Federal Tax Reform in a Post-Chapter 9 Era

December 4, 2017

Good Morning! In this a.m.’s Blog, we consider the fiscal and governing challenges that the pending federal tax “reform” legislation might have for the nation’s city emerging from the largest municipal bankruptcy in American history, before returning to the governance challenges in Puerto Rico.  

Visit the project blog: The Municipal Sustainability Project 

Harming Post Chapter 9 Recovery? As the House and Senate race, this week, to conference on federal tax legislation, the potential fiscal impact on post chapter 9 Detroit provides grim tidings. The proposed changes would eliminate federal tax credits vital to Detroit’s emergency from chapter 9 municipal bankruptcy; the elimination of low-income housing tax credits would reduce financing options for the city: the combination, because it would adversely affect business investment and development, could undercut the pace of the city’s recovery. Most at risk are historic rehabilitation and low income housing tax credits: the House version of the tax “reform” legislation proposes to eliminate historic tax credits—the Senate version would reduce them by 50%; both versions propose the elimination of new market tax credits. The greatest threat is the potential elimination of the Low Income Housing Tax Credit (LITC), proposed by the House, potentially undercutting as much as 40% of the current financing for low income housing in the Motor City. While both the House and Senate versions retain a 9% low income housing tax credit, the credit, as proposed, would limit how much the Michigan State Housing Development Agency may award on an annual basis—putting as much as $280 million at risk. According to the National Housing Conference, the production of low income housing could decline by as much as 50%. The combined impact could leave owners and developers of low income housing with fewer options for rehabilitation—an impact potentially with disproportionate omens for post-chapter 9 municipalities such as Detroit.   

Is There Promise or Democracy in PROMESA? Since the imposition by Congress of the PROMESA, quasi-chapter 9 municipal bankruptcy legislation, under which a board named by former President Obama appointed seven voting members, with Gov. Puerto Rico Governor Ricardo Rosselló serving as an ex officio member, but with no voting rights—there have been singular disparities, including between the harsh fiscal measures imposed on the U.S. territory, measures imposing austerity for Puerto Rico, even as the PROMESA Executive Director receives an annual salary of $625,000—an amount 500% greater than the executive director of Detroit’s chapter 9 bankruptcy oversight board, and some $225,000 more than the President of the United States—with Puerto Rico’s taxpayers footing the tab for what is perceived as an unelected board acting as an autocratic body which threatens to undermine the autonomy of Puerto Rico’s government. Unsurprisingly, the Congressional statute includes few incentives for transparency, much less accountability to the citizens and taxpayers of Puerto Rico. Indeed, when the Center for Investigative Journalism and the Legal Clinic of the Interamerican University Law School, attorneys Judith Berkan, Steven Lausell, Luis José Torres, and Annette Martínez—both in one case before the San Juan Superior Court and in another before federal Judge Jay A. García-Gregory, as well as the Reporter’s Committee for Freedom of the Press submitted an amicus brief seeking clarification with regard to the legal standards of transparency and accountability which should be applied to the board, the PROMESA Board asserted that the right of access to information does not apply to it. 

Governance in Insolvency. As we have followed the different and unique models of chapter 9 and insolvencies from Central Falls, Rhode Island, through San Bernardino, Stockton, Detroit, Jefferson County, etc., it has been respective state laws—or the absence thereof—which have determined the critical role of governance—whether it be guided via a federal bankruptcy court, a state oversight board, in large part determined by the original authority under the U.S. system of governance whereby the states—because they created the federal government—individually determine the eligibility of municipalities to file for chapter 9 municipal bankruptcy. In Puerto Rico, sort of a hybrid, being neither a state, nor a municipality, the issue of governing oversight is paving new ground. Thus, in Puerto Rico, it has opened the question with regard to whether the Governor or Congress ought to have the authority to name an oversight board—a body—whether overseeing the District of Colombia, New York City, Detroit, Central Falls, Atlantic City, etc.—to exercise oversight in the wake of insolvency. Such boards, after all, can protect a jurisdiction from pressures by partisan and outside actors. Moreover, the appointment of experts with both experience and expertise not subject to voters’ understandable angst can empower such appointed—and presumably expert officials, to take on complex fiscal and financial questions, including debt restructuring, access to the municipal markets, and credit.  Moreover, because appointed board members are not affected by elections, they are in a sometimes better position to impose austerity measures—measures which would likely rarely be supported by a majority of voters—or, as former D.C. Mayor Marion Barry said the District of Columbia oversight Board, it “was able to do some things that needed to be done that, politically, I would not do, would not do, would not do,” such as firing 2,000 human-service workers. 

In Puerto Rico—which, after all, is neither a municipality nor a state, the bad gnus is that these governance disparities are certain to continue: indeed, despite the PROMESA Board’s November 27th recommendations, Gov. Rosselló announced he would spend close to $113 million on government employees’ Christmas bonuses-an announcement the PROMESA Board responded to by stating that its members expect “to be consulted during the formulation and prior to the announcement of policies such as this to ensure the Government is upholding the principles of fiscal responsibility.” (Note: it would have to be a challenge for PROMESA Board members to observe the current federal tax bills in the U.S. House and Senate as measured by Congress’ Joint Committee on Taxation and the Congressional Budget Office and believe that Congress is actually exercising “fiscal responsibility.”)

