OLS: Even After Midyear Cuts, Christie’s Still $526 Million Short

Mark J. Magyar | April 2, 2014 | Budget, Politics
Budget chairman questions retroactive pension cut, tobacco bond maneuver, and need to make cuts year after year

Credit: NJTV
State Treasurer Andrew Sidamon-Eristoff.
Another year, another $500 million difference of opinion between Gov. Chris Christie’s treasurer and the nonpartisan Office of Legislative Services.

For the fourth year in a row, David Rosen, the OLS budget and fiscal officer, warned yesterday that Treasurer Andrew Sidamon-Eristoff’s revenue projections for the current and upcoming fiscal years would come up at least $500 million short — $526 million this year, to be exact.

Rosen’s track record has been good so far: Over the past three years, the Christie administration’s revenue projections have come up more than $1.6 billion short overall, forcing a series of controversial midyear budget cuts topped off this year by a retroactive pension cut and a costly tobacco bond refinancing that Democrats criticized.

“All of the credit-rating agencies have downgraded our credit outlook to negative because this administration keeps proposing structurally imbalanced budgets based on overly optimistic revenue projections,” Senate Budget Committee Chairman Paul Sarlo (D-Bergen) complained. “We’re always behind, we’re always trying to balance the previous year’s budget, and that keeps forcing bad decisions.”

“If the governor was correct in his budget speech that our pension system is in terrible shape, then why did we cut $244 million in pension payments that would have reduced our unfunded liability?” he demanded. “And how does it make sense to do a tobacco bond refinancing grab that will save us $92 million now but cost us $400 million in the future?”

Sidamon-Eristoff defended both the decision to change the state’s pension formula and the refinancing of the tobacco bonds — which provided more than $185 million of the $697 million in budget cuts needed so far to plug a hole in the current Fiscal Year 2014 budget — as sound fiscal policy during a wide-ranging and often testy two-hour appearance before Sarlo’s committee.

He said he saw no reason to make further cuts in the Fiscal Year 2014 budget or to revise his February projection that state revenues would rise 5.8 percent to a record $34.447 billion in Fiscal Year 2015, despite Rosen’s less optimistic forecast.

Quoting Yogi

For Rosen, who testified before Sidamon-Eristoff, yesterday was, “in the words of New Jersey Hall of Fame member Yogi Berra, ‘déjà vu all over again,’” he said. For the third year in a row, Rosen noted, state revenues fell short of the Christie administration’s projections, and for the fourth year in a row, the OLS is projecting that revenues will come in lower than administration projections.

Rosen yesterday projected that FY14 revenues will come in $216.6 million lower than the Christie administration expects and the FY15 receipts will come up $309.4 million short for a combined budget shortfall of $526 million.

The difference in revenue projections, as Sen. Jennifer Beck (R-Monmouth) pointed out and Rosen acknowledged, is actually quite small — less than 1 percent on next year’s $34.447 billion budget.

The problem is that three years of unmet revenue forecasts and subsequent midyear budget gaps have forced the Christie administration to eat away at what was once a robust $800 million surplus, but is now down to just $300 million — a minimal reserve that has proven insufficient to cover midyear revenue shortfalls, as the three credit rating agencies have repeatedly warned.

New Jersey not only has one of the smallest state surpluses on a percentage basis, but also that surplus has to cover the fiscal vicissitudes of a tax system that is one of the most volatile in the nation. New Jersey has one of the most graduated state income taxes. The top 1 percent of filers pay almost half the state’s income tax, and as a result state income tax collections go up and down with the S&P 500 Stock Market Index.

Next year’s projected budget growth is driven by the expectations of both the Christie administration and the OLS that income taxes will grow more than 8 percent — although OLS’s income tax forecast is $113 million less. “Should the five-year-old bull market falter this year, these forecasts could prove overly optimistic,” the OLS warned, and the state’s skimpy surplus will provide little protection.

Sidamon-Eristoff argued yesterday that Treasury’s year-round monitoring of state spending enables the Christie administration to find savings in state programs as needed to fill midyear gaps, even with a small surplus.

But Sarlo countered that the Christie administration has plugged midyear budget holes through a series of questionable fiscal maneuvers, including the diversion of New Jersey Turnpike money to balance the budget instead of being used to provide pay-as-you-go funding for transportation construction projects, the delay of property tax rebate payments from one fiscal year to the next to provide a $390 million one-shot budget savings, and bond restructurings that will add to future debt-service costs.

Sarlo said he agreed with the assertion of Moody’s Investors Service that the tobacco bond restructuring and retroactive pension payment cut used by the Christie administration to help fill this year’s $800 million budget hole showed that the state had run out of easy solutions.

