The SLC Fiscal Affairs & Government Operations Committee (FAGO) convened on Saturday, July 12, for a program session and on Sunday, July 13, for a business session during the 62^nd SLC Annual Meeting.  The following is a summary of the speaker presentations and Committee activities from each of these programs.  An attendance list is attached.

Program Session, July 12, 2008

I.          National and Regional Economic Trends

             Chad Wilkerson, Assistant Vice President and Oklahoma City Branch Executive for the Federal Reserve Bank of Kansas City

             Dr. Mark Snead, Oklahoma State University

Background

A growing number of economists believe that the economy is teetering on the brink of a recession or in one already.  Information on the near-to mid-term forecast on the possible direction of the national economy with references to the state of the housing and energy sectors along with details on how globally interconnected our financial system has become remains important to state policymakers.  Similarly, an Oklahoma-specific economic forecast, information on how the state is dealing with a deteriorating national and regional economy alongside the state energy sector’s impressive performance, remains of interest too.

Mr. Wilkerson’s Presentation

Mr. Wilkerson began his presentation by providing a quick overview of the purpose and structure of the Federal Reserve System and its role in setting monetary policy in the United States.  In assessing the state of the national economy, Mr. Wilkerson indicated that not only was economic growth sluggish, inflation was rising along with stresses evident in the financial and credit markets.  He noted that forecasts called for improvements in the economy by 2009.  In terms of real gross domestic product (GDP) growth, Mr. Wilkerson stated that rates were well below average, particularly since fall 2007, a trend that has continued right through the second quarter of 2008.

According to Mr. Wilkerson, since the end of 2007, the U.S. economy has faced several risks including oil prices rising by 61 percent through mid-July 2008, U.S. home prices falling by 8 percent through May 2008 and the S & P 500 declining by 16 percent through mid-July.  More recently, the nation’s credit situation has deteriorated after improving to an extent in the spring.  Further compounding these problems, Mr. Wilkerson indicated was the fact that overall inflation rates remained high with core inflation numbers also remaining elevated.  Notwithstanding these setbacks, Mr. Wilkerson noted that the forecasts call for a measured rebound in national economic growth along with a decline in inflation by 2009.

In terms of the outlook for the SLC states, Mr. Wilkerson stated that economic growth in the region often outpaced the nation in recent years even though it has slowed in 2008.  Housing difficulties are hitting some Southern states hard even though not all the states are experiencing the same kind of setbacks.  On a positive note, Mr. Wilkerson predicted that the economic outlook for the South remained moderately positive, citing the boosts emerging from the export and energy sectors in selected SLC states.

Further elaborating on these comments for the Southern states, Mr. Wilkerson noted that job growth in the SLC states has outpaced the nation since the 2001 recession.  As of May 2008, job growth in the region stood under 1 percent while for the nation at large it stood was in negative territory.  The SLC states with dominant energy sectors (Texas, Oklahoma and Louisiana) all demonstrated decent non-farm payroll employment growth levels; all but three SLC states (Tennessee, Missouri and Florida) were in positive territory in terms of non-farm payroll employment in a comparison between May 2007 and May 2008.  In terms of home prices, Mr. Wilkerson indicated that while they were declining in most SLC states, there was wide variation; home prices in Florida, Virginia and Missouri, he noted, had declined by more than 5 percent between the first quarters of 2007 and 2008.  Similarly, home prices in Texas, Oklahoma and West Virginia had actually increased during this same period.  He also stated that foreclosure rates in the South were rising, but that the rates in only two Southern states were worse than the national average.

On a positive note, Mr. Wilkerson noted that exports were an important ingredient in Southern states and that this sector was providing an important boost to their economies during these difficult times.  Texas, Louisiana, Alabama, Tennessee, South Carolina, Kentucky are the leaders on this front with the exports as a percent of GDP in these states in 2007 ranking between nearly 8 percent and over 21 percent.  According to Mr. Wilkerson, most impressively, year-to-date export growth in nine SLC states (as of April 2008) exceeded the national average.  In conclusion, Mr. Wilkerson stated that 2009 job growth forecasts for Southern states were mixed but moderately positive with 14 of the 16 SLC states estimated to rank in positive territory.

