Program Review and Investigations Committee




<MeetMDY1> November 4, 2010


Call to Order and Roll Call

The<MeetNo2> Program Review and Investigations Committee met on<Day> Thursday,<MeetMDY2> November 4, 2010, at<MeetTime> 10:00 AM, in<Room> Room 131 of the Capitol Annex. Representative Kelly Flood, Chair, called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Senator John Schickel, Co-Chair; Representative Kelly Flood, Co-Chair; Senators Vernie McGaha, R.J. Palmer II, Dan "Malano" Seum, Brandon Smith, and Katie Kratz Stine; Representatives Dwight D. Butler, Terry Mills, and Arnold Simpson.


Guests: Andrew Hartley, Staff Attorney, Lynsey Womack, General Counsel, Department for Local Government; Hollie Spade, Executive Director, Office of Legal Services, Cabinet for Economic Development; Mike Burnside, Executive Director, Jennifer Jones, Legal Counsel, Kentucky Retirement Systems.


LRC Staff: Greg Hager, Committee Staff Administrator; Rick Graycarek, Christopher Hall, Colleen Kennedy, Van Knowles, Lora Littleton, Jean Ann Myatt, Sarah Spaulding, Cindy Upton, and Stella Mountain, Committee Assistant; Program Review and Investigations Committee Staff. Jon Roenker, Emily Spurlock, Mike Clark, LRC Staff Economists Office.


Staff Report: Transparency and Accountability of Quasi-governmental Entities

Cindy Upton said the objectives of the study were to identify the types and number of quasi-governmental entities, their organizational and fiscal characteristics, the services they provide, their employee benefit plans, their accountability mechanisms, and the transparency of their operations.


In the report, the term “transparency” means that information on an entity’s use of public funds is available to the General Assembly and the public. Examples are open records and open meetings requirements. “Accountability” means that an entity can justify its use of public funds in accordance with laws and regulations. Examples are preparation of audited financial statements and other reports required by the General Assembly.


The term “quasi-governmental entity” is not defined in statute. The report uses a definition from the Congressional Research Service, which defines quasi-governmental entities as entities that are created by governments to serve public interests but that maintain a legally separate status. Board members often are appointed by government officials, and government officials may serve on a governing board.


Among the reasons that governments may create separate organizations are because the demand for services exceeds the ability to provide them within the traditional framework of government, to allow greater citizen input, to enable the governing board and management to focus on one specific function, or to overcome a government’s constitutional or statutory limitations on the issuance of debt.


The number and types of quasi-governmental entities in Kentucky are not known. There is no central information repository for reporting them. New entities often are created while existing entities with similar purposes are not dissolved. Some creations are not true “entities” because they consist of groups of people who make decisions on public issues but have no separate staff, office, or other costs.


Public corporations of the state are created in statute and are subject to open meetings and open records requirements. All but two are required to prepare annual financial statements and have them audited.


Recommendation 2.1 is that the General Assembly may wish to consider amending KRS Chapter 247 and KRS Chapter 251 to require the Kentucky Agricultural Finance Corporation and the Kentucky Grain Insurance Corporation to publish annual audited financial statements.


Ms. Upton said that Program Review staff grouped quasi-governmental entities of the state by their predominant function: state infrastructure, local infrastructure, economic development, education and training, agriculture, housing, arts, healthcare, general state financing, and fiduciary entities.


A way to evaluate transparency and accountability is to look at the entities that can issue bonded debt and whether the debt service is paid from appropriations. Not all quasi-governmental entities of the state can issue debt and the state has not issued general obligation bonds since 1965.


 At the local and regional levels, many quasi-governmental entities are allowed by statute to be created. They can be created under the Interlocal Cooperation Act, in which two or more local governments join together to provide services or facilities, or they may be created as special districts, such as water districts or local air boards. Other arrangements are not specified in statute; they often follow a public/private partnership approach to providing public services.


An interlocal cooperation agreement is allowed in statute and is required to include a description of any separate legal entity that will be created by the partnership. The Department for Local Government approves agreements between cities and counties and keeps a list. The Office of the Attorney General approves all others and maintains individual files but does not compile them. On the list kept by the Department for Local Government, it is not clear how many agreements actually created separate entities, and most agreements are entered into for sharing revenues and providing services, such as drug task forces.


