The 3rd meeting of the Interim Joint Committee on Appropriations and Revenue was held on Thursday, August 28, 2003, at 1:00 p.m. (CDT), at the Allen County High School in Scottsville, Kentucky. Senator Richard Sanders, Jr., Co-Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Richard Sanders, Jr., Co-Chair; Representative Harry Moberly, Jr., Co-Chair; Senators Brett Guthrie, Paul Herron, Jr., Robert Leeper, Vernie McGaha, R. J. Palmer, II, Dan Seum, and Jack Westwood; Representatives Royce Adams, Rocky Adkins, Joe Barrows, Scott Brinkman, Dwight Butler, Jim Callahan, Mike Cherry, Robert Damron, Bob DeWeese, Jon Draud, Danny Ford, Jimmie Lee, Thomas McKee, Fred Nesler, Stephen Nunn, Charles Siler, John Will Stacy, Jim Wayne, Robin L. Webb, and Rob Wilkey.
Legislative Guests: Speaker Jody Richards, 20th House Legislative District; and Representative Tommy Thompson, 14th House Legislative District.
Guests Appearing Before the Committee: Judge Johnny Hobdy, Allen County Judge-Executive; Mayor Robby Cline, Mayor of Scottsville; Larry Williams, Allen County School Superintendent; Secretary Dana Mayton, Revenue Cabinet; Mary Lassister, Acting State Budget Director; Robert W. Cox, Deputy Director, Governor's Office of Economic Analysis; Dr. Merl Hackbart, Member of Consensus Forecasting Group; Daniel Williams, Emma Arterburn, and Paul Curtis Foster, students at Allen County High School; Chris Derry, President of Bluegrass Institute for Public Policy Solutions, Bowling Green; and Roger Recktenwald, Executive Director, Kentucky Infrastructure Authority.
Guests: Paul Blanchard, Eastern Ky University; Darrell Calvert, Allen County School Board; Johnny Bernley, Scottsville City Council; Janet Johnson, Scottsville Extension Service; Chris Derry, Bowling Green Bluegrass Institute; Jeff Harper, Ky Farm Bureau; Chris Meld, WVLE, Scottsville; Lisa Simmons, ACS, Scottsville; Ken Goforth, Scottsville City Council; Tedd B. Calvert, Allen County Circuit Clerk; Former Mayor Dell Hall, Scottsville; Byron Jeffries, Metcalfe County Superintendent; Jordan Clarke; Wootan Insurance; Harry Woodward, Scottsville; James Jitter Allen; Mrs. Sandy Williams; Harriette Fowler; Nancy Long; Martha Bazzell; Jim Bazzell; Tommy Long; Roy Williams; Wilson Stone; Scott Wegenast, Ky Action; Lowell Hammers, ACSHS; Debby Spencer, WKC; Mrs. Sue Val Roberts, ACSHS; Danny Shiflett and Jimmy Shaw, Teachers, Allen County High School; and Mrs. Terry Wilkey.
LRC Staff: Terry K. Jones, Pam Thomas, Lou Pierce, Budget Review Staff, and Kathy King.
Chairman Sanders gave opening remarks and introduced Allen County High School students Katie Miller, Amber Weaver, Megan Wheat, Paul Curtis Foster, and Steven King, who assisted local officials and school staff with set-up for the meeting and additional support to LRC staff during the meeting.
House Speaker Jody Richards and Representative Rob Wilkey gave welcoming remarks to committee members and guests and thanked local officials from Allen County and surrounding counties for the hospitality extended to members of the committee.
County Judge-Executive Johnny Hobdy, Mayor Robby Cline, and Superintendent Larry Williams presented their opening remarks and thanked members for coming to Allen County and its surrounding counties.
Chairman Sanders asked for a motion to approve the minutes of the July 31, 2003 meeting. Representative Lee made the motion which was seconded by Representative Siler and adopted by voice vote without objection.
