Actions have been
and may be taken by the State during less favorable economic periods to ensure
resource/expenditure balances (particularly in the GRF), some of which are
described below. None of those actions were or are being applied to
appropriations or expenditures needed for debt service or lease payments
relating to any State obligations.
The
appropriations acts for the 2008-09 biennium include all necessary appropriations
for debt service on State obligations and for lease payments relating to lease
rental obligations issued by the Ohio Building Authority and the Treasurer of
State, and previously by the Ohio Public Facilities Commission.
The
following is a selective general discussion of State finances, particularly GRF
receipts and expenditures, for recent and the current bienniums.
1996-97
.
From a higher than forecasted mid-biennium GRF fund balance, $100,000,000 was
transferred for elementary and secondary school computer network purposes and
$30,000,000 to a new State transportation infrastructure fund. Approximately
$400,800,000 served as a basis for temporary 1996 personal income tax
reductions aggregating that amount. Of the GRF biennium-ending fund balance,
$250,000,000 was directed to school buildings, $94,400,000 to the school
computer network, $44,200,000 to school textbooks and instructional materials
and a distance learning program, $34,400,000 to the BSF, and $262,900,000 to
the State Income Tax Reduction Fund (ITRF).
1998-99
.
GRF appropriations of approximately $36 billion provided for significant
increases in funding for primary and secondary education. Of the first fiscal
year (ended on June 30, 1998) ending fund balance of over
$1.08 billion, approximately $701,400,000 was transferred to the ITRF,
$200,000,000 into public school assistance programs, and $44,184,200 into the
BSF. Of the GRF biennium-ending fund balance, $325,700,000 was transferred to
school building assistance, $293,185,000 to the ITRF, $85,400,000 to SchoolNet
(a program to supply computers for classrooms), $4,600,000 to interactive video
distance learning, and $46,374,000 to the BSF.
2000-01
.
The State’s financial situation varied substantially in the 2000-01 biennium.
The first fiscal year of the biennium ended with a GRF cash balance of
$1,506,211,000 and a fund balance of $855,845,000. A transfer of $49,200,000
from that balance increased the BSF to $1,002,491,000 (or 5% of GRF revenue for
the preceding fiscal year). An additional $610,400,000 was transferred to the
ITRF.
In
the middle of the second year of the biennium, the State enacted supplemental
appropriations of $645,300,000 to address shortfalls in its Medicaid and
disability assistance programs. The State’s share of this additional funding
was $247,600,000, with $125,000,000 coming from fiscal 2001 GRF spending
reductions and the remainder from available GRF moneys. The reductions were
implemented by OBM prior to March 1, 2001 applying a 1 to 2% cut to most
State departments and agencies. Expressly excluded from the reductions were
debt service and lease rental payments relating to State obligations, and
elementary and secondary education.
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In
March 2001, new lowered revenue estimates for fiscal 2001 and for fiscal 2002
and 2003 were announced. Based on indications that the Ohio economy continued
to be affected by the national economic downturn, GRF revenue estimates for
fiscal 2001 were reduced by $288,000,000. In addition, OBM projected higher
than previously anticipated Medicaid expenditures. Among the more significant
steps taken to ensure the positive GRF ending fund balance at June 30, 2001
were further spending reductions (with the same exceptions noted above for debt
service and education) and authorization to transfer from the BSF to the GRF
amounts necessary to ensure an ending GRF fund balance of $188,200,000. The
State ended fiscal 2001 with a GRF fund balance of $219,414,000, making that
transfer unnecessary.
2002-03
.
Ongoing and rigorous consideration
was
given by the Governor and the General Assembly to revenues and expenditures
throughout fiscal 2002-03, primarily as a result of continuing weak economic conditions
with budgetary pressures during this period primarily due to lower anticipated
levels of receipts from certain major revenue sources.
Consideration
came in four general time frames – the June 2001 biennial appropriation act,
late fall/early winter 2001, late spring and summer 2002 and late winter/spring
2003. Significant remedial steps included authorization to draw down and use
the entire BSF balance, increased cigarette taxes, and use of tobacco
settlement moneys previously earmarked for other purposes.
The
biennial GRF appropriations act passed in June 2001 provided for biennial GRF
expenditures of approximately $45.1 billion without increases in any major
State taxes. That Act and the separate appropriations acts for the biennium
included all necessary debt service and lease rental payments related to State
obligations. That original appropriations act also provided for transfers to
the GRF of $160,000,000 from the BSF and $100,000,000 from the Family Services
Stabilization Fund aimed at achieving fiscal year and biennium ending positive
GRF fund balances, based on then current estimates and projections.
The
Ohio economy continued to be negatively affected by the national economic
downturn and by national and international events, and in October 2001 OBM
lowered its GRF revenue estimates and projected GRF revenue shortfalls of
$709,000,000 for fiscal 2002 and $763,000,000 for fiscal 2003. Executive and
legislative actions taken to address those shortfalls included:
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Spending
reductions and limits on hiring and major purchases. Governor ordered
spending reductions were at the annual rate of 6% for most State agencies,
with lesser reductions for correctional and other institutional agencies, and
with exemptions for debt service related payments, primary and secondary
education and the adjutant general.
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December
2001 legislation, the more significant aspects of which included authorizing
the additional transfer of up to $248,000,000 from BSF to the GRF during the
current biennium thereby reducing the estimated BSF balance to $607,000,000;
reallocating to the GRF a $260,000,000 portion of tobacco settlement receipts
in fiscal 2002 and 2003; and authorizing Ohio’s participation in a
multi-state lottery game estimated to generate $40,000,000 annually beginning
in fiscal 2003.
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Continuing
weak economic conditions and lower than anticipated personal income and
corporate franchise tax receipts then led OBM in the spring of 2002 to project
higher estimated GRF revenue shortfalls of approximately $763,000,000 in fiscal
2002 and $1.15 billion in fiscal 2003. Further executive and legislative
actions were taken to ensure positive GRF fund balances for fiscal 2002 and the
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biennium. In
addition to further appropriation reductions for certain departments and other
management steps, those actions included legislation providing for: additional
transfers to the GRS of the then remaining BSF balance ($607,000,000) as needed
in fiscal 2002 and 2003, and of $50,800,000 of unclaimed funds; a $50,000,000
reduction in the fiscal 2002 ending GFR balance to $100,000,000; increased
cigarette tax by 31¢ per pack (to a total of 55¢ per pack) estimated by OBM to
produce approximately $283,000,000 in fiscal 2003; additional transfers to the
GRF of $345,000,000 from tobacco settlement moneys received in fiscal 2002 and
2003 previously earmarked for construction of elementary and secondary school
facilities and replacing the moneys for that purpose authorized general
obligations bonds; and extension of the State income tax to Ohio-based trusts
and “decoupling” certain Ohio business taxes from federal tax law economic
stimulus changes affecting business equipment depreciation schedules to produce
approximately $283,000,000 in fiscal 2003.
Fiscal
2002 ended with positive GRF balances of $108,306,000 (fund) and $619,217,000
(cash) based on the remedial steps described above, including transfers of
$289,600,000 from tobacco settlement moneys and $534,300,000 from the BSF
(leaving fiscal 2002 ending BSF balance $427,904,000, with that entire balance
appropriated for GRF use if needed in fiscal 2003).
On
July 1, 2002, the Governor issued an executive order directing a total of
approximately $375,000,000 in GRF spending cutbacks for fiscal 2003 reflecting
prior budget balancing discussions with the General Assembly. Excluded from
those department and agency cutbacks ranging up to 15% were elementary and
secondary education, higher education, alcohol and drug addiction services, and
the adjutant general. Also expressly excluded were debt service and lease
rental payments relating to State obligations, and ad valorem property tax
relief payments (made to local taxing entities).
Based
on continuing reduced revenue collections (particularly, personal income taxes
and sales tax receipts for the holidays) and projected additional Medicaid
spending, OBM in late January 2003 announced an additional fiscal 2003 GRF
shortfall of $720,000,000. The Governor ordered immediate additional reductions
in spending intended to generate an estimated $121,600,000 of GRF savings
through the end of the fiscal (expressly excepted were appropriations for or
relating to debt service on State obligations).
The
Governor also proposed and the General Assembly enacted by March 1, 2003, the
following additional revenue enhancements, transfers and expenditure reductions
for fiscal 2003 to achieve a positive GRF fund balance at June 30, 2003 as then
estimated by OBM: an additional 2.5% reduction in local government fund
distributions to most subdivisions and local libraries, producing an estimated
$30,000,000 savings; transfers of $56,400,000 to the GRF from unclaimed funds
and various rotary funds and a one-month acceleration in sales tax collections
by vendors filing electronically, to produce $286,000,000.
To
offset the General Assembly’s enactment of legislation that did not include
proposed additional taxes on cigarettes and liquor, beer and wine, the Governor
on March 25 ordered additional reductions in GRF appropriations spending
aggregating $142.5 million for the balance of fiscal 2003. Included were
reductions (generally at an annualized rate of 2.5%) of $90.6 million in State
foundation and parity aid to school districts and an additional $9.3 million in
Department of Education administration spending, $39.2 million in instructional
support to higher education institutions, and other selected reductions
totaling $3.4 million. The Governor also identified approximately $20 million
in excess food stamp administration funds available to offset the need for
further expenditure reductions. Expressly excepted from those reductions were
appropriations for or relating to debt service on State obligations.
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Based
on the Administration’s continuing monitoring of revenues, and as an
anticipated step in the then ongoing 2004-05 biennial budget and appropriations
process, OBM reported revised revenue estimates to the General Assembly on June
11, 2003. Those estimates revised fiscal 2003 revenues downward by an
additional $200,000,000 from OBM’s January 2003 adjusted baseline, based
primarily on updated income and sales tax receipts through May 31. The Governor
and OBM addressed this additional fiscal 2003 revenue shortfall through
additional expenditure controls and by drawing upon $193,030,000 of federal
block grant aid made available to the State prior to June 30 under a federal
law effective on May 28, 2003.
The
State ended the 2002-03 biennium with a GRF fund and cash balances of
$52,338,000 and $396,539,000, respectively, and a balance in the BSF of
$180,705,000.
Additional
appropriations actions during the 2002-2003 biennium, affecting most
subdivisions and local libraries in the State, relate to the various local
government assistance funds. The original appropriations act capped the amount
to be distributed in fiscal 2002 and 2003 to essentially the equivalent monthly
payment amounts in fiscal 2000 and 2001. Subsequent legislation amended the
level to the lesser of those prior fiscal year amounts or the amount that would
have been distributed under the standard formula.
2004-05
.
The GRF appropriations act for the
2004-05 biennium was passed by the General Assembly and signed (with selective
vetoes) by the Governor in June 2003. The Act provided for total GRF biennial
revenue of approximately $48.95 billion and total GRF biennial expenditures of
approximately $48.79 billion. That Act and the separate appropriations acts for
the biennium included all necessary debt service and lease-rental payments
related to State obligations.
Among
other expenditure controls, the Act included Medicaid cost containment measures
including pharmacy cost management initiatives, limited expenditure growth for
institutional services and implementation of managed care for higher-cost
populations; continued phase-out of certain tangible personal property tax
relief payments to local governments; the closing by consolidation of three
institutional facilities during the biennium; adjustments in eligibility
guidelines for subsidized child care from 185% to 150% of the federal poverty
level and freezing certain reimbursement rates; no compensation increases for
most State employees in fiscal 2004 and limited one-time increases in fiscal
2005; and continued limitation on local government assistance fund
distributions to most subdivisions and local libraries to the lesser of the
equivalent monthly payments in fiscal 2003 or the amount that would have been
distributed under the standard formula.
The
GRF expenditure authorizations for the 2004-05 biennium reflected and were
supported by revenue enhancement actions contained in the Act including:
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A one-cent
increase in the State sales tax (to six percent) for the biennium (expiring
June 30, 2005), projected to generate approximately $1.25 billion in each
fiscal year.
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Expansion of
the sales tax base to include dry-cleaning/laundry services, towing, personal
care and other services, and satellite television, projected in the aggregate
to produce approximately $69,000,000 annually. (The inclusion of satellite
television in the sales tax base, projected to produce approximately
$21,000,000 annually, is subject to an ongoing legal challenge.)
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Moving local
telephone companies from the public utility tax base to the corporate
franchise and sales tax, projected to produce approximately $29,000,000
annually.
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Elimination
of the sales tax exemption for WATS and 800 telecom services coupled with the
enactment of a more limited exemption for call centers, projected to produce
approximately $64,000,000 annually.
