Lottery Funds Not Adequately Supporting State Financial Aid Programs

The House has recently identified new lottery funds as a potential source of revenue to help pay down Kentucky’s pension liability. Whatever happens with that proposal, it’s important to understand that the student financial aid programs that currently receive almost all of the lottery revenue are already substantially underfunded.

Capping the monies for college scholarships, even while allowing up to 2 percent annual growth as proposed by the House, would mean that our neediest students would continue to be turned away for financial aid. More dollars are needed both to pay back the pension debt to workers and to help more Kentuckians afford college.

According to a recent Kentucky Higher Education Assistance Authority (KHEAA) presentation, current lottery revenues do not come close to funding all of the students eligible for the state’s financial aid programs. It’s true that the merit-based Kentucky Educational Excellence Scholarship (KEES) is fully funded meaning all eligible students receive scholarships—although the individual scholarship base amounts have been frozen since KEES was established in 1998. But the critically important need-based programs—the College Access Program (CAP) and the Kentucky Tuition Grant (KTG)—turn away more and more students each year due to a lack of funds.1

CAP and KTG funds are distributed on a first come, first served basis, and the number of students denied assistance more than doubled between 2008 and 2011—increasing from close to 40,000 students in 2008 to more than 80,000 in 2011. Each year the date that CAP funding is exhausted is earlier than the previous year. While in 2011 it was in early March for CAP, in 2012 the cut-off date was mid-February.2

As illustrated in the chart below, since 2011 more eligible students are denied need-based aid than receive it. In 2012 the state appropriated $90 million for CAP and KTG, leaving more than $111 million in unmet need for these programs.

need-based aid unmet need

Source: Chart was included in this presentation: Robin Morley and Becky Gilpatrick, “Lottery Funded Student Aid Programs,” Presentation to the House Budget Review Subcommittee on Postsecondary Education, February 7, 2013.

These state scholarship programs—especially for need-based aid—have never been more important than they are now. Tuition at Kentucky’s public colleges and universities has skyrocketed—increasing more than 200 percent since 1998. Even tuition at the state’s community colleges is unaffordable for many. Meanwhile, Kentucky has set an ambitious goal for increasing the share of adults with college degrees from the current rate of 32 percent to 43 percent by 2020.3

In order to adequately fund the state’s scholarship programs and its pension system—not to mention its many other important underfunded programs and services—Kentucky needs much more revenue than an expanded lottery and other gambling can provide. When it comes to the state’s staggering revenue needs, a lottery strategy is no replacement for tax reform.

  1. While funding has not decreased, the number of eligible students applying has increased.
  2. In 2009 it was late April before CAP funding was exhausted. Robin Morley and Becky Gilpatrick, “Lottery Funded Student Aid Programs,” Presentation to the House Budget Review Subcommittee on Postsecondary Education, February 7, 2013. Students apply by filling out the FAFSA as soon after January 1 as possible.
  3. Realizing Kentucky’s Educational Attainment Goal: A Look in the Rear View Mirror and Down the Road Ahead,” National Center for Higher Education Management Systems, September 6, 2011, http://cpe.ky.gov/NR/rdonlyres/81AB2E18-9122-4BAA-86C1-B6804D2CCE9A/0/NC.… According to a recent report, the state is not making good progress on closing the associate’s and bachelor’s degree graduation rate gaps for lower-income students and decreasing financial barriers to college access and completion. Council on Postsecondary Education, “Stronger by Degrees: 2010-2011 accountability report,” 2012, http://dataportal.cpe.ky.gov/sadashboard/AccountabilityReport/accountabilityreport.pdf.

Gambling Revenues Are No Substitute for Tax Reform

The House has proposed generating new revenues for the state pension system by expanding the lottery and utilizing revenues from instant racing. However, the plan generates only a portion of the funds needed to make the annual pension payment, while gambling revenues tend to grow slowly over the long-term. If such a proposal advances, it should not replace the need for state tax reform that generates additional and sustainable revenues.