Nevertheless, there might be some help at hand for the U.S. territory: House Ways and Means Committee Chairman Kevin Brady (R-Tx.), in trying to mold in conference with the Senate the pending tax reform legislation, is considering options to avert what top Puerto Rican officials fear could be still another devastating blow to its already tottering economy: both versions would end Puerto Rico’s status as an offshore tax haven for U.S. companies—a devastating potential blow, especially given the current federal Jones Act which imposes such disproportionate shipping costs on Puerto Rico compared to other, competitive Caribbean nations. Now, the Governor, as well as Puerto Rico’s Resident Commissioner Jenniffer Gonzalez, Puerto Rico’s sole nonvoting member of Congress, are warning that Puerto Rico’s slow recovery from Hurricane Maria could suffer an irreparable setback if manufacturers decide to close their factories. Commissioner Gonzalez said 40% of Puerto Rico’s economy relies on manufacturing, with much of that related to pharmaceuticals; ergo, she is worried that any drop in the $2 billion of annual revenue these businesses provide would undercut the economic recovery plan instituted by the PROMESA Board. The Commissioner notes: “Forty percent of the island is living in poverty,” even though the federal child tax credit only applies to a third child for residents of Puerto Rico.

Thus, many eyes in Puerto Rico—and, presumably in the PROMESA Board—are laser focused on the House-Senate tax conference this week, where the House version would extend, for five years, the so-called rum cover which provides an excise tax rebate to Puerto Rico and the U.S. Virgin Islands on locally produced rum—a provision which Republican leaders appear unlikely to retain, albeit, they appear to be amenable to changes which could help reboot the island’s economy. (Puerto Rico produces 77% of the rum consumed in the U.S., according to the Puerto Rico Industrial Development Agency.) In a sense, part of the challenge is that for Puerto Rico, the issue has become whether to focus its lobbying on retaining its quasi-tax haven status. Gov. Rosselló worries that if that status were altered, “companies with a strong presence on the island would be forced to shutter those operations and decamp for the mainland or, worse, a lower-tax country…This would put tens of thousands of U.S. citizens in Puerto Rico out of work and demolish our tax base right as we are trying to rebound from historic storms.” Chairman Brady, after meeting with Commissioner Gonzalez at the end of last week, told reporters the meeting was with regard to “ideas on how best to help Puerto Rico…I know the Senate too has some ideas as well…“Yeah, we’re going to keep working on that.” In conference, the House bill imposes a 20% excise tax on payments by a U.S. company to a foreign subsidiary; the Senate bill proposes a tax ranging from 12.5% to 15.625% on the income of foreign corporations with intangible assets in the U.S. Unsurprisingly, Puerto Rico officials and U.S. businesses operating there describe both the House and Senate versions as putting Puerto Rico at a disadvantage—or, as one official noted: “The companies are asking from exemptions from all of this if Puerto Rico is involved…They want to be exempted from the taxes going forward that would prevent companies from accumulating untaxed profits abroad.” Foreign earnings, which includes revenues earned by corporations operating in Puerto Rico, could be repatriated at a 14% rate if the funds were held in cash and 7% if its illiquid assets under the House bill; the Senate version would tax cash at 10% and illiquid assets at 5%. Companies operating in Puerto Rico would be taxed at the same rate on the mainland of the U.S. and in foreign countries. In addition, the average manufacturing wage is three times lower in Puerto Rico than on the mainland and companies operating there can claim an 80% tax credit for taxes paid to the territorial government, according to officials. Senate Finance Committee Chair Orrin Hatch (R-Utah) noted he wishes to “help Puerto Rico, but not in this tax bill.”

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What Lessons Can State & Local Leaders Learn from Unique Fiscal Challenges?

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eBlog, 04/25/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenges in Michigan and how the upswing in the state’s economy is—or, in this case, maybe—is not helping the fiscal recovery of the state’s municipalities. Then we remain in Michigan—but straddle to Virginia, to consider state leadership efforts in each state to rethink state roles in dealing with severe fiscal municipal distress. Finally, we zoom to Chicago to glean what wisdom we can from the Godfather of modern municipal bankruptcy, Jim Spiotto: What lessons might be valuable to the nation’s state and local leaders?  

