The 2nd meeting of the Interim Joint Committee on Appropriations and Revenue was held on Thursday, July 31, 2003, at 1:00 p.m., in Room 131 of the Capitol Annex. Representative Harry Moberly, Jr., Co-Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Representative Harry Moberly, Jr., Co-Chair; Senator Richard Sanders, Jr., Co-Chair; Senators Brett Guthrie, Ray Jones, II, Robert Leeper, Vernie McGaha, R.J. Palmer, II, Joey Pendleton, and Dan Seum; Representatives Royce Adams, Rocky Adkins, Joe Barrows, Scott Brinkman, Jim Callahan, Larry Clark, Jack Coleman, Jesse Crenshaw, Bob DeWeese, Jon Draud, Joni Jenkins, Jimmie Lee, Mary Lou Marzian, Charles Siler, John Will Stacy, Tommy Turner, and Rob Wilkey.
Guests Appearing Before the Committee: Robert W. Cox, Deputy Director, Governor's Office of Economic Analysis; Dr. Larry Lynch, consultant for the committee and member of the Consensus Forecasting Group; Mary Lassiter, Acting State Budget Director; Charlotte Quarles, Director, Division of Tax Policy, Revenue Cabinet; Gary Bale, General Counsel, Finance and Administration Cabinet; Bill Thielen, General Counsel, Kentucky League of Cities; and Debra Gabbard, Budget Director, Office of Policy and Budget, Transportation Cabinet.
Guests: Karen Jones, Ky-ASAP; Steve Shannon, KARP; Jim Goodman, Dept. of Parks; Erik Siegel, EQC; Andrew Stukenberg, KAHCF; William Bowker, Public Service Commission; Donna G. Brown; Dennis Langford, Ky HBC; and Mike Ridenour, Lexington Chamber of Commerce.
LRC Staff: Terry K. Jones, Pam Thomas; Lou Pierce, Susan Gitzinger, and Kathy King.
Chairman Moberly asked for a motion to approve the minutes of the June 19, 2003 meeting. Representative Lee moved for approval of the minutes. The motion was seconded by Senator Pendleton and adopted by voice vote.
Representative Crenshaw, Co-Chair of the Budget Review Subcommittee on Justice and Judiciary, reported three appropriations increases for the Justice Cabinet that were reviewed and approved by the subcommittee at their morning meeting. Representative Crenshaw moved for approval of the increases. The motion was properly seconded and adopted by voice vote.
Representative Wilkey, Co-Chair of the Budget Review Subcommittee on Economic Development, Natural Resources, and Tourism, reported that the subcommittee did not meet but six appropriations increases from the Natural Resources and Environmental Protection Cabinet and three appropriations increases from the Tourism Development Cabinet had been reviewed by members of the subcommittee and staff and should be approved. Representative Wilkey moved for approval of the increases. The motion was properly seconded and adopted by voice vote.
Representative Lee, Co-Chair of the Budget Review Subcommittee on Human Resources, reported that the subcommittee had met and approved two appropriations increases for the Cabinet for Families and Children and four appropriations increases for the Cabinet for Health Services. Representative Lee moved for approval of the increases. The motion was properly seconded and adopted by voice vote.
Representative Barrows said he would like to know how the cabinets are planning to spend the recently received federal money.
Senator Guthrie, Co-Chair of the Budget Review Subcommittee on Education, said the subcommittee did not meet but he and other members of the subcommittee and staff had reviewed two appropriations increases for the Education, Arts and Humanities Cabinet, one for Postsecondary Education, and three for the Workforce Development Cabinet and found them to be in order. Senator Guthrie moved for approval of the appropriations increases. The motion was properly seconded and adopted by voice vote.
Representative Adams, Co-Chair of the Budget Review Subcommittee on General Government, Finance and Public Protection, said the subcommittee met and reviewed nine requests for increases for Government Operations, one increase for the Finance and Administration Cabinet, and three increases for the Public Protection and Regulation Cabinet. The subcommittee agreed with the requests for increases. Representative Adams moved for approval of the appropriations increases. The motion was properly seconded and adopted by voice vote.
Mary Lassiter, Bob Cox, and Dr. Larry Lynch appeared before the committee to discuss year-end revenue receipts and accounts close-out.
