THE BOND BUYER: Court ruling keeps pressure on Kansas finances

By Richard Williamson
October 6, 2017
DALLAS – The Kansas Supreme Court’s recent finding that this year’s increase in school funding failed to meet constitutional requirements means that state budget pressures will continue, credit analysts said.
tax rate whiplash

“S&P Global Ratings anticipates that the continued negative pressures on state finances will keep Kansas’ finances vulnerable and pressure its credit rating until the state provides a sustainable funding solution for its schools which is approved by the courts,” wrote S&P analysts Oladunni Ososami and David Hitchcock. S&P maintains a negative outlook on the state’s AA-minus rating.

The court ruling creates uncertainty for a credit position that had strengthened with the passage of tax increases earlier this year.

“Our focus on the effects of the ruling will be on how the state addresses the additional school funding, and the extent to which the additional funding leads to larger gaps in the state’s 2019 budget as well as future budgets,” they added.

The court ruled on Oct. 2 that the $488 million of school funding added by Senate Bill 19 for the biennium is inadequate to meet constitutional requirements. The court gave the state until April 30 to present an adequate funding plan.

Under the ruling the state can review and make necessary adjustments to its current budget to address the court decision.

“While we expect that the ruling will increase expenditures and put additional pressure on the budget, it gives the state some time to figure out how much more to pay school districts, which is currently uncertain,” the S&P analysts said. “State officials anticipate that the additional funding proposed will affect the fiscal 2019 budget but not 2018.”

Though the justices did not specify how much more funding was needed, their latest ruling in Gannon v. Kansas declared that, under the facts of this case, the state has not met its burden of establishing that school districts have reasonably equal access to substantially similar educational opportunity through similar tax effort by imposing different procedures for certain districts to raise their maximum local option budget.

The school districts sued for more than $800 million in additional funding, which is nearly twice the state legislature’s adopted additional funding of $488 million over the next two years.

The current state budget includes a revised structural budget gap, which S&P reckons is about 4% of expenditures in 2017, 3.3% in 2018, and 3.6% in 2019. That is expected to leave the budgetary fund balance at about $134.8 million at the end of fiscal 2019, analysts said.

“The calculated deficits do not include Kansas’ significant transfers from its highway fund, which are proposed to be ongoing despite resulting slowdowns in the state’s long-term highway capital plan,” analysts said. “Also, the calculated structural deficit does not include underfunding of the actuarial annual pension contributions, which is expected to persist through the biennium.”

The Oct. 2 court ruling was the fifth school finance decision involving Article 6 of the Kansas Constitution, which imposes a duty on the legislature to “make suitable provision for finance of the educational interests of the state.”

The plaintiffs, which included several school districts, filed suit in 2010 asserting that the state violated the constitutional requirement by inequitable and inadequate funding of K-12 public education. A three-judge panel determined in 2013 after a trial that the state government had inequitably and inadequately funded education for years in violation of Article 6.

On appeal, the Supreme Court held that 2015 legislation meant to remedy the situation was constitutionally inadequate.

“Evidence showed that not only was the state failing to provide approximately one-fourth of all its public school K-12 students with the basic skills of both reading and math, but that it was also leaving behind significant groups of harder-to-educate students,” the court declared. “And substantial competent evidence showed that the student performance reflected in this evidence was related to funding levels.”

The court gave the 2017 legislature time to bring the state’s education financing system into compliance with Article 6 of the Kansas Constitution.

The Oct. 2 ruling applies to Senate Bill 19, approved by lawmakers this year to increase funding in an effort to meet the court’s expectations.

The ruling comes as Gov. Sam Brownback prepares to join the Trump administration, awaiting confirmation to a position heading the State Department’s Office of International Religious Freedom, and after the state’s GOP-dominated legislature away from their fellow Republican governor’s 2012 tax cuts, which created severe revenue shortfalls.

“Lawmakers came together during the 2017 session to right Kansas’ fiscal ship, but work remains to repair the damage done by five years of a failed tax policy,” said a statement from the Kansas Center for Economic Growth, which generally favors progressive policies. “From districts unable to keep the doors open five days a week, to the mass exodus of teachers from our state, to a superintendent sacrificing his own salary because of worries his district won’t make the next month’s payroll, nearly every community has suffered from the state’s budget crisis.”

A joint statement from Republican legislative leaders called the court’s ruling an “unrealistic demand.”

“This ruling shows clear disrespect for the legislative process and puts the rest of state government and programs in jeopardy,” said the joint statement by Senate President Susan Wagle, R-Wichita, Vice President Jeff Longbine, R-Emporia, and Majority Leader Jim Denning, R-Overland Park.

As a result of lawmakers’ decision on June 6 to override Brownback’s veto on Senate Bill 30, the state’s deepening budget shortfalls appear to be abating.

SB 30 ended some of the Brownback income tax cuts that were designed to eventually end the state income tax entirely.

After the legislature’s action, Moody’s Investors Service revised its negative outlook on the state’s Aa2 rating to stable. The veto override should generate about $600 million of new revenue per year, equating to 10% of the budget, and “go a long way toward solving the state’s budget challenges,” analysts said.

“The combination of lower tax rates and tax-exempt pass-through income that commenced in 2013 depressed the state’s revenues by hundreds of millions of dollars and contributed to a budget gap of about $500 million,” Moody’s analyst Dan Seymour wrote. “The state has consistently closed this gap through such credit-negative techniques as deferring pension contributions and depleting reserves.”

Indications of a comeback continued Oct. 2 as the Kansas Department of Revenue reported that tax collections so far this fiscal year are running $142.8 million ahead of last year. The state’s fiscal year began July 1.

For the fiscal year to date, taxes totaled $1.516 billion. September tax collections totaled $602.59 million. Receipts show corporate, individual, and sales tax collections continue to exceed fiscal year to date revenue projections, officials said.

Corporate income tax collections totaled $66.24 million in September, which is $3.79 million above this point last year. In raising taxes, the legislature eliminated a provision allowing most corporations to avoid income tax. The new law aside, the figures indicate gains in the manufacturing, trade, and transportation industries, Williams said.

“Revenue receipts from individual income taxes are exceeding the revenue estimates,” Revenue Secretary Sam Williams said.

Revenue estimates are difficult to determine, Williams said, because holders of pass-through entities are not required by the new tax law to make estimated payments, as long as they pay their taxes in full by April 17, 2018. Also, employers are implementing the new withholding tables at varying rates. The combination of these two factors complicates revenue estimating for this fiscal year, Williams said.

“We are going to continue watching and analyzing the trends of revenue receipts in the coming months,” Williams said. “I’m pleased to see continued strength in sales tax and corporate income tax revenue.”

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