David Rosen, the chief budget analyst in the nonpartisan Office of Legislative Services warned lawmakers in both the Senate and Assembly this week that revenue projections for the current and upcoming fiscal years will likely come up $526 million short due to “lackluster” growth in major tax revenue in recent years. He also warned that the coming fiscal year beginning July 1 would be largely the same. This news foretells another tough budget season.
“Without the luxury of the revenue growth experienced elsewhere, you face even harder choices than your counterparts in some other state capitals,” he told the Senate panel, April 1. Similar sentiments were expressed to their Assembly counterparts a day later.
Rosy Forecast
Rosen argued that the Administration’s FY2015 budget plan appeared to once again rely on revenue estimates that are more rosy than realistic – noting a trend. For the third year in a row, Rosen noted, state revenues fell short of the Christie administration’s projections, and for the fourth year in a row, the OLS is projecting that revenues will come in lower than administration projections. But he added that this year, the difference between Administration’s estimates and the OLS projections is the smallest ever.
The OLS analyst estimated the state would collect $217 million less in tax revenue than Christie’s target for the current fiscal year. For the coming 2015 fiscal year, OLS expects $309 million less — bringing this year’s shortfall to the $526 million projected.
Rosen’s track record has been good so far: Over the past three years, the Christie administration’s revenue projections have come up more than $1.6 billion short overall, forcing a series of controversial midyear budget cuts topped off this year by a retroactive pension re-calculation and a costly tobacco bond refinancing.
In comparison, State Treasurer Andrew Sidamon-Eristoff, who testified after Rosen both days, defended both the decision to change the state’s pension formula and the refinancing of the tobacco bonds — which provided more than $185 million of the $697 million in budget cuts needed so far to plug a hole in the current Fiscal Year 2014 budget — as sound fiscal policy during a wide-ranging and often testy two-hour appearance before the committees. He also indicated he saw no reason to make further cuts in the Fiscal Year 2014 budget or to revise his February projection that state revenues would rise 5.8 percent to a record $34.447 billion in Fiscal Year 2015, despite Rosen’s less optimistic forecast.
Why Worry About It?
In the backdrop is increasing pressure from the investment houses. Moody’s Investors Service and Fitch Ratings in recent months have both put New Jersey on notice – lowering their outlook on the state’s debt to negative. The credit-rating agencies warned they could downgrade the state unless there was improvement in the state economy or in the budget.
The problem is that three years of unmet revenue forecasts and subsequent midyear budget gaps have forced the Administration to eat away at what was once a robust $800 million surplus – now just $300 million — a minimal reserve that has proven insufficient to cover midyear revenue shortfalls, as the three credit rating agencies have repeatedly warned.
New Jersey not only has one of the smallest state surpluses on a percentage basis – it is also home to a state that sees intense volatility in its tax collection. New Jersey has one of the most graduated state income taxes. The top 1 percent of filers pay almost half the state’s income tax, and as a result state income tax collections go up and down with the S&P 500 Stock Market Index.
And this volatility is occurring while the state budget is under intense expense pressure due to rising costs for health care, transportation, pensions and school funding.
In comparison, Sidamon-Eristoff argued yesterday that Treasury’s year-round monitoring of state spending enables the Christie administration to find savings in state programs as needed to fill midyear gaps, even with a small surplus.
Senate Budget Chair Paul Sarlo disagreed, countering that the administration has plugged midyear budget holes through a series of questionable fiscal maneuvers, including the diversion of New Jersey Turnpike money to balance the budget instead of being used to provide pay-as-you-go funding for transportation construction projects, the delay of property tax rebate payments from one fiscal year to the next to provide a $390 million one-shot budget savings, and bond restructurings that will add to future debt-service costs.
Signs of Life Under Pressure
Next year’s projected budget growth is driven by the expectations of both the Christie administration and the OLS that income taxes will grow more than 8 percent — although OLS’s income tax forecast is $113 million less. “Should the five-year-old bull market falter this year, these forecasts could prove overly optimistic,” the OLS warned, and the state’s lean surplus will provide little protection. Nonetheless, healthy growth in the stock market could provide much-needed relief for the state budget, Rosen said.
