The Hole Truth

Comptroller Susan Combs' quiet acknowledgment that Texas will show a $1.3 billion deficit at the end of the budget year contrasts with the happy face she's put on state finances leading up to the 2010 elections. The numbers are the worst since 2003, when the Legislature responded with $10 billion in spending cuts, and increased fees, tuition and other revenue sources to balance the budget. And the deficit gives ammunition to lawmakers who want to trim spending in 2011.

Publicly, the state's chief financial officer has said there's no reason to adjust income and spending estimates to account for the effects of the recession on the Texas budget: mostly, falling tax revenue. But on Wall Street — where the bond markets require hard numbers before they'll lend money — Combs had to report the deficit that will require legislative attention, and that it will have to borrow from other state funds to meet cash-flow requirements.

The deficit came to light because of a routine borrowing exercise. Every year, the state borrows money to make up for a cash-flow gap created every autumn, when its bills arrive faster than its revenue. The state normally pays the loan back in the spring and summer, when revenues catch up. But this year, there's a dull-but-important fact hidden in that cash flow estimate: State leaders looked a year ago and determined that the "deep hole" — when the cash-flow demand peaks — would be $7.8 billion. Now, Combs has told the debt markets that the deep hole is actually $10.8 billion, or about $3 billion worse. 

Next week, Texas is set to sell $7.8 billion in cash-flow notes, officially called Texas Revenue Anticipation Notes, or TRANs. (It will have to make up the remaining $3 billion by borrowing from other state funds.) The disclosure documents accompanying that borrowing contain the first public disclosure of a deficit in the current budget. Even though state leaders have already ordered agencies to trim up to $1.2 billion from their current finances, the state will come up $1.3 billion short, the disclosure documents reveal.

Officials with the comptroller's office say the documents they've filed in anticipation of the TRAN borrowing have nothing to do with whether there's a deficit — only the cash-flow issue. They point to particular documents — the comptroller's biennial revenue estimate and certification — as the official word on whether the budget is in or out of balance. "This is not a revenue estimate," says RJ DeSilva, a spokesman for Combs. "We wouldn't have an answer to that until the revenue estimate comes out in January."

Yet the office acknowledges that its revenue forecasts — last made in 2009 — are not holding true because of underperforming sales and franchise tax collections. Combs hasn't put a number on that erosion and isn't expected to until the end of this year. That's the normal schedule — and it also falls conveniently after the November elections. Officially, her office says the disclosures don't address whether there's a deficit in the current budget. 

Even so, the closest she's come to quantifying the state's fiscal problem is in the documents outlining the cash-flow issue. They identify the $3 billion change in cash requirements — an outgrowth of the state's economic slowdown. They break the news on the $1.3 billion deficit expected at the end of the year. They reveal that the state will have to borrow the $3 billion from other state funds that would otherwise be earning interest for the treasury. And they say that — even after all of that is done — the state won't be able to cover $236 million in checks at year-end unless the Legislature votes to revise the current budget, either with a cut in spending or by tapping the Rainy Day Fund.

The limping retail economy, which is improving but still lags the comptroller's projections, has darkened the cash-flow picture over the last year. The state's Cash Management Committee — an unimportant-sounding thing that's made up of the governor, the lieutenant governor, the speaker of the House and the comptroller — looked at the numbers a year ago and decided the state would need to borrow up to $7.8 billion to cover cash-flow needs. Now that it's time, the need has swollen to $10.8 billion. But rather than ask for a recalibration in an election year, Combs went to market with the original number, knowing that the rest is available in other state accounts. The quick version: Texas doesn't have any real cash-flow worries, but its budget is in worse shape that officeholders have admitted.

The state shouldn't have trouble getting the cash-flow loan. Texas is a blue-chip borrower, and the comptroller expects to get a good interest rate and to have plenty of ready lenders buying the notes. Three major rating agencies — Fitch, Moody's Investor Service and Standard & Poor's — all noted the state's budget shortcomings while giving the TRAN offering high ratings.

Staffers for the two legislative leaders — Lt. Gov. David Dewhurst and House Speaker Joe Straus — referred questions about the funds to the comptroller. Katherine Cesinger, a spokeswoman for Gov. Rick Perry, downplays the problem: "The comptroller’s statement is a forecast, a snapshot in time."

"We’ll close out fiscal 2010 this month, and sales tax revenues are trending in the right direction for 2011," Cesinger says. "When the comptroller releases her assessment in January, we’ll know more about where we stand and where we stand for the 2012-13 biennium. Until then, the Texas economy continues to be among the strongest in the country, with the lowest unemployment rate of the top 10 states, and we continue to attract top employers seeking lower taxes, reasonable regulatory structure, a fair legal system and a skilled workforce."

The wait until January also lets candidates duck questions about the expected shortfall in the next budget — the difference between what the comptroller says will be available to spend and what it would cost to keep state government rolling at its current clip. Estimates of that problem range from an optimistic $10 billion to a pessimistic $18 billion. In preparation for lean times expected in the next biennium, state leaders ordered agencies to ready their budgets for cuts of up to 10 percent in the next budget, which lawmakers will write in 2011.

The last time the state faced a serious budget crisis, then-Comptroller Carole Keeton Strayhorn maintained throughout 2002 that the state's shortfall would be in the range of $5 billion. When the Legislature convened in January 2003, she surprised everyone by raising that projection to $10 billion, saying the revenue outlook was worse than anticipated — and that the state was on its way to ending that budget with a $1.8 billion deficit. Perry, who was (correctly) anticipating a political challenge from Strayhorn, cried foul and said the comptroller should've leveled with the public and state leaders, including him. This time, the current comptroller has kept her mouth shut publicly but is by all accounts keeping Perry and other state leaders informed about the numbers. Though they haven't talked openly about it, nobody in that circle seems surprised by Combs' deficit disclosure.

Texas lawmakers are constitutionally required to balance the budget — to spend no more than the amount of money the comptroller says will be available over a two-year period. But there's nothing that says the state has to end every biennium in the black, so long as lawmakers believe it'll be in the black based on comptroller's projections when they do their budgeting.

The problem state officeholders are now facing has as much to do with politics as with finance. Financially, the numbers should work out. That last $236 million in spending that requires legislative attention is a relatively small 0.1 percent nick in a $182.3 billion budget.

Also, lawmakers return to Austin months before the current budget plays out. In years past, they've developed a habit of approving "supplemental appropriations bills" to cover any expenses that have arisen since they left town. The easiest way to do that is to hit the Rainy Day Fund or other funds for the money, which requires approval from two-thirds of each house of the Legislature. Since the session starts in January and the budget runs through August, they'll have plenty of time to plug that hole.