Budget “Off The Tops” Bad Policy

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Direct transfers of taxpayer money sent to a specific business or industry is always a tough sell to politicians, let alone the voting public. But, that is why some corporations pay lots of money to lobbyists. If we can’t get a company more revenue (via a taxpayer-funded payment) why don’t we lower their expenses via a tax loophole that lowers how much they pay in taxes?
These sort of special interest tax breaks come in a variety of different forms but the net effect of each is the same – revenues are diverted from the appropriation process and instead sent to some “special” group.   A shrewd lobbyist will often make sure the program is funded in a way that their client(s) will receive their funding even if the statute is changed in the future.  However, that should not preclude bringing these special interest deals to an end.  This is especially important given that the reduction in tax rates will increase the impact of these programs on the revenue stream even as the state continues along the path to eliminating the individual income tax.
These transfer schemes are funded in a number of different ways that obscure the transaction from both the public and the appropriation process.  For example, there are a number of these special deals that are funded by payroll withholding taxes. The payroll withholding exemptions are programs where the state abates collection of state income tax withheld on employee’s wages.  The state then provides either a program or directly funds some benefit for the employer.   These programs come in many forms and often are nearly impossible to find within the very complex tax and revenue reporting statements.   In general these programs require relatively long commitments by the state of taxpayer funds.  The discontinuance of these type of programs will not generally eliminate the programs immediately but it will create savings going forward that could be substantial to the maintenance of a stable fiscal environment and a more transparent tax code. It would also be a breach of trust, on some level, to yank away a promise made by the state to an entity or individual. But, that doesn’t mean we have to let these program exist into perpetuity.

Investments in Major Projects and Comprehensive Training (IMPACT)
IMPACT provides for major project investment to provide financial assistance to defray business costs.  IMPACT uses withholding revenue for a direct funding source to pay for bonds issued by the state for projects.  In fiscal year 2013 that percentage was 2% and the program expended $25,420,654 of funds that otherwise would have gone to the state coffers.   The good news is that Kansas stopped issuing bonds in the IMPACT program effective Dec. 31, 2011. The bad news was it was replaced with other programs that are very similar.   The IMPACT payments will extend on for a number of years in to the future because of the bond’s that funded those projects.   This ability to bind future legislators and taxpayers to these sort of “deals” is, in and of itself, problematic but there is more damage done to the state of Kansas than just the direct cost of these bonds.
Bad policy like the type of special interest payment that IMPACT represents often have negative impacts in the future that are not foreseen at the time of their passage.  For example, the IMPACT bonds were at the heart of the recent Moody’s down grade of the Kansas state bond rating.  The IMPACT bond’s ratings were reviewed by Moody’s rating agency because the funding source to pay off the bonds – withholding taxes – was being reduced by a cut in the tax on wage earners in the state income tax rates.  The media, which generally is not comprised of individuals with a financial background, reported that the change in the IMPACT bond ratings were caused by the broad tax cuts, which is only partially true.   What the media in general did not report, at least not with the same enthusiasm as their portrayal of the impact of the income tax cuts, was that Moody’s noted the long running unfunded liabilities of the Kansas Public Employees Retirement System (KPERS) and the lack of spending cuts as key elements of their downgrade.
However, analysis of the IMPACT bond rating issues bring to light another important problem with these type of give a ways.  Future legislators have their hands tied because their predecessors have committed future tax revenues in a manner that precludes the ability to bring an immediate cessation, or even partial reduction, in the special interest funding source without repercussions such as the recent bond rating issue.

