Restructuring Done Right: Separate and Diffuse Power, Concentrate Accountability

This piece was originally published in June of 2011, when the Senate was considering major restructuring legislation. That legislation has just come before the Senate again. Download the .pdf of our fact sheet here.

The Senate is currently considering legislation (H 3066) that would  eliminate the Budget & Control Board (BCB), devolving the BCB’s  responsibilities to a cabinet-level Department of Administration and a  newly created entity called the State Financial Affairs Authority  (SFAA). The Budget & Control Board would also continue to manage the  state retirement system until July 1, 2013, at which time the BCB would  be abolished and the retirement system would come under the purview of a  new agency, the Public Employee Benefit Agency.

Background

The House passed the Department of Administration bill (H 3066) in March, but the current bill is very different. As originally passed, H 3066 would have created a Department of Administration that would handle some of the functions currently delegated to the BCB. The bill would not have eliminated the BCB and would not have brought about any substantial cost-savings. It also would have allowed the BCB to retain those functions – for instance, retirement system management, bill analysis, and budget oversight – at the core of the BCB’s power, making the BCB what is arguably a fourth, hybrid branch of government.

On June 2, 2011, the Senate passed an amendment to H 3066 that would eliminate the BCB altogether. The amended version of H 3066 would do the following:

• Create a Department of Administration that would take over many of the day-to-day agency management activities previously housed at the BCB. These include the Division of General Services; the Division of State Information Technology; and the Office of Human Resources.
• Create a State Financial Affairs Authority in charge of fiscal oversight (including making across-the-board budget cuts), procurement, bond approval and related services, and insurance services. The SFAA would comprise the governor, state treasurer, comptroller general, one senator elected by the full Senate, and one House member elected by the full House.
• Create a Legislative Fiscal Office that would write fiscal impact statements and assist the General Assembly in writing the budget.
• Create a Public Employee Benefit Agency, delegating the details of what this agency might look like to a transition committee appointed by the BCB.

All in all, the amended version of H 3066 is an improvement over the current system, if only because the bill removes the Senate Finance Committee chairman and the House Ways & Means Committee chair from their ex officio posts on the BCB. As indicated above, legislative appointees to the new SFAA would be elected by a majority in each chamber. That said, the SFAA would essentially be a pared down version of the BCB, with a resulting loss in accountability and transparency.

The better option is to eliminate the BCB altogether in a manner that disperses power, but concentrates accountability. After all, that is the end goal of restructuring. With that aim in mind, we recommend the following reforms:

Abolish Both the Budget & Control Board and the State Financial Affairs Authority

Under the current version of H 3066, the BCB would be abolished as of July 1, 2013. But in its place will be a new agency, the SFAA, only marginally better than the last. As indicated above, the SFAA would be responsible for fiscal oversight (including making across-the-board budget cuts), procurement, bond issuance and related services, and insurance services. These activities, however, properly belong to either the legislative branch or the executive branch – not a hybrid agency, such as the BCB or the SFAA.

Take Responsibility for Enacting Targeted Budget Cuts

While the BCB exists to assist lawmakers in crafting the budget, the Board’s ability to make across-the-board budget cuts has served the practical function of enabling the Legislature to avoid making difficult budget decisions.  State law (§11-9-980 and §1-11-495) authorizes the BCB (and, second to the Board, the Director of the Office of State Budget) to make across-the-board budget cuts if revenue collections do not meet projections set by the BCB itself (specifically, the Board of Economic Advisors). Such cuts may be made by the BCB even when the General Assembly is in session. In addition, the BCB (by a vote of four members) may authorize agency deficit spending and may take money from surplus funds to make up the shortfall.

H 3066 continues this practice by giving the SFAA the same power to make across-the-board budget cuts and authorize agency deficits.

The BCB’s/SFAA’s power over the budget is highly unusual. In most states, either the legislature or the governor is responsible for making mid-year budget cuts. In 20 states, the legislature’s approval is required to cut the budget; in 10 others, the governor may reduce allocations, but not appropriations. A good rule of thumb here, as suggested by the S.C. Supreme Court decision Jackson v. Sanford (2011), is that governors may cut spending, but not in a manner that alters legislative intent.

Given that the Legislature is constitutionally obligated to make budget appropriations, the General Assembly should be solely responsible for making mid-year budget cuts and addressing agency deficits. At the same time, the executive branch should exercise oversight over agency spending. For these reasons, we recommend the following reform:

No deficit spending may occur without specific authorization from the full Legislature. Upon a finding that an agency expects to run a budget deficit, the governor must certify the existence of this deficit and request that the General Assembly address this deficit. If the General Assembly is not already in session, the governor must call the Legislature into special session, per Article IV, §19 of the state constitution, so as to address this shortfall. In turn, deficit spending by any agency must be authorized by the General Assembly as standalone legislation. Similarly, in the event of an overall budget shortfall, the General Assembly must be called into session to address the shortfall.