Mr. Cox said General Fund revenue receipts for FY 2003 totaled $6,783.5 million, an increase of 3.4 percent over FY 2002, but $75.7 less than the official revenue estimate made in January 2003 by the Consensus Forecasting Group. Most of the shortfall was in the sales and use tax and the individual income tax. These two taxes alone account for about 75 percent of the General Fund. The sales and use tax receipts grew by 2.8 percent, or $64.2 million, which represents its second consecutive year of growth below 3.0 percent. In the five years prior to FY 2002, sales tax revenue growth averaged 4.7 percent. Individual income tax receipts rose by 1.6 percent, an increase of $43.9 million from 2002. Corporate income and license taxes combined performed better than expected at $40.7 million. Coal severance taxes have continued to decline. Property tax receipts rose slightly and lottery receipts would have exceeded the official estimate but legislation enacted by the 2003 General Assembly directed money from unclaimed prize funds to go to the Affordable Housing Trust Fund rather than the General Fund. The "other" category includes insurance premium taxes, inheritance taxes, the bank franchise tax, and cigarette and liquor taxes and they all performed close to expectations. Mr. Cox said the actual receipts came within 1.1 percent of reaching the official estimate made in January 2003.
The individual income tax experienced rapid growth in the mid to late 1990s, but growth halted in March 2001, when the national economy went into a recession. Receipts have continued to decline. The sales tax has also slowed down since the mid 1990s. Mr. Cox said corporate license and income taxes are very volatile and difficult to forecast. There have been revenue declines in four out of the last ten years and even though there is an increase in FY 2003, the increase is close to the receipts received in 1995.
Mr. Cox said General Fund revenues were boosted for the first seven months of the fiscal year because of some extraordinary one-time events. In August, there was an unanticipated large sales tax payment. The Tax Amnesty Program brought in money in September and October. There was an unexpected inheritance tax gain in December, and there was another large gain in individual income taxes received in January. All of these revenue increases were the result of a single, one-time event usually involving transactions of financial assets. The last five months of FY 2003 have been very disappointing. Without the one-time, extraordinary money, economic growth was only about 0.5 percent.
The Road Fund grew by $4 million, or 0.4 percent from the previous fiscal year. Most of the growth was in the area of investment income when some bonds were liquidated to reduce the balances in the Road Fund. Motor fuels taxes were up two percent. Motor vehicle usage tax was up 0.8 percent, and the weight distance tax was up 2.1 percent.
Representative Barrows asked if any of the revenue growth was due to legislative action on fund transfers. Ms. Lassiter said the growth did not come from fund transfers. She said most of the growth was due to one-time tax payments and some was from fees.
Representative Barrows asked if the cabinet generated increased investment income by holding on to money longer and not paying on condemnation cases as scheduled, or by slowing down contracts. Ms. Lassiter said the increase in investment income is from bonds being liquidated on the debt side when the Road Fund was being spent down according to the spend-down plan. The bond market is quite stable right now so there were some capital gains as a result.
Representative Coleman asked about the status of the Streamlined Sales Tax Project. Mr. Cox said Kentucky has been a participant in the Streamlined Sales Tax Project since its beginning in 2000 and is one of the first states to pass enabling legislation that will allow Kentucky to serve on the governing board for the Streamlined Sales Tax Agreement. Kentucky's legislation does not go into effect until July 1 of 2004. About 20 other states have also passed legislation but the effective dates all vary. The purpose of the project is to request that Congress grant states the power to collect sales tax that is owed to them for remote sales. Mr. Cox said Congress has the ultimate authority under the Constitution to decide the rules of interstate commerce.
Representative Coleman asked if there are any forecasts on how much money Kentucky would be entitled to collect on remote sales. Chairman Moberly said there were estimates that it may be as much as $280 million by 2006. Mr. Cox said revenue estimates on internet sales are all over the board from millions to hundreds of millions depending on how it is estimated, the base revenue, and the compliance that is achieved. Since passage of the agreement by a number of states, several vendors who have both physical presence and internet presence in Kentucky have voluntarily come forward and agreed to pay revenue on their internet sales. About $4.5 million is expected to be realized from that voluntary action. Ms. Quarles said more and more states are becoming interested in joining the agreement and the project is moving forward much faster than anticipated. Kentucky was the second state to pass enabling legislation and is the largest of the first eight states that joined the agreement. Ms. Quarles said some bills have been introduced in Congress and it is believed that Congress will take some action around the first part of November because of the Internet Tax Freedom Act and the moratorium on the access fee. Remote vendors are launching some resistance at the federal level because their pool of money will start to dwindle when they have to learn to compete with in-state people again.
Senator Sanders asked how many vendors have begun collecting the sales tax. Ms. Quarles said the cabinet is tracking vendors and will share the information with the chairmen when more information is available.
Dr. Lynch said the Consensus Forecasting Group was formed in FY 1993-94 by Executive Order and codified in legislation in 1996 to provide revenue forecasts. Preliminary revenue estimates are due October 15 and final estimates are due by the 15th day of the legislative session. Senate Bill 2 from the 2003 legislative session made two changes: (1) it gave LRC the power to convene the Consensus Forecasting Group to consider revisions; and (2) staff for the Consensus Forecasting Group would be provided by the LRC. Forecasts have now been done for ten years. The first seven years were underestimated and the last three years have been overestimated. The estimates for Kentucky correlate almost perfectly with national economic forecasts. Dr. Lynch said economic turnarounds are very difficult to forecast because the structure of the economy changes continuously.
