September 16, 2014

Treasury Creates $1.5 Billion Credit Line To Sustain State Operations

Responding to a request from the Corbett Administration, Pennsylvania Treasurer Rob McCord, in consultation with Auditor General Eugene DePasquale, has extended a $1.5 billion line of credit to the Commonwealth so it can cope with a General Fund cash balance that plunged below zero earlier this week.
The administration borrowed $700 million against that line of credit on Monday.
The state’s main operating account dipped to around negative $20 million Monday morning prior to the transfer. It had not approached zero this early in the fiscal year in more than a decade.
“Pennsylvania is now compelled to borrow unusually early in the fiscal year to pay its daily bills,” said McCord. “To solve the problem in the near term, I have decided, in collaboration with the Auditor General, to make funds available temporarily that will allow the state to continue operating. This will save state taxpayers a substantial amount of money in borrowing costs.”
“As the state’s fiscal watchdog, I am relieved that Treasurer McCord is able to offer a plan to bail the commonwealth out of this immediate budget problem,” DePasquale said. “I remain concerned that the need for a loan this early in the budget year is a strong indicator of the bigger budget problems the governor and legislators will face in the coming months and years.”
Revenue typically comes into the state unevenly during the course of the fiscal year, but Pennsylvania’s cash balance has, on average, been in steady overall decline. The 10-year average for early September is $2.241 billion.
Last year it stood at $2 billion in early September – still below average but not as dire – and Treasury was not asked to create a $1.5 billion internal line of credit by the administration until December. This year a loan is necessary three months earlier.
The internal loan of up to $1.5 billion will come from Treasury’s cash investment fund, “Pool 99” (McCord is sole custodian of that fund). The loan will help the administration avoid higher interest rates and fees it would have incurred through the financial markets.
It will also allow the administration to draw from the line of credit only as needed, avoiding “negative carry” or interest payments on the full credit line when that amount is not needed immediately.
A government in a weak cash flow position sometimes issues Tax Anticipation Notes (TANs) – short term borrowing that it repays when tax revenues increase further into the year. Under state law, both the Treasurer and the Auditor General must approve the issuance of TANs.
Because it would ordinarily be required in the case of such borrowing, McCord considered it prudent to secure the input and agreement of Auditor General DePasquale before extending the line of credit.
The General Fund will repay Treasury by the end of the fiscal year and at a 0.25 percent interest rate that, although modest, will still be enough to generate positive return for the taxpayers and for stakeholders in the Pool 99 fund.
Treasury probably would not have earned as high an interest rate from such short-term market investments as it is gaining in this case from the General Fund.
While agreeing to the line of credit, the Treasurer and Auditor General said Pennsylvania’s precariously low cash balance was symptomatic of deeper financial problems that can no longer be ignored.
“Although we are pleased to be able to help the administration during this difficult time with an innovative, win-win solution that saves money, we also recognize this loan really just masks a much larger chronic budget problem that plagues our state,” McCord said. “Like a family buying groceries and paying the heating bill on credit, you can get away with it for a little while, but eventually you have to pay the credit card bill.”
McCord and DePasquale pointed to the cumulative problems created by tax breaks for selected businesses, and reliance on one-time revenue sources. Reductions since 2011 in the Capital Stock and Franchise Tax have cost Pennsylvania’s General Fund an estimated total of $1.8 billion.
A natural gas drilling tax, levied at the five percent rate common in other gas-producing states, could have yielded almost $1.6 billion cumulatively since fiscal year 2010-11.
In this budget year, if the state had retained the Capital Stock and Franchise tax at its 2011 level and applied a 5 percent drillers tax, the commonwealth would be on schedule to receive $1.686 billion ($786 million and $900 million respectively) in new revenue. This $1.686 billion is clearly more than the credit line requested by the administration.
“We are in this position because instead of evaluating and considering all available revenue, this year’s budget relied heavily on one-time funding sources and overly optimistic revenue projections,” DePasquale said. “To the average family, it would be like buying a house based on a raise you anticipate, but did not yet receive. Then finding out you can’t afford the mortgage.”
To mask the shortfalls resulting from foregone revenue, the state has used gimmicks such as transfers of excess funds intended for other purposes. While that helps to balance the annual budget, it leaves holes in future budgets because the revenue does not recur year after year. Approximately 8.5 percent of the current General Fund budget is based on one-time revenue sources.
As a result, the state’s Independent Fiscal Office predicted annual structural deficits – incoming revenue lower than expenditures within a fiscal year – of more than $800 million this year and more than $2 billion by the 2018-19 fiscal year if the state remains on its current track.
“As bad as the bottom line is right now, if anything, the state’s true financial condition is even worse than it appears because Pennsylvania has papered over its problems by draining other funds to balance the last several budgets,” McCord said.
Pennsylvania is in a much weaker financial condition than most other states. Many are enjoying budget surpluses while Pennsylvania has struggled to overcome annual deficits that are due mostly to insufficient revenue. The national average among states for the combined General Fund and Rainy Day Fund balances as a percent of expenditures is estimated to be more than 8 percent in 2014. Pennsylvania has no Rainy Day Fund budget reserve and a General Fund balance barely above zero.
“When the budget was passed in July, I said we would regret it by mid-December because the revenue was not matched to the expenses,” DePasquale said. “The fact that the state needs a loan this early in the fiscal year is more proof that we need more realistic budgets in the future.”
House Majority Leader Mike Turzai (R-Allegheny) issued the following statement in response to the politically motivated press event held by State Treasurer Rob McCord and State Auditor General Eugene DePasquale:
"The Commonwealth has a balanced budget and will be paying its bills on time using the same fiscal management and cash flow tools it has always used.
"Unfortunately, the recent press event hosted by the treasurer and auditor general is nothing more than political theater and an unnecessary waste of time.
"The truth is this agreement between the treasury and the administration is not uncommon. Ironically, the treasurer and auditor general did not see it important to have a similar press event when this same deal was made last year in a non-election year.
"The one-sided characterization of the state's cash flow position failed to point out the real reasons state cash reserves are off from historical norms. The treasurer and auditor general ignored the fact that that federal government fiscal policy caused a $400 million hit to Pennsylvania income tax collections, and the state has had to expedite Medicaid payments in anticipation of the impending cut of federal government FMAP payments to Pennsylvania by more than $340 million. Also, the state sent more than $200 million in advance funding to help the Philadelphia School District.
"What is also concerning is that while the agreement is in fact a positive alternative to private market Tax Anticipation Notes for the General Fund, the treasurer is actually unnecessarily charging the taxpayers a higher interest rate than he gets for short-term investments on the private market."
House Democratic Leader Frank Dermody (D-Allegheny) and Appropriations Committee Minority Chair Joe Markosek (D-Allegheny) say the concerns about the state's General Fund cash balance expressed today by the state treasurer and auditor general are valid and should be taken very seriously.
"When the current state budget passed on June 30 without one Democratic vote, we and many other observers faulted its overreliance on one-time revenue sources and questionable assumptions about revenue," said Dermody.
"Even so, a cash flow problem like we have now is unusual so soon in a budget year," he said. "It's a clear sign that the Republican budget was not right to begin with."
Markosek concurred: "The budget that was signed into law created a huge fiscal mess for Pennsylvania and for future legislatures and governors. We agree with the state's two independently elected financial officers that there is reason to be concerned.
"The short-term loan of Treasury funds allows the state to continue paying its bills for the time being, but it does not solve the problem," Markosek said.
The Independent Fiscal Office and the nation's three major credit rating agencies have all noted that choices made in recent Pennsylvania budgets are creating a structural budget deficit that cannot be solved with one-time fixes.