Games People Play

April 01, 2007

Most Oklahomans know very little and care even less about the State Board of Equalization. But when you consider the board's ability to affect state spending and to promote or hinder tax cuts, this is a group whose work deserves closer scrutiny.

Here's who sits on the board: Governor Brad Henry, Lt. Governor Jari Askins, State Treasurer Scott Meacham, Attorney General Drew Edmondson, State Auditor and Inspector Jeff McMahan, State Superintendent of Public Instruction Sandy Garrett, and Terry Peach, president of the State Board of Agriculture.

Essentially this group has the last word on the estimated revenue from all sources that is available in the coming fiscal year for the state to spend (or to use for tax cuts). These revenue sources are projected a year in advance and the board "certifies" these projections as available monies for whatever purpose that revenue source has been directed to by statute.

The majority of the "certified" revenue is general revenue and is available for appropriations. This is revenue directly controlled by legislators through their direction of its expenditure. It is also the available "source" of any tax cut. One of the largest general-revenue streams is the individual income tax. Any reduction in income taxes directly affects the amount of money available for the politicians' discretionary spending, so a tax cut comes out of money left over after politicians have funded government.

Most of the projections of the various tax revenues are produced by the Oklahoma Tax Commission and then reviewed (and sometimes adjusted) by the Office of State Finance (OSF) before presentation to the Board of Equalization. Those numbers that are not generated by the Tax Commission, such as the Oklahoma Education Lottery Trust Fund numbers, are the products of agency work within OSF. In any case, OSF has final approval over the final revenues that are submitted to the Board of Equalization for certification, which, as we'll see in a moment, can be more than problematic.

What's Wrong With This Process?

Obviously every member of the Board of Equalization is currently from one political party, but even if that weren't the case an incestuous relationship exists. The final calculation of certified revenues is provided by OSF, which is under the direction of Mr. Meacham-not because he's the state treasurer, but because he also serves in the governor's cabinet as secretary for revenue and finance. Thus, the governor is really the one who controls the final numbers the entire board receives. Even if the remaining board members were inclined not to row in the same direction, their hands are tied by the projections they receive from Mr. Meacham's Office of State Finance. Furthermore, when you consider that the governor also appointed Mr. Peach, you see that nearly half the board serves one master.

If the certified revenue forecast by the Board of Equalization turns out to be lower then the amount actually received, then the government is left with "excess revenue." If the board's forecast is too high, then state spending has to be reduced correspondingly. Because the state budgets a year in advance, a revenue shortfall is clearly more difficult to deal with than an excess revenue situation. Unsurprisingly, both situations can lead to elected officials and their allies gaming the system.

First, consider the situation where actual general revenues exceed the certified revenues and, thus, excess general revenue is available. This is the more common occurrence, since to err on the side of caution is almost always the better approach when it comes to budget forecasting. However, over the years big-spending politicians came to see the upside of having excess revenues, so they developed ways to exploit the situation to their advantage.

One way they do this is through the clever use of "supplemental appropriations." The monies that fund these supplemental appropriations come from those "excess general revenues," with the majority available for supplemental appropriation (after filling the Constitutional Reserve Fund).

Here's how the game is played. Supplementals are appropriations that occur after the legislative session is over. Granted, this practice makes some sense when you consider that emergency needs can occur in anyone's budget, but clever politicians aren't using it for emergency needs. They have learned that they could make their spending increases appear smaller if they make a nod-and-wink agreement to under-fund an agency's regular yearly operating budget, knowing they can come back later and give the agency supplemental appropriations with which to finish the year.

For example, in FY-2006 legislators gave to agencies more than $185 million in funding that was not included in the spending numbers when the legislators left town in May 2005. However, the legislators counted this spending in the base for FY-2006 when they calculated the FY-2007 increase. This bit of shrewdness resulted in understating both the total spending for FY-2006 and the spending increase for FY-2007. Games people play.

Now in the converse situation of a certified revenue shortfall, general appropriations amounts are reduced across the board to all agencies. In other words, the Scenic Rivers Commission and the Department of Education have the same percentage reduction in available monies to spend.

