Pension reform, taxes and the budget: Matt Bevin reaches his defining moment as governor

FRANKFORT, Ky. — Drowned out amid the uproar over pension reform and stunning allegations of sexual harassment in the legislature this fall has been a public policy message that will have a far greater impact on the lives of Kentuckians:

The next state budget has a $1 billion hole to fill, and if there is no new revenue, massive cuts to programs are coming when the legislature convenes to tackle the problem. 

John Chilton, Gov. Matt Bevin's budget director, told the state pension oversight board on Aug. 28 and again on Nov. 2, “To be fiscally responsible, we need to free up an additional $1 billion per year."

Chilton was describing the likely hole in the budget if lawmakers fully fund pension reform and meet other needs such as replenishing a depleted state "Rainy Day" fund. It's a hole that he said can be filled only by a combination of spending cuts, revenue increases and reducing the cost of pensions. 

How the state deals with this intertwined mix of legislation — the long-simmering pension crisis, the 2018-20 state budget, and possibly tax reform — stands as the defining moment of the administration of Matt Bevin.

It will also be the first time in Kentucky history that a state budget will be crafted by a Republican governor, a Republican House and a Republican Senate.

More:Gov. Matt Bevin says he might not call special session on pension reform

More:Kentucky gave $15M to a manufacturer. Now, one of its investors is raising money for Bevin

House Speaker Pro Tem David Osborne, who has been leading the House GOP since Jeff Hoover stepped down as speaker over a sexual harassment scandal, said he could not dispute the estimate of a $1 billion budget problem. “I think the cuts are going to be significant. At this point I think that’s all the specificity I can give,” said Osborne, a Prospect Republican.

Rep. Jim Wayne, a Louisville Democrat, said that without new revenue, the budget outlook “is the bleakest it’s ever been in my 27 years in Frankfort. It’s really a disaster in terms of investing in our state and our people.”

The bleak outlook means there will be no new money to fight the opioid crisis or hire more social workers to deal with burgeoning numbers of abused and neglected children coming into the state’s care.

Universities are sure to take another big whack. Even the core funding program for public schools — a priority spared from earlier rounds of cuts — might well be cut this time.

Small agencies and programs considered nonessential could be abolished. State workers, who haven’t gotten raises in six of the last eight years, will get none for the next two. In fact, the tight budget raises the prospect of layoffs.

Bevin has ruled out alternative ways to raise revenue such as legalizing casinos or recreational marijuana. And pushing anything that could be called a tax increase through Republican-dominated legislative chambers would be the tallest of orders.

From September:Judge: Talk to lawmakers about marijuana legalization, not me

Yet the governor said in an interview with the Kentucky Chamber of Commerce in October that he stood by a statement he made to the General Assembly in February — he will propose a tax reform plan in 2018 that would modernize the state's tax code and close many loopholes.

“You can’t cut your way into everything. You can’t," Bevin said in that interview. "We’ve already cut a lot of the fat out of government. Is there more fat to cut? There is, sadly. But will it be enough for everything? No." 

The 2018 legislative session will convene at noon Jan. 2. Lawmakers hope to pass a pension reform bill quickly. And Bevin will propose the 2018-20 state budget to them Jan. 16.

Why is there a billion-dollar hole?

Chilton declined requests to be interviewed for this article. But a look at the current budget and revenue projections posted on his office’s website shows the budget outlook would be tight even without big additional outlays for pensions.

While revenue growth for the next fiscal year that begins July 1 is expected to be modest — about 2.7 percent, generating $292 million in new money — that money might be considered already spent.

That's because the current budget spends about $425 million in “one-time” funds on recurring expenses. For instance, the budget takes a carryover balance at the beginning of the year and spends it, it takes $187 million in surplus funds in the public employee health insurance fund and spends it, and so on.

Some one-time money will be available for the next budget, but probably not nearly so much. One source could be a “Permanent Pension Fund” that Bevin established last year that Chilton recently reported had a balance of $148 million.

Another problem is that some areas of state spending are sure to require increases. Sen. Chris McDaniel, the Taylor Mill Republican who chairs the Senate budget committee, said he expects about $78 million more will be needed next year for Medicaid to pay partly for the larger share of the cost being shifted to states for the expansion under Obamacare next year as well as increases in the base costs of the program.

More:Pension plans will need nearly $800 million more next year, KRS says

And stubborn growth in the state’s prison population will require adding about $50 million per year for the Department of Corrections, McDaniel said.

A third problem is that the Rainy Day Fund — a reserve used to pay unbudgeted expenses and protect against revenue shortfalls — is expected to dry up by the end of this year. Chilton has said Bevin wants to re-establish that fund with at least $150 million, although he said bond rating agencies would like to see $550 million in it.