Dr. Snead’s Presentation

According to Dr. Snead, Oklahoma’s economic outlook was sound with a number of the state’s key economic fundamental remaining strong.  Specifically, Oklahoma’s energy sector injected a boost to the state economy, and the housing market in the state, unlike so many other areas of the country, is steady.  He also indicated that the agriculture sector was healthy and that the state’s manufacturing sector, led by the strong performance of the energy industry, was outperforming national levels.  While both the metropolitan and micropolitan areas of the state are doing well, the state’s rural sector has been growing as a result of the progress of the energy sector.  Consumer spending also was strong.  In addition, he indicated that due to inward migration, population growth in the state was higher than U.S. levels.  However, he cautioned that the state is not immune to national economic conditions, which have deteriorated slightly faster and more deeply than anticipated in his initial 2008 outlook.

In further elaborating on Oklahoma’ economic performance, Dr. Snead indicated that job growth gap between the state and nation currently lies in the range of less than 1 percent.  Most, if not all, of this performance is due to the boost from the energy sector and projected that overall job gains should remain broad-based with the greatest hiring strength in the energy, construction, professional and business services, health services, and leisure and hospitality industries.  In framing Oklahoma’s position vis-à-vis the rest of the country, Dr. Snead noted that the non-energy states with housing issues, as expected, lag national standards on the jobs front.  As of May 2008, Oklahoma ranked eighth nationally in terms of percentage job growth over a 12-month period.  He noted the distinct oil and gas-related hiring spike in the state both in terms of actual numbers and in percentage growth terms.  According to Dr. Snead, recent data revisions suggested that the state’s oil and gas firms continued to increase, hiring at a near 10 percent annual pace, the single most important factor in maintaining state job growth above the U.S. level in both 2008 and 2009.

Dr. Snead maintained that the state’s housing price gains remained in the 5 percent range throughout the nation’s housing boom, a number considerably lower than the national average, which was as high as 12 percent during the height.  This steady growth rate ensured that the state did not experience the sharp drop in housing stock values demonstrated in so many states, but particularly California, Florida, Nevada and Arizona.  Also, the state Legislature had enacted a $500 million personal income tax reduction, which had acted as an additional stimulus to economic activity in the state.  This tax stimulus acted to bolster retail sales in the state even though there has been a drop in the rate of growth in 2007 and 2008, compared to prior years.  The performance of the retail sales sector certainly has helped overall state tax revenues.

A further boost to the state revenue inflows according to Dr. Snead emerged from oil and gas severance tax inflows, which currently remain at record levels.  In particular, oil severance taxes will amount to nearly $1 billion by 2009.  Another point stressed by Dr. Snead was the fact that state income growth continues to move upwards.  Despite the limited weakening in growth expected in both 2008 and 2009, the state should make up more ground relative to the nation and reach 90 percent of U.S. per capita income in 2008.  He indicated that the ongoing strength in income growth has driven state per capita personal income to its highest level relative to the nation since the bottom of the oil bust in the 1980s.  In closing, Dr. Snead noted that the economic story in Oklahoma and much of the central region of the country is quite different, as broad economic conditions remain quite strong relative to the nation.

II.        Fiscal Dimensions of Enhancing Homeland Security and Emergency Preparedness

             Donald Hamilton, Executive Director, Memorial Institute for the Prevention of Terrorism (MIPT), Oklahoma

Background

At a time when the demand for homeland security funds remains very high, states continue to face the unenviable combination of shrinking state revenue inflows and dwindling federal funds for homeland security and emergency management.  The Oklahoma City-based Memorial Institute for the Prevention of Terrorism (MIPT), an organization created in the aftermath of the 1995 Murrah Federal building terrorist attack, engages in research and study and prepares programs and reports which allow policymakers to have access to the best and most complete information to avert terrorism and/or lessen the impact of a terror event or a natural disaster.

Mr. Hamilton’s Presentation

According to Mr. Hamilton, in the aftermath of the September 11, 2001, attacks, policymakers at all levels were forced to confront the onerous reality that even though there was a high threat of a major terrorist attack with high consequences, the probability that such an attack would occur remained low.  He emphasized the fact that terrorism is just one of the many risks for which states must prepare but it is certainly not the most likely or the most severe of the many risk categories that state policymakers must plan for in their agency operations.  Mr. Hamilton maintained that it was important for state policymakers to keep this fact in perspective.  Indeed, it is far likelier that policymakers would have to confront the awesome consequences of a tornado, a hurricane, an ice storm, a bridge collapse or a campus gunman than a major terrorist attack along the lines of the 1995 Murrah Building attack in Oklahoma City, for instance.