Secretary Dana Mayton presented an update on the Streamlined Sales Tax Project (SSTP). She said states that collect a sales tax are losing sales tax revenue because of the huge increase in remote sales from internet and catalog sales. Companies that do not have a physical presence (nexus) in a state with a sales tax are not required to collect a sales tax. Because internet and catalog sales have increased dramatically, mainstream retailers are at a competitive disadvantage and complain that customers often come to their showroom to decide what they want to purchase and then go home and order it over the internet to keep from paying the sales tax. Retailers who do have a nexus are required to collect the sales tax and they also have the expense of a showroom, stocking inventory, and overhead expenses. Secretary Mayton said there has been some confusion between the SSTP and the Internet Tax Freedom Act (ITFA). She said the ITFA prohibits a sales tax from being applied to internet access fees. However, Kentucky has never tried to collect a tax on internet access fees. Secretary Mayton said SSTP began in early 2000 when a group of states joined together to urge Congress to require collection from all sellers for all types of commerce and to simplify and modernize sales and use tax collection and administration. The participating states have been working together to develop model definitions and model procedures. Kentucky has been a participant in the project since its inception. During the 2001 Regular Session, the General Assembly passed legislation permitting Kentucky to continue as an active participant in the SSTP negotiations. Kentucky was able to cast its affirmative vote when the agreement was signed in November 2002. During the 2003 Regular Session, the General Assembly passed legislation allowing Kentucky to petition to become a member of the governing board of SSTP states. The governing board will be composed of participating states that have passed provisions that are in compliance of the Streamlined Sales Tax Agreement. There are currently 39 participating states and 20 of those states have enacted conforming legislation. Several other states have pending legislation. The terms of the Agreement become effective when at least ten states representing 20 percent of the population of those states imposing a sales tax have passed enabling legislation. Secretary Mayton said North Carolina just recently became the 20th participating state to enact legislation. If their legislation is in compliance, the 20 percent population rule is met and the agreement can actually take effect. The next step will be to certify those states as being in substantial compliance. The implementing states will meet sometime this fall to create the governing board from the states that have passed legislation and review each state's legislation and vote whether or not the legislation is sufficiently in compliance with the model legislation.
Secretary Mayton noted that a positive effect of the project is that several large retailers have come forward voluntarily and have agreed to collect the sales tax on their internet and remote sales for a period of three years to give the Revenue Cabinet time to get the program up and going. There are currently ten registered taxpayers voluntarily collecting the taxes and the Multi-State Tax Commission says there are more retailers who will join. The cabinet is trying to track receipts from those companies and will know more about the increased collections in January or February after the holidays.
Representative Lee asked what happens to states that do not want to participate in the agreement. Secretary Mayton said the presumption is that Congress will allow the participating states to collect their sales tax but states that are not participating would not be required to collect the tax. Several states that were observer states have now become implementing states so there is more pressure on states to participate.
Representative Lee said the large states must be experiencing the same problems as Kentucky is and it would be beneficial if those states became implementing states. Secretary Mayton said there was a lot of concern early on about the differences between the small states and large states. For example, South Dakota relies solely on its sales tax so it had to become a participating state. As the project has progressed, more states have joined the effort, including two large states, Texas and Florida. She said the project started out slowly but it is moving in the right direction.
Chairman Sanders asked how much sales tax from internet purchases is not being collected. Secretary Mayton said the loss is around $150 to $180 million. She said the Fox Report estimates the loss will exceed $280 million by 2006.
Senator Westwood asked what is meant by "partially enacted." Secretary Mayton said there are some states with unique issues that may experience a budgetary impact if they enact all of the compliance rules. For example, most states round down from four and under and up from five and above. Some states, however, do not follow that rounding rule and, therefore, do not meet the project compliance requirement for rounding. If there is a budgetary impact, a state may have to decide if it can afford to lose a few million if it means it will be able to collect $100 million.