In other words, because the state constitution (Article X, §7) requires a balanced budget, state leaders should treat an unbalanced budget as an “extraordinary occasion” requiring the General Assembly to meet in special session.

Requiring a special session to authorize deficit spending/cut the budget is a solution that respects the division of powers between the executive branch and the legislative branch, upholding in particular, the Legislature’s authority over budget appropriations. It is also a reform that would bring greater accountability to lawmakers and promote debate over making targeted, more efficient cuts, as opposed to across-the-board cuts.

Revitalize the Legislative Audit Council (LAC)

Instead of creating a separate Legislative Fiscal Office, we recommend policymakers expand the Legislative Audit Council’s responsibilities to include writing fiscal impact statements.  Such statements generally provide a static analysis of how certain legislation will affect state revenue.

In addition, the LAC should be empowered to conduct audits of every state agency, perhaps on a staggered five-year schedule. Currently, the LAC is limited to conducting performance audits, program evaluations, and policy studies. But a review of best practices by the National Conference of State Legislatures suggests the LAC should also be performing sunset reviews, providing financial analysis of the state budget, and producing best practices advisories to state agencies. As recommended below, the LAC should also be required to annually audit the state retirement system. Most important, the LAC must continue to maintain its independence, functioning as a nonpartisan, objective source of analysis for lawmakers and the public.

Require the Office of State Budget to Write Dynamic Impact Statements

H 3066 would move the Office of State Budget (OSB) under the Department of Administration. According to its website:

The Office of State Budget is responsible for the development and oversight of the process for preparing the annual state budget. This includes requests for funds, allocations of funds, and the responsible utilization of funds to achieve the needs of state  government. The Office provides data to the Governor’s Office for its use in making annual budget recommendations to the General Assembly and works closely with the legislature throughout the budgetary cycle.

The OSB is also responsible for writing fiscal impact statements (along with the BEA). H 3066 would strip this power from the OSB and transfer it to a Legislative Fiscal Office. A better option, as mentioned above, is to empower the LAC to write fiscal notes. Similarly, the OSB should retain its current ability to write fiscal impact statements.

What would make the most sense is to develop a complementary approach to bill analysis requiring distinct methodologies. Under this reform, the LAC would continue to write fiscal notes that show the impact of various bills on state revenue. (Currently, the BEA is responsible for doing this, per §2-7-71.) By contrast, the OSB should approach the writing of fiscal impact statements from an opposite perspective – that is, from the perspective of the taxpayer.

Such an approach, otherwise known as dynamic impact analysis, would show how government activity – i.e., taxes and regulations – influences individual behavior and the economy. In particular, dynamic impact statements predict how government policies, such as tax increases or cuts, affect job creation, personal income, and state gross domestic product.

While a handful of states are using dynamic impact analysis approaches, Texas probably has the best model. In Texas, a dynamic impact analysis must be conducted on every bill that would raise or lower taxes or fees by at least $75 million. The analysis must project out to five years the bill’s impact on the following areas:

• Tax and fee revenue;
• Program costs;
• “The effects on incentives to work, save, invest, and conduct economic affairs”;
• “The resulting change in the overall level of economic activity.”

In addition, the law requires that dynamic impact statements be audited after five years. Conducted by the Texas comptroller, the audit must assess “the accuracy of the relevant fiscal note prepared for the bill and the accuracy of the relevant dynamic fiscal impact statement prepared for the bill.” Such audits are carried out on every impact statement for a bill or joint resolution passed into law.

Along these same lines, the OSB should be tasked with writing dynamic impact analyses on important bills and joint resolutions. Such statements would show the overall effect of state policies on job creation, personal income, and state gross domestic product.

Write a Robust Executive Budget

The Office of State Budget is also responsible for helping write the budget. H 3066 would essentially remove this power and transfer it to the Legislative Fiscal Office. Similarly, the Office of Research and Statistics, except for the employees required to  support the governor’s executive budget writing duties, would be transferred to the Legislative Fiscal Office.

