEADWINDS

Yet more small private liberal arts institutions finds the current headwinds facing the sector too much for their ratings to bear. There are two latest casualties which have seen their Moody’s ratings downgraded. Saint Michael’s College (SMC)  is  a small private coeducational Catholic institution located in Colchester, Vermont offering experiential learning near Burlington, Vermont. Like so many of its size it is dependent upon ongoing demand to generate sufficient operating revenues through tuition. Under current economic conditions and demographic trends, this leaves an institution’s finances under constant pressure.

In the case of SMC, net tuition revenue decreased 15% over the fiscal 2015-19 period as enrollment declined 20%. In fiscal 2019 the college recorded operating revenues of $73 million and for fall 2019 enrolled 1,721 full-time equivalent (FTE) students. Outstanding rated bonds are an unsecured general obligation of the college. There are no debt service reserve funds. So the College’s ability to cover debt service is not in peril in the short run but, the long term outlook is quite negative in the face of current enrollment trends.

All of this added  up to a downgrade of the SMC debt by Moody’s to Baa2 from Baa1. Some $50 million of bonds are subject to the downgrade. The rating outlook remains negative. The school needs to diversify its revenue streams (especially in terms of donation support) or it will continue its tuition reliance, vulnerability to several negative trends, and need to draw down quasi-endowment funds to cover operations.

On the West Coast, Linfield College is a small undergraduate college with two locations in Oregon. The main, primarily traditional liberal arts campus is in McMinnville, Oregon. The college also has the Linfield Good Samaritan School of Nursing in Portland and the Online and Continuing Education division with online students nationwide. Linfield generated $62 million of revenue in fiscal 2019, and in fall 2019, the college had 1,763 full-time equivalent students. Their rating action reports could have been essentially exchanged for each other.

Linfield was downgraded to Baa2. Its rating outlook is negative. Pardon us if the rest sounds familiar. The credit is highlighted by prior multiple years of significant enrollment declines. absent continued net tuition revenue growth, the college will struggle to restore fiscal balance. Enrollment losses led to two consecutive years of deepening operating deficits, with debt service coverage below 1x in fiscal years 2018 and 2019. A comparatively small and shrinking scale, with $62 million of revenue, down nearly 8% over the past five years, will make material expense reductions difficult as the college invests in programs and facilities to sustain competitiveness.

The sector remains a minefield for investors.

RED LIGHT ON TOLLS IN CONNECTICUT

It appears that the ongoing inability of the State of Connecticut to agree on a program to fund transportation hit another red light. For some time, the Governor has been trying to persuade legislators and voters that a plan to levy tolls on trucks using the interstate highways in the state was away to enhance transportation funding without increasing the burden on state residents. a significant portion of annual truck volume originates  and ends out of state so the view was that tolls on trucks were a painless way for the state to develop a new funding source.

It appears now however, that the plan has been overwhelmed by politics. Gov. Ned Lamont announced that he was withdrawing his plan to collect tolls. It had always been the subject of Republican opposition but it became clear that even with a substantial Democratic majority in the Senate, that the votes were not there to enact it. That reflects the excessive politization of the issue on both sides of the debate.

This means that regardless of one’s view of the toll plan, the defeat puts the state’s credit back to square one in some ways. The immediate response would be to issue general obligation debt for transportation crowding out a myriad of projects from capital funding. That would put more pressure on general revenues during a period of high anti-tax sentiment. This effectively closes off an increase in any of the state’s major taxes for transportation funding.

It is a credit negative outcome for the State of Connecticut.

AND CAUTION LIGHTS FOR OTHER TOLLS

When the State of Alabama decided not to move forward with a toll funded project to improve resilience through the Interstate 10 Mobile River Bridge and Bayway project, opposition to tolls was a main driver supporting the opposition.  The project would have marked the first tolled interstate through a public-private partnership. Now that project decision has emboldened other opponents of tolls to finance needed highway infrastructure.