Fiscal & Physical Municipal Balancing I. Nearly a decade after the upswing in Michigan’s economic recovery, the state’s fiscal outlook appears insufficient to help the state’s municipalities weather the next such recession. Notwithstanding continued job growth and record auto sales, Michigan’s per-capita personal income lags the national average; assessed property values are below peak levels in 85% of the state’s municipalities; and state aid is only 80% of what it was 15 years ago.  Thus, interestingly, state business leaders, represented by the Business Leaders for Michigan, a group composed of executives of Michigan’s largest corporations universities, is pressing the Michigan Legislature to assume greater responsibility to address growing public pension liabilities—an issue which municipal leaders in the state fear extend well beyond legacy costs, but also where fiscal stability has been hampered by cuts in state revenue sharing and tax limitations. Michigan’s $10 billion general fund is roughly comparable to what it was nearly two decades ago—notwithstanding the state’s experience in the Great Recession—much less the nation’s largest ever municipal bankruptcy in Detroit, or the ongoing issues in Flint. Moreover, with personal income growth between 2000 and 2013 growing less than half the national average (in the state, the gain was only 31.1%, compared to 66.1% nationally), and now, with public pension obligations outstripping growth in personal income and property values, Michigan’s taxpayers and corporations—and the state’s municipalities—confront hard choices with regard to “legacy costs” for municipal pensions and post-retirement health care obligations—debts which today are consuming nearly 20 percent of some city, township, and school budgets—even as the state’s revenue sharing program has dropped nearly 25 percent for fiscally-stressed municipalities such as Saginaw, Flint, and Detroit just since 2007—rendering the state the only state to realize negative growth rates (8.5%) in municipal revenue in the 2002-2012 decade, according to numbers compiled by the Michigan Municipal League—a decade in which revenue for the state’s cities and towns from state sources realized the sharpest decline of any state in the nation: 56%, a drop so steep that, as the Michigan Municipal League’s COO Tony Minghine put it: “Our system is just broken…We’re not equipped to deal with another recession. If we were to go into another recession right now, we’d see widespread communities failing.” Unsurprisingly, one of the biggest fears is that another wave of chapter 9 filings could trigger the appointment of the state’s ill-fated emergency manager appointments. From the Michigan Municipal League’s perspective, any fiscal resolution would require the state to address what appears to be a faltering revenue base: Michigan’s taxable property is appreciating too slowly to support the cost of government (between 2007 and 2013, the taxable value of property declined by 8 percent in Grand Rapids, 12% in Detroit, 25% in Livonia, 32% in Warren, 22% in Wayne County values, and 24% in Oakland County.) The fiscal threat, as the former U.S. Comptroller General of the General Accounting Office warned: “Most of these numbers will get worse with the mere passage of time.”

Fiscal & Physical Municipal Balancing II. Mayhap Michigan and Virginia state and local leaders need to talk:  Thinking fiscally about a state’s municipal fiscal challenges—and lessons learned—might be underway in Virginia, where, after the state did not move ahead on such an initiative last year, the new state budget has revived the focus on fiscal stress in Virginia cities and counties, with the revived fiscal focus appearing to have been triggered by the ongoing fiscal collapse of one of the state’s oldest cities, Petersburg. Thus, Sen. Emmett Hanger (R-Augusta County), a former Commissioner of the Revenue and member of the state’s House of Delegates, who, today, serves as Senate Finance Co-Chair, and Chair of the Health and Human Services Finance subcommittee, has filed a bill, SJ 278, to study the fiscal stress of local governments: his proposal would create a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Although the legislation was rejected in the Virginia House Finance Committee, where members deferred consideration of tax reform for next year’s longer session, the state’s adopted budget does include two fiscal stress preventive measures originally incorporated in Senator Hanger’s proposed legislation—or, as co-sponsor Sen. Rosalyn Dance (D-Petersburg), noted: “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.” To enhance the state’s authority to intervene fiscally, the budget has set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe crisis. Thus, a workgroup, established by the auditor of public accounts, would determine an appropriate fiscal early warning system to identify fiscal stress: the proposed system would consider such criteria as a local government’s expenditure reports and budget information. Local governments which demonstrate fiscal distress would thence be notified and could request a comprehensive review of their finances by the state. After a fiscal review, the commonwealth would then be charged with drafting an “action plan,” which would provide the purpose, duration, and anticipated resources required for such state intervention. The bill would also give the Governor the option to channel up to $500,000 from the general fund toward relief efforts for the fiscally stressed local government.

Virginia’s new budget also provides for the creation of a Joint Subcommittee on Local Government Fiscal Stress, with members drawn from the Senate Finance Committee, the House Appropriations, and the House Finance committees—with the newly created subcommittee charged to study local and state financial practices, such as: regional cooperation and service consolidation, taxing authority, local responsibilities in state programs, and root causes of fiscal stress. Committee member Del. Lashrecse Aird (D-Petersburg) notes: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress…This insight will be essential in forming effective solutions that will be sustainable long-term…Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our Commonwealth’s success.”