A better option would be to empower the Office of State Budget to assist the governor in preparing a robust executive budget. State law requires the governor to write and submit a state budget to the presiding officer of each legislative chamber. The law reads as follows:

Within five days after the beginning of each regular session of the General Assembly the [governor]  shall submit to the presiding officer of each house printed copies of a budget, based on its own conclusions and judgments, containing a complete and itemized plan of all proposed expenditures for each state department, bureau, division, officer, board, commission, institution, or other agency or undertaking, classified by functions, character, and object, and of estimated revenues and borrowings for each year, beginning with the first day of the next fiscal year. Opposite each item of the proposed expenditures the budget must show in separate parallel columns the amount appropriated for the last preceding appropriation year, for the current appropriation year and the increase or decrease (§11-11-70).

In most states, the governor is primarily responsible for writing the state budget. In neighboring North Carolina, for instance, the governor is officially recognized as the “director of the budget” and is constitutionally obligated to prepare, recommend and administer the budget (cf. Article III, § 5). As cited above, South Carolina law likewise requires the governor to prepare a comprehensive budget. Given this responsibility, the governor should work with agencies in a proactive manner to set spending priorities, with the Legislature retaining its duty to actually appropriate funding for these priorities.

Moreover, expanding the governor’s budget writing responsibilities would complement recent legislation requiring state agencies to provide the governor with “detailed statements of the sources of all federal and other funds contained in their budgets,” including programmatic and financial information for all federal funds (cf. S 312). The legislation also requires the governor to specifically review and request all federal funding.

In addition to improving transparency regarding federal funding, the governor should prepare a budget using multiple budgeting formats – for instance, using detailed program descriptions and supporting justification for budget increases and cuts.  In short, the governor’s executive budget should be a model of transparency that prompts the General Assembly to actively debate state spending priorities.

Reform the State Retirement System and Limit the Influence of Lobbyists

Most major public education retirement plans, according to a 2010 study by the National Education Association, are administered by boards of trustees with fiduciary duties. In many states, active/retired participants make up about half of trustee board appointments. Many boards also include gubernatorial appointees. South Carolina’s BCB is the only retirement board among these plans in which every member serves ex officio. The result is a lack of accountability regarding a state pension plan carrying a $12 billion unfunded liability.

Improving upon the current system, H 3066 would transfer control over the state’s pension plan to a Public Employee Benefit Agency. A transitional committee, that would likely include several lobbyists, would then advise the Legislature on what the structure and governance of this new agency would be.

In theory, creating a commission “to conduct a comprehensive survey of the structure, trustee governance, and operations of other [retirement] systems throughout the United States and make recommendations to the General Assembly concerning the legislative actions that are needed to implement” an efficient and effective retirement system is a good idea. Likewise, it is a good idea to invite vested participants in the plan to serve on this committee.

A few caveats, though:

• The General Assembly needs to clarify whether this new agency would be controlled by the executive branch (good idea) or the legislative branch (bad idea). In turn, H 3066 should clarify that the transitional committee is essentially a study committee and will in no way determine the governance of the Public Employee Benefit Agency.
• In particular, the General Assembly should clarify that authorizing language that would create a Public Employee Benefit Agency must be passed as standalone legislation by the General Assembly, following the transitional committee’s report.
• Even more important, lobbyists and any individuals employed by entities that otherwise employ lobbyists, should be prohibited from serving on this transitional committee. We might also suggest that a private sector actuary, an economist, and a certified financial planner serve on the committee. Under the amended bill, it is  likely lobbyists and vested bureaucrats will dominate the committee, as well as any future retirement board of trustees. A better option is to have experts in retirement planning and economics develop a commonsense, innovative approach to restructuring the state’s ailing retirement system.

As far as the governance of the Public Employee Benefit Agency goes, we recommend the creation of a cabinet-level agency, the director of which would be appointed by the governor, with the consent of the Senate. In addition, a seven-member advisory board should assist the director in his work. The members of this board could include two ex officio representatives and five gubernatorial appointees: the state treasurer, the comptroller general, a private sector actuary, a certified financial planner that specializes in retirement planning, and three active/retired participants in the retirement plan. (Again, excluding lobbyists.) Likewise, the Legislative Audit Council should be required to conduct an annual audit of the state retirement plan. This audit should be complemented by an outside audit by a private sector firm.

Make the Legislature Accountable for Issuing Public Debt

As indicated above, the SFAA would be empowered to authorize and execute bond sales, as well as coordinate the state’s liability insurance coverage. As far as insurance goes, this activity should be transferred to the Department of Administration. The Department would already be tasked with administering the state’s Insurance Reserve Fund, so handling state liability coverage makes sense.