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Adjustments
in the corporate franchise tax through the adoption of the Uniform Division
of Income for Tax Purposes Act (UDITPA) for apportionment of business income
among states, and an increase in the corporate alternative minimum tax,
projected in the aggregate to produce approximately $35,000,000 annually.
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The
Act also authorized and OBM on June 30, 2004 transferred $234,700,000 of
proceeds received from the national tobacco settlement into the GRF. In
addition, the Act authorized the draw down during the biennium of federal block
grant and Medicaid assistance aid made available to the State under a federal
law effective May 28, 2003. OBM drew down $211,600,000 and $316,800,000 of
those federal monies in fiscal 2004 and 2005, respectively.
Based
on regular monitoring of revenues and expenditures, OBM in March 2004 announced
revised GRF revenue projections for fiscal 2004 and 2005 based primarily on
reduced revenue collections from personal income taxes. In response to OBM
reducing its GRF revenue projection by $247,100,000 (1.02%) for fiscal 2004 and
by $372,700,000 (1.48%) for fiscal 2005, the Governor ordered fiscal 2004
expenditure reductions of approximately $100,000,000. On July 1, the Governor
ordered additional fiscal 2005 expenditure cuts of approximately $118,000,000
and a reduction of $50,000,000 in State spending on Medicaid reflecting an
increased Federal share of certain Medicaid services. Expressly excluded from
those reductions were debt service and lease rental payments relating to State
obligations, State basic aid to elementary and secondary education,
instructional subsidies and scholarships for public higher education, in-home
care for seniors and certain job creation programs. The balance of those
revenue reductions were offset by GRF expenditure lapses and, for fiscal 2005,
elimination of an anticipated $100,000,000 year-end transfer to the BSF while
maintaining a one-half percent year-end GRF fund balance.
The
State ended fiscal 2004 with a GRF fund balance of $157,509,000. Improving
economic conditions had a positive effect on revenue in fiscal 2005. With GRF
revenue receipts modestly outperforming estimates for much of the fiscal, OBM
in June 2005 increased its GRF revenue estimates by $470,700,000. Final fiscal
2005 GRF revenue came in $67,400,000 above that revised estimate. With fiscal
2005 spending close to original estimates, the State made the following fiscal
year-end allocations and transfers: $60,000,000 to address a prior-year
liability in the Temporary Assistance to Needy Families program; $40,000,000 to
a disaster services contingency fund; $50,000,000 to the State’s share of the
school facilities construction program; and $394,200,000 to the BSF. After
these and certain smaller transfers, the State ended fiscal 2005 and the
biennium with a GRF fund balance of $127,800,000 and a BSF balance of
$574,205,000.
2006-07
.
Consistent with State law, the
Governor’s
Executive Budget for the 2006-07 biennium was released in February 2005 and
introduced in the General Assembly. After extended hearings and review, the GRF
appropriations Act for the 2006-07 biennium was passed by the General Assembly
and signed (with selective vetoes) by the Governor on June 30, 2005. That Act
provided for total GRF biennial revenue of approximately $51.5 billion (a 3.8%
increase over the 2004-05 biennial revenue) and total GRF biennial
appropriations of approximately $51.3 billion (a 5.0% increase over the 2004-05
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biennial
expenditures). Spending increases for major program categories over the 2004-05
actual expenditures were: 5.8% for Medicaid (the Act also included a number of
Medicaid reform and cost containment initiatives); 3.4% for higher education;
4.2% for elementary and secondary education; 5.5% for corrections and youth
services; and 4.8% for mental health and mental retardation. The Executive
Budget, the GRF appropriations Act and the separate appropriations acts for the
biennium included all necessary debt service and lease rental payments related
to State obligations.
The
GRF expenditure authorizations for the 2006-07 biennium reflected and were
supported by a significant restructuring of major State taxes, including:
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A 21%
reduction in State personal income tax rates phased in at 4.2% per year over
the 2005 through 2009 tax years.
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Phased
elimination of the State corporate franchise tax at a rate of approximately
20% per year over the 2006 through 2010 tax years (except for its continuing
application to financial institutions and certain affiliates of insurance
companies and financial institutions).
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Implementation
of a new commercial activity tax (CAT) on gross receipts from doing business
in Ohio that phased in over the 2006 through 2010 fiscal years. When fully
phased in, the CAT will be levied at a rate of 0.26% on gross receipts in
excess of $1,000,000.
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A 5.5% State
sales and use tax (decreased from the 6.0% rate for the 2004-05 biennium).
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An increase
in the cigarette tax from $0.55 per pack (of 20 cigarettes) to $1.25 per
pack.
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The
then Governor signed into law on June 5, 2006 legislation enacted by the
General Assembly imposing a limitation on most GRF appropriations commencing
with the 2008-09 biennium. This statutory limitation initially uses fiscal 2007
GRF appropriations as a baseline and then applies an annual growth factor of
the greater of 3.5% or the sum of the inflation rates and rate of State
population change. Every fourth fiscal year thereafter becomes a new base year.
GRF appropriations for State debt service payments are expressly excepted from
this statutory limitation. This legislation was enacted as an alternative to a
proposed “tax and expenditure limitation” (TEL) amendment to the Ohio
Constitution that was withdrawn from the November 2006 general election ballot.
The
State ended fiscal 2006 with a GRF cash balance of $1,528,812,000 and a GRF
fund balance of $1,025,967,000. Of that ending GFR fund balance, the State
carried forward $631,933,000 to cover the expected and planned for variance of
fiscal 2007 GFR appropriations over estimated revenue, to offset the one-time
cost of accelerating the phase-in of reductions in State personal income tax
withholding rates, and to maintain 0.5% of fiscal 2007 GFR revenue as an ending
fund balance. The remaining $394,034,000 was deposited into the BSF increasing
its balance to $1,012,289,000 (which includes $40,045,000 in receipts collected
from a broad tax amnesty initiative and deposited in June 2006). The State
ended fiscal 2007 with a GRF cash balance of $1,432,925,000 and a GRF fund
balance of $215,534,000.
Current
Biennium
.
Consistent with State law, the Governor’s Executive Budget for the 2008-09
biennium was released in March 2007 and introduced in the General Assembly.
After extended hearings and review, the GRF appropriations Act for the biennium
was passed by the General Assembly and signed (with selective vetoes) by the
Governor on June 30, 2007. Reflecting the continued implementation of the
restructuring of State taxes commenced in 2006-07, that Act reflects total GRF
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biennial
estimated revenues of approximately $53.5 billion (a 3.9% increase over the
2006-07 biennial revenue) and total GRF biennial appropriations of
approximately $52.4 billion (a 2.1% increase over the 2006-07 biennial
expenditures). Spending increases for major program categories over the 2006-07
actual expenditures are: 2.2% for Medicaid (the Act also included a number of
Medicaid reform and cost containment initiatives); 13.2% for higher education;
5.25% for elementary and secondary education; 4.92% for corrections and youth
services; and 4.7% for mental health and mental retardation. The Executive
Budget and the GRF appropriations Act complied with the law discussed above
under 2006-07 limiting appropriations for the 2008-09 biennium. The Executive
Budget, the GRF appropriations Act and the separate appropriations acts for the
biennium included all necessary debt service and lease rental payments related
to State obligations.
The
GRF expenditure authorizations for the 2008-09 biennium reflected and were
supported by tax law changes contained in the Act, including:
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Restructuring
nonresident tax exemption for Ohio motor vehicle purchases projected to
produce approximately $54.0 million over the biennium.
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Restoring
local government fund support by committing a set percent of all tax revenues
deposited into the GRF. Local governments will receive 3.7% of total GRF tax
revenues annually and local libraries will receive 2.22% of total GRF tax
revenues annually.
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Eliminating
the $300 per month cigarette and tobacco product importation exemption
projected to produce approximately $25.0 million annually.
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The
GRF appropriations Act also created the Buckeye Tobacco Settlement Financing
Authority to securitize tobacco settlement receipts payable to the State under
the November 1998 national tobacco settlement. On October 29, 2007, the
Authority issued its $5.53 billion Tobacco Settlement Asset-Backed Bonds,
Series 2007 to fund capital expenditures for higher education ($938.0 million)
and common school ($4.112 billion) purposes over the next three years in lieu
of the State issuing GRF-backed general obligation bonds to fund those capital
expenditures. The resulting debt service savings to the GRF will fund the
expansion of the homestead exemption property tax relief program in the Act.
The Act reprograms all prior General Assembly allocations of those anticipated
tobacco receipts to enable the pledge of 100% of those receipts to the payment
of debt service on the Authority’s obligations. The State had previously
enacted legislation allocating its anticipated share of those receipts through
Fiscal year 2012 and making a partial allocation thereafter through fiscal
2025. Except for fiscal 2002 through 2004, none of the receipts were applied to
existing operating programs of the State. Under those previously enacted
allocations, the largest amount was to be applied to elementary and secondary
school capital expenditures, with other amounts allocated for smoking cessation
and other health-related purposes, biomedical research and technology transfer,
and assistance to the tobacco growing areas in the State.
OBM
continually monitors and analyzes revenues and expenditures and prepares a
financial report summarizing its analyses at the end of each month. The most
recent Monthly Financial Reports are accessible via OBM’s home page on the
Internet at http://www.obm.ohio.gov/finrep, and copies are available upon
request to OBM.
The
incurrence or assumption of debt by the State without a popular vote is, with
limited exceptions, prohibited by the State Constitution. The State may incur
debt to cover casual deficits or to address failures in revenues or to meet
expenses not otherwise provided for, but limited in amount to $750,000. The
Constitution expressly precludes the State from assuming the debts of any
county, city,
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town or
township, or of any corporation. (An exception in both cases is for debts
incurred to repel invasion, suppress insurrection, or defend the State in war.)
The Constitution provides that “Except the debts above specified . . . no debt
whatever shall hereafter be created by, or on behalf of the state.”
By
18 constitutional amendments approved from 1921 to present, Ohio voters have
authorized the incurrence of State general obligation (GO) debt and the pledge
of taxes or excises to its payment, all related to the financing of capital
facilities, except for three that funded bonuses for veterans, one that funded
coal technology research and development, and one for research and development
activities. Currently, tax supported general obligation debt of the State is
authorized to be incurred for the following purposes: highways, local
infrastructure, coal development, natural resources, higher education, common
schools, conservation, research and development, and site development. Although
supported by the general obligation pledge, highway debt is also backed by a
pledge of and has always been paid from the State’s motor fuel taxes and other
highway user receipts that are constitutionally restricted in use to highway
related purposes.
A
1999 constitutional amendment provides an annual debt service “cap” applicable
to most future issuances of State general obligations and other State direct
obligations payable from the GRF or net State lottery proceeds. Generally, and
except for the additional $650,000,000 of general obligation debt approved by
the voters at the November 8, 2005 election for research and development and
the development of sites and facilities, new obligations may not be issued if
future fiscal year debt service on those new and the then outstanding bonds of
those categories would exceed 5% of the total estimated GRF revenues plus net
State lottery proceeds during the fiscal year of issuance. Those direct
obligations of the State include, for example, special obligation bonds that
are paid from GRF appropriations, but exclude bonds such as highway bonds that
are paid from highway user receipts. Pursuant to the amendment and implementing
legislation, the Governor has designated the OBM Director as the State official
to make the 5% determinations and certifications. Application of the cap may be
waived in a particular instance by a three-fifths vote of each house of the
General Assembly and may be changed by future constitutional amendments.
In
addition to its issuance of highway bonds, the State has financed selected
highway infrastructure projects by issuing bonds and entering into agreements
that call for debt service payments to be made from federal transportation
funds allocated to the State, subject to biennial appropriations by the General
Assembly. The highest annual State payment under those agreements in the
current or any future fiscal year is $114,535,618 in fiscal 2009. In the event
of any insufficiency in the anticipated federal allocations to make payments on
State bonds, the payments are to be made from any lawfully available moneys
appropriated to ODOT for the purpose.
State
agencies also have participated in buildings and equipment, information systems
and non-highway transportation projects that have local as well as State use
and benefit, in connection with which the State has entered into lease-purchase
agreements with terms ranging from 7 to 20 years. Certificates of Participation
(COPs) have been issued in connection with those agreements that represent
fractionalized interests in and are payable from the State’s anticipated
payments. The maximum annual payment under those agreements, made from GRF
appropriations, is $16,700,825 in Fiscal Year 2017 and the total GRF-supported
principal amount outstanding is $137,590,000. Payments by the State are subject
to biennial appropriations by the General Assembly with the lease terms subject
to renewal if appropriations are made. The OBM Director’s approval of such
agreements is required if COPs are to be publicly-offered in connection with
those agreements.