What will pensions cost?

The biggest issue that pushes the budget problem to at least $1 billion is paying for pension reform. That cost will depend on what the reform bill ultimately looks like.

But the additional tab will be huge if only because Bevin and Republican leaders say the bill must require a new funding approach — called “level dollar funding” — that calls for paying pension costs like a home mortgage, with equal payments each year over 30 years.

This approach would require a big boost in funding starting next year compared to the current approach, which pays for pensions based on a percentage of public payrolls and increase each year.   

This month Chilton said, “We continue to think there will be a need for another $700 million in General Fund dollars – in addition to what we’ve been contributing in the past” to fund pension reform next year.

More on Kentucky pension reform:What does this proposal do?

Chilton has said that increase could be significantly reduced depending on the provisions of any pension reform bill. But one provision of the reform bill unveiled by Bevin and Republican leaders in October that would generate the most savings — a 3 percent contribution by all public employees for retiree health benefits — has been met with strong opposition. It's unclear if it will be part of a pension reform bill that can pass the House.

Adding $700 million to pension spending per year would be a massive shift in an $11 billion annual General Fund budget, and it would come on top of huge increases approved for pensions in 2016 at Bevin’s request. In 2008, pensions consumed just 6.7 percent of the budget — a percentage that grew to 13.4 percent this year. If $700 million more is added next year, pensions will take up about 20 percent of General Fund spending in 2018-19.

Jason Bailey, executive director of the Kentucky Center for Economic Policy, said more money is needed for pensions but that the level-dollar approach would generate too much — requiring other public services “to be cut by huge amounts.”

“This overreaction to past underfunding (of pensions) would set up unprecedented budget cuts a few short months from now, especially if there is no new revenue on the table," Bailey said in a recent article.

Bailey said his analysis of reports by consultants to the Bevin administration and the Teachers' Retirement System shows that the level-dollar approach will require far more than an additional $700 million for pensions next year — with most of the new money going to the teachers' system rather than the state’s worst-funded plan for most Kentucky government employees.

But Bevin and Republican legislative leaders say the funding approach is key to finally bringing the state's massive pension debt under control and preventing liabilities from ever again spinning out of control. Senate Republican Leader Damon Thayer put it this way: "It begins paying for an accurate representation of what Kentucky owes.”

Could cuts include education?

A shortage of $1 billion, or 9 percent of revenues, would mean cuts much deeper than 9 percent to most agencies. That’s because some programs, like Medicaid and Corrections, will need more money next year, not less. The state also is obliged not to cut what it owes in debt payments on bonds. And for the past decade, the main school funding program — known as Support Education Excellence in Kentucky, or SEEK — has been preserved from cuts.

Chilton said in November that if the programs that are normally exempt from cuts are exempt again, cutting $1 billion in spending would amount to a 34 percent funding reduction to the remaining state agencies.

If the SEEK program — the state’s largest annual spending item — is added to those programs cut, Chilton said the cuts to state agencies would be nearly 17 percent.

Thayer said that because SEEK is such a large part of the state budget that “it is highly likely that it is going to be trimmed.”

What about a tax increase?

Bevin has called for tax reform since the outset of his 2015 campaign for governor, and in his recent interview with the chamber he promised that tax reform will be passed during 2018, though not necessarily in the regular legislative session.

“I’m debating whether I’ll submit two budgets. One with tax reform in it, and one without to give people the option,” Bevin said.

In that interview the governor insisted that he’s never backed away from his comments in his State of the Commonwealth address in February when he promised to modernize the tax code in a way that would respect no “sacred cows” and suggested the plan would raise revenue.

“I’ve never walked that back," Bevin told the chamber. "I could not be more clear about this. We are going to modernize our tax code. We exempt far too many things.” 

From February:In his own words, Bevin discusses tax reform

This week in an interview with WHAS Radio’s Terry Meiners, Bevin did not give a direct answer when asked if he would have to raise taxes to tackle the pension and budget crisis.

“We’ve got to address the pension problem first," he said. "We have to deal with the budget. … Once we know what the cost of those are, where then is the money going to come from? That’s when tax conversation comes into play.”

But Thayer said of any tax increase, “I’m not for it. ... And in general, that’s not why Republicans run for office.”

Said Osborne, "It's impossible to speculate until we see what is going to be part of tax reform. ... But tax reform is always incredibly difficult, which is why it's rarely been done."

Tom Loftus: 502-875-5136; tloftus@courier-journal.com; Twitter: @TomLoftus_CJ. Support strong local journalism by subscribing today: www.courier-journal.com/toml