Dr. Lynch said the Consensus Forecasting Group has begun meeting to develop the four-year planning forecast by August 15. The group is relying somewhat on the Kentucky index of leading economic indicators which is not designed to make a numerical forecast but to point out turning points. The most recent three months were negative which signals a downturn in the economy. The economic news at the national level keeps fluctuating. The group has also begun to monitor a variety of economic data that comes in weekly which provides more input. The group also checks with other states to identify some of their successful revenue estimating methods, but most states are in the same situation as Kentucky, and even the federal government has had difficulty forecasting revenue.
Representative Stacy asked if there are any areas of the economy that are doing better than others. Dr. Lynch said the health services sector does very well in Kentucky. He said Kentucky based a high percentage of its economy on the manufacturing sector which has been very weak during this economic downturn.
Ms. Lassiter said when HB 269 was enacted, it was anticipated there would be a beginning balance of $23.5 million, continued appropriations of $107.2 million, an official consensus estimate of $6.8 billion, tobacco settlement revenues of $127 million and fund transfers of $327 million. Total resources in the General Fund amounted to $7.4 billion. Expenditures appropriated in the budget were $7.2 billion and the reserve for continued appropriations came to $102.5 million. The undesignated fund balance is $138.7 million. In April, the revenue shortfall was predicted to be $81 million, but the actual revenue shortfall is $75.7 million. Adding to the $75.7 million shortfall were unbudgeted expenditures of $14 million resulting in a total shortfall of $89.9 million.
The Executive Branch put cost-saving measures into effect and has reduced expenditures in two categories through unbudgeted lapses and severance tax appropriation reductions. The Finance and Administration Cabinet has been proactive in refinancing state debt and has realized savings through reduced interest rates. All branches of state government have made an effort to reduce the size of the state workforce and have reduced costs for contracting, printing, utilities, leasing, state travel, and the number of state vehicles.
There were three provisions in the budget bill relating to cost saving measures and state workers. The Governor issued an Executive Order on December 3, 2002 saying that the state workforce would be reduced by 1,000 individuals by December 2003. As of July 1, there were 743 more employees but this is due to the hiring of interim employees for the Department of Parks during the peak summer months. The Department of Parks hired approximately 1,300 interim employees for the summer. When those 1,300 employees are backed out of the system this fall, the number of employees will drop 557 toward the 1,000 employee reduction that is required by December 3, 2003. She said the administration is confident that the 1,000 employee reduction goal will be met by December. House Bill 269 also requires that the number of principal assistants in state government be reduced to where it was at the beginning of the administration. At the beginning of the administration, there were 106 principal assistants, and in December, there were 178. Today, there are 102 principal assistants so the Executive Branch has met that target. A third requirement was for the Executive Branch to reduce the number of non merit employees by 250 from the number of non merit employees that were in the system when the budget was enacted. There were 914 non merit employees when the budget was enacted and that number has been reduced by 103 non merit employees.
The enacted budget protected education, public safety and human services, which are the largest areas of state government. The Executive Branch began FY 2003 without a legislatively enacted budget and cabinets operated on the Governor's spending plan. As a result, there are a significant amount of lapsed dollars in some areas of state government. Severance tax appropriation reductions are formula-driven and when receipts were down, the appropriations were reduced. There were excess tobacco receipts of $3.8 million, $327 million in fund transfers, and an excess of $2.6 million primarily in the area of flexible spending accounts for local school districts that was in excess of what was estimated and budgeted. In addition, Kentucky has received some federal fiscal relief. The first installment of $68.7 million has already been received. A second installment of $68.7 million is expected in October for FY 2004. These added resources total $113.7, which is $23.8 million over budget. House Bill 269 calls for any money over budget to go to the Budget Reserve Trust Fund. The General Assembly appropriated $5.1 million to the rainy day fund in 2003, and $25.9 million for FY 2004. The addition of the $23.8 million brings the total of the Budget Reserve Trust Fund from a zero balance in 2002 to $54.8 million.
Ms. Lassiter said Kentucky begins the fiscal year on target with $138.7 million in the bank and it once again has money in its rainy day fund. Kentucky is in its third consecutive year of revenue shortfalls, and it is very likely that the trend will continue for next year. There is a structural imbalance in the two-year budget and even though the federal money provided some relief, it is one-time money and adds to the structural problem for FY 2004.