Tobacco Road

Yesterday’s Senate Budget Committee hearing provided the first real public explanation of what OLS diplomatically characterized as the “extraordinary action” by Sidamon-Eristoff that resulted in the state giving up $406.7 million in tobacco bond payments from FY2017 to FY2023 in exchange for a one-shot cash infusion of $91.6 million to help plug the hole in the FY14 budget.

“The history of the Tobacco Settlement Fund is that the McGreevey administration and the Corzine administration clearly mishandled it, and clearly now the current administration has mishandled it because it needed to plug budget holes in the current year,” Sarlo said angrily, criticizing both Christie and his Democratic predecessors.

“Giving up $400 million-plus a few years down the road makes no sense. This is almost a repeat performance of the mistakes made by previous administrations.”

New Jersey’s Tobacco Settlement Fund was set up as part of a master agreement with the major tobacco companies to compensate states for the increased healthcare costs caused by cigarette smoking in 1998. The fund was expected to provide New Jersey’s state government with $7.6 billion in payments at a rate of $200 million to $250 million a year in perpetuity, Rosen explained.


But Democratic Gov. Jim McGreevey, facing a major budget crisis in the regional recession that followed the attacks on the World Trade Center, decided in 2002 to “securitize” the tobacco money by setting up a Tobacco Settlement Financing Corp. The company then sold the future tobacco payments to private bondholders in order to create “the mother of all one-shots” — a $1.557 billion payment in FY2003 and a $1.611 billion infusion in FY2004 that McGreevey used to balance those budgets.

In 2007, when the Tobacco Settlement Financing Corp. decided to refinance $3.62 billion in bonds, Democratic Gov. Jon Corzine, whose treasury was swimming in revenue before the Great Recession hit, reacquired 23.74 percent of the bonds, which subsequently produced payments of about $55 million a year to the state treasury.

Part of the 2007 bond sale was a series of capital appreciation bonds (better known as zero-coupon bonds) that were sold at deep discounts with the promise that they would pay their bondholders $1.28 billion in June 2041. Capital appreciation bonds “are known as a distinctly horrible means of public finance,” Sidamon-Eristoff said.

Because of the decline in tobacco revenue caused by a drop in smoking, “it was clear that if we did nothing, the bonds would go into default by 2041,” Sidamon-Eristoff said. “The bonds were not obligations of the state, but it was clear the state would be at least connected to it. It was incumbent on us not to suffer future governors or legislatures to be elevated into default.”

The bondholders included major players like the OppenheimerFund Inc., Goldman Sachs, and Columbia Management Investment Fund, and when the bondholders and Barclays Bank approached Sidamon-Eristoff, who by statute served as head of the Tobacco Settlement Financing Corp., the treasurer was ready to act.

“An arrangement was done between the treasurer, the corporation headed by the treasurer, and the bondholders . . . of these zero-coupon bonds which had really fallen to junk bond status,” Rosen explained. According to the deal, the state shored up the fiscal health of the bonds by giving up $406.7 million it would have been owed between FY2017 and FY2023 in exchange for an upfront cash infusion of $91.6 million this year and the promise of additional payments after 2041.

Barclays made $4 million to $5 million for handling the deal, the price of the bonds tripled in four days in early March after the deal was announced, and the zero-coupon bond ratings jumped from C+ junk bond status to A- investment grade.

Sidamon-Eristoff got a $91.7 million plug for his current year budget deficit, although he did not mention the $406.7 million price tag in lost revenue from FY17 to FY23 in his explanation of the deal.

Rosen did. The bottom line, he said, is that “In FY14, we get $91 million. In FY17 to FY23 or FY24, we don’t get $406 million we would otherwise have received. We could conceivably get $1 billion or $2 billion in the 2040s,” but that is not guaranteed and those dollars will be worth less than dollars today.

Sidamon-Eristoff said the refinancing made it more likely that the state would get revenues that would otherwise be paid to bondholders from 2041 to 2049. “We have 91-and-a-half million in our pocket now and got further net present value savings coming to us. Fiscally and from a debt management point of view, this was a no-brainer. I feel very strongly given the current environment we should look for savings wherever we can,” Sidamon-Eristoff said, referring to the state’s current budget problems.

Left unsaid was New Jersey Policy Perspective budget analyst David Rousseau’s observation that while Barclays, the large institutional bondholders, and Sidamon-Eristoff were big winners in the deal, those responsible for balancing New Jersey’s state budgets from FY17 to FY24 will lose $56 million to $67 million a year in revenue.

The first two budgets will still be the job of the Christie administration, but the responsibility for the four to five budgets that follow will fall upon his successor.