Iowa Auditor Proposes Budget Reform To Improve Ratings, Close GAAP Deficit

CHICAGO - Iowa Auditor Richard Johnson last week proposed a budget reform plan that he believes could raise the state's unenhanced short-term ratings with the credit agencies.

Mr. Johnson said his proposal, which he outlined before Gov. Terry Branstad's Committee on Government Spending Reform, would create two state budget reserve funds and eliminate an estimated $298 million general fund deficit by the end of fiscal 1994, as determined by generally accepted accounting principles. Iowa's fiscal 1992 general fund budget, which went into effect July 1, is $3.2 billion.

The plan, however, would not erase the state's GAAP deficit by the end of fiscal 1993 - as required under current law. But state officials have conceded that complying with that deadline will probably be impossible and that the law will have to be changed to give Iowa more time to get its fiscal house in order. The law, passed in 1987, also requires the state to complete a switchover to a GAAP-based accounting system from its cash-based system by the end of fiscal 1993.

By eliminating the GAAP deficit and creating the reserves, Mr. Johnson said the rating agencies might consider Iowa a strong enough credit that the state no longer would need to purchase a bank letter-of-credit to ensure it receives the top ratings when it does its annual issuance of short-term tax and revenue anticipation notes.

"That would be a goal," he stated, adding that a letter of credit the state purchased for a $330 million Trans issue in July cost $600,000.

George Leung, vice president and managing director of state ratings at Moody's Investors Service, said implementation of Mr. Johnson's plan would be viewed by the rating agency as "a positive development."

"We've been talking with the state about those issues for years," he said.

Noreen Domanico, a vice president at Standard & Poor's Corp., said she had not seen Mr. Johnson's proposal, so she could not comment on it yet.

Since 1987, Iowa's Trans issues have been backed by a letter-of-credit and rated SP-1 plus by Standard & Poor's and MIG-1 by Moody's, the highest possible ratings. The last time the state went to the market with short-term notes without a letter of credit - a $463 million issue in 1986 - the Trans were rated SP-1 by Standard and Poor's and MIG-2 by Moody's.

The Iowa constitution bars the state from issuing long-term general obligation debt.

In addition to improving the state's credit posture, Mr. Johnson said the creation of the reserve funds could possibly eliminate the state's need to issue notes to pay for operating expenses, a practice the auditor said probably violates the state constitution's prohibition on ending a fiscal year more than $250,000 in debt without prior approval by voters.

Mr. Johnson said the state used $250 million of the $330 million Trans issue in July to pay bills incurred before fiscal 1991 ended on June 30.

"I think the way the proceeds are being used probably violates the constitution," Mr. Johnson said. "Under this plan, we still might need to issue notes for cash-flow purposes, but not at the level we have in recent years and not to pay old bills."

Ironically, Mr. Johnson's opinion on the use of Trans proceeds is shared by the tax watchdog group - Iowans for Tax Relief - that filed a lawsuit in Polk County District Court in February against the auditor and other state officeholders on the grounds, in part, that the annual issuance of Trans represented the refinancing of an unconstitutional state debt. The lawsuit was dismissed on technical grounds in April.

Ed Failor, a lobbyist for Iowans for Tax Relief, said the group it does not support the auditor's plan and instead is exploring other ways to challenge the state's practice of issuing Trans.

Mr. Johnson said he has asked state Attorney General Bonnie Campbell to issue a legal opinion on the constitutionality of the state's use of Trans.

According to a written summary provided by Mr. Johnson, his budget reform plan would be financed beginning in fiscal 1993 by annual transfers of $150 million from the Road Use Tax Fund, an account now dedicated solely to funding road projects with cash. The road fund, with revenues of about $700 million a year, is comprised of collections from the state's gasoline tax, motor vehicle registration fee, and sales tax on vehicle purchases.

The transfers would be used to eliminate the $298 million GAAP deficit, establish cash-flow and emergency reserve funds, each totaling $90 million and finance construction and maintenance of state buildings on a pay-as-you-go basis.

The auditor's plan would require approval by the General Assembly and the governor.

David Fisher, chairman of the governor's Committee on Government Spending Reform, said Mr. Johnson's proposal will be one of many ideas that will be considered.

The 22-member panel, comprised of business, labor, and political leaders, began meeting last month to explore possible cuts and efficiencies that could be made in state government. Mr. Fisher said the committee hopes to make recommendations to the governor by Dec. 15. He added those recommendations could be the basis for a budget reform plan the administration would present to the General Assembly next year.

Richard Vohs, a spokesman for Gov. Branstad, said the governor is willing to consider any plan that helps eliminate the GAAP deficit. He added that the governor and legislative leaders would talk early next year about possibly changing the law that requires the state to complete a switchover to a GAAP-based accounting system and eliminate its GAAP deficit by June 30, 1993.

"It might be too tough to pull in our belts that much in that amount of time," Mr. Vohs said. "If we can get on a solid path to paying our bills on time, that might be better than reaching an arbitrary deadline."

The state first uncovered a GAAP deficit at the end of fiscal 1989, when Iowa completed its first comprehensive annual financial report. The GAAP deficit at that time was $42.2 million.

That financial report was the first step in the switchover to GAAP-based accounting from cash-based accounting, a move that state Treasurer Michael Fitzgerald said had been prompted by rating agency officials' concerns over the inadequacy of the cash-based accounting system. Mr. Fitzgerald added the lack of GAAP-accounting had harmed ratings on Trans issued by the state without a letter-of-credit prior to 1987.

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