Mr. Hamilton posed the question how can states afford to prepare for all these scenarios at a time when state budgets are under tremendous pressure with the downturn in the economic and rapidly dwindling federal homeland security and emergency management funds.  At the outset, he stated, it is important for states to acknowledge that they cannot afford to prepare for every eventuality.  Fortunately, states do not need to do so for the following reason: Even though technology now allows small groups, whether terrorists or the deranged, to do damage on a scale previously limited to governments and acts of God, Mr. Hamilton indicated that there had been less change than the perceived level.  He noted that contemporary homeland security preparedness involved being ready for natural disasters and emergencies, a task states have worked on for decades, together with the potential implications of acts of terrorism caused by human malice.

In order to continue preparing adequately for this new development, Mr. Hamilton recommended the following measures:

• Understand Terrorism – Malicious human behavior shocks far more than accidents or acts of God.  It is, after all, designed to terrify.

• First, Be Prepared – While preparedness and prevention are different disciplines, it is important that states work on preparedness first because it permits the state to better leverage resources.  Example: if a state is prepared to respond to a major industrial accident, it is largely prepared for a truck bomb.

• Double Dip –Avoid spending significant resources on single-use items or programs.  Example: how many bomb robots does a state need given a reasonable assumption about expected usage?

• Watch Out for the Tail – Purchasing a bomb robot is not the entire scenario for a state or local government; the government has to plan for maintenance, training, staff time to retrain, all activities that could extend for several years with ongoing costs.

• Look for Multiple Uses – For instance, if the government strengthened and consolidated its public health department, the state will end up with healthier citizens even though it might never have to contend with a bio-terrorist attack.  Better vaccination rates, reduced obesity, fewer cases of diabetes will save more lives than terrorists will take.

According to Mr. Hamilton, the extensive experience states have formulated after decades of dealing with emergency management, public safety, public health and disaster recovery issues will hold them in good stead in contending with the recent challenges of terrorism.  In this regard, prevention is a critical component here because unlike a tornado, terrorism can be prevented.  Prevention comprises the following dimensions: intelligence, training, public awareness and targeted outreach.

In closing, Mr. Hamilton reiterated that states should not overspend on terrorism-only capacities but seek to double, triple and quadruple dip, if possible.  He strongly recommended funding single-use capacities only if they are indispensable against a threat likely to happen.  In turn, he recommended that policymakers constantly think about all-hazards preparedness as a means to both heighten better use of scarce financial resources and better preparedness.

Business Session, July 13, 2008

III.       Impact of Federal Budget Decisions on State Finances

              Elizabeth McNichol, Center on Budget and Policy Priorities (CBPP), Washington, D.C.

Background

Federal budget decisions have enormous implications for state finances and actions at the federal budget level; the impact of rising federal budget deficits on state economies; a glimpse into how states, particularly the SLC states, are faring vis-à-vis access to federal funds; and specifics on the Bush Administration’s fiscal year 2009 budget, all impact states.

Ms. McNichol’s Presentation

According to Ms. McNichol, federal budget decisions impact on state finances in primarily three ways: (1) federal grants-in-aid are an important revenue source for states; (2) state tax codes are connected to the federal tax code; and (3) federal rules govern the operation of some state programs.  Consequently, it is critical that state policymakers carefully review trends related to the federal budget to be prepared and forewarned about fluctuations in the federal budget.

In 2007, Ms. McNichol stated that the composition of the federal budget included defense and security (22 percent); Medicare, Medicaid and SCHIP (21 percent); Social Security (21 percent); various public services such as veterans’ benefits, education, scientific and medical research, transportation, national parks (18 percent); safety net programs (9 percent); and interest on debt (9 percent).  She also noted that sources of revenue for state and local governments included taxes (55 percent); federal aid (21 percent); current charges (15 percent); and miscellaneous general revenue (9 percent).

In this context, Ms. McNichol indicated that the role the federal tax code played in the finances of the different SLC states remained very important, particularly because it may or may not influence the level of revenues flowing into these SLC state coffers.  For instance, North Carolina and South Carolina are linked to the federal tax code because they use federal taxable income levels; then, eight SLC states (Georgia, Kentucky, Louisiana, Maryland, Missouri, Oklahoma, Virginia and West Virginia) use the federal adjusted gross income levels.  While Alabama, Arkansas and Mississippi do not have a federal starting point in terms of defining their tax categories, three SLC states (Florida, Tennessee and Texas) do not have a personal state income tax.