Municipal Bankruptcy—or Opportunity? The Chicago Civic Federation last week co-hosted a conference, “Chicago’s Fiscal Future: Growth or Insolvency?” with the Federal Reserve Bank of Chicago, where experts, practitioners, and academics from around the nation met to consider best and worst case scenarios for the Windy City’s fiscal future, including lessons learned from recent chapter 9 municipal bankruptcies. Chicago Fed Vice President William Testa opened up by presenting an alternative method of assessing whether a municipality city is currently insolvent or might become so in the future: he proposed that considering real property in a city might offer both an indicator of the resources available to its governments and how property owners view the prospects of the city, adding that, in addition to traditional financial indicators, property values can be used as a powerful—but not perfect—indicators to reflect a municipality’s current situation and the likelihood for insolvency in the future. He noted that there is considerable evidence that fiscal liabilities of a municipality are capitalized into the value of its properties, and that, if a municipality has high liabilities, those are reflected in an adjustment down in the value of its real estate. Based upon examination, he noted using the examples of Chicago, Milwaukee, and Detroit; Detroit’s property market collapse coincided with its political and economic crises: between 2006 and 2009-2010, the selling price of single family homes in Detroit fell by four-fold; during those years and up to the present, the majority of transactions were done with cash, rather than traditional mortgages, indicating, he said, that the property market is severely distressed. In contrast, he noted, property values in Chicago have seen rebounds in both residential and commercial properties; in Milwaukee, he noted there is less property value, but higher municipal bond ratings, due, he noted, to the state’s reputation for fiscal conservatism and very low unfunded public pension liabilities—on a per capita basis, Chicago’s real estate value compares favorably to other big cities: it lags Los Angeles and New York City, but is ahead of Houston (unsurprisingly given that oil city’s severe pension fiscal crisis) and Phoenix. Nevertheless, he concluded, he believes comparisons between Chicago and Detroit are overblown; the property value indicator shows that property owners in Chicago see value despite the city’s fiscal instability. Therefore, adding the property value indicator could provide additional context to otherwise misleading rankings and ratings that underestimate Chicago’s economic strength.

Lessons Learned from Recent Municipal Bankruptcies. The Chicago Fed conference than convened a session featuring our former State & Local Leader of the Week, Jim Spiotto, a veteran of our more than decade-long efforts to gain former President Ronald Reagan’s signature on PL 100-597 to reform the nation’s municipal bankruptcy laws, who discussed finding from his new, prodigious primer on chapter 9 municipal bankruptcy. Mr. Spiotto advised that chapter 9 municipal bankruptcy is expensive, uncertain, and exceptionally rare—adding it is restrictive in that only debt can be adjusted in the process, because U.S. bankruptcy courts do not have the jurisdiction to alter services. Noting that only a minority of states even authorize local governments to file for federal bankruptcy protection, he noted there is no involuntary process whereby a municipality can be pushed into bankruptcy by its creditors—making it profoundly distinct from Chapter 11 corporate bankruptcy, adding that municipal bankruptcy is solely voluntary on the part of the government. Moreover, he said that, in his prodigious labor over decades, he has found that the large municipal governments which have filed for chapter 9 bankruptcy, each has its own fiscal tale, but, as a rule, these filings have generally involved service level insolvency, revenue insolvency, or economic insolvency—adding that if a school system, county, or city does not have these extraordinary fiscal challenges, municipal bankruptcy is probably not the right option. In contrast, he noted, however, if a municipality elects to file for bankruptcy, it would be wise to develop a comprehensive, long-term recovery plan as part of its plan of debt adjustment.

He was followed by Professor Eric Scorsone, Senior Deputy State Treasurer in the Michigan Department of Treasury, who spoke of the fall and rise of Detroit, focusing on the Motor City’s recovery—who noted that by the time Gov. Rick Snyder appointed Emergency Manager Kevyn Orr, Detroit was arguably insolvent by all of the measures Mr. Spiotto had described, noting that it took the chapter 9 bankruptcy process and mediation to bring all of the city’s communities together to develop the “Grand Bargain” involving a federal judge, U.S. Bankruptcy Judge Steven Rhodes, the Kellogg Foundation, and the Detroit Institute of Arts (a bargain outlined on the napkin of a U.S. District Court Judge, no less) which allowed Detroit to complete and approved plan of debt adjustment and exit municipal bankruptcy. He added that said plan, thus, mandated the philanthropic community, the State of Michigan, and the City of Detroit to put up funding to offset significant proposed public pension cuts. The outcome of this plan of adjustment and its requisite flexibility and comprehensive nature, have proven durable: Prof. Scorsone said the City of Detroit’s finances have significantly improved, and the city is on track to have its oversight board, the Financial Review Commission (FRC) become dormant in 2018—adding that Detroit’s economic recovery since chapter 9 bankruptcy has been extraordinary: much better than could have been imagined five years ago. The city sports a budget surplus, basic services are being provided again, and people and businesses are returning to Detroit.

Harrison J. Goldin, the founder of Goldin Associates, focused his remarks on the near-bankruptcy of New York City in the 1970s, which he said is a unique case, but one with good lessons for other municipal and state leaders (Mr. Goldin was CFO of New York City when it teetered on the edge of bankruptcy). He described Gotham’s disarray in managing and tracking its finances and expenditures prior to his appointment as CFO, noting that the fiscal and financial crisis forced New York City to live within its means and become more transparent in its budgeting. At the same time, he noted, the fiscal crisis also forced difficult cuts to services: the city had to close municipal hospitals, reduce pensions, and close firehouses—even as it increased fees, such as requiring tuition at the previously free City University of New York system and raising bus and subway fares. Nevertheless, he noted: there was an upside: a stable financial environment paved the way for the city to prosper. Thus, he advised, the lesson of all of the municipal bankruptcies and near-bankruptcies he has consulted on is that a coalition of public officials, unions, and civic leaders must come together to implement the four steps necessary for financial recovery: “first, documenting definitively the magnitude of the problem; second, developing a credible multi-year remediation plan; third, formulating credible independent mechanisms for monitoring compliance; and finally, establishing service priorities around which consensus can coalesce.”