Recommendation 3.1 is that the Department for Local Government should consider creating a uniform record-keeping system for interlocal cooperation agreements. In addition to the information it currently tracks, the department should consider detailing in its records the nature of each agreement and whether a separate entity is created. The department may wish to communicate and share its record-keeping system with the Office of the Attorney General so that similar information may be compiled by and obtainable from each.


The Department for Local Government reports 1,149 individual districts in the state. KRS 65.065 details when audits are required of districts and how the audits should be conducted. Using the definition of “district” from KRS 65.060, it appears as though all but two, drainage taxing districts and nontaxing waste management districts, have audit requirements. KRS 65.067 discusses bonding requirements for officers, officials, and employees of special districts. The statute does not rely on the definition of “district” in KRS 65.060.


Recommendation 3.2 is that the General Assembly may wish to consider whether KRS 65.060 should be applicable to all districts.


Ms. Upton said quasi-governmental entities at the local level are mostly special districts. Program Review staff grouped them by their predominant function: infrastructure, transportation, economic development, public health and safety, land use and planning, and community and social services.


In response to a question from Representative Flood, Ms. Upton said that quasi-governmental entities were categorized in part based on which agencies were responsible for overseeing them.


Based on the 2008 Local Debt Report, infrastructure is the primary category, with the highest number of individual entities and amount of debt reported. More than 100 water districts reported debt. Transportation also is a large amount relative to the others, primarily due to the effect of airport entities. Some local governments have issued general obligation debt to support their quasi-governmental entities.


The state has a number of economic development programs that are specified in statute and operated through the Cabinet for Economic Development. The report describes the state’s incentive and loan programs, the entity that approves incentives or loans, and the maximum amount that can be approved. Program Review staff categorized them according to purpose as workforce training programs, energy and environmental programs, manufacturing and similar programs, business loan programs, and a personal and corporate investment fund program.


The three major approaches to economic development at the local level identified in the study are the public authority, the private foundation, and the public/private partnership. A public authority can be created as an industrial development authority under KRS 154.50, as a nonprofit entity under KRS Chapter 273, or by way of an interlocal cooperation agreement under KRS Chapter 65. As a public agency, it is subject to the state’s open meetings and open records laws. A private foundation can be formed as a nonprofit corporation under KRS Chapter 273. Its funding typically is provided by private individuals, businesses, and local industries. It is not subject to open records and open meetings laws. It has less oversight and more confidentiality. A public/private partnership uses a blended approach and is usually formed under KRS Chapter 273. Since it receives funding from both the public and private sectors, it also receives policy input from both sectors. The degree of involvement by one sector or another can determine whether it is subject to open records and open meetings laws.


Elected officials often are members of a local economic development entity, sometimes as voting members. Elected officials often appoint members to the governing board of the entity. A local government’s responsibility for debt of an economic development entity depends on how an interlocal corporation agreement, an entity’s bylaws, or a loan agreement is structured. There may not be a legal obligation for a local government to cover an unpaid debt of an industrial authority, but local officials may perceive a moral obligation to do so. Local government financial contributions to the entities vary. Some make regular appropriations; others do not contribute at all. State assistance also varies. Many economic development entities receive assistance, either directly or through their local governments. The sources include the Area Development Fund, coal severance taxes, line-item appropriations, assistance from the Kentucky Infrastructure Authority, and Community Development Block Grants.


Two associations of local government officials, the Kentucky Association of Counties and the Kentucky League of Cities, are viewed by some as being quasi-governmental entities. Senate Bill 88 of the 2010 regular session deemed them to be public entities. Both provide training, financial, and insurance services to their members. The State Auditor’s Office has examined their financial transactions, policies, and procedures and recommended a number of changes.


Participation in the retirement system for state employees is established in statute. A person’s access to the system depends on whether his or her employer participates in the system. A board member of a quasi-governmental entity who also is a state official participates in the retirement system by virtue of his or her state employment. Private-sector board members do not participate. Determining who is an “employee” can be difficult. Some quasi-governmental entities do not have their own employees. They use staff from state government agencies.


To determine an entity’s eligibility, the board reviews its articles of incorporation (for statutory authority), its bylaws, and its budget (to determine its funding source). The review is intended to determine if an entity is sufficiently governmental to participate. If so, the request is forwarded to the governor for the required executive order.