Senator Sanders thanked Secretary Mayton for her testimony and introduced Mary Lassiter, Acting State Budget Director, Dr. Merle Hackbart, Member of Consensus Forecasting Group, and Robert W. Cox, Deputy Director, Governor's Office of Economic Analysis.
Ms. Lassiter said General Fund July receipts were up by 8.4 percent. The sales and use tax grew by 3.2 percent; the individual income tax grew by 10 percent; corporate income and license taxes grew by 23 percent; property taxes grew by 57 percent; and "other" taxes were up almost 30 percent. Coal severance tax receipts were down slightly, and the lottery was flat. Ms. Lassiter noted that even though there is an 8.4 percent increase for this July, the increase is based on a comparison to July receipts from last year when there was negative 3.6 percent growth. She told the committee that the growth required for the existing official forecast is 4.6 percent for the year so there must be 4.3 percent growth for the balance of the year to meet the budgeted revenues. Ms. Lassiter said the two most important taxes are the sales tax, which is 35 percent of the General Fund tax receipts, and the individual income tax, which accounts for 42 percent of the General Fund tax receipts. To meet the official estimated growth, the sales tax will need to grow 4.7 percent for the rest of the year and the individual income tax will need to grow 8.6 percent for the rest of the year.
Ms. Lassiter said the Road Fund had a 6.2 percent growth for July. There was no growth in the motor fuels taxes and the motor vehicle usage tax was a negative 6.5 percent. The negative percentage is because motor vehicle sales were very high last year due to car dealers offering zero or low interest rates. There was a substantial increase in the license and privilege tax but this is because a payment came in July when it was expected in June. Last year, the payment came in June. The Road Fund is expected to grow 1.4 percent for the fiscal year and it only needs one percent growth over last year for the rest of the fiscal year.
Dr. Hackbart explained the history of the Consensus Forecasting Group, which was an initiative enacted by legislation in 1997. Many states have begun providing long-term forecasts and the federal government also provides a long-term outlook which is very helpful in understanding general fiscal conditions. Because many states are experiencing structural budget problems and their continuing revenues do not match their continuing expenditures, a long-term outlook is important because it can identify some of the implications of future programs and appropriations.
Dr. Hackbart said the Consensus Forecasting Group follows a series of steps to determine its long-term estimates. First, the group must establish and analyze the true economic revenue base for the previous fiscal year; it must analyze the national long-term economic forecast; establish the long-term Kentucky economic forecast; reforecast FY 2004 economy and revenues; and finally prepare long-term forecasts for the General Fund and the Road Fund for the future years. In FY 2003, the state received extraordinary one-time revenue which had a major impact on the revenue growth for FY 2003 in the amount of $192.5 million. To establish a true economic revenue base for 2003, the group had to adjust for the one-time revenue. Because last year's base was much lower than anticipated, the most recent forecast for FY 2004 suggests that the current rate of growth will not meet the original forecast produced in January of this year. The realized revenue base for FY 2003 was $6,783.5 million. To reach an actual recurring revenue base, the value of the one-time events at $192.5 million were backed out bringing the recurring base down to $6,591 million for FY 2004 and future years.
Chairman Sanders asked if the federal relief money that Kentucky received is included in the revenue base for the forecast. Dr. Hackbart said that they were not because they are one-time funds that will be used to help balance the budget for 2003 and 2004.
Dr. Hackbart continued his testimony by noting that the major reason for an adjustment downward for FY 2004 in the current fiscal year is due to a slower than anticipated economic recovery for both the national economy and the state economy as well as the reduced revenue base for FY 2003. Global Insight, a national analyst group, reduced the anticipated growth rate for FY 2004 from 4.4 percent to 3.3 percent. Their expectation for personal income was dropped from 6.0 percent growth in FY 2004 to 4.3 percent growth, and the U.S. employment growth compared to the original forecast is also expected to be much slower for the current fiscal year, down from 1.8 percent to about 0.6 percent. In January of last year, it was anticipated that personal income growth would be about 4.8 percent. That figure has been adjusted downward to 3.2 percent for the current fiscal year. Employment growth is down from 1.4 percent to 0.2 percent, and Kentucky manufacturing growth is expected to decline this fiscal year on a continual basis.