Bringing up the current fiscal situation, Ms. McNichol stated that 11 of the 16 SLC states face shortfalls in their fiscal year 2009 budgets.  Texas, Louisiana, Missouri, North Carolina and West Virginia do not anticipate a shortfall in the current fiscal year.  While these expected budget shortfalls range from a high of $3.4 billion (or 11 percent of the state general fund) in Florida to a low of $200 million (or 1 percent of the state general fund) in Georgia, Ms. McNichol indicated that cumulatively the expected shortfalls in the current fiscal year amounted to $7.7 billion (or 5.7 percent of the state general fund).  She added that the state revenues and expenditures never fully recovered from the 2001 recession and noted that the onset of further revenue declines in numerous states would be particularly challenging for policymakers.

In reverting back to how the federal budget deficit impacts state finances, Ms. McNichol indicated that in the 2001 to 2008 period, domestic spending at the federal level grew more slowly than any other federal budget area.  For instance, while defense and security spending (spurred by a number of war-related priorities) grew by an average of over 9 percent, Social Security, Medicare and Medicaid grew by under 4 percent, other mandatory programs expanded by 3 percent and domestic discretionary spending grew by 1.3 percent.  Given that the 2001 recession caused a state fiscal crisis that extended for four years, Ms. McNichol estimated that the current downturn could have an adverse impact on state finances beyond 2010.

The looming shortfall in the federal budget also has resulted in disagreement between Congress and White House on the enactment of a federal budget this year.  For instance, the president has called for slashing domestic discretionary spending by nearly 3 percent while Congress has called for a nearly 4 percent increase.  Ms. McNichol maintained that the resolution of this disagreement and the level of spending that will finally be agreed on will impact state finances significantly.  According to Ms. McNichol, the looming federal fiscal crisis can be traced to rising healthcare costs in the private and public sectors; the aging of the population, which raises the costs of Social Security, Medicare, and Medicaid; and the Bush tax cuts.

Ms. McNichol concluded her remarks by providing details on where the SLC states stood in terms of receiving federal aid as a percentage of general state revenues.  While the U.S. average was 20.7 percent, only four SLC state (Florida, Georgia, Maryland, Virginia) general funds contained a lower percentage of federal aid.

IV.       Rating Agency Perspectives on State Finances

              James Breeding, Standard & Poor's, Dallas, Texas

Background

The work of the credit rating agencies remain critically important to state finances and communicating how an agency like Standard & Poor’s devises state debt rating levels; calculates the impact of state action in complying with GASB 45/OPEB requirement in calculating state ratings; assess the level of debt that states seem to be accumulating in recent years; and measures how the financial woes of the bond insurance industry impacts state and local government finances remains of great value to policymakers.

Mr. Breeding’s Presentation

Mr. Breeding’s presentation covered the following areas: ratings in general; state debt ratings; impact of GASB 45; state debt levels; and bond insurance.  Given the volatility in the economy, each of these issue areas had broad impacts on the health of state finances.

According to Mr. Breeding, a Standard & Poor's issue credit rating is a current opinion of the creditworthiness of an obligor—such as a state or local government—with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs).  He emphasized that a credit rating is not a recommendation to purchase, sell, or hold a financial obligation, just like it does not comment on market price or suitability for a particular investor.  He added that credit ratings are based, in varying degrees, on a number of considerations, including: the likelihood of payment; the nature of and provisions of the obligation; the protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors' rights; and an assessment of default risk.

In terms of the actual ratings, Mr. Breeding stated that a Triple ‘A’ (AAA) rating constituted the highest rating assigned by Standard & Poor's and that ratings from  ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.  On a global scale, a Standard & Poor's rating helps investors determine which bonds and issuers might meet their individual risk tolerance and investment objectives.