Balancing the Odds for Puerto Rico’s Fiscal Future

eBlog, 03/15/17

Good Morning! In this a.m.’s eBlog, we consider the tea leaves from the outcome of yesterday’s snowy session on Puerto Rico in New York City’s Alexander Hamilton Building, where the PROMESA Board considered Puerto Rico Governor Ricardo Rosselló’s most recent efforts to reassert ownership and control of Puerto Rico’s fiscal future.

Is There Promise or UnPromise in PROMESA? The Puerto Rico Oversight Board, meeting yesterday in the Alexander Hamilton Building in New York, unanimously certified the latest turnaround plan by Governor Ricardo Rosselló to alleviate the U.S. territory’s fiscal insolvency, albeit with some critical amendments, including the implementation of a 10% progressive reduction in public pension benefits by FY2020, albeit, as was the case in Detroit’s plan of debt adjustment, adjusted so that no retiree would fall below the federal poverty level: the decade-long plan thus permits the payment of 26.2% of debt due, while imposing austerity measures including partial government employee furloughs and elimination of their Christmas bonus, unless the government meets targets for liquidity and budgeting. The plan would cut pension spending by 10%, in what the Board determined would ensure sufficient fiscal resources to fund 26% of debt due in the next nine years as a “first salvo.” Emphasizing the critical need to address a $50-billion debt load among Puerto Rico’s three main public retirement systems and a depletion of available funds by 2022, the PROMESA Board added it would also formulate efforts to fund existing pension obligations on a pay-as-you-go basis, liquidating assets and using revenues of the government’s General Fund to that end.  Board Executive Director Ramón Ruiz Comas said the Oversight Board wanted to implement additional “safeguards to ensure sufficient liquidity and budgetary savings,” designed to generate $35 to $40 million in monthly savings, including the elimination of Christmas bonus payments to public employees, and a furlough program to begin July 1st—the furlough would eliminate four work days per month for most personnel working in the executive branch, and two work days per month for teachers and other front-line personnel—the furlough would exempt law enforcement personnel. In addition, the Board conditioned the Christmas bonus elimination and work reduction program on the budget proposal for FY2018 which the government is scheduled to submit by April 30: if the government’s liquidity plan and right-sizing measures are able to generate an additional $200 million in cash reserves by June 30th, the furlough program would be deferred to September 1st or eliminated outright; likewise, the removal of Christmas bonuses could be reduced or eliminated if the Oversight Board finds that the government’s plan is producing enough cash-flow. Subsequent to that part of the session, Gerardo Portela, Director of the commonwealth’s Fiscal Agency and Financial Advisory Authority made a presentation on behalf of Puerto Rico’s muncipios of the fiscal plan—a plan which had undergone various changes over last weekend in a contentious set of negotiations between local officials and the PROMESA Board. Puerto Rico Governor Gov. Rosselló Nevares is slated to give a live televised address to provide his public response to the board’s recommendations. 

The Dean of municipal insolvency debt, Jim Spiotto, noted the import of having creditors involved in these efforts, as their support could be vital to spurring reinvestment in Puerto Rico’s economy. Mr. Spiotto’s comments came in the context of a possible agreement by some creditors to reinvest in some part of Puerto Rico, enhancing the possibility that the PROMESA Board may be willing to consider Puerto Rico’s willingness to increase its payback of debt, according to Mr. Spiotto, something which could occur under PROMESA’ Title VI.

At the session, the Oversight Board was asked about the status of debt negotiations with Puerto Rico’s bondholders and about the possibility, already requested by Gov. Ricardo Rosselló, of pushing back a stay on litigation beyond its current end on May 1st—to which Oversight Board member Arthur González responded that negotiations had yet to proceed to an outline with regard to what fiscal resources would be available for debt service: he did say that the fiscal plan would provide such an outline, and that he thought there was real hope to reaching agreements with creditors, adding that the PROMESA Board had yet to determine whether the current stay on litigation should be extended.

Balance or Imbalance. Brad Setser, a senior fellow at the Council on Foreign Relations, told the Bond Buyer that the proposed plan’s near term fiscal austerity may be too severe, warning that the “drag on Puerto Rico’s economy–and ultimately on its ability to collect tax revenues–may still be underestimated.” As in Detroit’s plan of debt adjustment, U.S. Bankruptcy Judge Steven Rhodes’s recognition that preserving the Detroit Institute of Arts was vital to the Motor City’s long-term recovery, so too, Mr. Setser recognizes that any final agreement which would handicap Puerto Rico’s economic growth prospects could backfire.  

 

 

What Do Today’s Fiscal Storms Augur for Puerto Rico and New Jersey’s Fiscal Futures?