Based upon the new forecast that Global Insight has produced for the national economy for FY 2004 and their projection of future growth, the growth rate for personal income for FY 2004 is 4.3 percent expanding through the following years to a more stable growth rate in the 5.5 percent range. Employment is expected to be very slow for FY 2004 at about 0.6 percent going to 1.5 percent to 2.0 percent in the out-years. Manufacturing employment is expected to take a hit again nationwide. Typically, the manufacturing sector are the higher paying jobs so the manufacturing job loss is of most concern to Kentucky because of withholding taxes and other revenue implications. Modest recovery with stable growth is anticipated after FY 2004. Global Insight also identifies some key drivers of the future economic outlook, and the consumer is an important player in that process. The recent rebates that consumers have received could be a short-term stimulus to retail sales. There are concerns about consumer confidence and if consumers will spend to help the economy move forward. Business investment is another area of strong concern. It has been slow throughout this economic downturn and there is concern nationwide. Surveys of some major U.S. corporations about their recent tax package and how accelerated depreciation will impact their ability and interest in investing in new plants and equipment is a concern. The majority of those business firms have indicated that it is going to have very little impact upon their business decision-making. They are more concerned about the economy and what is going to happen in the future.
Representative Wilkey said there is a significant amount of unemployment and underemployment. Economic growth must be in the 2.5 percent growth range in order to maintain employment at a flat rate. He asked how the national economic growth percentages compare to employment growth. Dr. Hackbart said the latest estimates for unemployment for the U.S. is around 6.2 percent to 6.3 percent. He said there must be stronger recovery to begin to deal with the unemployment problem.
Dr. Hackbart said Kentucky's economy in the long-term is performing in line with the U.S. economy except for the current fiscal year because Kentucky has a higher percentage of its labor force involved in the manufacturing sector. If the economy recovers as the national forecasting groups are predicting, it will be a positive for Kentucky, but it continues to be very difficult to predict.
The total General Fund forecast for the upcoming fiscal year is $6,816.6 million, which is about a 0.5 percent growth over FY 2003 as recorded. Economic revenue growth for the current fiscal year is projected to be about 3.4 percent and while it is a recovery, it is a slow recovery. Kentucky also has a continuing problem with its structural imbalance and elasticity.
The original forecast made last January for the current fiscal year was $7,091 million. The new forecast for the current fiscal year is $274.4 million less than the January forecast. The next forecast will be made on October 15 and it is the budget planning forecast required by statute.
The revenue forecast for the Road Fund for FY 2004 represents a growth rate of 1.4 percent. The Road Fund performed better in July than anticipated and only needs a 1.0 percent growth rate for the rest of the fiscal year. The Road Fund is a separate fund dedicated to road maintenance and construction.
Dr. Hackbart said there are several long-range revenue outlook concerns. There is continuing erosion of the sales tax base and erosion of the personal income tax base. The consumer is switching consumption habits toward services and away from manufacturing goods. In addition, remote sales and internet sales are rising rapidly. The pension exclusion will have a major impact on the elasticity of the individual income tax and the withholding tax because more Kentucky citizens will be eligible for the pension exemption. Another concern is the volatility of the corporate license tax. Dr. Hackbart said these trends need to be dealt with because they will not be solved by economic recovery.
Representative Siler asked if the 8.4 percent increase in revenue receipts is an indication of an improved economy. Ms. Lassiter said it is too early to draw any conclusions because the July receipts are only one month of data and even though the percentage is up, it is based on 2003 July receipts, which were very negative. However, there is some growth and that is encouraging.
Representative Draud asked how the $274 million shortfall for FY 2004 impacts the structural imbalance. Ms. Lassiter said the $274 million shortfall is only on the revenue side. At the end of the session, it was estimated that there would be a $400 million structural imbalance by the end of the biennium. If those two figures are added together, there will be challenges to keep existing programs.