According to Mr. Breeding, a ratings outlook assesses the potential direction of a long-term credit rating over the intermediate term, typically six months to two years.  In determining this rating outlook, consideration is given to any changes in the economic and/or fundamental business conditions of the state or local government.  While an outlook is not necessarily a precursor of a rating change or future CreditWatch action, a positive outlook means that a rating may rise; a negative outlook means that a rating may be lowered; a stable outlook means that a rating is unlikely to change; and a developing outlook means a rating may be raised or lowered.  In 1986, only about 20 percent of municipal bonds rated by Standard & Poor's held AAA or AA ratings; by 2007, more than 35 percent were rated that highly.  Similarly, more than 99 percent of rated municipal issuers are investment grade, compared with less than 20 percent of corporate issuers that Standard & Poor's has rated in recent years.  He stated that Standard & Poor's ratings system continues to evolve with changing conditions although the economy; financial performance and flexibility of the government entity; debt burden; and administration and management remain paramount in the process.

Notwithstanding the ongoing economic turmoil with some states facing greater challenges than others, Mr. Breeding noted that the state credit sector through fiscal year 2007 was strong.  He stated that Standard & Poor's upgraded state credit ratings in 11 states from 2006 through June 2008 (California, Hawaii, Indiana, Maine, Nevada, Oregon, Tennessee, Washington, Alaska, Wyoming, and Montana); downgraded one state (Michigan); and provided a positive outlook rating to another state (Kentucky).  He commented that as of July 12, 2008, 18 percent of the states had AAA ratings; 26 percent had AA+ ratings; 44 percent had AA ratings; 4 percent had A+ ratings; and 8 percent had AA- ratings.  Notwithstanding these positive developments, given the setbacks the economy has faced in 2008, Mr. Breeding noted that it is indisputable that this weak economy will tax states' 2009 budgets significantly.

He also informed legislators that Standard & Poor's had introduced the Financial Management Assessment (FMA) in 2006, which among other things, highlights in a consistent manner the most transparent aspects of management that are common to most governments.  Overall, state governments have well-developed policies in nearly all areas incorporated into the new FMA scores.  In fact, 16 states had strong FMA scores, 33 secured good FMA scores and one state (California) secured a standard FMA score.

In terms of public pensions, Mr. Breeding indicated that this was another pressure point affecting a vast number of states.  Standard & Poor’s latest (February 2008) pension report indicated U.S. state pension funding levels fell slightly but given the turmoil in the markets in the last six months, it is likely that funding levels have dropped even further.  The top three state plans in terms of funding levels in this 2008 survey were Oregon, North Carolina and Florida, while West Virginia, Rhode Island and Connecticut were termed the worst funded plans.  States also have been grappling with their Other Post Employee Benefit (OPEB) liabilities and devising funding strategies.  While 40 of the 50 states have completed valuations he added, based on the reports done to date, OPEB liabilities total $357 billion to $394 billion.  Mr. Breeding indicated that states already have initiated action to deal with these OPEB liabilities such as establishing trust funds; reducing benefits; containing healthcare costs; increasing employee contributions; and moving to annual required contribution (or ARC funding), Utah.

Mr. Breeding indicated that total debt issued by states and state authorities had increased tremendously in recent years, from $110 billion in 1998 to about $180 billion in 2007.  Total debt per capita in states ranged from $21 to more than $4,200 and that debt as a percent of personal income ranged from 0.1 percent to more than 9 percent in certain states.  The volatility in the bond insurance industry affects local governments and other government entities more severely than states, he concluded.

V.        Nominating Committee Report

The Nominating Committee, comprising Senator Douglas Henry, Tennessee; Senate President Pro Tem Charles Colgan, Virginia; and Senator Ted Little, Alabama, chaired by Senator Henry, presented its recommendations for Committee chair and vice chair for 2008/2009.  Senator Henry announced that there was a single name submitted for chair and a single name submitted for vice chair.  Consequently, Representative Daniel T. Cooper, South Carolina, was elected chair, and Representative Jim Fannin, Louisiana was elected vice chair for the upcoming year.

Southern Legislative Conference 63^rd Annual Meeting

Winston-Salem, North Carolina

The SLC will meet for the 63^rd Annual Meeting in Winston-Salem, North Carolina, August 15-19, 2009.  In keeping with the wishes of the SLC presiding officers, please note that meeting notification does not authorize travel.

SLC Staff Contact

If you have any questions regarding this report or the 2008 SLC Annual Meeting, please contact Mr. Sujit CanagaRetna in the Atlanta office at (404) 633-1866 or scanagaretna@csg.org.