Alabama law now states that prior to building any new toll roads, bridges, or tunnels, the state Department of Transportation must conduct a public hearing in each affected county. A pending bill, SB151,  would add a requirement for the Alabama DOT to complete an economic impact study prior to any toll project being undertaken. A second bill, SB 152, would give voters the final say on any toll project. Specifically, voters would decide whether to put into the state’s Constitution a requirement for a public vote in any county where a toll project is planned.

A 1978 Maryland law requires the state to get consent from local government leaders in the nine counties on the Eastern Shore before moving forward with any toll plans in the area. Now legislation would be introduced which would impose that requirement statewide. It is in direct response to plans tolls to cover costs to widen Interstate 270 between I-495 and I-70, and portions of I-495 in Montgomery and Prince George’s counties. The project would create toll lanes to relieve congestion along existing roads which would remain toll free.

The Wyoming legislature early in its current session rejected proposals to place tolls on Interstate 80 where it runs through the state. Recently, the Florida DOT announced that it was suspending the use of dedicated lanes subject to tolling along the Palmetto Expressway. The State will reduce the number of northbound express lanes from two to one, add a regular southbound lane and create new access to the express lane. It will also reduce the minimum 50-cent toll to zero, meaning tolls will be suspended indefinitely.

The change in Florida reflects the perception that congestion was not meaningfully reduced as the toll lanes did not see the demand which was expected. Two Miami-area legislators who say the tolls lanes have had a disastrous effect on traffic gridlock sponsored a bill to get rid of the tolls and convert the express lanes to regular lanes which was pending at the time of the suspension announcement. During the suspension, construction will take place on the highway, along with short-term work like restriping lanes and moving lane dividers. 

ILLINOIS BUDGET

Gov. J.B. Pritzker released a $42 billion state budget that ties education support, pension funding and other programs to the fate of a constitutional amendment authorizing a graduated income tax to pay for more spending.  “To address the uncertainty in our revenues, this budget responsibly holds roughly $1.4 billion in reserve until we know the outcome in November. Because this reserve is so large, it inevitably cuts into some of the things that we all hold most dear: increased funding for K-12 education, universities and community colleges, public safety and other key investments—but as important as these investments are, we cannot responsibly spend for these priorities until we know with certainty what the state’s revenue picture will be.”

This puts the vote in November, 2020 at the forefront of the effort to solidify and improve the state’s credit. Fiscal 2021 is projected to be the first year that the State will fully fund its required pension contribution after years and years of delay and underfunding. It reflects the Governor’s view that a constitutional amendment necessary to cut benefits would not be approved by the electorate. On the spending side, Pritzker said his administration has already identified $225 million in budget savings for the upcoming fiscal year, and as much as $750 million through the end of his first term. The biggest share of the savings, according to Pritzker’s office, came from are costs for state employees reduced health care costs for state employees, accounting for $175 million in the upcoming year, and an estimated $650 million over the next three years. These cuts were negotiated with the relevant unions.

Under the Evidence Based Funding formula that lawmakers approved in 2017, state funding for public schools is supposed to increase by at least $350 million. Meanwhile the state’s mandated pension costs, including the cost of paying down pension obligation bonds  that were issued in 2003, are scheduled to increase nearly $460 million, to a total of $10.4 billion.

ILLINOIS CANNABIS

The sale of legal recreational cannabis products began on January 1 in Illinois. We now have at least one month of data to see what the take from cannabis taxes is and how that relates to expectations. So far, the buzz seems to be pretty good from the revenue standpoint.

According to the Illinois Department of Revenue, January sales generated more than $7.3 million in cannabis tax revenue and more than $3.1 million in sales tax revenue. This represents some over 37% of the amount projected to be collected by the end of June. Customers spent more than $39.2 million on recreational marijuana during the first month of legal product.

The majority of sales were to residents. As has been the case where adjacent states have no or only some level of legality, out-of-state residents spent more than $8.6 million some 22% of the total sales. The strong numbers were produced despite shortages. Shortages have become a staple of the startup phase of any legal sales regime.

Illinois is just the latest example of the disjointed way in which government has undertaken the process. By now there ought to be a better way to assess demand and permit supply accordingly. It has been characteristic to see regulatory impacts on one problem can needlessly impede the industry from operating standpoint. The numbers also reveal the potential. Marijuana-infused products are taxed at 20%. All other marijuana with 35% THC or less is taxed at 10%, and marijuana with THC content higher than 35% is taxed at 25%. Municipalities can levy an additional 3% tax however those revenues were not included in the state data.

