Without the state’s most recent internal borrowing, a $600 million certificate of indebtedness (COI) issued June 30, the state general fund (SGF) would have been out of money on July 5, just five days into the new fiscal year, and wouldn’t have a positive balance again until June 21, 2012.

Even with the $600 million loan the SGF balance is projected to drop to only $38.4 million on February 29, 2012, according to a cash-flow model prepared by the Division of the Budget.

State law allows a COI when annual SGF revenues will be sufficient to fully cover the year’s expenditures and obligations but insufficient to meet expenses during certain months. A $700 million FY2011 certificate was paid back June 27.

The COI must be paid off from SGF funds before the end of the fiscal year for which it is issued. That isn’t a problem as long as revenues don’t drop. It’s not even a problem when revenue does come up short – as long as the governor and legislature can make mid-year spending cuts big enough to cover the shortage.

It will be a problem when an unexpected drop in revenue coincides with some disaster that requires state funds for recovery, especially if the state’s idle funds are tied up until the next infusion of revenue, because, unlike the federal government, Kansas can’t spend money it doesn’t have.

How we got here

When a family or business looses income they have to cut spending, and not just on paper. They don’t get to change the rules by making late payments without a penalty and if they choose to borrow to make ends meet they have to pay back what they borrow plus interest.

Such rules are for the little people and businesses and local governments, but state government plays a whole different game. Some of the moves made in 2003 to balance the state budget during a previous, less severe recession are still haunting Kansas and have locked the state into internal borrowing to pay its bills.

The introduction of each year’s Comprehensive Annual Financial Report (CAFR) for state government says, “As a cash flow management policy, the State seeks to avoid borrowing from its own idle funds to meet expenditure obligations of the State General Fund.”

But Kansas has used a Certificates of Indebtedness (COI) to borrow from the state’s idle funds 22 times since 1983; including an unbroken string of 16 COIs beginning in FY2000. Two were issued in 2002, three in 2009.

The term idle funds is somewhat misleading since the money stays invested by the state’s Pooled Money Investment Board and the interest earned still goes into the state general fund. It includes revenues not spent from previous years as well as any cash balances not immediately needed to pay the state’s bills.

In a perfect world, where government only takes what it needs for essential services and revenues are perfectly timed to pay the bills, idle cash might be returned to taxpayers in the form of tax reductions. But in the world we live in idle cash serves as a buffer to let the state pay its bills on time.

One of the dangers in starting with a low ending balance and maintaining low reserves is the inability to respond quickly to disaster. Governor Sam Brownback asked for and the State Finance Council has approved $10 million for disaster recovery from flooding in northeast Kansas and drought in the southwest.

A recession that started before 2000 and got worse after the September 11, 2001, attacks gets much of the blame for budget woes in the early 2000s. That seems to indicate a revenue problem. SGF data from 2000 to 2008 looks more like a spending problem. Expenditures increased 39.7 percent while revenues climbed only 35.5 percent.

The imbalance between the growth of revenue and expenditures from 1998 to 2003 is even worse. Revenue grew 5.5 percent but expenditures grew 8.9 percent.

That’s just the tip of an off-balance iceberg according to the Institute for Truth in Accounting, an advocate for more open and honest accounting for government finance. If all financial obligations, including promised pension payments and health care benefits for retirees, are added up the Kansas state budget was actually $5.2 billion out of balance by FY2011 according to Truth in Accounting.

The April 2003 Consensus Revenue Estimate predicted a $264 million budget shortfall with less than three months to close the gap before the end of the fiscal year.

The Legislature was under pressure from a school finance lawsuit that eventually reached the Kansas Supreme Court. Then-incoming Governor Kathleen Sebelius promised no further cuts to schools after a mid-year cut by outgoing Governor Bill Graves.

The Legislature and Sebelius balanced the budget with what the Wichita Eagle called “creative accounting.” They:

• Exempted the 2003 budget from a 1990 law requiring an ending balance of at least 7.5 percent
• Delayed a $213 million payment to schools until July 2003, into the next fiscal year
• Moved half-year property tax payments from June to May starting in FY2004 to book the revenue before the end of the fiscal year

Double counting

The July 2011 payment to schools included about $220 million that will show up as revenue on school districts’ June balance sheets.

Americans for Prosperity, in their “Commonsense Budget Proposal” for FY2011 said, “Moving a large amount of expenditures into another month and hence a different budget cycle does nothing to change the amount of those expenditures. This sort of accounting chicanery only delays the inevitability of budget problems, and in many ways exacerbates them.”

Steven J. Anderson, currently serving as Brownback’s Budget Director, wrote the AFP report, released Feb. 2, 2010.

Bob Williams, president of State Budget Solutions, a non-partisan organization consulting on state budget reform, said, “It’s an accounting gimmick to mask what’s really happening.”

