Safest Return Imperiled as Kansas Considers Tax Cut: Muni Credit
Proposals to cut income taxes are threatening a winning streak for municipal bonds from Kansas and Oklahoma, which have been the safest among U.S. states for more than two years.
Debt of Kansas and Oklahoma issuers has earned 7.79 percent and 7.32 percent, respectively, since the end of 2009, after adjusting for volatility, according to data compiled by Standard & Poor’s and Bloomberg through April 13. The risk-adjusted gains were the highest among 26 states tracked by S&P.
Republican Governors Sam Brownback of Kansas, the biggest U.S. wheat exporter, and Mary Fallin of Oklahoma, home to two of the largest U.S. oil fields, have benefited from gains in commodity prices. They have proposed tax cuts to stimulate job growth and attract business. The plans portend a “risky” trend for municipal debt as state finances are still rebounding from the recession that ended in 2009, Chris Mier at Loop Capital Markets LLC in Chicago, said in an interview.
The states “have nowhere to go but down” in terms of risk-adjusted performance, said Mier, Loop’s chief municipal strategist. “This has got to be one of the more worrisome trends in state and local finance. If this gains acceptance, it’s an experiment in state and local finance at a very vulnerable time.”
Neither Kansas nor Oklahoma has projected a budget deficit for next fiscal year. Thirty states have forecast or addressed a gap for the period, according to the Center on Budget and Policy Priorities, a Washington nonprofit focused on issues affecting lower-income Americans. States and the District of Columbia faced $49 billion of shortfalls in the period, after closing more than $500 billion of gaps in the previous four years.
Issuers in Kansas and Oklahoma have sold a combined $1.2 billion of debt this year, or about 10 percent of those in California, the largest U.S. municipal borrower, Bloomberg data show. While Kansas has no general-obligation debt, S&P’s index includes bonds sold by agencies such as the Transportation Department and cities such as Wichita. The Oklahoma index includes the state’s general obligations, agencies and municipalities such as Oklahoma City.
Without adjusting for volatility, Kansas debt trailed the $3.7 trillion municipal market in the past year, 12.1 percent to 12.75 percent, while Oklahoma securities returned 11 percent, according to S&P. Puerto Rico, which beat all U.S. states in the past 12 months with a 16 percent return, is third from the bottom after accounting for volatility.
Brownback’s proposal lowers the individual income tax to a range of 3 percent to 4.9 percent, from 3.5 percent to 6.45 percent, and eliminates the levy for some non-wage business income. The plan is paid for by halting certain deductions and credits and forgoing a scheduled sales-tax decrease. It would cost $90 million in fiscal 2013, $99 million the following year and $50 million by 2017, according to the budget division.
Lawmakers have passed their own bills and reconvene April 25 to negotiate. Those measures would cost at least $233 million next year and as much as $911 million in 2017, the Legislative Research Department estimates.
If politicians “don’t do it prudently and they don’t have verifiable offsets for reducing the revenues, then yes I think they are at risk,” Bob Campbell, who oversees about $300 million in Kansas bonds at American Independence Financial Services in Wichita, said of the state’s returns.
“I’m optimistic that the politicians, in whether it be Kansas or Oklahoma, will be prudent and will follow the same kind of path they have over the years,” he said.
Fallin, 57, would cut the income tax to a range of zero to 3.5 percent, from 0.5 percent to 5.25 percent, with the eventual goal of eliminating it, according to her fiscal 2013 budget. A version of the plan passed the House of Representatives and awaits a vote in the Senate. It will cost the state $383 million in projected revenue in fiscal 2013 and $980 million the following year, according to the Oklahoma Tax Commission.
“There is a balance where you can right-size government itself, you can reduce spending, also let people keep more of their hard-earned money and create a more competitive business environment,” Fallin said in an interview in New York last week. “Investors are out looking for where can they find the best rate of return in whatever state.”
At least 10 states passed tax cuts last year, said Michael Leachman, director of state fiscal research at the center on budgets.
Brownback, 55, and Fallin lead states with jobless rates below the 8.2 percent national average. Kansas’s rate was 6.1 percent in February, while Oklahoma’s was 6 percent.
Kansas has gotten a boost as U.S. farm exports rose to a record in 2011. Oklahoma is benefiting as crude has averaged more than $100 a barrel this year.
In the final quarter of 2011, the states ranked eighth and 10th, respectively, in terms of tax-revenue growth relative to the prior three months, according to Bloomberg Economic Evaluation of States. The states have closed about $6 billion of deficits combined since fiscal 2009.
“Part of the rationale for these tax changes is that they will jump-start the Kansas economy -- that’s giving a lot of credence to fiscal policy,” said Donna K. Ginther, an economics professor at the University of Kansas in Lawrence. “Our state budget is already very lean.”
Individual income tax accounted for 46 percent of Kansas general-fund revenue in fiscal 2012, according to the Legislative Research Department. It made up about 35 percent in Oklahoma in fiscal 2011, according to Ron Jenkins, a State Finance Office spokesman. Income tax “is the single most important source of state revenue,” according to Fallin’s budget.
Brownback’s “road map of controlling state spending while reducing the tax burden on all Kansans has put our state on sound fiscal footing and has returned business confidence so investments and job creation are flowing into our state,” Sherriene Jones-Sontag, his press secretary, said by e-mail. The governor’s efforts “will continue to make Kansas a great place for bond investors.”
Kansas has a AA+ issuer rating from S&P and Aa1 from Moody’s Investors Service, both second-highest. Oklahoma general obligations have a Aa2 Moody’s rating, third-highest, and AA+ from S&P.
Fallin said last week that she met credit-raters in New York in January and asked them to review the state’s grade. Moody’s kept the state’s rating unchanged in February, citing constraints to financial flexibility such as the “high bar to raise taxes” and a “trend towards reduction in personal income tax.”
The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. The returns aren’t annualized. Higher volatility increases the prospect for losses.
Following are descriptions of coming sales:
PENNSYLVANIA plans to sell $950 million of tax-exempt general-obligation bonds via competitive bid as soon as today. It’s the state’s biggest sale of long-term, tax-exempt debt since 2006, data compiled by Bloomberg show. Moody’s rates the debt Aa1. (Updated April 17)
ATLANTA, Georgia’s biggest city, plans to sell about $492 million in tax-exempt and AMT airport-revenue bonds as soon as this week, according to the offering document. The proceeds will go toward construction at Hartsfield-Jackson Atlanta International Airport. (Updated April 17)