Representative Stacy asked if the current economic situation is similar to any other economic recession. Dr. Hackbart said this recession is relatively mild compared to previous recessions which may mean a slower recovery. Due to low interest rates, consumers have continued to buy large ticket items such as homes and cars so there has not been a pent-up demand for goods that has been the case in previous recessions.
Representative Brinkman asked how much revenue is being lost because of the pension exclusion. Mr. Cox said there are several different pension exclusions enumerated in the Tax Expenditure Report which will be prepared in the next couple of months.
Daniel Williams, a student at Allen County High School, asked if there are any new revenue sources that can be used for education. Representative Stacy said the gubernatorial candidates have identified some revenue sources for education. Chairman Sanders said students are the future of Kentucky and members of the Appropriations and Revenue Committee are committed to trying to keep the momentum going for Kentucky education. However, budget constraints are a concern during these difficult economic times because the budget must be balanced. Representative Wilkey said education is important to Kentucky and in order to continue the momentum for education, it will be necessary to make some very difficult decisions about Kentucky's tax structure. As Dr. Hackbart pointed out, Kentucky's revenue stream is not growing with the economy because of the elasticity of the revenue. Attempts to cut waste and spending are not enough to address an already significant budget shortfall. He said legislators may have to make some very difficult decisions in January and begin to address comprehensive tax reform. Representative Cherry said there is no better expenditure than education because there is a return on the investment. Statistics show that a college graduate makes a million dollars more in a lifetime than a high school graduate. Secondary education spending has declined over the last six or seven years from 48 percent to 41 percent and that trend needs to be reversed. It will be difficult to reverse that trend without some increased revenue. Two issues that have been discussed that would increase revenue are expanded gambling and raising taxes on cigarettes.
Emma Arterburn, a senior at Allen County High School, asked about the future of the KEES scholarship program. Chairman Sanders said the KEES scholarship program was enacted in 1998, and funding was based on lottery proceeds. High school students could receive a maximum of $2,500 for college tuition for maintaining a "C" average, or better. Lottery proceeds are in jeopardy and may be further impacted because Tennessee has enacted a lottery. Chairman Sanders said he believes the program will be continued but it may be necessary to make changes, for example, by increasing the grade point average. The Council on Postsecondary Education has the ability by law to adjust the KEES scholarship funding based on lottery proceeds. Representative Cherry said the lottery is supporting the KEES program right now but maximum KEES expenditures will not be reached until school year 2006. At that time, the lottery is supposed to provide 45 percent for KEES and 55 percent for need-based scholarships. He said there will probably have to be some adjustments made to the program because it is another tough issue that demands revenue.
Paul Curtis Foster, a student at Allen County High School, asked how Kentucky will be impacted when Tennessee's lottery goes into effect and how Kentucky will be able to make up the lost revenue. Chairman Sanders said the Consensus Forecasting Group has included the impact of lost revenue from Tennessee's lottery in their estimates. He said one advantage that Kentucky's border counties have is that Tennessee just raised their sales tax last year to about 10 percent, and there are no exemptions for food or medicine, which Kentucky does have. It is believed that some Tennesseans will continue to come to Kentucky to shop for food and medicine. As for making up the lost revenue, there is the issue of looking at comprehensive tax reform and the elasticity of the state budget where the budget is more in line and growing with the economy.
Chairman Sanders thanked the students for their questions. He said the state has invested significant more dollars per student based on the student population and that momentum needs to be maintained. The budget situation is serious. The two largest areas of growth are human resources and prisons.