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A
statewide economic development program assists the financing of facilities and
equipment for industry, commerce, research and distribution, including
technology innovation, by providing loans and loan guarantees. The law
authorizes the issuance of State bonds and notes secured by a pledge of
portions of the State profits from liquor sales. The General Assembly has
authorized the issuance of these obligations with a general maximum of
$500,000,000 to be outstanding at any one time. The aggregate amount from the
liquor profits to be used in any fiscal year in connection with these bonds may
not exceed $45,000,000. The total of unpaid guaranteed loan amounts and unpaid
principal of direct loans may not exceed $800,000,000. Pursuant to a 2000 constitutional
amendment, the State has issued $100,000,000 of bonds for revitalization
purposes that are also payable from State liquor profits. The maximum annual
debt service on all state bonds payable from State liquor profits is
$39,573,516 in fiscal 2008.
Certain
State agencies issue revenue bonds that are payable from revenues from or
relating to revenue producing facilities, such as those issued by the Ohio
Turnpike Commission. By judicial interpretation, such revenue bonds do not
constitute “debt” under the constitutional provisions described above. The
Constitution authorizes State bonds for certain housing purposes (issued by the
Ohio Housing Finance Agency) to which tax moneys may not be obligated or
pledged.
Litigation
was commenced in the Ohio courts in 1991 questioning the constitutionality of
Ohio’s system of school funding and compliance with the constitutional
requirement that the State provide a “thorough and efficient system of common
schools.” On December 11, 2002, the Ohio Supreme Court, in a 4-3 decision on a
motion to reconsider its own decision rendered in September 2001, concluded (as
it had in its 1997 and 2000 opinions in that litigation) that the State did not
comply with that requirement, even after again noting and crediting significant
State steps in recent years.
In
its prior decisions, the Ohio Supreme Court stated as general base threshold
requirements that every school district have enough funds to operate, an ample
number of teachers, sound and safe buildings, and equipment sufficient for all
students to be afforded an educational opportunity.
With
particular respect to funding sources, the Court concluded in 1997 and 2000
decisions that property taxes no longer may be the primary means of school
funding in Ohio.
On
March 4, 2003, the plaintiffs filed with the original trial court a motion to
schedule and conduct a conference to address compliance with the orders of the
court in that case, the State petitioned the Ohio Supreme Court to issue a writ
prohibiting that conference on compliance, and the trial court subsequently
petitioned the Ohio Supreme Court for guidance as to the proper course to
follow. On May 16, 2003, the Ohio Supreme Court granted that writ and ordered
the dismissal of the motion before the trial court. On October 20, 2003 the
United States Supreme Court declined to accept the plaintiff’s subsequent
petition requesting further review of the case.
The
General Assembly has taken several steps, including significantly increasing
State funding for public schools. In addition, at the November 1999 election
electors approved a constitutional amendment authorizing the issuance of State
general obligation debt for school buildings and for higher education facilities.
December 2000 legislation addressed certain mandated programs and reserves,
characterized by the plaintiffs and the Court as “unfunded mandates.”
Under
the current financial structure, Ohio’s 613 public school districts and 49
joint vocational school districts receive a major portion (but less than 50%)
of their operating moneys from State subsidy appropriations (the primary
portion of which is known as the Foundation Program) distributed in
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accordance
with statutory formulae that take into account both local needs and local
taxing capacity. The Foundation Program amounts have steadily increased in
recent years, including small aggregate increases even in those fiscals in
which appropriations cutbacks were imposed.
School
districts also rely upon receipts from locally voted taxes. In part because of
provisions of some State laws, such as that partially limiting the increase
(without further vote of the local electorate) in voted property tax
collections that would otherwise result from increased assessed valuations,
some school districts have expressed varying degrees of difficulty in meeting
mandated and discretionary increased costs. Local electorates have largely
determined the total moneys available for their schools. Locally elected boards
of education and their school administrators are responsible for managing
school programs and budgets within statutory requirements.
The
State’s present school subsidy formulas are structured to encourage both program
quality and local taxing effort. Until the late 1970’s, although there were
some temporary school closings, most local financial difficulties that arose
were successfully resolved by the local districts themselves by some
combination of voter approval of additional property tax levies, adjustments in
program offerings, or other measures. For more than 20 years, requirements of
law and levels of State funding have sufficed to prevent school closings for
financial reasons, which in any case are prohibited by current law.
To
broaden the potential local tax revenue base, local school districts also may
submit for voter approval income taxes on the district income of individuals
and estates (and effective July 1, 2005, municipal income taxes that may be
shared with school districts). Many districts have submitted the question, and
income taxes are currently approved in 145 districts.
Original
State basic aid appropriations for the 1992-93 biennium of $9.5 billion
provided for 1.5% and 4.8% increases in the two fiscal years of the biennium
over appropriations in the preceding biennium which were subject to State
spending reductions for fiscal 1992 of 2.5% of annual Foundation Program
appropriations. There were no reductions for the 172 districts with the lowest
per pupil tax valuations, and the reductions were in varying amounts with
varying effects for the other districts. Foundation payments were excluded from
the then Governor’s spending reduction order for fiscal 1993.
Biennial
school funding State appropriations from the GRF and Lottery Profits Education
Fund (but excluding federal and other special revenue funds) for recent biennia
were:
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1996-97 –
$10.1 billion representing a 13.6% increase over the preceding biennium
total.
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1998-99 –
$11.6 billion (18.3% over the previous biennium).
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2000-01 –
$13.3 billion (15% over the previous biennium).
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2002-03 –
$15.2 billion (17% over the previous biennium before the expenditure
reductions).
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2004-05 –
$15.7 billion (3.3% over the previous biennium before the expenditure
reductions).
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2006-07 –
$16.4 billion (4.5% over the previous biennium before the expenditure
reductings).
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State
appropriations for the purpose made for the 2008-09 biennium are $17.2 billion
(4.9% over the previous biennium), representing an increase of 1.7% in fiscal
2008 over 2007 and 3.8% in fiscal 2009 over 2008.
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Those
total State 2008-09 biennial appropriations exclude non-GRF and federal
appropriations, but include appropriations from the GRF and the lottery profits
education fund (LPEF). The amount of lottery profits transferred to the LPEF
totaled $648,106,000 in fiscal 2004, $645,137,000 in fiscal 2005, $646,276,000
in fiscal 2006 (which excludes $5,820,000 transferred to the Deferred Prize
Trust Fund) and $669,327,000 in fiscal 2007. Ohio’s participation in the
multi-state lottery commenced in May 2002. A constitutional provision requires
that net lottery profits be paid into LPEF to be used solely for the support of
elementary, secondary, vocational and special education purposes, including
application to debt service on general obligation bonds to finance common
school facilities.
In
response to the 1997 Ohio Supreme Court decision holding certain provisions for
local school district borrowing unconstitutional, the General Assembly created
the school district solvency assistance program. Beginning in fiscal 1999,
local school districts in fiscal emergency status as certified by the Auditor
of State could apply for an advancement of future year Foundation Program
distributions. The amount advanced was then deducted, interest free, from the
district’s foundation payments over the following two-year period. Six school
districts received a total of approximately $12,100,000 in solvency assistance
advancements during fiscal 1999, with another six districts receiving a total
of approximately $8,657,000 in fiscal 2000. This solvency assistance program
was held to be not in compliance with the Constitution by the Supreme Court. In
fiscal 2001 four districts received approximately $3,800,000 under a
restructured solvency assistance program. The program was further modified in
December 2000 to allow districts that experience an unforeseen catastrophic
event to apply for a grant. In fiscal 2006, no districts received catastrophic
grants and one district received a solvency advance in the amount of $41,000.
In fiscal 2007, two districts received solvency advances in the amount of
$16,937,000 and no district received catastrophic grants.
Legislation
was enacted in 1996 to address school districts in financial straits. It is
similar to that for municipal “fiscal emergencies” and “fiscal watch”, but is
particularly tailored to certain school districts and their then existing or
potential fiscal problems. There are currently nine school districts in fiscal
emergency status and thirteen in fiscal watch status. New legislation has
created a third, more preliminary, category of “fiscal caution.” A current
listing of school districts in each status is on the Internet at
http://www.auditor.state.oh.us.
Ohio’s
943 incorporated cities and villages rely primarily on property and municipal
income taxes to finance their operations. With other subdivisions, they also
receive local government support and property tax relief moneys from State
resources.
Federal
courts have ruled that the State shared joint liability with the local school
districts for segregation in Cincinnati, Cleveland, Columbus, Dayton and
Lorain. Subsequent trial court orders directed that some remedial costs be
shared by the State and the respective local districts. For that purpose,
recent appropriations, decreasing in each biennium were $100,800,000 in
1998-99, $23,700,000 in 2000-01, and $1,000,000 in 2002-03. All cases were
settled prior to the end of fiscal 2003 and there is no further State
liability.
For
those few municipalities and school districts that on occasion have faced
significant financial problems, there are statutory procedures for a commission
composed of State and local officials, and private sector members experienced
in business and finance appointed by the Governor to monitor the fiscal affairs
and for development of a financial plan to eliminate deficits and cure any
defaults. (Similar procedures have recently been extended to counties and
townships.) Twelve municipalities and two townships are in “fiscal emergency”
status and seven municipalities in preliminary “fiscal watch” status.
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At
present the State itself does not levy ad valorem taxes on real or tangible
personal property. Those taxes are levied by political subdivisions and local
taxing districts. The Constitution has since 1934 limited the amount of the
aggregate levy of ad valorem property taxes on particular property, without a
vote of the electors or municipal charter provision, to 1% of true value in
money, and statutes limit the amount of that aggregate levy without a vote or
charter provision to 10 mills per $1 of assessed valuation — commonly referred
to in the context of Ohio local government finance as the “ten-mill
limitation.”
Special Considerations Regarding Pennsylvania
This
section briefly describes current economic trends in Pennsylvania, as described
in the Official Statement, dated December 13, 2007, relating to the
Commonwealth of Pennsylvania General Obligation Bonds, Second Series A of 2007,
Second Series B of 2007 and First Refunding Series of 2007.
Pennsylvania
has historically been dependent on heavy industry, although the past thirty
years have witnessed declines in the coal, steel and railroad industries.
Recent sources of economic growth in Pennsylvania have led to diversification
of the Commonwealth’s economy. Relative growth has been experienced in the
service sector, including trade, medical and health services, education and
financial institutions. Agriculture continues to be an important component of
the Commonwealth’s economic structure, with nearly one-third of the
Commonwealth’s total land area devoted to cropland, pasture and farm woodlands.
The
population of Pennsylvania experienced a slight increase in the period 1997
through 2006. Persons 65 or older comprise 15.2% of Pennsylvania’s population,
compared with 12.4% of the United States population. The Commonwealth is highly
urbanized, with 79% of the Commonwealth’s 2006 mid-year population estimate
residing in metropolitan statistical areas. The two largest metropolitan
statistical areas, those containing the Cities of Philadelphia and Pittsburgh,
together comprise almost 44% of the Commonwealth’s total population.
The
Commonwealth utilizes the fund method of accounting, and over 150 funds have
been established for purposes of recording receipts and disbursements of the
Commonwealth, of which the General Fund is the largest. Most of the
Commonwealth’s operating and administrative expenses are payable from the
General Fund. The major tax sources for the General Fund are the sales tax, the
personal income tax, the corporate net income tax and the capital stock and
franchise tax. Major expenditures of the Commonwealth include funding for
education, public health and welfare and transportation.
The
constitution of the Commonwealth provides that operating budget appropriations
of the Commonwealth may not exceed the actual and estimated revenues and
available surplus in the fiscal year for which funds are appropriated. Annual
budgets are enacted for the General Fund (the principal operating fund of the
Commonwealth) and for certain special revenue funds which together represent
the majority of expenditures of the Commonwealth.
The
following financial information is based on the Commonwealth’s budgetary basis
financial data.