“During tax year 2013, the S&P 500 index jumped 29 percent and that will enhance our collections this spring,” he said.
Tobacco Discussion
The hearings also provided the first real public explanation of what OLS characterized as the “extraordinary action” by Sidamon-Eristoff that resulted in the state giving up $406.7 million in tobacco bond payments from FY2017 to FY2023 in exchange for a one-shot cash infusion of $91.6 million to help plug the hole in the FY14 budget.
New Jersey’s Tobacco Settlement Fund was set up as part of a master agreement with the major tobacco companies to compensate states for the increased healthcare costs caused by cigarette smoking in 1998. The fund was expected to provide New Jersey’s state government with $7.6 billion in payments at a rate of $200 million to $250 million a year in perpetuity, Rosen explained.
But Gov. Jim McGreevey, facing a major budget crisis in the regional recession that followed the attacks on the World Trade Center, decided in 2002 to “securitize” the tobacco money by setting up a Tobacco Settlement Financing Corp. The company then sold the future tobacco payments to private bondholders in order to create “the mother of all one-shots” — a $1.557 billion payment in FY2003 and a $1.611 billion infusion in FY2004 that McGreevey used to balance those budgets.
In 2007, when the Tobacco Settlement Financing Corp. decided to refinance $3.62 billion in bonds, Gov. Jon Corzine, whose treasury was swimming in revenue before the Great Recession hit, reacquired 23.74 percent of the bonds, which subsequently produced payments of about $55 million a year to the state treasury.
Part of the 2007 bond sale was a series of capital appreciation bonds (better known as zero-coupon bonds) that were sold at deep discounts with the promise that they would pay their bondholders $1.28 billion in June 2041. Capital appreciation bonds “are known as a distinctly horrible means of public finance,” Sidamon-Eristoff said.
Because of the decline in tobacco revenue caused by a drop in smoking, “it was clear that if we did nothing, the bonds would go into default by 2041,” Sidamon-Eristoff said. “The bonds were not obligations of the state, but it was clear the state would be at least connected to it. It was incumbent on us not to suffer future governors or legislatures to be elevated into default.”
The bondholders included major players like the OppenheimerFund Inc., Goldman Sachs, and Columbia Management Investment Fund, and when the bondholders and Barclays Bank approached Sidamon-Eristoff, who by statute served as head of the Tobacco Settlement Financing Corp., the treasurer was ready to act.
“An arrangement was done between the treasurer, the corporation headed by the treasurer, and the bondholders . . . of these zero-coupon bonds which had really fallen to junk bond status,” Rosen explained. According to the deal, the state shored up the fiscal health of the bonds by giving up $406.7 million it would have been owed between FY2017 and FY2023 in exchange for an upfront cash infusion of $91.6 million this year and the promise of additional payments after 2041.
Barclays made $4 million to $5 million for handling the deal, the price of the bonds tripled in four days in early March after the deal was announced, and the zero-coupon bond ratings jumped from C+ junk bond status to A- investment grade.
Sidamon-Eristoff got a $91.7 million plug for his current year budget deficit, although he did not mention the $406.7 million price tag in lost revenue from FY17 to FY23 in his explanation of the deal.
Rosen did. The bottom line, he said, is that “In FY14, we get $91 million. In FY17 to FY23 or FY24, we don’t get $406 million we would otherwise have received. We could conceivably get $1 billion or $2 billion in the 2040s,” but that is not guaranteed and those dollars will be worth less than dollars today.
Sidamon-Eristoff said the refinancing made it more likely that the state would get revenues that would otherwise be paid to bondholders from 2041 to 2049. “We have 91-and-a-half million in our pocket now and got further net present value savings coming to us. Fiscally and from a debt management point of view, this was a no-brainer. I feel very strongly given the current environment we should look for savings wherever we can,” Sidamon-Eristoff said, referring to the state’s current budget problems.
Resources
- Legislative Budget and Finance Officer's Testimony
- State Treasurer' s Testimony
- Governor's Proposed Budget for FY15
- OLS Analysis
Source: NJSpotlight, Star Ledger