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eBlog, 03/13/17

Good Morning! In this a.m.’s eBlog, we consider the frigid challenges awaiting Puerto Rico in New York City’s Alexander Hamilton Building today, where even as a fierce winter storm promises heavy snow, the U.S. Territory of Puerto Rico will likely confront its own harsh challenge by the PROMESA Board to its efforts to reassert ownership and control of Puerto Rico’s fiscal future. Then we turn south to New Jersey, where there are fiscal and weather storm warnings, with the former focused on a legacy of public pension debt that Governor Chris Christie will bequeath to his successors.

Is There Promise or UnPromise in PROMESA? In the wake of changes made by Puerto Rico Governor Ricardo Rosselló Nevares to update its economic growth projections to address a concern expressed by the PROMESA Oversight Board, it remains unclear whether that will be certified by today—when the Board will convene in New York City in the Alexander Hamilton building to act on measures intended to guide the fiscal future of the U.S. territory over the next decade. The update was made in an effort to close a new gap between Puerto Rico’s projected revenue and expenditure projections, since the new economic projections altered all the Government’s revenue estimates. Gov. Rosselló, in an interview with El Nuevo Día, explained his administration had ordered four new measures to correct the insufficiency, which had been estimated at $262 million: the first measure would be an increase in the tax on tobacco products, an increase projected to add around $161 million in public funds, nearly doubling the current rate. The Governor proposed eliminating Christmas bonuses from the highest salaries in the government and public corporations, albeit without providing details with regard to the distinction between an executive salary and a non-executive salary, stating the changes would generate savings of between $10 million and $20 million. He also said the revised, updated plan would reflect an additional $78 million by means of the reconfiguration of the property tax through an appraisal process, as well as modifications to achieve $35 million in savings by means of changing the amount of sick and vacation days which public servants accrue, noting: “We were able to evaluate some of the economic development projections, and, even though our economists don’t agree with the Oversight Board’s s economists, we’ve used the Board’s economic projections within our model for the sake of getting the fiscal plan certified…(Due to the changes) we’ve prepared, some initiatives to have additional savings of up to $262 million. We had already assuaged some of the Board’s concerns within the same proposal we had made, and those were clarified.”

The Governor indicated that the decision taken yesterday does not imply that he will support other proposals made by the Board, noting that he especially opposed the suggestions to reduce the working hours of public employees by almost 20% and cutting professional services in the government by 50%, in order to reduce costs immediately in an effort to ensure the government does not run out of cash by the first two quarters of the next fiscal year, admitting that current projections suggest they are short by around $190 million, and warning: “This (the Board’s proposals) has a toxic effect on workers and on the economy.”

In response to the PROMESA Board’s apprehensions about the double counting of revenues in its submitted plan, the Governor noted: “We’ve established that our public policy is to renegotiate the debt. The idea is to keep everything in one place so we can work with it. The debt service will be affected depending on economic development projections, but we haven’t touched that part of the fiscal plan. We’re focusing on preparing the collection areas, because we’re aware that (government revenues) have been overestimated in the past. We’ve answered questions about healthcare, revenue, government size, and we’ve worked on the pension category within our administration’s public policy about protecting the most vulnerable as much as possible.”

As for today’s session in New York, noting that he believes the government has succeeded in answering the Board’s questions and concerns, and, using the Board’s economic growth numbers, the Governor believes the updated plan will address the revenue gap without major cuts, noting: “That’s no small thing. We’ve been able to dilute it and make the impact progressive, in the sense that those who have more have to contribute more, and keep the most vulnerable from losing access. We’ve established a plan of cost reduction. Now, the plan guarantees structural changes in the government so it operates better, as well as changes to the healthcare model and the educational model. It defends the most vulnerable, it doesn’t reduce the payroll by 30% or 20%, and it doesn’t reduce working hours like they’ve asked, and we reduced tax measures.” Nevertheless, Gov. Rosselló noted that the Board’s proposed service delivery cuts of as much as 50% affect health care and education—defining those two vital government services as ones in which such deep proposed cuts could trigger a drop in the economy by 8% or 9%, noting: “I’m very aware that the ones that are in the middle of all this are the people of Puerto Rico.” Indeed, the plan considers cuts to retiree pensions, lapses in the basic coverage of the Mi Salud healthcare program, a freeze in tax incentives, agency mergers, privatizations, and reductions in transfers to the University of Puerto Rico and to municipalities. On the revenue side, the Governor’s proposal seeks to increase the collection of the Puerto Rico Sales and Use Tax, the property tax, and corporate taxes. In addition, it boosts the cost of insurance, penalties, and licenses granted by the Government.

With or without the endorsement of Governor Rosselló’s administration, when the PROMESA Board meets today in the Alexander Hamilton US Custom House, the agenda includes certifying a plan that some argue goes far beyond not only considering the Governor’s proposed fiscal recommendations, but to some marks a transition under which the PROMESA Board members will “will become both the Legislative and Executive powers in Puerto Rico.” That is to note that this and ensuing fiscal budgets, or at least until the government of Puerto Rico is able to balance four consecutive budgets and achieve medium- and long-term access to financial markets—will first be overseen and subject to approval by the Oversight Board, as well every piece of legislation which has a fiscal impact.

