Challenging Fiscal Odds?

December 11, 2018

Good Morning! In this morning’s eBlog, we report on the fiscal challenges of doing something the federal government no longer is able to do: balance budgets—first considering the leadership efforts in Multnomah County, Oregon, before looking east to the Platte County, Missouri, which appears to be on the precipice of a default, and, finally, heading south to Puerto Rico to warm up from this week’s bitter chills on the mainland.

Challenging the Governing Odds. Multnomah County, Oregon, 264 years old, in the eastern part of Washington, was where County commissioners met for the first time on January 17, 1855. The county, named after the Chinookan word for the “lower river,” referring to where the Oregon City Falls splash toward the Columbia River, gained its political makeup after, nearly a century ago, in 1924, the county’s three commissioners were indicted and recalled by voters “in response to ‘gross irregularities’ in the award of contracts for construction of the Burnside and Ross Island bridges,” since these bridges had been supported by the Klu Klux Clan. Today, the County’s five-year General Fund forecast contains a challenging paradox for the upcoming FY2020 budget and beyond: while the Portland metropolitan area’s economy remains robust, and local unemployment remains at low levels, the County will be unable to cover the cost of current General Fund services in the coming years—seemingly due to fast-growing labor costs and revenue growth hobbled by the structure of its property tax system. In its upcoming FY2020 budget, County, County General Fund resources will be $5.9 million, a level just over 1% short of covering the cost just to maintain current service levels; costs are projected to continue to outpace revenue growth by $5 million to $10 million per year in the following years: that means that over the next five years, as a result of this structural deficit, the County’s leaders will need to find $35 million in new revenue, make ongoing program reductions, or find some combination of the two: the onerous fiscal and governing challenge will to come up with the equivalent of cuts and new tax revenues to equate roughly 5 percent of its current General Fund operating expenditures.

It appears this growing deficit is driven by a fundamental mismatch between the County’s major revenue sources and cost drivers: on the revenue side, constitutional property tax limits and the plateauing of our economically sensitive revenues (business income taxes and motor vehicle rental taxes) result in slower, but steady, revenue growth. At the same time, rapid growth in housing and energy prices have driven up inflation, which has translated to a higher cost-of-living adjustment: the County’s 6.6% labor cost growth for FY2020 is driven by an estimated 4.0% COLA, higher public pension costs (an increase of 2.2% of payroll), and labor contracts settling above the status quo.  If there is some good gnus, it is that there appear to be fewer fiscal uncertainties for FY2020, because nearly all of the County’s open labor contracts have been settled, and funding has been secured for the County’s major facility projects. With the midterm elections behind it, there appear to be fewer potential state ballot measures in play. Over the longer term, the County faces a two-fold challenge in preparing its FY2020 budget: the first will be closing the $5.9 General Fund deficit while maintaining critical services for its residents; the second will be maintaining financial resilience as the County’s leaders prepare for a potential next recession and addresses its growing structural deficit.

Attention Yuletide Shoppers: Shopping for Fiscal Fallout? Platte County, Missouri, a county of nearly 90,000 named for the Platte River, and organized in 1838, has been shopping for fiscal trouble: it seems the Zona Rosa shopping center bonds the County issued have become the subject of a lawsuit to determine which party will be held responsible for the fiscal shortfalls in the wake of the County’s failure to make a payment on the Zona Rosa bonds. Last week, Moody’s moodily downgraded unrelated municipal bonds, including Platte County’s Neighborhood Improvement District bonds and the Special Obligation Refunding and Improvement Building bonds. The issue relates to the shopping center’s continued failure to generate enough sales tax revenues to retire bonds, creating a payment shortfall. Although the shopping center’s previous owner, Olshan Properties, traditionally paid the difference, the new owner, Trademark Property Co. of Fort Worth, Texas, has made clear it is not obligated to cover revenue shortfalls. The bond trustee, UMB Bank, has argued that the County should make up the difference. Unsurprisingly, however, Platte County asserts it is not legally obligated to pay; indeed, last month, the County filed a petition seeking a declaration of its legal obligation. A bench trial is scheduled for May 24. For County leaders, the issue involves potential risk for its taxpayers. Here, the private activity municipal bonds, issued to finance for private-use parking garages in the shopping center, are essentially a private loan to benefit a commercial enterprise, so that, unsurprisingly, the County is less than eager to picking up the tab for a private enterprise which is seeking to walk away from its fiscal obligations. But a default could have fiscal repercussions for the County, which appears to be left holding the proverbial bag: it appears to be at risk of default should it opt not to make a bond payment on the shopping development—a payment due on Zona Rosa’s parking garages which was due at the beginning of the month—two days later, Platte County Circuit Court Judge James Van Amburg issued an order that Platte County must set aside $763,390 in a reserve fund until conclusion of the pending lawsuit. Thus, even though Commissioners have said they had not decided if they would cover the payments, and that they were unlikely to without a long-range plan; the matter now lies in the judicial realm. At the end of last week, Judge Van Amburg denied a motion filed by UMB Bank, the trustee for the bonds, seeking an injunction to require the county to pay the 2018 shortfalls on the Zona Rosa Bonds. Early last month, the county filed a petition seeking a declaration from the circuit court regarding the legality of a demand that the county repay bonds issued in 2007 for infrastructure at Zona Rosa. Judge Van Amburg set this matter for a bench trial next May 24th—where Platte County appears certain to assert that, contrary to the trustee’s demand, it has no obligation to make payment on the bonds. Because the bonds issued for Zona Rosa are revenue bonds, the sole source of funding for repayment comes from a 1 percent sales tax within Zona Rosa. The County has also asserted that the trustee’s demand is inconsistent with the Missouri Constitution, which prevents the county from incurring debt without taxpayer approval. According to the lawsuit, the Platte County Commission has sole discretion on whether to appropriate and use taxpayer funds to pay the bonds.  For now, the payment shortfall was covered by the trustee itself from a reserve fund. Tax collections to finance the bonds in Zona Rosa have come up short every year, but former ownership covered the shortfall until last year. Two months ago, the County received notice from the bond trustee that revenues to make the bond payment were short more than $1 million.