A recent NCSL report surveyed the states on their economic situations and got back 43 responses. Of those 43 states, 39 had budget shortfalls during FY 2003, and for nearly every state, it was the second consecutive year of budget problems. It was Kentucky's third year for budget problems. Eleven states collected less in 2003 than 2002. The outlook for 2004 is grim for all states. In enacted budgets for 2004, 31 states are cutting spending, 29 states are tapping their rainy day funds, 23 states are reducing the size of their state workforce, eight states are using tobacco funds to help balance their budgets, and several states have borrowed money against their tobacco receipts, or against their pension funds. Ms. Lassiter said Kentucky has not had to resort to such extreme measures. The situation is still critical for Kentucky but Kentucky is benefiting from good financial management, good practices and is not as bad off as many other states.
The Road Fund also had a surplus of $23.6 million which goes into the state construction account. The Transportation Cabinet has followed the same reductions in expenditures as the rest of state government to reduce costs.
Ms. Lassiter said budget instructions were distributed to state agencies on July 23 for the agencies to begin working on their budget requests. The Consensus Forecasting Group will issue their planning report for the next three fiscal years on August 12, and October 15 is the statutory date for release of the official revenue estimates. Agency budget requests are due November 3, although November 15 is the statutory deadline. November 4 is election day, December 9 is inauguration day, and January 27 is the deadline for the new Governor to introduce the Executive Budget.
Representative Draud asked if the budget situation is so critical that there might be a $400-$500 million shortfall. He asked if education will be spared from budget cuts. Ms. Lassiter said it is premature to know if cuts will have to be made in education. She said when the session ended, Governor Patton issued a statement that projected a structural budget imbalance of about $400 million. The federal fiscal money and the one-time unanticipated funds received this year relieved the shortfall for this fiscal year but it is non recurring money that contributes to the structural imbalance in the budget.
Chairman Moberly said there was discussion during session authorizing implementation of a fee on traffic citations to enable localities to make up lost revenue, but it did not pass in the legislation. There was language in the budget that was interpreted by some to mean that the fee could be implemented. An interpretation has been made by Secretary Gordon Duke, Finance and Administration Cabinet, as required by the budget when there is a request for an interpretation.
Gary Bale, General Counsel, Finance and Administration Cabinet, said the legal opinion is that the budget bill language relative to HB 162/SCS is deemed to be surplusage and of no legal effect, and thereby provides no authorization either for the generation of the additional fees which were contemplated by that bill, or for the appropriation for expenditure of any funds which would have been generated by such proposed additional fees.
Bill Thielen, General Counsel, Kentucky League of Cities, said that he respectfully disagrees with Secretary Duke's interpretation. He said it is his belief that when the language was included in the budget bill, the General Assembly intended to and did incorporate by reference into the budget the language that was in House Bill 162, and thereby adopted it for the duration of this budget cycle through 2004. He asked that the committee consider registering its disapproval of the interpretation and request that Secretary Duke reconsider his interpretation. Mr. Thielen said cities are facing the same budget concerns as the state is and they are struggling to provide needed services to their citizens on a shrinking base.
The committee did not take action on the interpretation.
Mr. Thielen thanked the committee and said he will work with the legislature to create a proposal for the 2004 session that will provide an alternative plan for cities to expand their revenue base.
Chairman Sanders said he would like to see a proposal that would benefit all cities and allow more communities the opportunity to receive base court revenue.
Chairman Moberly explained Executive Order 2003-652, which relates to reorganization of the Commonwealth postsecondary education prepaid tuition trust fund and moves if from the Treasurer's Office to the Higher Education Assistance Authority. The committee did not take any action on the Executive Order.
Chairman Moberly explained Executive Order 2003-758, which relates to the transfer of funds within the Transportation Cabinet for closing toll-road booths. In February 2003, Kentucky secured $13 million in federal funding to eliminate tolls on both the Daniel Boone Parkway and the Louis B. Nunn Parkway. House Bill 269 provides that if federal funds become available to support retirement of toll-road debt, each affected toll facility shall be closed, and all affected personnel shall be reassigned within the Transportation Cabinet. No committee action was taken on the Executive Order.
Senator McGaha asked how many employees were affected by the closure of the toll booths and if those employees were moved to other areas of state government. Debra Gabbard, Budget Director, Transportation Cabinet, said there were 88 employees who were offered jobs within the Transportation Cabinet and most of those positions were in the highway district offices. One employee chose to come to central office to the Department of Vehicle Regulation. The money that was budgeted for these employees within the department was transferred with the employee.
Senator McGaha asked what function the employees were performing in their new positions within the cabinet and if there was overstaffing. Ms. Gabbard said she would provide that information.
With no further business, the meeting was adjourned at 2:50 p.m.