Promoting Employment Across Kansas (PEAK)
The PEAK program allows companies that create 100 new jobs within a specified two-year period to retain 95% of employee withholding taxes for up to 10 years.  Not surprisingly with such a generous incentive companies have grown its use rapidly going from $2.7 million in expenditures in 2010 to an estimated $12.5 million in 2012 years.   The “cap” on this program going forward is: In FY 2014, the cap is $12 million. In FY 2015, the cap is $18 million, $24 million in FY 2016, $30 million in FY 2017, $36 million in FY 2018, and $42 million 2019.    Immediately freezing the cap at the current level and eliminating the program going forward to prevent new obligations generates significant savings going forward for the state. This is giveaway is even more troubling when considering that a recent analysis from Kansas City’s Kauffman Foundation found that, “PEAK incentives recipients are statistically not more likely to generate new jobs than similar firms not receiving incentives.”

Kansas Bioscience Authority (KBA)
The KBA’s short lifespan is a microcosm of what can go wrong with the concept of dedicated directed funding.   The lack of transparency created by bypassing the scrutiny of the appropriation process often leads to expenditures that generate headlines but don’t create economic growth.
The legislation that created the KBA produced a number of programs and funding streams. It also set the total funding limit to the authority over 15 years at almost $582 million.  The funding was to be for a period of 15 years from the effective date of the establishment of the KBA and required the State Treasurer to annually pay 95% of withholding above the certified base, as certified by the Secretary of Revenue, on Kansas wages paid by bioscience employees to the bioscience development (code categories from NAISC) and investment fund of the KBA.
The amount of funding transferred to the KBA grew from almost $20 million in 2006 to nearly $36 million by 2008 before the creation of the annual funding cap of $35 million in 2009.   Issues with operations and management emerged in 2011 which led to a forensic audit by an outside CPA firm.  The audit pointed to a number of issues that led subsequent legislatures to reduce the Authority’s funding to $11.3 million in 2012, $6.3 million in 2013, and $4.0 million in 2014 (KBA funding history here). It is doubtful that the current Administration or legislatures would increase funding above current levels but the $35 million is still the statutory cap leaving open that possibility.
There is a secondary issue with KBA’s statutory cap caused by the treatment of these type of dedicated directed funding in the budgeting process.   These statutory caps for entities like KBA are considered to be at their cap amount when forecasting future budgets.  The $35 million of KBA statutory cap, for example, creates an illusion in fiscal impact statements issued by the Kansas Legislative Research Department (KLRD) because those statements show the full statutory amount of $35 million being spent every year for the five years they project.   Based on the current trend line of KBA funding this will not happen and, instead, creates a significant overstatement of expenditures and helps create fiscal deficits where none may exist.   These projections are used by legislators and the media and should strive to present as accurate a picture as possible of current and possible future realities. A more proper and accurate display of these type of funded programs for five year projections like KLRD produces would consider whether spending could be altered or removed completely. This should be reflected in either the actual amount shown, if there was a history of partial funding, or, at the very least, in a separate line item with a notation that the sum could be arbitrarily reduced or eliminated.

Job Creation Fund
Another of those dedicated directed funds is the Job Creation Fund (JCF).  The Job Creation Program Fund or the “deal closing” fund, its more press-friendly moniker, lets the state, led by the Office of the Governor, make investments and extend incentives aimed at attracting or retaining businesses within a range of statutory guidelines.  The funding for the JCF was from the elimination of three other credits:  Kansas Enterprise Zone, Job Expansion and Investment Credit Act and a refundable credit for property taxes paid on machinery and equipment.  This sort of reallocation of funding sources carry the coveted title of “revenue neutral” and hence have no fiscal impact statement for legislators to worry about when the funding was created.   This allowed elected officials to be able to say on one hand they eliminated special interest funding while creating another special interest fund out of the “elimination” of those entities.  The annual cap on JCF funds is $10 million  which is how much could be immediately saved by letting JCF join its now-defunct predecessors in state history.
Transfers Out of the State General Fund
There is another area where what would be State General Funds are diverted from the appropriation process.   There are a number of transfers out of the State General Fund with the largest and most notorious being the $135 million School District Improvements Fund.  Not only does this amount not get counted in the school formula, the recent Gannon ruling on school funding pointed directly to this fund as an example of inequity in funding.  This “inducement” to issue bonds for new buildings was a bad idea both from a policy and process aspect.   Policy-wise the Kansas Supreme Court’s Gannon ruling was correct in pointing out that only the growing school districts could use this fund with a few big school districts garnering most of the monies.   Process-wise the choice to use a transfer as the funding mechanism not only bypassed the school finance formula but also ensured that these funds are not counted by the National Center for Education Statistics; NCES is the “go to” place for comparing education-related data from across the country and is run by the U.S. Dept. of Education.