Participation in the retirement system for county employees also is established in statute. The county or school board must issue an order authorizing the entity’s participation. An executive order from the governor is not needed. Some entities enter as part of a city or county government; others enter separately. It can be difficult to ascertain whether a specific local quasi-governmental entity is participating because it may have entered the system as part of the local government. A board member who is also a local government official participates if his or her employer has joined the system. Employees of that entity also participate. Private-sector board members do not participate.


Participation in the state-administered health plan is established in statute. Anyone participating in one of the retirement systems is eligible to participate in the health plan. In addition to current employees, local or district retirees who are members of the County Employees Retirement System can join the health plan when retiring before age 65, even if they had private insurance before retirement.


Approve Minutes for October 14, 2010

Upon motion made by Senator Schickel and seconded by Representative Mills, the minutes of the October 14, 2010 meeting were approved by voice vote, without objection.


Representative Flood said that the first part of the next meeting would be devoted to choosing study topics for 2011. Members should submit topics to be received by November 15.


In response to a question from Senator Schickel about Recommendation 2.1, Ms. Upton said the lack of a statutory requirement for audits of all state corporations could have been an oversight.


In response to a question from Senator Schickel, Ms. Upton said that special districts are granted the authority to tax in statute but that she did not know the intent or history behind this authority.


In response to a question from Representative Simpson, Ms. Upton said that local governments can be held responsible for quasi-governmental entities’ debt in some instances.


Representative Simpson commented that too many entities are in the state retirement and healthcare systems.


In response to a question from Representative Simpson, Ms. Upton clarified that anyone in the state-administered retirement systems automatically qualifies for the state healthcare system too. Entities whose employees qualify for state retirement systems are described in statute but the governing board of the retirement systems must sometimes make the determination of whether an entity is sufficiently public to qualify. A recommendation goes to the governor, who issues an executive order.


In response to a question from Senator McGaha about debt of local quasi-governmental entities, Ms. Upton said that the reported debt of the Louisville Jefferson County Metropolitan Water and Sewer district was more than $2 billion.


In response to a question from Senator Schickel about the history of delegating authority to tax to special districts, Mr. Hartley said that authorization for taxing authority for special districts is spread piecemeal over many statutes. The state constitution authorizes taxing districts.


In response to a question from Representative Simpson about the Department for Local Government making recommendations to clarify the governing statutes, Mr. Hartley said that the department had commissioned a study of special districts years ago by the Northern Kentucky University law school on consolidation of statutes and clarification of what special districts are.


Representative Simpson commented that the committee should ask the Department for Local Government for recommendations.


Representative Flood said that the co-chairs could confer with Representative Simpson about this.


In response to a question from Representative Simpson, Ms. Jones said that entities meeting the definition of a public entity qualify for the retirement system.


In response to a question from Representative Simpson, Mr. Burnside said that a new employee represents a liability to the retirement system. Ideally, added employees would pay their way in the retirement system, but the full contributions from employers have not always been made and investments have not always met the actuarially determined goal.


In response to a question from Senator Schickel, Mr. Burnside said that the Kentucky Retirement Systems has not calculated how long it takes for the average employee to get benefits in excess of contributions but that he could look into this.


Staff Report: The Impact of Industrial Revenue Bonds on Property Taxes and School Funding

Jon Roenker and Emily Spurlock gave an overview of the report. Mr. Roenker said cities and counties may issue Industrial Revenue Bonds (IRBs) to purchase or construct industrial buildings for private entities. Ownership of the property may be transferred to the city or county for the duration of the bond. When transferred, the property may be subject to a reduced state property tax rate and may be exempt from local property taxes, which potentially reduces the tax base for the state and these districts. Under the state education funding formula, reduced assessments lead to an increase in state funding.


KRS 103.200 defines industrial buildings as land, buildings, real property, and personal property that is suitable for various types of activities. Included in the definition of industrial buildings are manufacturing facilities, transportation infrastructure, health care facilities, education facilities, recreation and cultural facilities, agricultural facilities, and incidental facilities for industrial sites. The statutory definition of an industrial building includes items that might not necessarily be commonly thought of as industrial buildings, such as water facilities, mineral resource processing facilities, convention and trade show facilities, hotels and motels, residential neighborhood preservation activities, historic buildings, and downtown business district redevelopment activities.


