”’Editor’s note: This is the testimony of the state’s Budget & Finance Department Director, Georgina K. Kawamura, made before the State Senate Ways and Means Committee and House Finance Committee on Jan. 6, 2004. Ms. Kawamura discussed the supplemental budget request made by the state departments and the overall fiscal situation of the state.”’

Senator Taniguchi, Representative Takamine, and Members of the Committees:Thank you for this opportunity to present to you an overview of the States financial condition.

According to recent indicators, the Hawaii economy appears to have rebounded from the depth of economic difficulty in the aftermath of September 11, 2001. Steady improvements in many areas — construction, real estate, tourism — have resulted in increasing employment and income for our citizens.

The Council on Revenues, the body that provides official revenue estimates to the State, met in September 2003 and, more recently, in December 2003. Its forecast projected continuing improvements in the current fiscal biennium and moderate growth in the near term. In September 2003, the Council estimated that general fund tax revenues would grow by 6.2 percent in FY 2004, by 6.9 percent in FY 2005, and between 5.3 percent to 6.8 percent during the 2006-09 period. These projections, while moderate, show a clear improvement over the past two years when actual general fund tax revenues suffered a decline of -3.5 percent in FY 2002 and grew by only 4.4 percent in FY 2003.

At the December 22, 2003 meeting, the Council modified its earlier projection from 6.2 percent to 5.2 percent for FY 2004 and from 6.9 percent to 7.9 percent for FY 2005. The numbers for the out-years remained the same.

At this time, with cautious optimism on the economy and projection of moderate growth in revenues, I am pleased to report that the State is in a better financial condition than last year. The General Fund Financial Plan that accompanies the proposed Executive Supplemental Budget for Fiscal Biennium (FB) 2003-05 shows a positive ending balance for each year in the planning period.

In the days to come, departments and agencies will be presenting their specific requests for your consideration. At this time, I would like to provide you with a general view of how the Executive Supplemental Budget was developed.

Within the framework of Hawaiis biennial budget system, the General Appropriations Act of 2003 (Act 200/03) established the spending plan for State programs and agencies for the current FB 2003-05. This year being a supplemental year, adjustments were considered only to meet the critical needs in areas that were deemed of high priority. Departments were encouraged to propose trade-offs and transfers between programs to accommodate priority changes or operational efficiency.

Underlying the many deliberations and decisions that culminated in the proposed Supplemental Budget was a general fiscal discipline that encompasses four basic principles:

*1. The State must learn to live within its means. Since it is unlikely that we will have enough resources to do everything, working within a revenue constraint forces government to be clear about its priorities.

*2. The budget should have structural balance. Our recurring expenses should match our recurring revenues to avoid a perpetual deficit position. We will need to realign the revenue and expense parameters from time to time to maintain an overall balance in the budget.

*3. The budget should adhere to sound budgeting principles and its presentations should be clear and simple. We would like to see all funding requirements be put into the budget and thus minimize off-budget appropriations. This will allow for a more comprehensive evaluation of our resource allocation decisions. We want to make sure that budgetary needs of authorized on-going programs be recognized and accounted for in the budget. The practice of providing only partial funding for on-going programs distorts the baseline and puts undue burden on future years. We will resist using the Emergency and Budget Reserve Fund, the States rainy day fund, as an expedient means in a tight budget condition. Reserve funds should be kept for what they are intended: a true emergency. We will explore ways to make the budget documents and information more transparent and easier to read. A possibility is to align budget presentations with departmental responsibilities instead of program areas.

*4. We will strive to establish fiscal stability and reduce fiscal stress. We know from experience that, despite sound policy and best effort, budget shortfalls and fiscal crises can occur. This is because many assumptions go into the planning numbers. Revenue projections and cost estimates do vary, and external conditions can derail the most careful plans. To even out fluctuations that can be disruptive to operations, we need to build an adequate reserve to maintain a degree of fiscal stability in the state budget.

In short, these are the fiscal guidelines that we will adhere to in managing the State budget. We may not get to these goals all at once, but we are committed to the principles.