Total
fiscal year 2005 revenues, net of reserves for tax refunds and including
intergovernmental transfers and additional resources, totaled $24,405.6
million. Total expenditures net of appropriation lapses and including
intergovernmental transfers and expenditures from additional resources were
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$24,053.9
million. As result of Commonwealth financial operations during the fiscal year,
the preliminary unappropriated surplus balance, prior to the statutorily
required 25 percent transfer to the Budget Stabilization Reserve Fund, was
$429.2 million, an increase of $162.5 million from the fiscal year 2004
preliminary ending balance. Following the statutorily required 25 percent
transfer to the Budget Stabilization Reserve Fund ($64.4 million) the fiscal
year 2005 final unappropriated surplus balance was $364.8 million as of June
30, 2005.
The
fiscal year 2005 budget was based initially on an estimated 4.5 percent
increase for Commonwealth General Fund revenues prior to accounting for any
changes in tax and revenue provisions enacted in the second half of fiscal year
2004. After adjustments for various tax rate and tax base changes enacted for
the fiscal year 2004 budget, total Commonwealth General Fund revenues were
projected to increase 3.8 percent over fiscal year 2004 actual receipts and
total $23,866.5 million prior to reserves for tax refunds. Total fiscal year
2005 Commonwealth revenues net of reserves for tax refunds, exceeded $24,308.5
million, a 6.5 percent increase over fiscal year 2004 receipts. The tax revenue
component of Commonwealth receipts, including the effects of the tax rate and
tax base changes enacted in fiscal year 2004, rose $1,666.4 million or 7.6
percent over fiscal year 2004 actual receipts. An estimated two-thirds of the
increase in tax revenues is associated with the various tax rate and tax base
changes. Total revenues to the Commonwealth exceeded the budget estimate by
$442.0 million or 1.9 percent. Personal income tax receipts grew by $1,013
million or 13.1 percent over fiscal year 2004 revenues. Revisions to the
personal income tax rate in December 2003 contributed to the large
year-over-year increase in these receipts. During fiscal year 2005, corporate
tax receipts grew $285.1 million or 10.7 percent, which generally reflected
improvements in the overall state and national economy. Sales and use tax
revenues to the Commonwealth grew $271.4 million or 3.5 percent over fiscal
year 2004 receipts. Receipts of Commonwealth non-tax revenues continued to
exceed the estimate as total revenue from this source exceeded $596.0 million.
Earnings from investments and revisions to the Commonwealth’s escheat program
continued to provide revenues well in excess of the estimate for fiscal year
2005. Various revisions to the Commonwealth’s escheat program were enacted as
part of the fiscal year 2003 and 2004 budgets. These revisions to the escheat
program have produced substantial non-recurring revenues during each of the two
most recent fiscal years. Additionally, significant non-recurring capital gains
earnings on the investment of available General Fund cash balances and
increased contributions from the Commonwealth’s liquor store profits
contributed to enhanced non-tax revenues during the prior two fiscal years.
Reserves for tax refunds in fiscal year 2005 were $1,000.0 million, a decrease
of $14.7 million or 1.4 percent from fiscal year 2004 levels.
Fiscal
year 2005 state-level expenditures, including supplemental appropriations and
net of appropriation lapses, totaled $22,956.8 million, an increase of 5.6
percent from fiscal year 2004 appropriations. A total of $148.1 million in
appropriations were lapsed in fiscal year 2005 and the fiscal year 2005 budget
continued to utilize an enhanced level of intergovernmental transfers for a
portion of medical assistance costs, albeit at a reduced rate from fiscal year
2004. Intergovernmental transfers replaced $697.9 million of General Fund
medical assistance costs in fiscal year 2005, compared to $738.7 million in
fiscal year 2004. In addition, approximately $399 million in additional funds,
primarily $377.6 million of remaining federal fiscal relief, was appropriated
in fiscal year 2005 to fund expenditures normally funded from Commonwealth
revenues. The ending unappropriated balance was $364.8 million for fiscal year
2005.
During
fiscal year 2006, revenues to the Commonwealth exceeded the certified estimate
by $864.6 million or nearly 3.5 percent. Final Commonwealth General Fund
revenues for the fiscal year totaled $25,854.1 million.
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Total
fiscal year 2006 revenues, net of reserves for tax refunds and including
intergovernmental transfers and additional resources, totaled $25,700.9 million.
Total expenditures, net of appropriation lapses and including intergovernmental
transfers and expenditures from additional sources, was $25,380.3 million. As
result of Commonwealth financial operations during the fiscal year, the
preliminary unappropriated surplus balance, prior to the statutorily required
25 percent transfer to the Budget Stabilization Reserve Fund, increased to
$685.4 million, including the beginning balance from the prior year of
operations. Accordingly, 25 percent of this preliminary balance or $171.4
million was transferred to the Budget Stabilization Reserve Fund. The final
fiscal year 2006 unappropriated surplus balance was $514.1 million as of June
30, 2006.
Revenues
available to the Commonwealth, including intergovernmental transfers and
additional sources, increased 5.3 percent. Fiscal year 2006 revenues (all
sources) totaled $25,700.9 million, an increase of $1,295.3 million over fiscal
year 2005. Intergovernmental transfer proceeds increased $3,819 million or 5.5 percent,
while funding from additional sources decreased $253.3 million or 63 percent,
primarily due to the expiration of the previously available one-time federal
fiscal relief that had been made available to the various states. General Fund
revenues grew $1,563 million or 6.3 percent during fiscal year 2006 when
measured on a year-over-year basis. Corporate tax receipts grew $425.8 million
over estimate, an 8.9 percent surplus to the year-to-date estimate. Personal
income taxes were $342.6 million over the estimate, a surplus of 3.7 percent
versus the year-to-date estimate. Sales and use taxes were essentially at
estimate as actual receipts were $65.2 million above estimate, a difference of
0.8 percent from the fiscal year estimate. Realty transfer tax revenues also
exceeded the estimate by $61.4 million or 12.5 percent based in part on
continuation of a strong housing market within the Commonwealth. Non-tax
revenues of the Commonwealth were below estimate for fiscal year 2006 by $61.4
million or 11.3 percent, due primarily to lower than projected earnings from
the Commonwealth’s escheats program. Reserves for tax refunds in fiscal year
2006 were $1,035 million, an increase of 3.5 percent from the fiscal year 2005
reserves. At the end of fiscal year 2006, approximately $103 million of
reserves were available for making tax refunds in the following fiscal year.
In
July 2005, the General Assembly approved and the Governor signed into law Act
45 of 2005, which authorized the issuance of up to $625 million in debt of the
Commonwealth to support programs commonly referred to as “Growing Greener II.”
The enactment of Act 45 implements the Governor’s major environmental
initiative in the fiscal year 2006 budget. The Growing Greener II program will
provide bond funding for the maintenance and protection of the environment,
open space and farmland preservation, watershed protection, abandoned mine
reclamation, acid mine drainage remediation and other environmental
initiatives. Additionally, Act 45 of 2005 authorizes the Governor to direct up
to $60 million in existing Growing Greener fees, that are otherwise directed
into the Commonwealth’s Environmental Stewardship Fund, to support General Fund
debt service for the authorized Growing Greener II bond issuances.
Fiscal
year 2006 appropriations from Commonwealth revenues, including supplemental
appropriations and net of appropriation lapses, totaled $24,664.6, an increase
of 7.4 percent from fiscal year 2005 expenditures. A total of $181.8 million in
appropriations were lapsed in fiscal year 2006, and the fiscal year 2006 budget
continued to utilize an enhanced level of intergovernmental transfers for a
portion of medical assistance costs. Intergovernmental transfers replaced
$735.7 million of General Fund medical assistance costs in fiscal year 2006,
compared to $697.9 million in fiscal year 2005. In addition, approximately
$145.9 million in additional funds were appropriated in fiscal year 2006 to
fund expenditures normally funded from Commonwealth revenues, a decrease from
$399 million in fiscal year 2005. The ending unappropriated balance was $514.1
million for fiscal year 2006.
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General
fund revenues of the Commonwealth exceeded the certified estimate by $649.6
million or 2.4 percent during fiscal year 2007. Final Commonwealth General Fund
revenues for the fiscal year totaled $27,449.1 million. Total fiscal year 2007
revenues, net of reserves for tax refunds and including intergovernmental
transfers and additional resources, totaled $27,193.7 million. Total
expenditures, net of appropriation lapses and including intergovernmental
transfers and expenditures from additional sources, were $27,007.9 million. As
a result of Commonwealth financial operations during the fiscal year, the
preliminary unappropriated surplus balance, prior to the statutorily required
25 percent transfer to the Budget Stabilization Reserve Fund, increased to
$707.9 million, including the beginning balance from the prior year of
operations. Accordingly, 25 percent of this preliminary balance or $176.9
million was transferred to the Budget Stabilization Reserve Fund. The final
fiscal year 2007 unappropriated surplus was $530.9 million as of June 30, 2007.
Revenues
available to the Commonwealth, including intergovernmental transfers and
additional sources, increased 5.8 percent. Fiscal year 2007 revenues (all
sources) totaled $27,193.7 million, an increase of $1,492.8 million over fiscal
year 2006. Intergovernmental transfer proceeds decreased $199 million or 27
percent, primarily due to the continued phase-out of intergovernmental
transfers. Funding from additional sources increased $111.8 million or 76
percent, primarily due to increased transfers from other state funds. General
Fund revenues grew $1,595 million or 6.2 percent during fiscal year 2007 when
measured on a year-over-year basis. Corporate tax receipts were $286.2 million,
or 5.6 percent over estimate for the fiscal year. Year-over-year growth in
corporate taxes were 5.6 percent during fiscal year 2007 as corporate net
income tax collections grew 8.3 percent and gross receipts tax collections grew
12.4 percent but receipts from the capital stock and franchise tax declined 7.5
percent on a year-over-year basis. The decline in capital stock and franchise
tax receipts was due to the continued phase-out of this tax. Personal income
taxes were $301.6 million over the estimate, a surplus of 3.0 percent versus
the year-to-date estimate, while year-over year growth in personal income tax
receipts was 7.7 percent. Sales and use taxes were essentially at estimate as
actual receipts were $14.9 million below estimate, a difference of 0.17 percent
from the fiscal year estimate. Sales tax collections grew 3.1 percent during
fiscal year 2007. A softening in the housing market let to realty transfer tax
revenues growing by only 3.4 percent during fiscal year 2007. Non-tax revenues
of the Commonwealth grew by 58 percent during the fiscal year, let by increased
liquor store profits and earnings on the investment of Commonwealth funds.
Reserves for tax refunds in fiscal year 2007 were $1,050 million, an increase
of 1.4 percent from the fiscal year 2006 reserves. At the end of fiscal year
2006, approximately $114 million of reserves were available for making tax refunds
in the following fiscal year.
Fiscal
year 2007 appropriations from Commonwealth revenues, including supplemental
appropriations and net of appropriation lapses, totaled $26,298.1 million, an
increase of 6.6 percent from fiscal year 2006 expenditures. A total of $105.4
million in appropriations were lapsed in fiscal year 2007, and the fiscal year
2007 budget contained a slightly reduced level of intergovernmental transfers
for a portion of medical assistance costs. Intergovernmental transfers replaced
$536.7 million of General Fund medical assistance costs in fiscal year 2007,
compared to $735.7 million in fiscal year 2006, a decrease of 27 percent. In
addition, approximately $257.7 million in additional funds were appropriated in
fiscal year 2007 to fund expenditures normally funded from Commonwealth
revenues, an increase from $145.9 million in fiscal year 2006. The ending
unappropriated balance was $530.9 million for fiscal year 2007.
The
adopted fiscal year 2008 budget provides appropriations and executive
authorizations totaling $27,162.1 million of Commonwealth funds against
estimated revenues, net of tax refunds and proposed tax reductions, of
$26,640.6 million. The $521.5 million difference between estimated revenues and
budgeted appropriations is expected to be funded by a draw down of the $530.9
million beginning
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balance. The
year ending unappropriated balance is currently estimated to be $7.1 million
for fiscal year 2008.
The
fiscal year 2008 revenue estimate for the Commonwealth is based upon an
economic forecast of 2.4 percent growth in gross domestic product from the
start of the third quarter of 2007 to the end of the second quarter of 2008.
Trends in the Commonwealth’s economy are expected to maintain their close
association with national economic trends. Personal income growth in
Pennsylvania is projected to remain slightly below that of the United States,
while the Pennsylvania unemployment rate is anticipated to be close to the
national rate. The tax revenue component of Commonwealth General Fund receipts
is expected to increase by $435 million or approximately 1.2 percent prior to
reserves for funds. The below average growth that is projected for fiscal year
2008 tax revenue is attributable to several legislative changes affecting
certain tax receipts. The continued phase-out of the capital stock and
franchise tax led to a reduction in fiscal year 2008 projected receipts by
approximately $241 million. Further, Act 44, which was enacted on July 18,
2007, altered the funding of public mass transit systems in the Commonwealth.