The issue for the County’s leaders, who under the misimpression that the county is not legally obligated to provide fiscal/financial assistance to the shopping center, is what the fiscal implications might be: at issue is that the Zona Rosa was financed in reliance on the issuance of municipal bonds which were to be financed via dedicated tax revenue from the development. But the project had the misfortune of opening in the middle of the Great Recession and has struggled with high vacancy rates for years. Tax revenue has consistently fallen short of expectations. After all, an empty shopping center not only imposes greater police costs, but also sharply reduced sales and use, and property tax revenues. Unsurprisingly, County officials argue that taxpayers should not be stuck with the tab. But municipal bond guru Matt Fabian warns that it will now be more expensive for the County to issue municipal bonds, because of the likely difficulty in finding purchasers of its debt, where that debt repayment depends on an annual appropriation from the government, or, as Mr. Fabian put it: “It hardly seems worth it when just restructuring the debt could have been an easy fix…From an economic development perspective, you’re now a non-investment grade county walking away from a bond. It’s hard to talk companies into moving there if that’s your debt profile.” For the County leaders, it seems clear that Santa is unlikely to step in and add something to their stockings: instead, a lump of proverbial coal appears likely—in the form of Platte County Circuit Court Judge James Van Amburg’s order that the County must set aside $763,390 in a reserve fund until conclusion of the pending lawsuit.  (Tax collections in Zona Rosa have underperformed every year, but the previous ownership covered the shortfall until last year—leading up to last October’s notice from the bond trustee that revenues to make the bond payment were short more than $1 million.) Like a lump of coal, the credit rating agencies have reduced the county’s credit rating: since the suit was filed last month, S&P has reduced Platte County’s bonds to junk rating.

Feliz Navidad? In the wake of the offering of a resolution in Congress by the Hispanic Caucus to reject the antiquated cabotage laws of the 1920 Jones Act, with the resolution noting said regulations are detrimental “to the development and economic well-being of the United States,” particularly for Puerto Rico, Alaska, and Hawaii; the Puerto Rico House of Representatives might consider acting on a measure to insist upon Congressional action, with the issue raised and ratified at a meeting of Hispanic leaders in San Diego last Saturday. As adopted, the resolution calls on President Trump and the Congress to promote to repeal of the statute, with the resolution reading: “According to a report published by the U.S. Commission on International Trade, it is estimated that the Jones Act causes between $50 million and $150 million in combined annual economic damages to the residents of Alaska, Hawaii, and Puerto Rico.” Under the federal rules of cabotage, the transport of maritime cargo between the mainland and Puerto Rico must be on ships that are built, owned by, flagged, and personed by an American crew. Jose Aponte, of the New Progressive Party, noted: “The imposition of the Jones Act (which does not apply to other jurisdictions in the Caribbean) on Puerto Rico has a devastating effect on the price paid to bring goods such as basic necessities, food, and even fuel.” To date, however, a cabal of ship-owners, with the support of House and Senate Republicans, and unions, supported by the Democrats, has prevented any progress in Congress in favor of eliminating or softening the federal cabotage rules. The government of Puerto Rico has indicated that it plans to present a proposal to the Trump administration in an effort to achieve a temporary administrative exemption which would allow the transportation of natural gas on foreign ships between U.S. ports and Puerto Rico. The efforts came as, last week, in the wake of a forum sponsored by the Cato Institute on federal cabotage rules, the arguments in favor of the Jones Act of 1920 were questioned: American Enterprise Institute economist Desmond Lachman noted: “Exempting Puerto Rico from the Jones Act would help the island substantially reduce the cost of its imports.”