I will now address the status of the General Fund Financial Plan.

”THE GENERAL FUND FINANCIAL PLAN”

The State’s FY 2003 began with a carry-over balance of $134 million in the General Fund and ended with a $117.2 million balance on June 30, 2003.

As you may recall, this Administration took office at a time when official estimates of general fund tax revenue growth were progressively lowered by the Council on Revenues. Between September 2002 and May 2003, the estimate was reduced from 6.1 percent to 1.8 percent. Facing a potential critical shortfall in revenues, we took the following immediate steps:

*A restriction of 5 percent was imposed on the discretionary operating budget along with restrictions on specific appropriations.

*A general hiring freeze was placed on all but the most essential vacancies.

*General obligation (G.O.) debt was restructured to reduce debt service expenses.

These actions helped hold down expenses. Finally, with actual tax collections higher than expected and the transfer of excess balances from a number of special funds, we were able to close out the year with a $117.2 million balance.

For the current FY 2004, proposed adjustments to the operating budget result in a reduction of $19.3 million due to G.O. debt restructuring and lower interest rates ($15.8 million) and increased federal funding for the QUEST program ($3.5 million).

In addition to the adjustments to Act 200/03, there will be legislative proposals for emergency appropriations for the following requirements:

*Full-year funding of collective bargaining expenses for Unit 1 (Blue Collar Employees) and Unit 5 (Teachers) under the previous contract ($7.4 million).

*Increase in workers compensation costs ($3.1 million).

*Additional funding for the Hawaii Health Systems Corporation (HHSC) ($14 million).

*Additional funding for placing inmates in out-of-state facilities ($2 million).

With the recently revised revenue estimates from the Council, the ending balance in the General Fund for FY 2004 is projected to be $87.3 million.

For FY 2005, proposed adjustments to the operating budget result in a net increase of $86.8 million. The increase is due mostly to the needs in the areas of health ($52 million), human services ($32.6 million), and public safety ($9.2 million). The major expenses include:

*Additional costs for the Adult Mental Health programs ($18.5 million).

*Full-year funding for the HHSC, which was not funded in Act 200/03 ($31.2 million).

*Additional costs for the foster care program ($3.6 million).

*Additional costs for QUEST ($11.8 million).

*Additional costs of placing inmates at out-of-state and federal facilities ($7.2 million).

Debt service costs will be reduced by $26.9 million due to G.O. debt restructuring and lower interest rates. Savings are also anticipated from the Employers-Union Trust Fund (EUTF); we will be submitting a message to identify the amount once the FY 2005 rates have been adopted by the EUTF board.

With the revised revenue estimates from the Council, the General Fund ending balance in FY 2005 is projected to be $81.2 million.

For the current FB 2003-05, management efforts to control expenditures for economy and efficiency will continue, and the hiring freeze remains in effect. We expect that total lapses will occur at the average level of $55 million a year.

On the revenue side, legislative proposals amending Hawaii tax laws will be submitted by the Administration for your consideration in this session. Some of these are expected to have an impact on general fund tax revenues. The tax initiatives will be introduced by Governor Lingle in her State of the State address.

To summarize, taking into account the additional requests contained in the Executive Supplemental Budget and the fiscal impact of legislative proposals to be submitted, the ending balance in the General Fund is projected to be $87.3 million in FY 2004 and $81.2 million in FY 2005, as indicated above.

For the out-years, from FY 2006 through FY 2009, the basic assumptions with respect to revenues and expenditures will continue. As projected by the Council, revenues are expected to grow in the moderate range between 5.3 percent to 6.8 percent, reflecting sustained improvements to the economy. Expenditures are expected to be held at a no-growth level, except for fixed costs and non-discretionary items. The General Fund Financial Plan shows a positive number for each of these years as well.

I should point out that these ending balances have been updated to reflect the December 2003 revised revenue estimates by the Council, which resulted in a net reduction of -$18.6 million for FY 2004 and increases in non-tax revenues averaging $6 million annually for the out years, as compared to the Councils September 2003 forecast. (Increases in non-tax revenues are mainly from ambulance fees, traffic fines, and other Judiciary Branch revenues.)

