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Speaking of State Credit Ratings & Income Tax Cuts . . .

As the House begins debating ways to increase revenue to fix our roads and whether our workers deserve an income tax reduction to offset those tax increases, a point will be made by those who oppose tax cuts that any meaningful reduction in our individual income tax rates will put our state’s credit rating at risk. Their point implies a recklessness on the part of those House members who advocate tax relief for South Carolina workers. This implication deserves further scrutiny.

South Carolina receives credit ratings from three organizations: Standard & Poor’s (S&P), Fitch, and Moody’s. Fitch and Moody’s has long rated our credit worthiness at AAA and Aaa, respectively. Our relationship with S&P has been more volatile. Historically, we enjoyed a AAA rating with them. After Hugo hit in 1989 they lowered our rating to AA+. We returned to AAA status in 1996. In 2005, they again lowered our rating to AA+ where it has remained.

Current income tax relief opponents claim that the 2005 ratings drop was primarily caused by the “Sanford Tax Cut” as they term it. That bill (sponsored by then Speaker David Wilkins and co-sponsored by many who oppose tax relief now) was similar to the relief being promoted by Gov. Haley in her current road funding bill which has been co-sponsored by 44 Republicans. The 2005 legislation passed the Republican controlled House but died in the Senate.

Gov. Haley’s opponents are employing some type of biased revisionism when they blame Gov. Sanford for our downgrade. If we review news reports from that time, our Democrat Treasurer Grady Patterson offered a different reason. After negotiating at length with S&P to maintain our AAA status, he said “the issue boils down to jobs, jobs, jobs”  – an issue that Gov. Haley has made the central theme of her time as Governor. Please see this  AP report from 2005 for more detail.

Our credit rating is a very important issue and we thank those who oppose income tax relief for bringing this to our attention. It raises several important questions:

How did a tax cut that did not actually become law lower our S&P credit rating to AA+?

Why have we been unable in the last decade to reclaim our AAA?

What methodology does S&P use to determine a state’s credit rating?

When did S&P last issue a report for South Carolina and what does it say?

The last question presents us with an excellent place to start. The latest S&P report was issued in 2014. It may be viewed at S&P SC Credit Rating 2014.

This 11 page document offers an independent analysis of our fiscal health. Though some will find the entire document fascinating, most will appreciate the following salient excerpts:

Page 1 – Rationale

S&P base their continued AA+ rating and stable outlook on our:

  • Growing economy, although growth has been historically cyclical in nature;
  • Positive revenue trends and financial operations;
  • Proactive budget adjustments to offset declining revenues in previous years
  • Maintenance of required budgetary reserves; and
  • Low to moderate debt levels.

The aforementioned strengths are partly offset by our view of South Carolina’s large unfunded pension and other post employment benefit (OPEB) liabilities.

Their rationale does not specifically mention tax policy but does note our positive revenue trends. It also counts our ability to proactively cut spending as a strength along with our low debt levels. Our unfunded pension liability continues to count against us.

Given their comments, a $500 billion bond offering might have proved more damaging to our credit rating than an income tax reduction. Also, anyone concerned about our credit rating should note that the Legislature’s pension “fix” passed a couple of years ago apparently did not impress.

Page 3 – Outlook

The stable outlook reflects what we consider South Carolina’s proactive management, contributing to improved financial performance in recent years. The outlook also reflects economic recovery after the recession, with an improved unemployment rate and state employment growth exceeding the national average. We believe South Carolina’s revenue performance has exceeded projections, and that its conservative revenue estimates will allow it to maintain or improve balances. We also view the state’s adopted long-term financial planning and forecasting strategies and moderate debt levels positively. We do not expect to change the ratings within the two-year outlook horizon.

Their outlook reads like an endorsement of our ability to recruit new employers – an ability that relies upon the cooperation of our Governor and Legislature. It also suggests that a meaningful income tax reduction could be achieved with that same cooperation. They also mention keeping our debt low again.

Page 7 – Budgetary Performance

In our view, South Carolina has constantly had well-defined financial management policies and a commitment to reserves despite budget challenges. In periods of economic decline, a focus on addressing budget imbalances include structural solutions, primarily from across-the-board budget cuts. There is a formal reserve set at 5% (up from 3%) that must be replenished within three years of being drawn upon. There is also a 2% capital reserve that is funded each year and can only be used for capital or to lower debt for the following year if it is not needed to cover any operating deficits. The state’s general and capital reserve funds are currently fully funded at the required amounts.

The paragraph continues on to describe the process of reducing spending should revenues fall.

The Legislature acted prudently to raise and fully fund our reserve accounts. That should always be the case before any tax cuts are considered.

Page 8 – Audited Fiscal 2013

On a generally accepted accounting principles basis, the state closed fiscal 2013 with $9.9 billion in revenues and $8.8 billion in expenditures. The state posted a $1 billion surplus before transfers and other sources and uses. After accounting for transfers and other sources and uses, the surplus is $915 million. The general fund closed fiscal 2013 with a $2.8 billion total general fund balance, up from $1.89 billion in fiscal 2012. The assigned general fund balance was recorded at $997 million, up from $495 million in fiscal 2012. The unassigned balance totaled $792 million, or 9% of expenditures, down from $945 million in fiscal 2012. Combined assigned and unassigned balances rose to 20% of expenditures, up from 17% in the previous year. In our view, general fund liquidity is good, with $3 billion in cash and cash equivalents as of fiscal year end 2013.

In other words, we seem to have a lot of cash on hand. That audited fact speaks for itself.

If nothing else, this report shows that House members looking for a meaningful income tax reduction to go with our roads revenue increase are not being reckless. Instead, we are forcing a prudent discussion about our revenue policy and this report suggests that meaningful income tax relief is long overdue.