Act 44 dedicates 4.4 percent of all sales and use tax receipts and transfers
these funds to the newly created Public Transportation Trust Fund. It is
estimated that $321 million in sales tax receipts that formerly were deposited
into the General Fund will now be deposited into the Public Transportation
Trust Fund. Finally, the enacted budget for fiscal year 2008 provided
miscellaneous tax reductions totaling $63 million. Fiscal year 2008
Commonwealth revenues from the personal income tax are forecasted to increase
by 4.8 percent, while receipts from the sales and use tax and the corporate net
income tax are estimated to decrease by 0.7 and 0.6 percent respectively. Projected
decreases in these two taxes are the result of the aforementioned legislative
changes recently enacted.
The
achievement of the budgeted results may be adversely affected by a number of
trends or events, including developments in the national and state economy.
General
obligation debt of the Commonwealth outstanding as of June 30, 2007 totaled
approximately $7.83 billion.
The
Commonwealth maintains two contributory benefit pension plans. The State
Employees’ Retirement System (“SERS”) covers all state employees and employees
of certain state-related organizations. The Public School Employees’ Retirement
System (“PSERS”) covers all public school employees. Membership in the
applicable retirement system is generally mandatory for the covered employees.
Employers and employees contribute jointly to these retirement programs. Annual
actuarial valuations are required by state law. The employer’s contribution
rate is computed to fully amortize the unfunded actuarial accrued liability of
the respective plan as determined by its actuary. The unfunded actuarial
accrued liability measures the present value of benefits estimated to be due in
the future for current employees based on assumptions relating to mortality,
pay levels, retirement experience and employee turnover, less the present value
of assets available to pay those benefits based on assumptions of normal cost,
supplemental annuity amortization, and employer and member contributions. At
the close of fiscal year 2002, the unfunded actuarial accrued liability was
($1,848) million for SERS and ($2,500) million for PSERS. At the close of
fiscal year 2005, the unfunded actuarial accrued liability for SERS was $2,216
million and for PSERS was $12,163 million.
Certain
litigation is pending against the Commonwealth that could adversely affect the
ability of the Commonwealth to pay debt service on its obligations, including
the following:
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In 1978, the
General Assembly approved a limited waiver of sovereign immunity. Damages for
any loss are limited to $250,000 for each person and $1,000,000 for each
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accident.
The Supreme Court of Pennsylvania has held that this limitation is
constitutional. Approximately 3,150 suits against the Commonwealth remain
open. The Commonwealth also represents and indemnifies employees who have
been sued under federal civil rights statutes for actions taken in good faith
in carrying out their employment responsibilities.
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In 1987, the
Supreme Court of Pennsylvania held that the statutory scheme for county
funding of the judicial system is in conflict with the Pennsylvania
Constitution, but stayed its judgment to afford the General Assembly an
opportunity to enact appropriate funding legislation consistent with its
opinion and ordered that the prior system of county funding shall remain in
place until this is done.
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Dozens of
cases have been brought challenging the Department of Revenue’s assessment of
insurance companies to provide funds to provide the funds due to Pennsylvania
residents insured by insurance companies which have become insolvent or are
otherwise in default to their insureds.
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A civil
rights action brought against two state troopers for the shooting of a twelve
year-old boy.
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The
Pennsylvania Intergovernmental Cooperation Authority (“PICA”) was created by
Commonwealth legislation in 1991 to assist the City of Philadelphia, the
Commonwealth’s largest city, in remedying its fiscal emergencies. PICA is
authorized to provide assistance through the issuance of funding debt and to
make factual findings and recommendations to Philadelphia concerning its
budgetary and fiscal affairs. This financial assistance has included grants
used by the City for defeasance of certain City general obligation bonds,
funding of capital projects and the liquidation of the cumulative general fund
balance deficit of the City of Philadelphia as of June 30, 1992, of $224.9
million. At this time, Philadelphia is operating under a five-year fiscal plan
approved by PICA on July 26, 2007.
No
further bonds may be issued by PICA for the purpose of either financing capital
projects or a deficit, as the authority for such bond issuance expired December
31, 1994. PICA’s authority to issue debt for the purpose of financing a cash
flow deficit expired on December 31, 1995. Its ability to refund existing
outstanding debt is unrestricted. PICA had $622.5 million in special tax
revenue bonds outstanding as of June 30, 2007. Neither the taxing power nor the
credit of the Commonwealth is pledged to pay debt service on PICA’s bonds.
As
of December 13, 2007, Moody’s rated the long-term general obligation bonds of
the Commonwealth “Aa2,” Standard & Poor’s rated such bonds “AA” and Fitch
rated such bonds “AA.” There can be no assurance that the economic conditions
on which these ratings are based will continue or that particular bond issues
may not be adversely affected by changes in economic or political conditions.
Special Considerations Regarding New Jersey
New
Jersey Economic Information and Trends
.
New Jersey’s economic base is
diversified, consisting of a variety of manufacturing, construction and service
industries, supplemented by rural areas with selective commercial agriculture.
New
Jersey’s economy continued to expand steadily in 2006, but at a slower pace
compared to the steady economic recovery in 2005. New Jersey’s payroll
employment increased at an average rate of
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0.9% last year
after growing at 1.0% in 2005. The average unemployment rate for New Jersey was
4.6% in 2006 compared to 4.5% in 2005. According to the United States Commerce
Department, Bureau of Economic Analysis, in a release dated June 21, 2007, the
preliminary growth rate for New Jersey’s personal income of 6.1% for the first
quarter of 2007 was above the revised 5.6% rate for the fourth quarter 2006 but
remains below the growth rate of 6.3% for the first quarter of 2006. The rate
of inflation in New Jersey is expected to remain modest. Low interest rate have
supported spending on housing and other consumer durables in New Jersey.
However, if interest rates increase in 2007, it would have a moderating
influence on interest-sensitive spending in the economy. The weakness in the
housing sector has persisted through June 2007, and if this trend continues, it
may have a softening effect on real consumer spending in 2007. New Jersey’s
economy is expected to follow the national trend, with the nation leading the
way in 2007. Despite near-term uncertainties in the economic outlook, the
economies of New Jersey and the nation are expected to continue expanding at a
moderate but steady pace in 2007 and improve in 2008. New Jersey and the nation
may experience further near-term slow growth, and the expected pace of economic
expansion may stall further if consumers, investors, and businesses become more
concerned about geopolitical tensions. To a large extent, the future direction
of economic expansion nationally and in New Jersey hinges on the assumption of
stable energy prices and financial markets, along with supportive monetary and
fiscal policies, geopolitical stability and no drastic fall off in the housing
sector. However, the fundamentals of New Jersey’s economic health remain stable
and the long run prospects for economic growth beyond 2007 are favorable.
New
Jersey’s Budget and Appropriation System - Current Operating Expenses.
The
General Fund
.
New
Jersey operates on a fiscal year ending on June 30. The General Fund is the
fund into which all New Jersey revenues, not otherwise restricted by statute,
are deposited and from which appropriations are made. The largest part of the
total financial operations of New Jersey is accounted for in the General Fund.
The New Jersey Legislature enacts an appropriations act on an annual basis
which provides the basic framework for the operation of the General Fund. The
undesignated General Fund balance at year end for fiscal year 2004 was $376.5
million, for fiscal year 2005 was $461.7 million and for fiscal year 2006 was
$1,216.7 million. For fiscal year 2007 and 2008, the balance in the
undesignated General Fund is estimated to be $1,047.9 and $102.5 million,
respectively. The fund balances are available for appropriation in succeeding
fiscal years.
Tax
and Revenue Anticipation Notes
.
In fiscal year 1992, New Jersey initiated
a program under which it issued tax and revenue anticipation notes to aid in
providing effective cash flow management to fund imbalances which occur in the
collection and disbursement of General Fund revenues and Property Tax Relief
Fund revenues. New Jersey has authorized the issuance of up to $2,500,000,000
of such notes for fiscal 2008. New Jersey has issued notes in the amount of
$2,000,000,000 on September 13, 2007. The notes shall be payable on June 24,
2008. Such tax and revenue anticipation notes do not constitute a general
obligation of New Jersey or a debt or liability within the meaning of the New
Jersey Constitution. Such notes constitute special obligations of New Jersey
payable solely from monies on deposit in the General Fund and Property Tax
Relief Fund that are legally available for such payment.
New
Jersey Capital Project Financings
General
Obligation Bonds
.
New Jersey finances certain capital projects through the sale of its
general obligation bonds. These bonds are backed by the full faith and credit
of New Jersey. Certain New Jersey tax revenues and certain other fees are
pledged to meet the principal payments, interest payments and redemption
premium payments, if any, required to fully pay the bonds. The aggregate
outstanding general obligation bonded indebtedness of New Jersey as of June 30,
2007 was
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$2,832,059,928.
The appropriation for the debt service obligation on outstanding projected
indebtedness is $438.8 million for fiscal 2008.
Pay-As-You-Go
.
In addition to payment from bond proceeds, capital projects can also be funded
by appropriation of current revenues on a pay-as-you-go basis. In fiscal 2008,
the amount appropriated for this purpose is $1,280.5 million.
Other
Long Term Debt Obligations of New Jersey
“Moral
Obligation” Bonds
.
The authorizing legislation for certain New Jersey entities provides
for specific budgetary procedures with respect to certain obligations issued by
such entities. Pursuant to such legislation, a designated official is required
to certify any deficiency in a debt service reserve fund maintained to meet the
payments of principal of and interest on the obligations and a New Jersey
appropriation in the amount of the deficiency is to be made. However, the New
Jersey Legislature is not legally bound to make such an appropriation. Bonds
issued pursuant to authorizing legislation of this type are sometimes referred
to as “moral obligation” bonds. Those New Jersey authorities and
instrumentalities that issue bonds that constitute a “moral obligation” of New
Jersey include: (i) New Jersey Housing and Mortgage Finance Agency; (ii) South
Jersey Port Corporation; and (iii) New Jersey Higher Education Student
Assistance Authority. There is no statutory limitation on the amount of “moral
obligation” bonds which may be issued by eligible New Jersey entities. As of June
30, 2007, outstanding “moral obligation” bonded indebtedness issued by New
Jersey entities total $1,764,685,000 and fiscal 2008 debt service subject to
“moral obligation” is $82,212,057.
Obligations
Supported by New Jersey Revenue Subject to Annual Appropriation
.
New Jersey has entered into a number of
leases and contracts described below (collectively, the “Agreements” and each
an “Agreement”) with several governmental authorities to secure the financing
of various New Jersey projects. Under the terms of the Agreements, New Jersey
has agreed to make payments equal to the debt service on, and other costs
related to, the obligations sold to finance the projects, including payments on
swap agreements defined below. New Jersey’s obligations to make payments with
respect to certain financings includes payments related to interest rate
exchange agreements described below (“swap agreements”) entered into with
respect to such financings. Under such swap agreements, the issuer is required
to pay a fixed rate to the swap counter party and the swap counterparty is
required to pay the issuer a variable rate in accordance with the swap
agreement. If the swap agreement is terminated prior to its stated termination
date, either the issuer or the swap counterparty may be required to make a
termination payment to the other party. If the payments to an issuer under a
swap agreement are not sufficient to pay the interest on the issuer’s related
obligation, the issuer must pay such deficiency. New Jersey’s obligation to
make payments under the Agreements is subject to and dependent upon annual
appropriations being made by the New Jersey Legislature for such purposes. The
New Jersey Legislature has no legal obligation to enact such appropriations,
but has done so to date for all such obligations. Below is a discussion of
those financings pursuant to which State authorities and instrumentalities have
entered into Agreements with New Jersey to secure the financing of various
State projects.
New
Jersey Economic Development Authority
.