There is also another series of transfers that have their own particular issues.  The adjacent list shows the recipient and the amount for FY-2015 (available at link above).  The picking of winners and losers by government is never a good idea and the direct transfer of taxpayer funding to companies is a suspect type of economic development.

 Transfers out of the State General Fund
Spirit Aerosystems Incentive ($3,500,000)
Eaton MDH Spec. Qual. Indus. Mfg. Fund ($30,000)
 Siemens Manufacturing Incentive ($650,000)
 Learjet Incentive  ($6,000,000)
 TIF Replacement Fund  ($900,000)
 Learning Quest Match  ($500,000)
 Total  ($11,580,000)

It is also troubling when local communities enter into Tax Increment Finance (TIF) arrangements, not to mention other subsidy giveaways, which are basically an agreement between a company or individual and the city to suspend property tax payments for that company or individual.  State taxpayers as a whole have to make up for lost revenues to the governing body of each such city from the TIF arrangement.  This means that a TIF issued in Johnson County is, at least in part, paid for by residents of Bourbon County and Elkhart. This distribution of funds from taxpayers across the state to individual “redevelopment areas” that were created by local governments in a manner that is basically hidden from the citizens is another great example of why these “off the tops” are bad policy.  Requiring these TIF subsidies to be debated in the light of the full appropriation process would no doubt lead to questions by legislators whose districts did not include cities who receive this subsidy.

A general thought for legislators, citizens and industry on these economic subsidies.   The reduction in income tax rates by the state on withholding rates has already provided a huge incentive for these companies in addition to the direct largess they receive from these dedicated funds.  The rate cut on withholding taxes increased the take home pay of their employees without those companies having to give a pay raise to their employees out of company funds. Note that the “incentive” of lower withholding taxes is applied to EVERY wage earner in the state and does not go about picking favored businesses, industries, or individuals. This type of transparent, rules-based, and equally-applied policy is the correct way to encourage economic growth and allow the free market to dictate outcomes not politicians or bureaucrats.

Every program that spends the funds of the taxpayer should be examined regularly and the nature of these “off the tops” suggests that is not happening. The need for transparency and accountability is especially true of programs that benefit any specific individual, company or sector of the economy at the expense of another.  Because of the contractual type of arrangement some of these represent we do not advocate for the state breaking existing contracts in regards to incentives.  But, the creation of new or expansion of existing economic development handouts that are direct redistributions from taxpayers to other sectors of the economy needs to be halted and those still in existence need to be reviewed.

A complete review of every agreement entered into by the state to ascertain if that agreement is contractual in nature or are not legally binding going forward should proceed this next legislative session.   The state should review those that are not legally binding and current renewals that can be foregone and put this “off the top” funding back in the appropriation process going forward.   How much could the state expect to realize would be determined by that review. Even a preliminary, informed estimate would be in the neighborhood of $50 million annually without breaking any contractual arrangements.   The following chart gives an estimate of just three programs with statutory flexibility.

 Total Dollars Returned to the State Coffers
 $s in Millions  FY16  FY17  FY18 FY18
 Freeze PEAK at Current Levels  $6 $12 $18 $24
Kansas Bioscience Authority $25 $25 $25 $35
Cease Job Creation Fund  $10 $10 $10 $10
 Totals $41 $47 $53 $69
The issue of transparency is front and center in all of these programs and it would be appropriate for every “off the top” to be displayed on both Consensus Revenue Estimates and Appropriation profiles so that legislators and citizens can see that a significant amount of funds have already been appropriated by these arrangements.
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