Kentucky statute provides authorization for Kentucky cities and counties to issue bonds for the financing of purchasing or constructing industrial buildings. If the city or county constructs or purchases the building, the property can be transferred to the city or county for the life of the bond. The property is then leased back to the private entity. These bonds are not considered a debt of the city or county that issues them.


An example of an IRB is a bond issued by Laurel County in 2008 for $16 million for purchase and refurbishment of a factory. A payment in lieu of taxes (PILOT) was made to East Bernstadt School District. The property was valued at $2.45 million in 2008 and at $16 million in 2010.


Two types of IRBs are tax-exempt and taxable. For tax-exempt IRBs, the interest income earned by the purchaser is not subject to federal income taxes, so purchaser of the bond is likely to accept a lower interest rate. In 1986, Congress placed a cap on the amount of tax-exempt bonds that can be issued each year. This cap is referred to as the Private Activity Bond Cap.


The Kentucky Private Activity Bond Allocation Committee (KyPABAC) is responsible for the distribution of Kentucky’s allocation of tax-exempt IRBs. At least 60 percent of the cap goes to state issuers in the first six months of the year, usually to the Kentucky Higher Education Student Loan Corporation to finance student loans and the Kentucky Housing Corporation to finance mortgage loans for low-income home buyers. During the last six months of the year, the remaining portion of the cap is allocated to local issuers.


There is no federal limit on the amount of taxable bonds that can be issued by local governments.


The IRB approval process at the local level includes having the local legislative body adopt an ordinance or resolution that details the project and the financing. At the state level, approval is not required for all IRBs. KRS 103.2101 assigns the primary responsibility for reviewing these projects to the State Local Debt Officer and the KyPABAC. The Kentucky Economic Development Finance Authority (KEDFA) is also involved in the approval and reporting process.


Transferred property has potential negative impact on revenues of local governments and school districts. Removal of the property from the tax rolls reduces the tax base for the local taxing districts. In some cases, a PILOT may be in place that would require the private entity to make a payment to the local taxing district that would experience reduced property tax revenue because of the property transfer. At the state level, the potential exists for a reduction in the state property tax rate.


Property tax rates and revenue can be affected by the transfer of property to a city or county during the IRB process. By statute, some types of IRBs must be reviewed by three state agencies: the State Local Debt Officer, KyPABAC, and KEDFA. If tax revenue is affected, agencies must document local support for reviewed IRBs.


Recommendation 1.1 is that if the General Assembly would like to better monitor the extent to which IRBs are issued to finance property that is transferred to a city or county, it should require the State Local Debt Officer and/or KyPABAC to review all projects that are financed in this manner.


House Bill 44, enacted in 1979, limits the state’s real property tax revenue growth to 4 percent per year on the value of real property existing in the prior year. HB 44 details the calculation of the compensating and 4-percent increase rates. The compensating rate is the rate that would allow a district to obtain approximately the same amount of revenue from real property that existed in the prior year. The 4-percent increase rate is the rate that generates 4 percent more revenue than the compensating rate.


At the local taxing district level, HB 44 sets a range of real property tax rates.  This range does not necessarily limit the tax rates that the local district can adopt, but does determine what actions the district must undertake in order for the rate to be adopted. Any rate above the 4-percent increase rate is subject to a public hearing and a recall vote. Any rate at or below the 4-percent increase rate and above the compensating rate is subject only to a public hearing. Any rate at or below the compensating rate is not subject to a public hearing or a recall vote.

            Staff selected IRBs issued in 2008 to examine the impact of transferred property on state and local tax rates. Six IRBs from 2008 involved property transferred to the local government, and thus could potentially have an impact on state and local real property tax rates and revenue. The total value of these six properties was approximately $108.1 million in 2010. Staff concluded that the value of the property transferred was not enough to affect the rate. Over the course of several years, there could be an impact. In any year, the value of property transferred could be sufficiently large to affect the rate.


