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Why it’s urgent for Texas to restructure its rainy day fund

Special to the Austin American-Statesman
by Glenn Hegar

July 13, 2017

On June 19, Standard & Poor’s issued a report that should serve as a wake-up call to every Texan.

The report analyzed our financial outlook on four major categories of spending and provided an overall ranking. Of the four major categories, only one — transportation spending — received a positive score. Our budget for pensions received a low “neutral” rating and public education barely edged into the neutral category. And the fourth category, Medicaid, received a negative outlook.

Our overall score was on the lower end of neutral. That’s not exactly a ringing endorsement for a state that prides itself on fiscal responsibility.

Many people may not be familiar with S&P, but governments are intensely interested in the company’s judgments. As one of the major credit rating agencies, its opinions affect our finances by raising or lowering the cost of borrowing. Being placed on credit watch — or even worse, a credit downgrade — can be very harmful for state budgets, as Illinois can attest to. Furthermore, the negative stigma damages a state’s image and can cause job expansions or company relocations to head elsewhere.

Long-term balance sheet issues don’t always require immediate action — and let’s face it, issues such as deferred maintenance in state buildings, employee pension benefits and teacher health care don’t get near as much attention as the more hot-button topics facing each new Legislature. Accordingly, these issues are allowed to persist despite the very real chance they could snowball, ultimately threatening our state’s budget and our credit rating.

I don’t want to minimize the hard work of our Legislature. As a former legislator myself, I know every Texas budget is the result of a complex tug of war between a multitude of competing needs and interests.

But if Texas continues its path, these efforts will not be enough.

During the recent legislative session, I offered lawmakers a plan to begin addressing our long-term commitments by making wiser use of our state’s Economic Stabilization Fund — the famous “rainy day fund,” the largest of its kind in the U.S. with a current balance of about $10 billion. While the Legislature plans to tap the fund for nearly $1 billion in the next two years, it has not addressed the fundamental flaws in the way the fund is structured.

State law requires my office to hold billions of the fund’s dollars in a way that doesn’t even meet historically low inflation rates. In 2015, the Legislature allowed my office to invest about a third of the rainy day fund at a higher rate of return — and that was a great first step. Right now, the state still has about $7 billion in the fund that earned just 0.7 percent in fiscal 2016. You could do about as well with an ordinary savings account at any credit union.

This year, I proposed a way to improve our return on the fund while creating a permanent financial source for our long-term financial obligations. Essentially, we’d maintain the “sufficient balance” called for in state law — $7.5 billion for the 2018-19 biennium — and invest it conservatively, but in vehicles that at least maintain its purchasing power.

Amounts above this balance would be invested in what I refer to as the Texas Legacy Fund, which would act like a permanent endowment within the Economic Stabilization Fund, generating investment income for addressing the persistent obligations that threaten our AAA credit rating. The principal would remain untouched.

My proposal garnered significant interest in the Legislature during the regular session — but not enough for the reforms to become law. The upcoming special session gives us another chance to finally begin tackling the financial obligations our state has pushed aside for too long.

In my opinion, restructuring the ESF is the only practical tool left in the box to keep Texas from falling under credit watch within the next few years. Our “patch, patch, patch” approach has about run its course. There’s no other solution that would pass muster with Texas voters — and no other option that will maintain the business-friendly climate that we have all worked so hard to preserve.

Employing this two-tiered approach to the rainy day fund would protect the Texas Miracle by leaving future generations a Texas-sized inheritance and ensuring our state’s finances stay strong. If we don’t take this opportunity, then shame on us and God help Texas.

Hegar is Texas Comptroller of Public Accounts.