So will New York be next?

UTILITY CYBER ATTACK

The Cybersecurity and Infrastructure Security Agency (CISA) of the Department of Homeland Security responded to a cyberattack affecting control and communication assets on the operational technology (OT) network of a natural gas compression facility. A cyber threat actor used a Spearphishing Link to obtain initial access to the organization’s information technology (IT) network before pivoting to its OT network. The threat actor then deployed commodity ransomware to Encrypt Data for Impact on both networks. Specific assets experiencing a Loss of Availability on the OT network included human machine interfaces (HMIs), data historians, and polling servers. Impacted assets were no longer able to read and aggregate real-time operational data reported from low-level OT devices, resulting in a partial Loss of View for human operators.

The attack did not impact any programmable logic controllers (PLCs) and at no point did the victim lose control of operations. Although the victim’s emergency response plan did not specifically consider cyberattacks, the decision was made to implement a deliberate and controlled shutdown to operations. This lasted approximately two days, resulting in a Loss of Productivity and Revenue, after which normal operations resumed. 

The attack highlights the need for utilities to have robust defense and recovery plans against cyber attacks. In this case, the victim’s existing emergency response plan focused on threats to physical safety and not cyber incidents. The victim cited gaps in cybersecurity knowledge and the wide range of possible scenarios as reasons for failing to adequately incorporate cybersecurity into emergency response planning.

Absent disclosure from municipal issuers, this situation sounds a lot like what one would expect to find at a smaller municipal utility. Two days of lost service, production, and or revenues is no small thing and this happened to a sophisticated private operator. Even if your local utility operations are prepared, those entities are at the mercy of other providers. The US natural gas pipeline industry, now the primary fuel supplier to the US power generation fleet, has no federally mandated cybersecurity standards.

Moody’s rightly points out that “Natural gas distribution utilities rely on pipeline infrastructure for gas distribution to customers for heating and other purposes, exposing them to the safety, operational and financial risks from pipeline cyberattacks. Because of the increased interdependence between electric utilities and natural gas pipelines amid the growing use of low-cost natural gas as a transition fuel to renewables and away from coal, the electric grid infrastructure is exposed to cyberattacks on natural gas pipelines.”

In addition to actions taken by utilities, investors can add to their protection by demanding robust disclosure as to cyber security actions being taken over and above procuring insurance. Insurance to provide funding for remediation is fine but some disclosure about the ability of an insurer to effect real change in terms of preparedness should be available. It is important to  have some sense of the potential damage to revenue streams which support for debt service since after all that is what pays debt service.

FLORIDA HIGH SPEED RAIL BACK IN COURT

Earlier this year, Indian River County announced that it decided to throw in the towel on its efforts in the federal courts to challenge the use of tax exempt debt to fund the development of the high speed rail line serving the Miami to Palm Beach corridor. It had been to date a costly and unsuccessful process. The county has spent $3.5 million on litigation with Virgin Trains, including other cases over other safety issues. Now, the Indian River County Commission has rethought that position and decided to move forward with an appeal to the U.S. Supreme Court. $200,000 of private money and a legal team including a retired judge once short-listed for the Supreme Court convinced the County that an appeal is viable.

Our view on this issue is colored by our view that it becomes tiresome to see private entities insist on being viewed as private risk takers while fully exploiting the use of tax exempt financing. No matter how you slice it, the use of tax exempt financing is the use of a public subsidy. We would like to see these private entities stand on their own to prove their point that private is better than public.

MANAGED RETREAT IN THE SPOTLIGHT

We have discussed the various approaches available to and taken by municipalities to deal with the specific issue of rising sea levels resulting from climate change. for some time. There haven’t been many examples where a municipality has been able to develop public support for the issue. Lately, one such municipality has been in the spotlight for its efforts to deal with the issue of rising sea levels which do not focus on hard infrastructure answers.

