The chairwoman of the House Finance Committee recently announced she will review the practice of setting up special funds for various state programs during the interim, a study that is long overdue.
The establishment of special funds began to proliferate in the late 1980s when the state general fund waxed with huge surpluses as a result of the economic bubble of Japanese investments, the adoption of the transient accommodations tax and a minor adjustment to income tax rates and brackets with the adoption of the base broadening provisions of the 1986 federal Tax Reform Act. By the end of fiscal year 1989, Hawaii’s state general fund posted a surplus of more than a half billion dollars. For state leaders, that surplus became an embarrassment as political commentators and radio disc jockeys called for a $400 refund per taxpayer.
Not wanting to give the money back, lawmakers turned to the tool of creating special funds. The educational facilities special fund was one of the first adopted, earmarking $90 million of annual general excise tax revenue for the purpose of catching up on the backlog of school repairs. How could one argue against such a plan? Taxpayers, lawmakers and educators had known and complained for years about the disrepair of Hawaii’s schools.
The problem with this action is it directed $90 million of general excise tax revenue away from the general fund and into the special fund. Had those dollars gone into the general fund, any spending would have been counted against the constitutional limit on general fund expenditures. That limit was enacted to monitor the state’s spending in relation to the state’s economic growth, which is called upon to support the level of spending. If state spending grows faster than the growth in the economy, then the burden of taxes taken grows heavier on the economy, potentially stifling its growth. By diverting tax revenues into special funds, the expenditures are not measured against the spending limit.
The other downside of earmarking revenues for a specified activity is it tends to create apathy on how those funds are spent since the money can’t be used for anything but that activity or program. Once the funds are designated, they are pretty much off the table to be used for other purposes. That program no longer has to compete with other state programs and services even if a higher priority or importance. Once out of sight, the special fund escapes the attention of lawmakers.
When the educational facilities special fund was created, lawmakers believed $90 million a year was what was needed to address the backlog of repairs. Several years into the program, when someone finally raised the question of just how much the Department of Education was spending from the special fund every year, it was discovered the department could barely process half of the annual amount, $45 million per year. When the source of funding was switched to bonds or borrowed money, during the financial crisis of the 1990s, it meant the educational facilities special fund got the first $90 million of proceeds every year, pushing other capital improvements to the back of the line.
Over the past 15 years, more and more of the state’s operating budget has been underwritten by special funds, many of which were created during that same time period. For example, 11.7 percent of the 1995-97 biennial budget appropriated by the Legislature was financed from special funds — not including three transportation special funds established long before statehood. That portion grew to more than 17.5 percent of the 2013-15 biennial budget.
Moving programs to special fund financing frees up general funds, allowing lawmakers to fund brand-new programs that probably would not have been funded in the past. Not only does this process obscure the growth and size of state government, but it also allows lawmakers to escape the governance of the constitutional general fund expenditure ceiling. As a result, neither taxpayers nor lawmakers have a clue as to the true size of government.
Lowell L. Kalapa is president of the Tax Foundation of Hawaii.