Balancing. The undelicate federalism balance of power will be subject to review next week, when the House Committee on Natural Resources’ Subcommittee on Insular Affairs has a scheduled PROMESA oversight hearing.

The Stakes & States of Yieldy—or Kicking the Pension Can Down the Road.  Alan Schankel, Janney Capital Markets’ fine analyst has now warned that the Garden State’s lack of a significant plan to address New Jersey’s deteriorating fiscal conditions will lead to more credit rating downgrades and wider credit spreads, writing that New Jersey is unique among what he deemed the nation’s “yieldy states,” because the bulk of its tax-supported debt is not full faith and credit, lacks a credit pledge, and some 90% of the debt payments are subject to annual appropriation. If that were not enough, Mr. Schankel wrote that the state is burdened by another fiscal whammy: it sports among the lowest pension funding levels of any state combined with a high debt load and other OPEB liabilities. Mr. Schankel warned the fiscal road ahead could aggravate the dire fiscal outlook, noting that the recent sales tax reduction from 7% to 6.625%, combined with phasing out the estate tax under last year’s $16 billion Transportation Trust Fund renewal, will reduce the state’s annual revenue by $1.4 billion by 2021—long after Gov. Christie has left office, noting that the state’s unfunded pension liabilities worsened when in the wake of FY2014—16 revenue shortfalls, New Jersey reduced pension funding to a level below the scheduled-ramp up Gov. Chris Christie had agreed to his as part of New Jersey’s 2011 pension reform legislation, emphasizing that public pension underfunding has been “aggravated by current leadership,” albeit noting that such underfunding is neither new, nor partisan: “This long history of kicking the can down the road seems poised to continue, and although New Jersey appropriation backed debt offers some of the highest yields among all states, we advise caution…Given the persistent lack of political willingness to aggressively address the state’s financial morass, we believe the future holds more likelihood of rating downgrades than upgrades.”

What Is the Role of A State When a Municipality Nears Insolvency?

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eBlog, 9/21/16

In this morning’s eBlog, we consider the difficult challenge for a state when one of its municipalities is on the brink of insolvency—and where its authority to file for chapter 9 municipal bankruptcy is uncertain—and the kinds of hard questions about its future. As we are noting, part of fiscal federalism involves signal differences in laws and authorities—on a state-by-state basis, with regard to options for municipalities on the brim of insolvency. Because only 18 states specifically provide authority to municipalities, that leaves a signal void in the remaining states and leaves those states in more awkward positions when a municipality within its borders likely will not be able, on its own, to avoid insolvency. Mayhap appropriately, we then delve further south to Jefferson County, Alabama, where the state’s actions were the critical lever to pushing the county into municipal bankruptcy—and where the County’s appeal efforts have been stymied for years.  

What Is a State to Do? The Richmond Free Press this morning ran an editorial about the foundering and near insolvency of the City of Petersburg, the small, independent city in Virginia, where the median income for a household in the city is under $29,000, and where the City Council this month adopted most of a package of tax increases and budget cuts, but rejected a proposal to close one of the city’s four fire stations—and where, it seems clear, the Commonwealth of Virginia is most unlikely to offer any fiscal relief. At heart, we noted, the Council was really holding a hearing about whether the small municipality has a future. Thus, this a.m., the editorial noted: “We remember the chilling headline in a New York newspaper when the Big Apple was facing bankruptcy…It was 1975, and President Gerald Ford declared he would veto any legislation calling for a federal bailout of New York City. The headline in the New York Daily News — ‘FORD TO CITY: DROP DEAD.’” Then the editorial noted that when Virginia Governor Terry McAuliffe was asked by a reporter earlier this month if there were plans to propose legislation to help financially stricken Petersburg, “the governor’s reply was a tad bit better than President Ford’s to New York City, but it may have had the same result: ‘I’m sure we’re not going to see legislation proposed to deal with this situation…We have no authority to give any money. But we do have the authority to send our team in to help get the books together, get the finances together…Our team has been here, they’ve been staying here, and we want to give all the assistance we can.’” However, as the editorial notes: “Clearly, the city needs technical experts in a lot of fields, including the state’s audit team. But it needs a lot more than that.”

The editorial adds that the state audit team learned, and disclosed in a public meeting, that Petersburg’s fiscal abyss was deeper hole than originally thought: it had about $14 million in unpaid bills as of June 30th: the auditors determined the municipality had been spending far more than it was bringing in nearly every year since 2012; the state team determined the city was planning to sink even deeper into red ink in its FY’2017 budget: that approved budget calls for the city to spend $12.5 million more than it expects to receive in revenue. The state team provided recommendations, such as pursue short-term financing to help meet immediate needs, but, as the editorial notes, “But so far, that has not worked, because the city is in such bad fiscal condition.” The editorial notes that state lawmakers, including House Majority Leader Kirk Cox (R-Colonial Heights), said a bailout for Petersburg was highly unlikely, in part, because it would set a bad precedent.