IRB projects approved by KEDFA receive a reduction in the state property tax. There have been 26 KEDFA-approved projects since 2003. Of those 26 projects, 23 have received the reduced state rate on full value of property, and 21 of the 26 had 100 percent of local property taxes abated. Staff determined that more than $600 million would have to be removed from the base in order to affect the state real property tax rate by one-tenth of one cent. Staff concluded that the exclusion of a property from the tax base can cause the local taxing district to adopt higher rates before public hearing/recall than would have been adopted in the absence of the IRB.


The choices of local taxing districts determine if a higher rate is adopted. Higher selected tax rates offset lost revenue and the tax burden is shifted to the other properties on the tax roll. If the rate is not increased, the district may collect lower tax revenues than it would have collected in the absence of the property being transferred.


IRBs that are not seeking the reduced state property tax rate are not subject to the jurisdiction of KEDFA. These projects are reported to the State Local Debt Officer as part of the reporting requirements of KRS 147A.020. Documentation showing local support of the project is only required for projects that meet the definitions of KRS 103.200 (k) through (n).


In the case of local taxing districts, property that is transferred to the city or county and removed from the tax rolls causes the district’s total value of assessments to be lower than it would otherwise be. As a result, for real property taxes, the compensating rate and the 4-percent increase rate would be higher than they would be in the absence of the property transfer. With higher compensating and 4-percent increase rates, the range of real property tax rates a district may adopt shifts upward.


Ms. Spurlock summarized the effect of property transfers on school districts. She said lower property assessments affect the amount of education funding a district receives from the state through Support Education Excellence in Kentucky (SEEK) funding formula, as well as the tax rates that are certified to the school district. She referred to the property in Laurel County to show the effect of a property tax exemption on a school district. When property currently worth $16 million was transferred to the county, the East Bernstadt Independent school district received more SEEK funding from the state, had different certified tax rates, and received a payment in lieu of taxes.


A major conclusion of the report is that when property is transferred to a tax exempt entity and is no longer included in the property assessment, there is a lower amount of funding required from the school district under the SEEK formula, and the state will contribute more funding.


The school funding that is available to the local district comes mainly from state and local sources. Local revenue is raised through taxes, such as property taxes on real and personal property and motor vehicles, as well as permissive taxes, such as utility and occupational taxes.


Ms. Spurlock provided a general overview of SEEK, focusing on the areas that are impacted by property assessments. Each district’s SEEK calculation begins with the guaranteed per pupil funding that is set in the budget. Additional funding provided is based on the numbers of students meeting specified criteria and transportation costs in the district. This totals to the adjusted SEEK base. The district is then required to provide a minimum level of funding. After subtracting the district’s required local effort of 30 cents per $100 of assessments, the state pays the remainder of the adjusted base funding. The state may provide additional funding (Tier I). After other adjustments, the result is the final state SEEK funding. One goal of SEEK is to provide more state funding to less wealthy districts and less state funding to more wealthy districts. For SEEK purposes, wealth is defined by total property assessments. Property assessments are directly entered into the SEEK calculation: through the required 30 cent local effort and through Tier I.


Since the minimum local effort required by the district is based on property assessments, a decrease in the property assessment in a district decreases the amount of funding that district is required to provide. Since the state pays the portion of the adjusted SEEK base that is not paid by the district, a decline in funding required from the district requires a dollar-for-dollar increase in funding provided by the state.


Property assessments are one factor used to calculate Tier I funding received by the state. Tier I funding is the funding over the required minimum local effort and up to 15 percent of Adjusted Base funding. The state contributes Tier I funding in districts whose per pupil assessment is less than 150 percent of the estimated statewide average per pupil assessment. The state contributes more funding to districts whose total tax revenues are high enough to indicate sufficient revenue above the required minimum. The effect would vary between districts, but a decline in property assessments would mean a lower per pupil assessment, which could make a district more likely to qualify for Tier I funding.  For districts that do receive Tier I funding, a lower per pupil assessment increases the state’s share of Tier I funding.


In addition to SEEK, districts participate in Facilities Support Program of Kentucky, which provides capital project funding. The district is required to raise a minimum level of revenue: 5 cents per $100 of assessments. A decline in assessments leads to a decline in funding required from the district. Since the state pays the portion of FSPK that is not paid by the district, a decline in FSPK funding required by the district requires a dollar-for-dollar increase in funding provided by the state.