According to the speaker’s February 26 presentation on the proposal, the House does not expect these new gambling options to generate enough revenue to make the full annual pension payment. Projections show an average of an additional $53 million a year in the first biennium growing to $92 million a year by 2020-2022. But the pension system needs $100-$120 million more annually starting the first year. Without more revenue, additional budget cuts will be necessary to make up the difference.

While the presentation predicted strong growth in new gambling revenues for the first six years as the Keno, i-lottery and instant racing games mature, the long-term viability of gambling revenues is also important; the unfunded pension liability is a recurring cost that must be paid off over a 30-year period. State contributions to the pension system will need to grow 3.9 percent per year according to the actuarial analysis for Senate Bill 2.

But historically, revenue growth from the lottery is slower than that. Over the past fifteen years, as shown in the graph below, lottery revenues have grown only about two-thirds as fast as tax revenues. Tax receipts have grown on average 3.4 percent per year while lottery revenues have grown only 2.1 percent.

Also, because we haven’t passed tax reform, tax revenue growth itself is poor–revenues don’t grow fast enough to keep up with growth in the economy, causing broader budget problems. According to consultants to the governor’s tax reform commission, the current tax system’s inability to keep pace with economic growth will result in an additional budget gap of over $1 billion by the end of the decade.

If the legislature moves forward with the House’s revenue proposal, the state will still need to act on tax reform that fairly generates additional needed dollars—both for the pension gap and to begin rebuilding Kentucky—and that creates a more reliable and sustainable revenue stream.

 lottery revenues

Source: KCEP analysis based on data from the Office of the State Budget Director and Bureau of Economic Analysis

Income Tax Cuts No Way to Grow Small Businesses

The claim that cutting state income taxes is an effective strategy to help small businesses create jobs is discredited in a new report released by the Center on Budget Policy and Priorities (CBPP).

The report shows that state personal income taxes have an insignificant effect on small business job creation. And by taking resources away from critical services like education, income tax cuts could harm a state’s ability to grow an entrepreneurial economy. CBPP notes that:

  • Taxable income for small businesses is typically modest enough that even a full repeal of state personal income taxes would not amount to the salary requirements for one full-time employee.
  • Nationally, only 2.7 percent of taxpayers own a small business with employees other than themselves, and the majority who have no employees have no plans to hire, either.
  • The minority of small businesses that would hire in the right conditions are far more responsive to increased demand for their products and services than to negligible tax cuts.
  • Small start-up companies creating a sizeable share of new jobs in the economy spend heavily on new equipment, product development and marketing such that they have relatively little taxable profit in their early years, and would therefore not benefit from tax cuts.

Quality-of-life and access to human capital, markets and business development resources bear much more on entrepreneur’s decisions about location than state income tax codes. In other words, “tax flight is a myth.”

The report cites a 2012 study commissioned by the U. S. Small Business Administration that found “no evidence of an economically significant effect of state tax portfolios on entrepreneurial activity.”

If more tax cuts aren’t the answer, then what can the state do to create jobs at small businesses in Kentucky?

In part, the same factors that attract and support small business drive economic development more broadly: access to quality education and healthcare for all ages, well-maintained infrastructure, an efficient court and justice system, universities producing innovative research and up-to-date communication systems.

To support job creation and economic growth, Kentucky must invest in these public goods and services.

But during the past six budget years, inadequate revenue has led to severe budget cuts: no funding for new school textbooks, childcare subsidy cuts, and the removal of health services from schools are just a few examples that directly impact Kentucky’s children and their future success. State income tax cuts would further diminish Kentucky’s inadequate revenue stream, resulting in even more cuts.

Yet arguments in favor of income tax cuts continue. The final recommendations by the governor’s tax reform commission included reducing the top income tax rate from 6 percent to 5.8 percent. While the recommended cut is small, it would result in a loss of much-needed revenue without any evidence that the cut would attract entrepreneurs or create jobs.