Caught between a Rock & a Hard Place: Virginia does not specifically authorize its municipal entities to file a petition for chapter 9 municipal bankruptcy—and only one entity, has ever attempted to file—an economic development authority, but its case was dismissed in 2001. The Virginia Constitution bars a city or town from incurring debt exceeding 10 percent of the assessed value of properties within its boundaries (see Virginia Constitution, article VII, §10); ergo, the editorial asks: “So what’s Petersburg to do?” Noting that the small municipality has slashed spending, including a $3.4 million cut to the city’s public schools budget, cut pay for its employees, frozen hiring, and raised taxes on everything from cigarettes, meals and lodging taxes to personal property taxes to bring the current budget into balance—but left untouched most of the $14 million in debt from previous years.”

It seems like a hot potato for Virginia lawmakers who appear to be apprehensive that the small municipality’s fiscal crisis could create a precedent for other cities, towns, or counties to seek bailouts from the state, or, as Del. R. Steven Landes (R-Augusta), Chairman of a newly formed task force studying the impact of fiscally stressed localities on the state and how to deal with such situations, put it: “I just hope we are not heading down this road where we are digging the state into a hole.” The Delegate’s question came in the wake of this week’s report to the legislature by Virginia’s Secretary of Finance Richard D. Brown on the city’s struggle to regain its financial footing, before members of the House of Delegates Appropriations Committee—even as Delegate Landes said that as far as he understood, Petersburg has not asked the state for financial help during its crisis. The audit findings presented by Sec. Brown had identified a projected $12 million budget deficit for the current fiscal year and found that by last June 30th, Petersburg had incurred $18.8 million in bills, of which $14.7 million were mostly unpaid obligations to “external entities” such as contractors, vendors, and a state agency. Secretary Brown alerted the committee to a looming October 1st payment deadline for $1.4 million owed to the Virginia Resources Authority, a premier funding source for local government infrastructure financing through bond and loan programs, reporting this was “a principal-and-interest payment,” adding that he would have to “take certain steps to intercept aid” from the state to Petersburg to make sure those payments are made, adding: “The state has never had to do that with our localities, so I think that this is a precedent that nobody really wants. That is why it is important for us to not even have to go there,” he testified, assuring the Committee members his department has provided “only technical assistance” to the city.

Unsurprisingly, some of the state lawmakers disbelieve the state’s aid has stopped there. Delegate Landes followed up: “You mentioned that we are not providing any direct financial assistance, but indirectly we are: Your time, your staff’s time and all these state agencies that are helping them move forward, it cost the Commonwealth money. Other localities have gotten into difficulties, and I don’t recall that we provided this kind of involvement…We are trying to help Petersburg on the school end, providing additional resources for their school system, and if they can’t pay their bills, how are they going to pay their superintendent?” Committee Chairman S. Chris Jones (R-Suffolk), said that although he agreed with Secretary Brown’s decision to intervene, he was concerned about Petersburg’s outstanding obligations to the Virginia Resources Authority: “We got to figure out what change we need to make from a state’s perspective; we need to protect ourselves…VRA debt can be an issue that can affect our bottom line. We cannot allow that to occur. It’s very distressing when you see what has occurred, and hopefully (the city) will continue to try to — in a very straightforward way — to deal with the issues.” To which, Secretary Brown responded that “[W]e wrestle with it, too,” but ultimately the state is tied to the city in terms of some of the debt obligations: “We can run, but we can’t hide from that. From my standpoint, it is better to be involved and help them over that hump…I have no intention to stay there long-term, but the consequences for the Commonwealth by not being involved, at this stage in the game with this critical Oct. 1 time frame on debt, is probably much worse than being involved.”

What is a County to do? The federal appeals court overseeing Jefferson County’s chapter 9 municipal bankruptcy appeal has, once again, delayed the case, with the previously scheduled December 12th arguments deferred by the 11th U.S. Court of Appeals to an uncertain future date—still another in a long, and increasingly costly, series of delays—of which there have been six so far this year. Jefferson County Commission President Jimmie Stephens noted: “It is very unusual to have this many delays, and I have expressed my frustration to counsel…Our team is ready and eager to have our day in court. We stand at their mercy.” Commission President Stephens has not addressed questions with regard to what these judicial delays are costing the county. Jefferson County exited Chapter 9 bankruptcy in December 2013, after selling $1.8 billion in sewer warrants to write down $1.4 billion of the sewer system’s debt. The plan of adjustment gives bondholders the right to go back to the bankruptcy court if the county fails to enact sewer system rate increases that service the debt. After the plan was implemented, a group of local ratepayers filed an appeal before U.S. District Judge Sharon Blackburn in the Northern District of Alabama. County attorneys argued that the appeal should be struck down, saying that it became moot when the plan of adjustment was implemented with the sale of new debt. In October 2014, Judge Blackburn rejected the county’s mootness contention, and ruled that she could consider the constitutionality of the plan—a decision Jefferson County appealed, and on which it now seems waiting for Godot.