As a result of an IRB and transfer of property to the county, the assessment in East Bernstadt Independent is $16 million lower than it would have been without the transfer. In the 2009-10 and 2010-11 school years, the exemption of property and lower assessment caused state base funding to increase $48,000, state Tier I funding to increase approximately $17,000, and state FSPK funding to increase $8,000. As a result of the property being exempt, the state paid approximately $73,000 more to this district each year than it would have without the property transfer.


The second effect in school funding is on school district property tax rates. For school districts, the effect of excluding property from taxation will vary between districts. Like local districts, the lower assessment may allow the district to adopt a higher tax rate without a public hearing or possible recall. The lower assessment could lower the minimum tax rate the district must levy in order to receive maximum state funding.


 Four tax rates are certified to each school district. Two rates are the HB 44 compensating and 4 percent increase rates. The subsection one rate is the rate that produces no more revenue than what would have been produced by the highest rate certified to the district in the prior year. As assessments decline, these three rates will rise.


The HB 940 rate, which is also called the Tier I rate, is the rate that produces enough revenue to qualify the district for maximum Tier I funding from the state. This rate is based on all taxes that are levied in the district, and on the prior year’s collection rate. Because Tier I funding is based in part on the district’s assessment, this rate is based on a minimum level of revenue needed given that district’s level of assessment. Because this rate uses the assessment, prior year revenues, and the prior year collection rate to determine a needed level of revenue, the effect of a decline in assessments on the Tier I tax rate would vary by district.


 The levied equivalent rate is the total of all tax revenue from all sources, divided by total assessments.  In order for a district to receive the maximum amount of Tier I funding from the state, the district has to raise enough revenue relative to its total assessments so that its levied equivalent rate is high enough. If the assessment declines, the district would not need to raise as much revenue to achieve a certain levied equivalent rate. If the assessment increases, the district would need more revenue to achieve its needed levied equivalent rate and it would have a higher assessment from which to raise that additional revenue. Districts collect revenue through multiple taxes, such as real and personal property taxes, motor vehicle taxes, utility taxes, and occupational taxes. All of these revenue sources are counted toward total revenue. If a district’s assessments change, the impact on each district’s levied equivalent rate would vary because it would depend on what other taxes were levied by that district and its tax rates.  


In 2009, the East Bernstadt Independent school district adopted the compensating rate of 29.5 cents per $100 of assessments. If $16 million in assessments had not been exempt due to an industrial revenue bond, the compensating rate that would have been certified to the district would have been 27.4 cents. If the district had still taken the compensating rate in this instance, this lower rate would have generated about $36,000 in additional revenue, since the rate would have been applied to the additional $16 million.


In 2010, the district adopted the Tier I tax rate of 39.2 cents per $100. If property had not been exempt, and the assessment had been $16 million higher, the Tier I rate certified to the district would have been 41.5 cents per $100. Assuming the district still opted to levy the Tier I rate, adopting this higher rate would have generated about $75,000 more revenue because the rate would have been higher and an additional $16 million would have been taxable.


A PILOT is in effect with the East Bernstadt Independent school district. The business agreed to pay the property tax that would have been paid to the school district if the property had remained taxable, based on the value of the property and the current tax rate. In 2009, the PILOT payment was approximately $47,000. In 2010, it was almost $63,000. PILOT payments are not accounted for in SEEK or property tax calculations.


 As a result of the exemption of property, the district potentially lost some revenue. The district gained PILOT money from the private business and more state funding for both SEEK and FSPK. In total, the lower assessment resulted in the district having approximately $84,000 more funding available in 2009, and approximately $60,000 more available in 2010.


Ms. Spurlock noted that the example provided shows potential effects in one district, but the effect may be different in other districts. Generally, districts with lower property assessments collect less tax revenue and more state SEEK and FSPK funding. The total effect of a lower property assessment in a given district would depend on factors such as the tax rates adopted by the district, the amount of the property exemption and the total assessment in the district, and the number of students in the district.


In response to a question from Senator McGaha, Ms. Spurlock agreed that a district with tax exempt property could benefit from a higher compensating tax rate, more state SEEK funding, and a payment in lieu of taxes. Others contributing to SEEK would, in effect, be paying for this.


The meeting was adjourned at 11:40 a.m.