Marina is located along the central coast of California, 8 miles west of Salinas, and 8 miles north of Monterey. It has a population of some 22,000. Sea walls are forbidden, and sand replenishment projects do not have local support. It does require real estate disclosures for sea level rise. It works to move infrastructure away from the water. It is working with a private resort in town to relocate its oceanfront . 

Much of the shoreline remains undeveloped. Marina’s coast has one of the highest rates of erosion in California and the city was also the site of an industrial facility which effectively removed tons and tons of sand annually. There are some other facilities including office buildings, a sewer pump and an aging water treatment facility. They are all subject to the impact of continuing erosion.

At some point, many of these facilities as well as public facilities including public beach infrastructure such as a parking lot and public restrooms will have to be moved. those types of facilities will be needed to maintain access to the ocean. Some of that can be accomplished through regulation but buy in from the public and from private property owners is essential. Municipal credits are in a position to be at the center of that debate.

We find the Marina example instructive. There is much focus on large events like natural disasters which inflict large scale damage and inspire large scale reactions. In reality, the impact of rising water levels is smaller scale. It’s situations like Marina, its steadily crumbling walkways and access points around the Great Lakes and other places seeing smaller scale but increasing incidents of erosion and undermining. Cities will increasingly face a choice between ongoing and incident based remediation – essentially an ongoing patching process or a longer term policy based approach.  

AV SPEED BUMP

Columbus, Oh has been at the forefront of efforts to test out the realistic potential of autonomous vehicle technology to provide practical mass transit alternatives. The city has been testing a small scale shuttle service with two 12-passenger shuttles which began running Feb. 5. An operator is always on board to monitor the shuttle. Now, a recent incident has taken the shuttles out of service. One unexpectedly stopped in the middle of a route and a woman fell from her seat onto the floor.

Now, the city has decided to take the vehicles out of service until the vendor can investigate the causes of the unplanned stoppage. It is portrayed as erring on the side of caution and we do not dispute that. It does highlight the fact that like many other implementations of new technologies, the use of AV technology will be a gradual process with both forward and backward steps being a part of the process.

In the wake of the Columbus incident, the vendor who provided the vehicles is coming under closer inspection by regulators. The National Highway Traffic Safety Administration (NHTSA) said operation of the battery-powered buses in 10 U.S. states would be suspended pending an examination of “safety issues related to both vehicle technology and operations.” The vehicles are all provided by Easy Mile now all Easy Mile vehicle use is subject to the suspension.

The deployment in Columbus that started earlier this month was the first public self-driving shuttle in a residential area. It is not the first incident with Easy Mile vehicles however. In July, one passenger in Utah was injured and required medical assistance when the EasyMile shuttle he was in came to an abrupt stop.

It is not a reason not to move forward but it is a reason for governments to be involved in the process at the earliest possible point. Successful development of AV technology into a major component of the mass transit service plan will rely on reliability and transparency throughout every phase of the development and implementation process. That will be the case for emerging micromobility technologies in their efforts to become mainstream.

HARTFORD UPGRADE

Some two and a half years after the city seriously contemplated bankruptcy, Hartford, CT has begun to move forward on the path to fiscal recovery. Those efforts were rewarded this week with an upgrade in its rating at least from Moody’s.  Moody’s Investors Service has upgraded the city of Hartford, CT’s long term issuer rating to Ba3 from B1. The outlook has been revised to stable from positive.  While it does not have any debt outstanding based solely on its underlying rating, the move does signal that the City may have turned a corner in its efforts to recover its financial standing.

Moody’s cited “stable financial operations and improved liquidity that has been achieved through adherence to the city’s financial recovery plan including the benefits of the state’s contract assistance agreement and cost saving measures taken by the city through labor contract agreements and tight expenditure controls. The rating also incorporates strong and continued state oversight through the Municipal Accountability Review Board (MARB) and contract assistance agreement.”

That discipline and oversight will remain important as Hartford has limited revenue flexibility resulting in part from the high percentage of exempt properties within the tax base, persistent challenges of high poverty, above average unemployment and low median family income. Those factors will continue to be the City’s prime credit characteristics and will make it difficult for the City to regain investment grade status on its own for a long time.

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