The New Jersey Economic Development
Authority (“NJEDA”) issues bonds secured by Agreements pursuant to the
following legislative programs: (i) Economic Recovery Bonds issued to finance
various economic development purposes (with payments made by New Jersey
pursuant to an Agreement being equivalent to payments due to New Jersey under
an agreement with the Port Authority of New York and New Jersey, subject to
appropriation by the New Jersey Legislature); (ii) Pension Bonds issued for the
purpose of financing the unfunded accrued pension liability for New Jersey’s
retirement system; (iii) Market Transition Facility Bonds
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issued to pay
current and anticipated liabilities and expenses of the Market Transition
Facility, which issued private passenger automobile insurance policies for
drivers who could not be insured by private insurance companies on a voluntary
basis; (iv) the School Facility Construction Bonds (the principal amount of
bonds authorized to be issued is $6 billion for the “Abbott” districts, $2.5
billion for all other districts and $100 million for county vocational school
district projects), pursuant to which the NJEDA issues bonds to finance New
Jersey’s share of costs for school facility construction projects and debt
service on the bonds is paid pursuant to a contract between the NJEDA and the
New Jersey Treasurer; (v) pursuant to the Motor Vehicle Security and Customer
Service Act, the NJEDA is authorized to issue bonds to pay the costs of capital
improvements for the New Jersey Motor Vehicle Commission facilities (authorized
in an amount not exceeding $160 million); (vi) pursuant to the Municipal
Rehabilitation and Economic Recovery Act the NJEDA is authorized to issue bond
for the purpose of making loans and grants to sustain economic activity in
qualified municipalities; (vii) pursuant to the Business Employment Incentive
Program Act, the NJEDA is authorized to issue bonds to provide funds for the
payment of, among other things, certain business employment incentive grants in
consideration of the attainment of certain employment promotion targets; (viii)
the lease financing program through which certain real property, office
buildings and equipment are financed with NJEDA bonds (secured by Agreements between
the New Jersey Treasurer and NJEDA); and (ix) pursuant to the Cigarette Tax
Securitization Act of 2004, the NJEDA is authorized to issue bonds payable, and
secured by, a portion, $0.0325 per cigarette, of the cigarette tax imposed
pursuant to N.J.S.A. 54:40A-1
et seq.
New
Jersey Educational Facilities Authority
.
The New Jersey Educational Facilities
Authority issues bonds secured by Agreements pursuant to seven separate
legislative programs to finance (i) the purchase of equipment to be leased to
institutions of higher learning; (ii) grants to New Jersey’s public and private
institutions of higher education for the development, construction and
improvement of instructional, laboratory, communication and research
facilities; (iii) grants to public and private institutions of higher education
to develop a technology infrastructure within and among New Jersey’s
institutions of higher education; (iv) capital projects at county colleges; (v)
grants to public and private institutions of higher education to finance and
refinance eligible educational facilities; (vi) grants to public libraries to
finance the acquisition, expansion and rehabilitation of buildings to be used
as public library facilities; and (vii) loans to public and private institutions
of higher education and public and private secondary schools, military schools
and boarding schools located within New Jersey to install automatic fire
suppression systems.
New
Jersey Transportation Trust Fund Authority
.
In July 1984, New Jersey created the New
Jersey Transportation Trust Fund Authority (the “NJTTFA”) for the purpose of
funding a portion of New Jersey’s share of the cost of improvements to its
transportation system. The principal amount of the NJTTFA’s bonds, notes or
other obligations which may be issued in any fiscal year commencing with the
fiscal year commencing July 1, 2006 and ending with the fiscal year beginning
July 1, 2010, generally may not exceed $1,600,000,000 in any fiscal year, as
such amount shall be reduced in each of those fiscal years by the amount by
which the appropriation of New Jersey funds to the Transportation Trust Fund
Account for that fiscal year shall exceed $895,000,000; provided, however, that
if a portion of that permitted amount of debt, less any reduction as provided
above, is not incurred in a fiscal year, an amount not greater than the unused
portion may be incurred in a subsequent fiscal year in addition to the amount
otherwise permitted, subject to the approval of the Joint Budget Oversight Committee
of the New Jersey Legislature. The obligations issued by the NJTTFA are special
obligations of the NJTTFA payable from a contract among the NJTTFA, the New
Jersey Treasurer and the Commissioner of Transportation, subject to
appropriation of the New Jersey Legislature.
- 41 -
New
Jersey Building Authority
.
The New Jersey Building Authority
(“NJBA”) issues bonds for the acquisition, construction, renovation and
rehabilitation of various New Jersey office buildings, historic buildings, and
correctional facilities. Pursuant to a lease agreement, New Jersey makes rental
payments to NJBA in amounts sufficient to pay debt service on the NJBA bonds.
New
Jersey Sports and Exposition Authority
.
Legislation enacted in 1992 authorizes
the New Jersey Sports and Exposition Authority (the “NJSEA”) to issue bonds for
various purposes payable from a contract between the NJSEA and the New Jersey
Treasurer. Pursuant to such contract, the NJSEA undertakes certain projects and
the New Jersey Treasurer credits to the NJSEA amounts from the General Fund
sufficient to pay debt service and other costs related to the bonds, subject to
appropriations by the New Jersey Legislature.
Garden
State Preservation Trust
.
In July 1999, New Jersey established the Garden State
Preservation Trust (“GSPT”) for the purpose of preserving, as open space,
farmland and historic properties. Pursuant to the enabling act of the GSPT, the
principal amount of bonds, notes or other obligations which may be issued prior
to July 1, 2009, other than refunding bonds, cannot exceed $1.15 billion. After
July 1, 2009, only refunding bonds can be issued. The obligations to be issued
by the GSPT will be special obligations of the GSPT payable from amounts paid
to it under a contract between GSPT and the New Jersey Treasurer, subject to
appropriations by the New Jersey Legislature.
New
Jersey Health Care Facilities Financing Authority
.
Pursuant to Legislation, the New Jersey
Health Care Facilities Financing Authority is authorized to acquire, construct
and lease a project to the New Jersey Department of Human Services (“DHS”) and
to issue bonds to finance each project, the debt service on which shall be paid
by DHS, subject to appropriations by the New Jersey Legislature.
Each
of the NJEDA, the NJBA, the NJSEA and the NJTTFA have entered into a number of
swap agreements with respect to certain bond issues. In each case, the
outstanding aggregate principal amount of the bonds is equal to the aggregate
notional amount of the swap agreements related thereto. The State’s obligation
to make payments under the swap agreements is subject to appropriation by the
New Jersey Legislature.
New
Jersey Certificates of Participation
.
New Jersey, acting through the Director
of the Division of Purchase and Property, has entered into a series of lease
purchase agreements which provide for the acquisition of equipment, services
and real property to be used by various departments and agencies of New Jersey.
Certificates of Participation in such lease purchase agreements have been
issued. A Certificate of Participation represents a proportionate interest of
the owner thereof in the lease payments to be made by New Jersey under the
terms of the lease purchase agreement, subject to appropriation by the New
Jersey legislature.
New
Jersey Supported School and County College Bonds
.
Legislation provides for future
appropriations for New Jersey aid to local school districts equal to a portion
of the debt service on bonds issued by such local school districts for
construction and renovation of school facilities (P.L. 1968, c. 177; P.L. 1971,
c. 10; and P.L. 1978, c. 74) and for New Jersey aid to counties equal to a
portion of the debt service on bonds issued by or on behalf of counties for
construction of county college facilities (P.L. 1971, c. 12, as amended). The
New Jersey Legislature has no legal obligation to make such appropriations, but
has done so to date for all obligations issued under these laws.
Department
of Human Services Programs
.
The NJEDA issues revenue bonds from time
to time on behalf of non-profit community services providers. The payment of
debt service on these bonds as
- 42 -
well as the
payment of certain other provider expenses is made by New Jersey pursuant to
service contracts between DHS and these providers, subject to appropriation by
the New Jersey legislature.
Conduit
Indebtedness of New Jersey Authorities and Instrumentalities
.
Certain State authorities and
instrumentalities are authorized to issue debt on behalf of various private and
governmental entities on a conduit basis. Under such circumstances, neither the
New Jersey authority or instrumentality acting as a conduit issuer nor the
State of New Jersey is responsible for the repayment of such debt. The payment
obligations with respect to such debt are solely that of the entity on whose
behalf the debt was issued. Those State authorities and instrumentalities that
issue debt on behalf of private and governmental entities on a conduit basis
include: (i) the New Jersey Economic Development Authority; (ii) the New Jersey
Health Care Facilities Financing Authority; (iii) the New Jersey Education
Facilities Authority; (iv) the New Jersey Housing and Mortgage Finance Agency;
(v) the New Jersey Environmental Infrastructure Trust; and (vi) the New Jersey
Redevelopment Agency.
Counties
and Municipalities
Regulation
of County and Municipal Finance
.
New Jersey’s county and municipal finance
system is regulated by various statutes designed to assure that all county and
municipal governments and their issuing authorities remain on a sound financial
basis. Regulatory and remedial statutes are enforced by the Division of Local
Government Services (the “Division”) in the New Jersey Department of Community
Affairs.
The
Local Budget Law (N.J.S.A. 40A:4-1
et seq.
)
(the “Local Budget Law”) imposes specific budgetary procedures upon counties
and municipalities (“local units”). Every local unit must adopt an operating
budget which is balanced on a cash basis, and items of revenue and
appropriation must be examined by the Director of the Division (the
“Director”). The accounts of each local unit must be independently audited by a
registered municipal accountant. New Jersey law provides that budgets must be
submitted in a form promulgated by the Division. The Division reviews all local
unit annual budgets prior to adoption for compliance with the Local Budget Law.
The Director is empowered (i) to require changes for compliance with law as a
condition of approval; (ii) to disapprove budgets not in accordance with law;
and (iii) to prepare the budget of a local unit, within the limits of the
adopted budget of the previous year with suitable adjustments for legal
compliance, if the local unit fails to adopt a budget in accordance with law.
This process insures that every local unit annually adopts a budget balanced on
a cash basis, within limitations on appropriations or tax levies, respectively,
and making adequate provision for (i) principal of and interest on indebtedness
falling due in the fiscal year, (ii) deferred charges and (iii) other statutory
expenditure requirements. The Director also oversees changes to local budgets
after adoption as permitted by law, and enforces regulations pertaining to
execution of adopted budgets and financial administration. In addition to the
exercise of regulatory and oversight functions, the Division offers expert
technical assistance to local units in all aspects of financial administration,
including revenue collection and cash management procedures, contracting
procedures, debt management and administrative analysis.
The
Local Government Cap Law (N.J.S.A. 40A:4-45.1
et
seq.
) (the “Cap Law”) limits the year-to-year increase of the total
appropriations of any local unit to either 2.5% or a cost-of-living adjustment
determined annually by the Director, whichever is less. However, where the
cost-of-living adjustment is less than 2.5%, the Cap Law also permits the
governing body of any local unit to approve the use of a higher percentage rate
up to 3.5%. Regardless of the rate utilized, certain exceptions exist to the
Cap Law’s limitation on increases in appropriations. The principal exceptions
to these limitations are: (i) municipal and county appropriations to pay debt
service requirements; (ii) requirements to comply
- 43 -
with certain
other New Jersey or federal mandates; (iii) appropriations of private and
public dedicated funds; (iv) amounts approved by referendum; and (v) in the
case of municipalities only, to fund the preceding year’s cash deficit or to
reserve for shortfalls in tax collections, and amounts required pursuant to
contractual obligations for specified services. The Cap Law was re-enacted in
1990 with amendments and made a permanent part of the municipal finance system.
Additionally,
new legislation constituting P.L. 2007, c.62, effective April 3, 2007, imposes
a 4% cap on the tax levy of a municipality, county, fire district or solid
waste collection district, with certain exceptions and subject to a number of
adjustments. The exclusions from the limit include increases required to be
raised for debt service on the local unit’s bonds and notes, increases to
replace certain lost state aid, increases in certain pension contributions,
increases in the reserve for uncollected taxes required for municipalities, and
certain increases in health care costs over 4%. The Division may approve
waivers for certain extraordinary costs identified by statute, and voters may
approve increases over 4% not otherwise permitted by a vote of 60% of the
voters voting on a public question.
Regulation
of the Issuance of Bonds by Counties and Municipalities
.
New Jersey law also regulates the
issuance of debt by local units. The Local Budget Law limits the amount of tax
anticipation notes that may be issued by local units and requires the repayment
of such notes within 120 days of the end of the fiscal year (six months in the
case of the counties) in which issued. The Local Bond Law (N.J.S.A. 40A:2-1
et seq.
) governs the issuance of bonds and
notes by the local units. No local unit is permitted to issue bonds for the
payment of current expenses (other than fiscal year adjustment bonds). Local
units may not issue bonds to pay outstanding bonds, except for refunding
purposes, and then only with the approval of the Local Finance Board. Local
units may issue bond anticipation notes for temporary periods not exceeding in
the aggregate approximately ten years from the date of issue. The debt that any
local unit may authorize is limited to a percentage of its equalized valuation
basis. In the calculation of debt capacity, the Local Bond Law and certain
other statutes permit the deduction of certain classes of debt (“statutory
deduction”) from all authorized debt of the local unit in computing whether a
local unit has exceeded its statutory debt limit. The Local Bond Law permits
the issuance of certain obligations, including obligations issued for certain
emergency or self liquidating purposes, notwithstanding the statutory debt
limitation described above, but, with certain exceptions, it is then necessary
to obtain the approval of the Local Finance Board.