However, there's an interesting twist that provides a perverse incentive to "over-estimate" some revenues. There are certain revenues-they're called dedicated, directed revenues-that are directed by statute to be spent in a certain way. The legislature and the governor theoretically have no input as to how these dedicated, directed revenues are spent. They must be spent according to existing law.

One such revenue source is the Oklahoma Education Lottery Trust Fund, whose revenue was promised to education. You'll recall that Brad Henry tossed around numbers like $500 million, and then $300 million, when he was pitching his lottery idea to the voters. Well, in the first full year of the lottery the Board of Equalization certified $124 million for the Lottery Trust Fund. The education lobby promptly divvied that up amongst themselves, committing much of it to the state-mandated teacher pay raises.

Well, lo and behold, as the actual dollars rolled in it became clear that someone had over-promised and under-delivered on the lottery. Lottery revenues totaled not $124 million, but rather $83 million.

You may ask, "So what? What's a $41 million shortfall among friends?" Well, the education lobby considered that to be "their" money. Indeed, they went ahead and spent it as if it were-even though the money never materialized-and then they asked for the "shortfall" to be made up with supplemental appropriated funds.

The ironic part is that one of the leaders of the charge to make up the shortfall is none other than ? one of the Board of Equalization members. The Oklahoman reported last month that state superintendent Sandy Garrett "asked lawmakers for a $58.3 million supplement to help school districts bridge that gap and pay for other state education needs. Because lottery funds were budgeted to cover $1,110 of each $3,000 pay raise, those raises are not fully funded, either, Garrett said."

In short, by committing the money to something the public supports-teacher pay raises-the education lobby and their political allies on the Board of Equalization set up the perfect scenario for assuring that no matter how far the board missed its projections, the legislature would be between a rock and a hard place and would have to make up any shortfall in funding. Unsurprisingly, the legislature did in fact provide a supplemental appropriation of $60 million to cover education's budgeting fiasco. Once again, the taxpayer is left holding the bag for government's fiscal irresponsibility.

How to Fix the Process

Taking politics out of this process would be like trying to remove the spots from a Dalmatian. However, there are common-sense ways to limit the abuses and move the taxpayers to the head of the line. After all, isn't your family budget as important as the state budget?

First, we must mandate that in excess general revenue situations any funds that exceed the Constitutional Reserve Fund requirements be returned to the people as individual income tax rebates. These rebates could easily be credited against the following year's individual income tax bills. The state already sends a Form 1098 to all taxpayers who received a refund the prior year, so the mechanism for informing the taxpayer of their rebate amount is in place. The cost to the state would be minimal, and the state would garner interest on the funds waiting return to the taxpayers.

Second, politicians need to understand that the constitutional "rainy day" fund isn't a personal checkbook but rather a source for those emergency needs that can occur between sessions. Expenditures from the state's "emergency" money should be limited to expenses that are not operating costs. They should not be included in the budget request the following year as "annualized costs," which is what can happen in the current budget game. If you need to fix a leaky roof, fine. But don't add it in to the next year's budget base as if you are going to fix it every year. A surprising amount of our bloated state spending came from just such political gamesmanship.

Third, gambling revenues and some of the other dedicated, directed revenue sources are volatile and do not lend themselves to year-in-advance certification. These should be handled on a spend-as-you-go basis. These funds should be distributed on a month-by-month basis as they actually come in. Agencies (such as the education department) which choose to commit risky revenues to reoccurring operating expenses would have to explain to the public their fiscal irresponsibility, rather than relying on the current win-win system they have now.

Finally, the Board of Equalization needs to operate in the light of day. The assumptions and mathematics behind the calculation of estimates have no proprietary reason to be secret. They should be provided to the general public to explain all Board of Equalization certifications. I suspect we'll find there has been a lot of political mathematics being used.

OCPA research fellow Steve Anderson (MBA, University of Central Oklahoma) is a Certified Public Accountant with more than 20 years experience in private practice. He previously spent two years as an analyst in the Oklahoma Office of State Finance, where he specialized in Medicaid and pension issues.

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