Bonds are a more complicated issue. All government bonds are a form of public debt. Essentially, two types of bonds exist: general obligation bonds and various types of revenue bonds. General obligation bonds are backed by the state constitution’s full faith and credit clause. Such bonds must be approved by the Legislature – a task the General Assembly delegates to its Joint Bond Review Committee (cf. §2-47-20). Other types of revenue bonds – for instance, county industrial revenue bonds (cf. §4-29-10) or higher-education bonds (cf. §59-147-10) – are not subject to direct legislative oversight. Instead, the Budget & Control Board must approve of these bonds.

H 3066 retains the BCB’s approval authority over various forms of bond notes, transferring this power to the State Financial Affairs Authority. In other words, a hybrid legislative-executive board will continue to hold power over much of the state’s debt. Yet, this arrangement has done little to reduce South Carolina’s debt burden.

According to the Mercatus Center, South Carolina government is carrying $40 billion in debt, including state, local, and school district debt, as well as unfunded liabilities on public employee pensions and post-retirement health benefits. State and local governmental outstanding debt accounts for 22 percent of gross state product – 4th worst in the nation. Clearly, more accountability is needed, especially as regards revenue bond debt not technically backed by the state’s full faith and credit clause (but for which taxpayers are indirectly obligated).

Toward this end, the Legislature should create a task force dedicated to studying how other states issue bonds and where approval authority for bond debt resides. Doing so would give lawmakers time to bring more transparency and accountability to the bond approval process instead of merely dumping these functions into the SFAA.

In the meantime, neither the BCB nor the SFAA should be in charge of approving bond debt. Until the task force reports its findings (for instance, before the start of the 2013 session), the Joint Bond Review Committee should take over whatever bond approval authority currently resides with the BCB.

In many states – neighboring North Carolina, for instance – general obligation bond debt must be approved by referendum. North Carolina likewise requires legislative authorization for all debt, including non-general obligation debt (i.e., issued as certificates of participation).

Similarly, the S.C. legislature should be required to authorize all debt. For instance, the General Assembly could exercise oversight over the Joint Bond Review Committee by passing an omnibus joint resolution containing all of the individual bond requests for each fiscal year. In addition, though, the Legislature should be required to pass as separate legislation (i.e., a joint resolution) all general obligation and revenue bond requests exceeding a cumulative $75 million for one project or recipient. This reform would prevent a repeat performance of the constitutionally questionable issuance of $270 million in bond debt on behalf of The Boeing Company. Originally, legislators authorized $170 million of state debt on behalf of Boeing, but the final total was pushed to $270 million after the Joint Bond Review Committee and the BCB tacked on another $100 million.

Increase Transparency for Procurement Activities

In the majority of states, including every state in the Southeast, procurement activities are housed in the executive branch.  Yet, H 3066 would allow the SFAA to continue to control procurement in a manner similar to the BCB. The better option, as delineated in the House version of H 3066, would be to transfer the Procurement Services Division of the BCB to the proposed Department of Administration. Similarly, all caps on property acquisition and transfers should be removed. Under the amended version of H 3066, the Department of Administration may only approve transactions that do not exceed $1 million.

Eliminate Redundant Agencies

Finally, instead of simply moving agencies from under the BCB to other departments, restructuring reform should seek to eliminate redundant agencies. For instance, the State Energy Office is being transferred from the BCB to the Office of Regulatory Staff. But why not eliminate this agency altogether?

Per state law (§48-52-410), the State Energy Office is South Carolina’s “principal energy planning entity” tasked with developing and implementing an “energy strategy” and “increasing the efficiency of use of all energy sources throughout South Carolina through the implementation of the Plan for State Energy Policy.”

But why does the state need an energy policy at all? Shouldn’t the free market, that is individual consumers and businesses, be trusted to make efficient and prudent energy use decisions? For instance, whether to expand the use of alternative energy sources? In essence, the State Energy Office’s vague, wide-ranging mission is an invitation for state bureaucrats to use taxpayer dollars and government regulations to impose their own energy preferences on the people of South Carolina.

For the most part, the activities conducted by the State Energy Office are far outside the scope of a limited and free government. Necessary programs, such as disposing of radioactive waste, should be moved to the Department of Health and Environmental Control. As much as possible, the Office’s remaining functions should be privatized or left to the free market. Similarly, the Legislature should use this opportunity to eliminate BCB agencies that do not provide core government services, rather than simply spinning these agencies off to other departments.

Conclusion

By all accounts, South Carolina is in desperate need of governmental restructuring. In particular, the state must modernize its administrative functions by eliminating the archaic Budget & Control Board. Replacing the BCB with a proxy State Financial Affairs Authority, however, is not the answer. The General Assembly needs to get restructuring right by implementing reforms that would actually improve state operations, increase budget transparency and accountability, eliminate redundant agencies, and reign in state debt.