School
Districts
Regulation
of School District Finance
.
All New Jersey school districts are
coterminous with the boundaries of one or more municipalities. They are
characterized by the manner in which the board of education, the governing body
of the school districts, takes office. Type I school districts, most commonly
found in cities, have a board of education, appointed by the mayor or the chief
executive officer of the municipality, constituting the school district. In a
Type II school district, the board of education is elected by the voters of the
district. Nearly all regional and consolidated school districts are Type II
school districts. The New Jersey Department of Education has been empowered
with authority to abolish an existing school board and create a State-operated
school district where the existing school board has failed or is unable to take
the corrective actions necessary to provide a thorough and efficient system of
education in that school district pursuant to N.J.S.A. 18A:7A-15
et seq.
(the “School Intervention Act”).
The State-operated school district, under the direction of a New Jersey
appointed superintendent, has all of the powers and authority of the local
board of education and of the local district superintendent.
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New
Jersey’s school districts operate under the same comprehensive review and
regulation as do its counties and municipalities, including, without
limitation, the new legislation constituting P.L. 2007, c.62, effective April
3, 2007, discussed above. Certain exceptions and differences are provided, but
New Jersey’s supervision of school finance closely parallels that of local
governments.
Regulation
of the Issuance of Bonds by School Districts
.
School district bonds and temporary notes
are issued in conformity with N.J.S.A. 18A:24-1
et seq.
(the “School Bond Law”), which closely parallels the
Local Bond Law (for further information relating to the Local Bond Law, see “
Counties and Municipalities - Regulation of the
Issuance of Bonds by Counties and Municipalities
” herein). Although
school districts are exempted from the 5 percent down payment provision
generally applied to bonds issued by local units, they are subject to debt
limits (which vary depending on the type of school system) and to New Jersey
regulation of their borrowing.
School
bonds are authorized by (i) an ordinance adopted by the governing body of a
municipality within a Type I school district; (ii) adoption of a proposal by
resolution by the board of education of a Type II school district having a
board of school estimate; (iii) adoption of a proposal by resolution by the
board of education and approval of the proposal by the legal voters of any
other Type II school district; or (iv) adoption of a proposal by resolution by
a capital project control board for projects in a State-operated school
district.
If
school bonds of a Type II school district will exceed the school district
borrowing capacity, a school district (other than a regional school district)
may use the balance of the municipal borrowing capacity. If the total amount of
debt exceeds the school district’s borrowing capacity, the Commissioner and the
Local Finance Board must approve the proposed authorization before it is
submitted to the voters. All authorizations of debt in a Type II school
district without a board of school estimate require an approving referendum,
except where, after hearing, the Commissioner and the New Jersey Department of
Education determine that the issuance of such debt is necessary to meet the
constitutional obligation to provide a thorough and efficient system of public
schools. When such obligations are issued, they are issued by, and in the name
of, the school district.
In
Type I and II school districts with a board of school estimate, that board
examines the capital proposal of the board of education and certifies the
amount of bonds to be authorized. When it is necessary to exceed the borrowing
capacity of the municipality, the approval of a majority of the legally qualified
voters of the municipality is required, together with the approval of the
Commissioner and the Local Finance Board. When such bonds are issued by a Type
I school district, they are issued by the municipality and identified as school
bonds. When bonds are issued by a Type II school district having a board of
school estimate, they are issued by, and in the name of, the school district.
School
District Lease Purchase Financings
.
School districts are permitted to enter
into lease purchase agreements for the acquisition of equipment or for the
acquisition of land and school buildings in order to undertake the construction
or the improvement of the school buildings. Lease purchase agreements for
equipment cannot exceed five years. Lease purchase agreements for school
facilities must be approved by the Commissioner, the voters or the board of
school estimate, as applicable. The payment of rent on an equipment lease and
on a five year and under facilities lease purchase agreement is treated as a
current expense and is within the cap on the school district’s budget. Under
the Comprehensive Education Improvement and Financing Act, lease purchase
payments on leases in excess of five years will be treated as debt service
payments and therefore receive debt service aid if the school district is
entitled and will be outside the school district’s spending limitation of the
General Fund.
- 45 -
New
Jersey School Bond Reserve Act
.
The New Jersey School Bond Reserve Act
(N.J.S.A. 18A:56-17
et seq.
)
establishes a school bond reserve within the constitutionally dedicated fund
for the support of free public schools (the “Fund”). Amendments to the Act
provide that the Fund will be divided into two school bond reserve accounts.
All bonds issued prior to July 1, 2003 shall be benefited by a school bond
reserve account funded in an amount equal to 1-1/2% of the aggregate amount of
issued and outstanding bonded indebtedness of New Jersey counties,
municipalities or school districts for school purposes issued prior to July 1,
2003 and all bonds issued on or after July 1, 2003 shall be benefited by a
school bond reserve account equal to 1% of the aggregate amount of issued and
outstanding bonded indebtedness of New Jersey counties, municipalities or school
districts for school purposes issued on or after July 1, 2003, provided in each
case, that such amounts do not exceed the moneys available in the applicable
account. If a municipality, county or school district is unable to meet payment
of the principal of or interest on any of its school bonds, the trustee of the
school bond reserve will purchase such bonds at the face amount thereof or pay
the holders thereof the interest due or to become due. There has never been an
occasion to call upon this Fund.
Local
Financing Authorities
Regulation
of Local Financing Authorities
.
The Local Authorities Fiscal Control Law
(N.J.S.A. 40A:5A-1
et seq.
)
provides for State supervision of the fiscal operations and debt issuance
practices of independent local authorities and special taxing districts by the
New Jersey Department of Community Affairs. The Local Authorities Fiscal
Control Law applies to all autonomous public bodies, created by local units,
which are empowered (i) to issue bonds, (ii) to impose facility or service
charges, or (iii) to levy taxes in their districts. This encompasses most
autonomous local authorities (sewerage, municipal utilities, parking, pollution
control, improvement, etc.) and special taxing districts (fire, water, etc.). Authorities
which are subject to differing New Jersey or federal financial restrictions are
exempted, but only to the extent of that difference.
Financial
control responsibilities over local authorities and special districts are
assigned to the Local Finance Board and the Director. The Local Finance Board
exercises approval over creation of new authorities and special districts as
well as their dissolution. The Local Finance Board prescribes minimum audit
requirements to be followed by authorities and special districts in the conduct
of their annual audits. The Director of the Division reviews and approves
annual budgets of authorities and special districts.
Regulation
of the Issuance of Bonds by Local Financing Authorities
.
Certain local authorities are authorized
to issue debt on behalf of various entities on a conduit basis. Under such
circumstances, neither the local authority acting as a conduit issuer, the
local unit creating such local authority nor the State of New Jersey is responsible
for the repayment of such debt. The payment obligations with respect to such
debt is solely that of the entity on whose behalf the debt was issued. The
Local Finance Board reviews, conducts public hearings, and issues findings and
recommendations on any proposed project financing of an authority or district,
and on any proposed financing agreement between a local unit and an authority
or special district.
Pollution
Control Bonds
.
In
the 1970s, the New Jersey Legislature initiated a comprehensive statutory
mechanism for the management of solid waste disposal within New Jersey that
required each county to develop a plan for county-wide controlled flow of solid
waste to a franchised location. The controlled flow of solid waste to a
franchised location enabled the imposition of above-market-rate disposal fees.
Most counties created independent local authorities or utilized existing local
authorities in order to finance, with the proceeds of bonds, the technically
complex and expensive infrastructure
- 46 -
required to
implement this statutory mechanism. Typically, the primary security for the
amortization of the bonds was the above-market-rate disposal fees, although
some bonds were further secured by a guaranty of the respective county. On May
1, 1997, in
Atlantic Coast Demolition &
Recycling, Inc. v. Board of Chosen Freeholders of Atlantic County
,
112 F.3d 652 (3d Cir. 1997), the United States Court of Appeals for the Third
Circuit held that New Jersey’s system of controlled flow of solid waste to
franchised locations unconstitutionally discriminated against out-of-State
operators of waste disposal facilities and, therefore, violated the Commerce
Clause of the United States Constitution. Subsequently, the United States
Supreme Court denied a petition for writ of certiorari. This decision has
terminated controlled flow of solid waste to franchised locations within New
Jersey. In the absence of controlled flow, franchisees facing competition from
other operators of waste disposal facilities are unable to charge
above-market-rate disposal fees. The reduction of such fees to competitive
levels has reduced correspondingly the primary source of security for the
outstanding bonds of the local authorities. The facts relevant to each local authority
within New Jersey remain unique. Some local authorities have successfully
implemented refunding and work-out financings. Other local authorities have
eliminated revenue shortfalls through the imposition of special waste disposal
taxes. In other cases, revenue shortfalls continue, but bond payment defaults
by such local authorities have been avoided as a result of a New Jersey program
by which New Jersey to date has voluntarily provided financial assistance to
qualifying local authorities to satisfy bond payment obligations on a given
bond payment date. However, no assurance can be given that such New Jersey
subsidies will be made available to such local authorities in the future (or
that sufficient funds will be made available to New Jersey for such purpose),
particularly given recent New Jersey budget reductions.
Qualified
Bonds
.
In
1976, legislation was enacted (P.L. 1976, c. 38 and c. 39) which provides for
the issuance by municipalities and school districts of “qualified bonds.”
Whenever a local board of education or the governing body of a municipality
determines to issue bonds, it may file an application with the Local Finance
Board, and, in the case of a local board of education, the Commissioner of
Education of New Jersey, to qualify bonds pursuant to P.L. 1976 c. 38 or c. 39.
Upon approval of such an application, the New Jersey Treasurer shall withhold
from certain New Jersey revenues or other New Jersey aid payable to the
municipalities, or from New Jersey school aid payable to the school district,
as appropriate, an amount sufficient to pay debt service on such bonds. These
“qualified bonds” are not direct, guaranteed or moral obligations of New
Jersey, and debt service on such bonds will be provided by New Jersey only if
the above mentioned appropriations are made by New Jersey.
Litigation
of the State of New Jersey
General.
At any given time, there are various
numbers of claims and cases pending against the State of New Jersey, State
agencies and State employees, seeking recovery of monetary damages that are
primarily paid out of the fund created pursuant to the New Jersey Tort Claims
Act (N.J.S.A. 59:1-1
et seq.
).
New Jersey does not formally estimate its reserve representing potential
exposure for these claims and cases. New Jersey is unable to estimate its
exposure for these claims and cases.
New
Jersey routinely receives notices of claim seeking substantial sums of money.
The majority of these claims have historically proven to be of substantially less
value than the amount originally claimed. Under the New Jersey Tort Claims Act,
any tort litigation against New Jersey must be preceded by a notice of claim,
which affords New Jersey the opportunity for a six-month investigation prior to
the filing of any suit against it. In addition, at any given time, there are
various numbers of contract and other claims against New Jersey and New Jersey
agencies, including environmental claims asserted against New Jersey, among
other parties, arising from the alleged disposal of hazardous waste. Claimants
in such
- 47 -
matters seek
recovery of monetary damages or other relief which, if granted, would require
the expenditure of funds. New Jersey is unable to estimate its exposure for
these claims.
At
any given time, there are various numbers of claims and cases pending against
the University of Medicine and Dentistry of New Jersey and its employees,
seeking recovery of monetary damages that are primarily paid out of the Self
Insurance Reserve Fund created pursuant to the New Jersey Tort Claims Act. An
independent study estimated an aggregate potential exposure of $134,900,000 for
tort and medical malpractice claims pending as of December 31, 2006. In
addition, at any given time, there are various numbers of contract and other
claims against the University of Medicine and Dentistry of New Jersey, seeking
recovery of monetary damages or other relief which, if granted, would require
the expenditure of funds. New Jersey is unable to estimate its exposure for
these claims.
Lawsuits
currently pending or threatened in which New Jersey has the potential for
either a significant loss of revenue or a significant unanticipated expenditure
are described in official statements relating to securities offerings of New
Jersey municipal obligations available as of the date of this SAI.