Accountants familiar with government and private accounting standards told KansasWatchdog the practice is called double counting and would not be allowed in a private business because it represents a fraud intended to deceive whoever reads the financial report.

The double counting approved by the Legislature and Sebelius in 2003 continues in Kansas. The practice recently surfaced in another government venture involving Sebelius, the Patient Protection and Affordable Care Act popularly known as Obamacare.

During a March 3, 2011, House Energy and Commerce hearing Rep. John Shimkus, R-Ill., insisted that Sebelius, now Health and Human Services Secretary, explain how $500 billion in Medicare cuts funds the program into the future and also funds health care reform. After some back and forth Shimkus asked, “ So, are you using it to save Medicare, or are you using it to fund health care reform? Which is it?”

Sebelius responded, “Both.” (video)

A nearly permanent problem

The state’s cash flow is still lopsided because the 2003 changes made receipts significantly larger at the end of the fiscal year and expenditures larger at the beginning of the year.

Property owners who elect to make half their property tax payments in December still make their second payment in May, shortly after the state gets a large shot of income tax revenue.

Schools still receive payments scheduled for June after July 1, the start of the new fiscal year. This year the delayed payment was more than $220 million according to Dale Dennis, deputy commissioner of education. Total July payments to schools will be $627.4 million.

The 2003 Comparison Report recognized the difficulty of moving the school payments back to June. “Barring a substantial infusion of money, the June school payment will have to continue to be made in July in future years.”

Legislators had the best opportunity to correct the situation when revenues increased by $1.29 billion from 2004 to 2007. The Legislature instead chose to increase spending by a nearly identical amount.

Over the next three years a $935 million SGF ending balance in 2007 became a $27.1 million deficit in 2010 as expenditures exceeded revenues by $408 million in 2008 and $477 million in 2009.

“What’s really irritating to me is if you talk to people in the Legislature during the 2000s, many of them will tell you they had money coming out of their ears,” said Rep. Jim Howell, R-Derby. “They were finding things to spend money on. They were approving new spending right and left.”

“They had those opportunities to be smarter and more mature and more responsible, and they didn’t take advantage of those things,” said Howell.

“We’ve gotten ourselves into the habit of internal borrowing and gimmicks to get around what would be good fiscal responsibility,” Howell said. “We couldn’t run our personal budgets this way. Businesses can’t run their budgets this way. But we allow the state to run its budget this way.”

Howell said pressure to spend rather than save for lean times drives discussion of ending balances. “When the house passed an $80 million ending and then a $50 million ending balance there were so many people in the media that used phrases like, ‘enormous ending balance,’ and said Republicans were being unreasonable for demanding such a large number – as if it was a large number.”

One Senate 2011 budget proposal called for a $5 million ending balance citing the need to fund government programs.

The state would need about $675 million in savings or additional revenue at the end of FY2012 to move the school payment back to June and restore a 7.5 percent ending balance.

The way forward

If the state’s economy continues to improve, as the Consensus Revenue Estimate predicts, and if there are no major unanticipated expenditures, such as natural disasters, the state will be able to continue to pay its obligations. If not, Brownback will have to cut spending or the State Finance Council will have to approve additional borrowing form state reserves.

The state’s 2011 ending balance, $160 million including revenues $87.6 million above the CRE, offers hope for the fiscal future but that could change quickly. National economic indicators haven’t looked good in recent months and changes in the economy tend to hit Kansas about six months late.

“Part of the reason for a 7.5 percent ending balance is because estimates can’t be relied on,” said Howell.

Sherriene Jones-Sontag, Brownback’s communications director, told KansasWatchdog:

“Governor Brownback’s long-term strategy for the budget is to build our reserves, lower our reliance on debt issuances and repair our budget’s structural imbalances. Correction of the school payment issue is part and parcel of this strategy. The reduction in the amount of the school payment that is delayed until July will reduce the amount of the certificate. It is not a coincidence that the amount of the certificate is roughly the sum of the 7.5% ending balance requirement and the aforementioned school payment. Given the difficult budget situation he found when he took office, restructuring the state’s budget is going to take much thought, hard work and cooperation.”

“We’ve got to demand we do better and at some point put our foot down and start weaning ourselves off these bad habits,” Howell said. “We may not be able to do it in just one year but may be able to over a series of years.”

Williams of State Budget Solutions said reliance on certificates of indebtedness just delays addressing the problem. “You have a bigger problem, but you just keep kicking the can down the street and the day of reckoning is coming.”

Williams advocates budget transparency to help fix budget problems. “One of the things we’ve really urged is that all budgets be posted online 72 hours before the final vote. Then people would identify these gimmicks, and you’d be able to stop it.”

“I’d say probably three fourths of legislators don’t even know about the certificates of indebtedness,” Williams said. “They don’t even know it’s occurring.”

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