Chris Derry, President of Bluegrass Institute for Public Policy Solutions, spoke against Kentucky's participation in the Streamlined Sales Tax proposal. He said proponents of the proposal are saying that it promotes equity among retailers when, in fact, it is a huge tax increase. Internet sales create more business. A person in rural Kentucky who develops a small business over E-Bay does not have the infrastructure that a Wal-Mart has so small businesses will be faced with an unfair advantage. Mr. Derry said school districts need more tax revenue and citizens are being forced to pay more in taxes. Governments consume about 42 percent of all that is produced in America. In 1900, it was six to seven percent. Mr. Derry said it is time to reconsider whether Kentucky should be included in the tax grab as a result of the Streamlined Sales Tax Project.
Chairman Sanders said Kentucky is required to have a balanced budget. He asked Mr. Derry how states and local communities can continue to provide necessary services without some level of funding. Mr. Derry said the issue is the principal of federalism in action and states being able to tax other people in other states for their benefit. The Quill decision established the nexus issue of saying that domestic companies can only be subject to tax in other states where they have a physical presence. The Streamlined Sales Tax proposal goes beyond that. He said there must be protection of liberties for American citizens.
Chairman Sanders asked Mr. Derry if he had any suggestions on where to find additional revenue resources for schools. Mr. Derry said the Bluegrass Institute of Public Policy Solutions is a state-based association and there are 42 other state-based associations throughout the United States that believe school choice will alleviate some of the budget problems that states are facing. Many parents do not believe their children are getting the quality of education they deserve in public schools and states should open up the notion of providing competition to government-based schools with a myriad of different options.
Representative Wilkey said school choice may be a possibility in metropolitan areas but it is not possible in rural areas where most Kentuckians live. The school system in Kentucky is excellent and most Kentuckians are happy with Kentucky's public education system. He said 60 percent of the state's budget goes to education. Medicaid and Corrections take another large chunk of the budget. There are about 670,000 Kentuckians on the Medicaid roles, and these citizens are elderly, disabled, or handicapped and suffer from illness. The areas mentioned consume about 90 percent of the budget. The other ten percent is used to operate the rest of state government. Representative Wilkey noted that the members of the Appropriations and Revenue Committee have pared the budget as much as it can to make sure that at least the basic level of services are provided to Kentuckians. A problem is that all Kentuckians expect a quality education, expect nursing home services for the sick and elderly, and they expect that criminals will be kept off the street. Providing these services with limited revenue is a challenge.
Senator Sanders introduced Roger Recktenwald, Executive Director, Kentucky Infrastructure, for an update on the water and sew projects.
Mr. Recktenwald said that the water projects that were appropriated in the 2000 General Assembly through the tobacco program are currently under construction. In the 2003 session, there were two allocations - one from the coal severance fund and the other from tobacco funds. Implementation of the projects has already started. The Finance Cabinet is preparing to sell bonds at the end of September and anticipates having the funds available for the projects by mid-October. Grant recipients that were line-items in the budget have been notified and asked to appoint a project administrator at the local level who can coordinate with the engineer on the project. Two meetings have been held with project administrators to talk through the process and assist with project implementation. As soon as the funds are available, the projects will go through the Capitol Projects and Bond Oversight Committee. After that, the local community will receive 85 percent of the value of the awarded project. The project administrator must maintain disbursement records and when the project is closed out, there will be an audit and the final 15 percent will be dispensed. Mr. Recktenwald said the process is moving quite smoothly. He said there are some communities that have asked if they can switch projects from what they originally selected and recommended. He said this is difficult to do because the budget language does not provide that level of flexibility. Consequently, the Authority may be asking for reauthorization or reappropriation for some projects in January. Mr. Recktenwald said the projects will be completed as expeditiously as possible.
Representative Siler said three projects in his district are all flowing at the proper pace. Mr. Recktenwald said the system is working because it is community-based.
Senator Sanders asked how many people will be served by these water projects. Mr. Recktenwald said 28,600 householders will receive public water for the first time in this current round that was just approved, and 712,000 householders will receive improved water service.
Chairman Moberly recognized Steve Mason, Budget Analyst with the Office of Budget Review, upon his retirement.
With no further business, the meeting was adjourned at 3:05 p.m. (CDT)