Tax Risks
As
with any investment, you should consider how your investment in shares of the
Fund will be taxed. The tax information in this Prospectus and SAI is provided
as general information. You should consult your own tax professional about the
tax consequences of an investment in shares of the Fund.
There
is no guarantee that a Fund’s income will be exempt from federal or state
income taxes. Events occurring after the date of issuance of a municipal bond
or after a Fund’s acquisition of a municipal bond may result in a determination
that interest on that bond is includible in gross income for federal income tax
purposes retroactively to its date of issuance. Such a determination may cause
a portion of prior distributions by a Fund to its shareholders to be taxable to
those shareholders in the year of receipt. Federal or state changes in income
or alternative minimum tax rates or in the tax treatment of municipal bonds may
make municipal bonds less attractive as investments and cause them to lose
value.
In
January 2006, the Kentucky Court of Appeals held, in Davis v. Department of
Revenue, that the state’s exemption of interest on its own bonds and those of
its political subdivisions and its taxation of interest on the bonds of other
states and their political subdivisions unlawfully discriminates against
interstate commerce. After the Kentucky Supreme Court declined to review the
decision, Kentucky officials petitioned the United States Supreme Court to
review the Davis decision, and the request was granted by the Court on May 24,
2007. A decision in the Davis case is anticipated sometime during the current
term of the United States Supreme Court, which commenced on October 1, 2007. If
the United States Supreme Court were to affirm the Davis decision, the tax
treatment of state and local government bonds of other states also may be held
to be unconstitutional. A determination that the tax-exempt treatment of state
and local government bonds unlawfully discriminates against interstate commerce
could cause interest on such tax-exempt obligations held by a Fund to become
taxable and the market value of such obligations to decline, which, in turn,
may negatively affect the value of a Fund’s shares.
Municipal Insurance
A
municipal security may be covered by insurance that guarantees the bond’s
scheduled payment of interest and repayment of principal. This type of
insurance may be obtained by either (i) the issuer at the time the bond is
issued (primary market insurance), or (ii) another party after the bond has
been issued (secondary market insurance).
- 48 -
Both
primary and secondary market insurance guarantee timely and scheduled repayment
of all principal and payment of all interest on a municipal security in the
event of default by the issuer, and cover a municipal security to its maturity,
enhancing its credit quality and value.
Municipal
security insurance does not insure against market fluctuations or fluctuations
in the Fund’s share price. In addition, a municipal security insurance policy
will not cover: (i) repayment of a municipal security before maturity
(redemption), (ii) prepayment or payment of an acceleration premium (except for
a mandatory sinking fund redemption) or any other provision of a bond indenture
that advances the maturity of the bond or (iii) nonpayment of principal or
interest caused by negligence or bankruptcy of the paying agent. A mandatory
sinking fund redemption may be a provision of a municipal security issue
whereby part of the municipal security issue may be retired before maturity.
Because
a significant portion of the municipal securities issued and outstanding is insured
by a small number of insurance companies, an event involving one or more of
these insurance companies could have a significant adverse effect on the value
of the securities insured by that insurance company and on the municipal
markets as a whole.
Municipal Market Disruption Risk
The
value of municipal securities may be affected by uncertainties in the municipal
market related to legislation or litigation involving the taxation of municipal
securities or the rights of municipal securities holders in the event of a
bankruptcy. Proposals to restrict or eliminate the federal income tax exemption
for interest on municipal securities are introduced before Congress from time
to time. Proposals also may be introduced before state legislatures that would
affect the state tax treatment of a municipal fund’s distributions. If such
proposals were enacted, the availability of municipal securities and the value
of a municipal fund’s holdings would be affected, and the Trustees would
reevaluate the fund’s investment objectives and policies. Municipal
bankruptcies are relatively rare, and certain provisions of the U.S. Bankruptcy
Code governing such bankruptcies are unclear and remain untested. Further, the
application of state law to municipal issuers could produce varying results
among the states or among municipal securities issuers within a state. These
legal uncertainties could affect the municipal securities market generally,
certain specific segments of the market, or the relative credit quality of particular
securities. There is also the possibility that as a result of litigation or
other conditions, power or ability of issuers to meet their obligations for the
payment of interest and principal on their municipal securities may be
materially affected or their obligations may be found to be invalid or
unenforceable. Such litigation or conditions may from time to time have the
effect of introducing uncertainties in the market for municipal securities or
certain segments thereof, or of materially affecting the credit risk with
respect to particular bonds. Adverse economic, business, legal or political
developments might affect all or a substantial portion of the Fund’s municipal
securities in the same manner. Any of these effects could have a significant
impact on the prices of some or all of the municipal securities held by a Fund.
Futures and Options Transactions
Positions
in futures contracts and options may be closed out only on an exchange which
provides a secondary market therefor. However, there can be no assurance that a
liquid secondary market will exist for any particular futures contract or
option at any specific time. Thus, it may not be possible to close a futures or
options position. In the event of adverse price movements, the Funds would
continue to be required to make daily cash payments to maintain its required
margin. In such situations, if a Fund has insufficient cash, it may have to
sell portfolio securities to meet daily margin requirements at a time when
- 49 -
it may be
disadvantageous to do so. In addition, the Funds may be required to make
delivery of the instruments underlying futures contracts they have sold.
The
Funds will seek to minimize the risk that it will be unable to close out a
futures or options contract by only entering into futures and options for which
there appears to be a liquid secondary market.
The
risk of loss in trading futures contracts or uncovered call options in some
strategies (e.g., selling uncovered stock index futures contracts) is
potentially unlimited. The Funds do not plan to use futures and options
contracts in this way. The risk of a futures position may still be large as
traditionally measured due to the low margin deposits required. In many cases,
a relatively small price movement in a futures contract may result in immediate
and substantial loss or gain to the investor relative to the size of a required
margin deposit. Each Fund, however, intends to utilize futures and options
contracts in a manner designed to limit its risk exposure to that which is
comparable to what it would have incurred through direct investment in stocks.
Utilization
of futures transactions by the Funds involves the risk of imperfect or even
negative correlation to each Fund’s respective benchmark Index if the Index
underlying the futures contracts differs from the benchmark Index. There is
also the risk of loss by the Funds of margin deposits in the event of
bankruptcy of a broker with whom a Fund has an open position in the futures
contract or option.
Certain
financial futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day’s settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of future positions and
subjecting some futures traders to substantial losses.
Swaps
The
use of swap agreements involves certain risks. For example, if the counterparty,
under a swap agreement, defaults on its obligation to make payments due from it
as a result of its bankruptcy or otherwise, the Funds may lose such payments
altogether or collect only a portion thereof, which collection could involve
costs or delay.
U.S. Federal Tax Treatment of Futures
Contracts
The
Funds may be required for federal income tax purposes to mark-to-market and
recognize as income for each taxable year their net unrealized gains and losses
on certain futures contracts as of the end of the year as well as those
actually realized during the year. The Funds may be required to defer the
recognition of losses on futures contracts to the extent of any unrecognized
gains on related positions held by the Funds.
In
order for the Funds to continue to qualify for U.S. federal income tax
treatment as a regulated investment company, at least 90% of their gross income
for a taxable year must be derived from qualifying income,
i.e.
, dividends, interest, income derived
from loans of securities, gains from the sale of securities or of foreign
currencies or other income derived with respect to the Funds’ business of
investing
- 50 -
in securities.
It is anticipated that any net gain realized from the closing out of futures
contracts will be considered gain from the sale of securities and therefore
will be qualifying income for purposes of the 90% requirement.
The
Funds distribute to shareholders annually any net capital gains which have been
recognized for U.S. federal income tax purposes (including unrealized gains at
the end of a Fund’s fiscal year) on futures transactions. Such distributions
are combined with distributions of capital gains realized on each Fund’s other
investments and shareholders are advised on the nature of the distributions.
Continuous Offering
The
method by which Creation Units are created and traded may raise certain issues
under applicable securities laws. Because new Creation Units are issued and
sold by the Trust on an ongoing basis, at any point a “distribution,” as such
term is used in the Securities Act of 1933, as amended (the “Securities Act”),
may occur. Broker-dealers and other persons are cautioned that some activities
on their part may, depending on the circumstances, result in their being deemed
participants in a distribution in a manner which could render them statutory
underwriters and subject them to the prospectus delivery and liability
provisions of the Securities Act.
For
example, a broker-dealer firm or its client may be deemed a statutory
underwriter if it takes Creation Units after placing an order with the
Distributor, breaks them down into constituent Shares, and sells such Shares
directly to customers, or if it chooses to couple the creation of a supply of
new Shares with an active selling effort involving solicitation of secondary
market demand for Shares. A determination of whether one is an underwriter for
purposes of the Securities Act must take into account all the facts and
circumstances pertaining to the activities of the broker-dealer or its client
in the particular case, and the examples mentioned above should not be
considered a complete description of all the activities that could lead to a
categorization as an underwriter.
Broker-dealers
who are not “underwriters” but are participating in a distribution (as
contrasted to ordinary secondary trading transactions), and thus dealing with
Shares that are part of an “unsold allotment” within the meaning of Section
4(3)(C) of the Securities Act, would be unable to take advantage of the
prospectus-delivery exemption provided by Section 4(3) of the Securities Act.
This is because the prospectus delivery exemption in Section 4(3) of the
Securities Act is not available in respect of such transactions as a result of
Section 24(d) of the 1940 Act. As a result, broker-dealer firms should note
that dealers who are not underwriters but are participating in a distribution
(as contrasted with ordinary secondary market transactions) and thus dealing with
the Shares that are part of an overallotment within the meaning of Section
4(3)(A) of the Securities Act would be unable to take advantage of the
prospectus delivery exemption provided by Section 4(3) of the Securities Act.
Firms that incur a prospectus delivery obligation with respect to Shares are
reminded that, under Rule 153 of the Securities Act, a prospectus delivery
obligation under Section 5(b)(2) of the Securities Act owed to an exchange
member in connection with a sale on the Amex is satisfied by the fact that the
prospectus is available at the Amex upon request. The prospectus delivery
mechanism provided in Rule 153 is only available with respect to transactions
on an exchange.
- 51 -
EXCHANGE
LISTING AND TRADING
A
discussion of exchange listing and trading matters associated with an
investment in the Funds is contained under the headings “Principal Risks of
Investing in the Funds,” “Additional Risks of Investing in the Funds,”
“Shareholder Information—Determination of Net Asset Value” and “Shareholder
Information—Buying and Selling Exchange-Traded Shares.” The discussion below
supplements, and should be read in conjunction with, such sections of the
Funds’ Prospectus.
The
Funds anticipate that their Shares will be traded in the secondary market at
prices that may differ to some degree from their NAV. There can be no assurance
that the requirements of the Amex necessary to maintain the listing of Shares
of the Funds will continue to be met.
The
Amex may but is not required to remove the Shares of the Funds from listing if:
(1) following the initial twelve-month period beginning upon the commencement
of trading of the Funds, there are fewer than 50 beneficial holders of the
Shares for 30 or more consecutive trading days, (2) the value of each Fund’s
respective underlying Index or portfolio of securities on which a Fund is based
is no longer calculated or available or (3) such other event shall occur or
condition exists that, in the opinion of the Amex, makes further dealings on
the Amex inadvisable. In addition, the Amex will remove the Shares from listing
and trading upon termination of the Trust.
As
in the case of other securities traded on the Amex, brokers’ commissions on
transactions will be based on negotiated commission rates at customary levels.
In
order to provide investors with a basis to gauge whether the market price of
the Shares on the Amex are approximately consistent with the current value of
the assets of the Fund on a per Share basis, an updated Intra-Day Optimized
Portfolio Value is disseminated intra-day through the facilities of the
Consolidated Tape Association’s Network B. Intra-Day Optimized Portfolio Values
are disseminated every 15 seconds during regular Amex trading hours based on
the most recently reported prices of Fund Securities. The Funds are not
involved in or responsible for the calculation or dissemination of the
Intra-Day Optimized Portfolio Value and make no warranty as to the accuracy of
the Intra-Day Optimized Portfolio Value.
The
Intra-Day Optimized Portfolio Value has a net other assets value component,
which is summed and divided by the total estimated Fund Shares outstanding,
including Shares expected to be issued by each Fund on that day, to arrive at
an Intra-Day Optimized Portfolio Value. The net other assets value component
consists of estimates of all other assets and liabilities of the Fund
including, among others, current day estimates of dividend income and expense
accruals.
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BOARD OF
TRUSTEES OF THE TRUST