At this time, collective bargaining costs, if any, have not yet been determined for those units that are still in negotiation or have not gone through formal arbitration. Therefore, no collective bargaining costs have been included in the Supplemental Budget for those units, except for estimated costs from arbitration for Bargaining Unit 10 (Institutional, Health, and Correctional Workers).

”G.O./G.O.R. BOND CIP PROGRAM”

With respect to capital improvement projects (CIP) to be funded with G.O. or G.O. Reimbursable bonds, a reduction of $6 million is recommended for FY 2004.

For FY 2005, adjustments to the CIP budget result in an increase of $258.6 million. The major projects include:

*$90 million for major repairs and maintenance of public schools.

*$20 million for new Department of Education facilities.

*$25 million for major repairs and maintenance in the University of Hawaii system.

*$38.4 million for improvements in State parks and small boat harbors.

*$18.2 million for improvements to the Waimanalo Wastewater Treatment Plant.

*$27.6 million for improvements and replacements of correctional facilities.

We are proposing a list of projects for which current authorizations should be lapsed to better reflect the current CIP plan in the budget bill.

The state sold $437 million of G.O. bonds in August 2003 at a true interest cost of 4.43 percent, one of the lowest borrowing rates in the past ten years. A portion of the sale will refund outstanding bonds with higher interest rates. The proposed G.O. bond issuance plan calls for sales of $475 million in FY 2005.

Debt service from G.O. bonds amounts to $348.7 million in FY 2005, or 8.9 percent of the general fund operating budget. This ratio has been averaging at about 12 percent for the past 10 years.

We would like to note that the States prudent approach in managing its budget in challenging and uncertain times has been favorably recognized by credit rating agencies. Presently, Hawaii maintains a Aa3 rating by Moodys and AA- by both Standard & Poors and Fitch, with a stable outlook.

”THE GENERAL FUND EXPENDITURE CEILING”

By law, general fund appropriations must comply with the expenditure ceiling requirements that are set forth in Section 9, Article VII of the Hawaii State Constitution and Section 37-92 of the Hawaii Revised Statutes.

At the aggregate level that includes all branches of government, total proposed appropriations from the General Fund for the Executive Branch, the Judiciary, the Legislature, and the Office of Hawaiian Affairs amount to $3,884.5 million in FY 2004 and $4,078.9 million in FY 2005. These amounts are within the expenditure ceilings for both FY 2004 ($4,680.4 million) and FY 2005 ($4,898.6 million).

For the Executive Branch, total proposed appropriations from the General Fund (which include the Executive Supplemental Budget for FB 2003-05 and other specific appropriation measures to be submitted) amount to $3,762 million in FY 2004 and $3,972.7 million in FY 2005.

These amounts are within the appropriation ceiling in FY 2004 ($3,978.1 million) but will exceed the appropriation ceiling in FY 2005 ($3,937.3 million) by $35.3 million (or 0.9 percent). The reasons for this excess are due to the substantial requirements in a number of health and human services programs that did not receive sufficient funding in Act 200/03, such as HHSC ($31.2 million), the Adult Mental Health programs (an additional $18.5 million), and QUEST (an additional $11.8 million).

”THE DEBT LIMIT”

Section 13, Article VII of the Hawaii State Constitution places a debt limit on G.O. bonds that may be issued by the State. The limit requires total debt service (principal and interest payments) not to exceed 18.5 percent of average general fund revenues.

It has been determined that the total amount of principal and interest calculated on a) all bonds issued and outstanding, b) all bonds authorized and unissued, and c) all bonds proposed in the Supplemental Budget, including State guaranties, will not cause the debt limit to be exceeded at the time of each bond issuance.

In closing, I want to thank you again for the opportunity to make this presentation. Should our financial outlook change during the course of the 2004 Session, we hope you will work with us to make appropriate adjustments.

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