Regalitos? Puerto Rico Gov. Ricardo Rosselló has signed legislation to overhaul Puerto Rico’s tax laws in a bid to attract foreign investment and help workers and some business owners as part of an effort to end a 12-year recession. The new provision creates an earned income tax credit, reduces a sales tax on prepared food, and eliminates a business-to-business tax for small to medium companies; according to officials, the new legislation represents nearly $2 billion in tax relief at a time when the U.S. territory is struggling to recover from Hurricane Maria and restructure a portion of its more than $70 billion public debt load. According to the Governor, the earned income tax credit will result in benefits ranging from $300 to $2,000 for each worker, representing a total of $200 million in annual savings. He also said an 11.5 percent sales tax on processed food will drop to 7 percent starting in October 2019. The legislation eliminates a business-to-business tax for businesses which generate $200,000 or less a year, representing $79 million in savings in five years, according to the Governor; while Treasury Secretary Teresa Fuentes noted that nearly 80 percent of businesses in Puerto Rico will benefit from that measure, adding that the new law reduces the tax rate for corporations from 39 percent to 37.5 percent—or, as she put it: “Today marks an important day for maintaining Puerto Rico’s competitiveness.” The measure also legalizes tens of thousands of slot machines, but also limits the number of machines owned, with legislators estimating they will generate at least $160 million a year. Up to $40 million of that revenue will go to the government’s general fund, with the remaining funds directed to help municipios and police officers.

Could the Grinch Steal Christmas? However, PROMESA Board Executive Director Natalie Jaresko has repeatedly said the U.S. territory needs a much broader tax reform to improve revenue collection and promote economic development. In addition, she asserted that the PROMESA Board also is concerned that the government and legislature have not proved that the changes will not “cannibalize,” a concern apparently shared by Antonio Fernos, a Puerto Rico economics and finance professor, who questioned the effectiveness of the new law, which appears to generate less overall revenue: “It doesn’t make sense: Why are they doing this, especially on an island that is insolvent and needs more sources of revenue?” Professor Fernos also argued that the earned income tax credit is insufficient to lure people out of the informal economy: “I don’t foresee anyone abandoning tax evasion schemes.”

Double Fiscal Standards? While Gov. Ricardo Rosselló said the new tax reform would provide $2 billion in tax relief to Puerto Rico’s taxpayers while cracking down on tax evasion, the PROMESA Oversight Board promptly released a statement questioning whether the reform would be revenue neutral—a term unknown any longer by the Trump White House or Congress. Instead, the PROMESA Board demanded that Gov. Nevares Rosselló certify the fiscal plan complies with the overseers’ plan by next Wednesday the 19th. The Governor put forth the plan, asserting it would be “fiscally neutral,” unlike the plan proposed by House Ways and Means Committee Chair Kevin Brady (D-Tx.). As proposed, the tax bill would provide for an earned income tax credit, reduction of individual and corporate tax rates, lowering of the sales and use tax rate for prepared foods, and elimination of the business to business tax for businesses with annual gross sales under $200,000—or, as the Governor described it: “We have reduced government’s operating expenses by nearly 22 percent when compared with the expenses of 2016…These fiscal responsibility actions allow us today to present this reform that is fiscally neutral and every dollar that is granted to the people has a source of repayment.” If the Legislature approves, the new tax credit would provide annual payments to low-income workers of between $300 and $2,000, depending on their income and number of dependents, and the sales and use tax rate on prepared foods would be reduced more than one-third to 7% from 11.5%, while the corporate tax rate would drop to 37.5% from 39%; individuals would be given a credit equal to 5% of their tax bill, the changes would be adjusted to reduce tax evasion and deduction abuses. Perhaps taking a page from Atlantic City, the plan would make legal video lottery machines—and taxes on such activities, with half the new tax revenues derived dedicated to support police pensions, 45% to support municipios’ finance health care insurance, and 5% to cover the administration costs for the video lottery machines. Puerto Rico Office of Budget and Management spokeswoman Iliana Rivera Deliz noted: “The tax reform has an average cost of $250 million per year for a total of over $1.09 billion in 5 years, without considering the earned income tax, which grants another $1 billion to eligible taxpayers [in the same period].”


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