Income taxes do not hinder job growth, but are one of the state’s most important revenue sources. Income taxes also keep up with growth in the economy better than other taxes and are fair – taxing people based on their ability to pay.

If Kentucky addresses tax reform this year – which it should – it must do with a clear understanding of the relationship between income taxes, public investment and economic growth.

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Bill Would Be a Step Toward Greater Accountability for Tax Breaks

Legislation introduced in the House proposes new reporting requirements for some economic development incentive programs, and is a step in the right direction toward greater scrutiny of these costly financial subsidies.

Kentucky needs better data on the cost-effectiveness of the business tax breaks it awards. A few years ago, the state created an online database that provides information on tax breaks when they are awarded, but provides no follow-up information about the resulting impact. House Bill 242 would require the Cabinet for Economic Development to post online information about the number of jobs actually created, wages paid and tax breaks received by companies participating in some of its programs, and to produce an annual report.

In 2013, the business tax breaks and financial assistance programs included in HB 242 will cost the state almost $200 million, according to the state’s tax expenditure report. As a tool for economic growth, tax breaks can be less effective and more costly than other proven strategies such as funding for early childhood education, small business assistance and job training.

Over the past 30 years, Kentucky has relied heavily on corporate tax breaks to attract business and create jobs while falling behind on other important factors like quality of living, a healthy and educated workforce and infrastructure.

HB 242 would help inform the debate. But even if it were to become law, there’s no guarantee the state would use the data generated to make tough decisions about whether to curb these programs. Unlike funding for education and health which are vulnerable to cuts each budget session, tax breaks are permanent fixtures in the tax code. Legislation should impose expiration dates on tax incentive programs in order to bring them up for regular review and allow legislators to weigh whether there are more valuable uses of state dollars. Otherwise, ineffective subsidies will continue to fly under the radar from year to year.

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Debt Limit Could Increase Costs for Kentucky

A Senate committee approved legislation today to limit debt service (the annual payments made on debt the state owes) in future years to six percent of the state’s revenue. Yet rather than saving money, Senate Bill 10 could end up increasing Kentucky’s costs.

There are two reasons debt payments go up as a share of revenue: 1) the state takes on more debt; and 2) the state takes in less revenue than expected. In the latter case, sagging revenues are usually the result of a recession.

But because interest rates are often low in a bad economy, it can be a good time to borrow for necessary investments. In the recent recession, the federal government helped stimulate the economy by creating subsidized bonds that allowed state and local governments to borrow at especially low rates. A hard limit on debt as a share of revenue could keep the state from taking advantage of those opportunities—and make costs higher by delaying bond issues to times when interest rates are up.

A limit could also keep the state from investing in necessary school construction and infrastructure projects exactly when the associated jobs are most needed—when unemployment is high.

Senate Bill 10 could prevent other sensible uses of debt, such as legislation introduced last session which would allow the state to issue bonds for cost-effective energy efficiency improvements in school buildings. The bonds would pay for up-front costs, and would be paid back over time through the resulting savings on utility bills.

Taking on debt should not be done lightly. Investments should be smart and have a demonstrated need and clear benefits. But an arbitrary limit on debt payments of 6 percent of revenue does not make those decisions more rational and responsible.

Despite its language suggesting otherwise, Senate Bill 10 could be suspended at any time by the legislature. Last year’s original version was a constitutional amendment–far worse for the restrictions it would have imposed.

Regardless of SB 10’s real impact or the bill’s fate in the House, if the question prompting this legislation is how to address our fiscal problems then Kentucky must look to the revenue side. Inadequate revenues have led to underinvestment in Kentucky’s needs and an increase in unwise forms of debt.

Persistent revenue shortfalls have led to debt restructuring that has pushed payments forward to future years. The result is the same as when credit card payments are delayed–total costs increase. Another key example is in the pension system, where inadequate revenues and partial payments to our retirement system over the years have led to the large pension liability we must now pay back.

To service our debts responsibly and intelligently, and to invest in Kentucky’s future, we must enact tax reform that generates more revenue and allows it to grow with the economy.

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