Grade Inflation–Details of S&P’s report giving Texas a AAA Credit Rating

Standard & Poor’s (S&P), the leading national credit rating firm, recently raised Texas’ general-obligation bond rating to AAA – the highest rating.  Unsurprisingly, the governor and other elected officials hailed this upgrade as vindication of recent legislative tax and budget decisions.
But reading the fine print shows that Texas’ revenue system has serious flaws and should get a grade of Needs Improvement.
Here are a few quotes from the S&P report pointing out potential rocks in the revenue road (All quotes from Ratings Direct, Texas: General Obligation. Oct. 2, 2013.  Emphasis added by CPPP)
Potential long-term budgetary pressures, which are primarily related to the growing proportion of school revenues Texas is required to fund, as well as insufficient new sources of recurring dedicated tax revenue to support the increased education funding”  (page 2)
“Historically, state officials have addressed budget shortfalls by implementing structural measures, including several sales tax increases following the 1980s oil bust and expenditure reductions following the recession in the early part of this century.  In our opinion, however, the state’s focus on structural solutions has shifted to incorporating a growing number of one-time solutions to its budget challenges. One such example was the 2012-2013 biennium. From an initially estimated gap of approximately $27 billion identified in 2011, state officials addressed approximately $12.2 billion of this gap through one-time revenue measures or deferral of expenditures. In addition, there have been other budget measures that have created the potential for long-term budget imbalances, particularly during times of economic decline. One such example is the set of revenue solutions adopted in the school finance reforms that the legislature approved in 2006. This legislation required school districts to reduce local school district property tax rates by one-third. The state committed itself to fill the revenue gap that this created. The legislature also approved several tax measures designed to provide the state with funds to offset the cost of property tax relief legislation. These measures, however, have been insufficient, in their current form, to fully cover the increase in expenditures related to property tax relief.”  (page 6)
“While we expect that the state’s budgetary performance will remain strong in the current biennium, we believe that there are also ongoing sources of potential budgetary pressure, particularly if the economy slows down significantly and revenue growth wanes. Chief among these potential sources of persistent imbalances is education funding. As we have said for the past six years, we believe the school finance reforms that the legislature approved in 2006 created a long-term source of budget pressure for the state. The taxes approved as part of this legislation have proven insufficient to cover the increase in state funding. In addition, we believe that the mismatch between when the state collects its franchise tax and other revenues and when most of the transfers to schools have to be made will likely increase the pressure on the state’s cash flow. Under current law, the state is required to transfer approximately 58% of annual payments to schools in the first three months of the fiscal year. If the timing of transfers to schools remains unchanged, Texas’ temporary cash shortfall in the early part of the fiscal year could grow significantly. Although the state has a very strong track record of successful issuance of TRANs to cover its temporary cash flow needs, and its overall liquidity has remained strong, we believe that unless the legislature approves changes to the timing of transfers to schools, the projected student enrollment growth could pressure the state’s liquidity, particularly during periods of slow revenue growth. In our opinion, the shift in education funding to a source that closely tracks the economic cycle (state general purpose funds) from a relatively stable one (local property taxes) could pressure the state budget, in particular during periods of economic decline. In our view, the state’s budget imbalance is likely to reappear unless the state identifies other sources of revenue or additional budgetary flexibility to fill what could be a growing funding gap and to smooth the timing of the required payments to local school districts.”  (page 10)

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