Number of Special Funds Should be Curtailed

by Lowell L. Kalapa, Tax Foundation of Hawaii

Recently the Chair of the House Finance Committee announced that she will be reviewing 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 toward the end of the 1980’s when the state general fund waxed with huge surpluses as a result of the economic bubble of Japanese investments and the adoption of the transient accommodations tax, or TAT, and only 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 a literal embarrassment as political commentators and radio disc jockeys called for a $400 refund per taxpayer.

But not wanting to give that money back - after all, raising taxes is a hard thing to do - lawmakers turned to the unimaginable tool of creating special funds. One of the first special funds was created by earmarking $90 million of general excise taxes to be deposited in the educational facilities special fund every year for the purpose of catching up on the backlog of school repairs. How could one argue against such a game plan, for taxpayers, lawmakers and educators had known and complained for years about the disrepair of Hawaii’s schools.

The problem with this action was it took $90 million of general excise tax revenues that had previously gone into the general fund and put those dollars into a special fund. Had those dollars gone onto the general fund, any expenditure of those dollars would have been counted against the constitutional limit on general fund expenditures. That spending limit was enacted to monitor how fast state spending is growing relative to the growth in the state’s economy which is called upon to support that level of spending. If state spending grows faster than the growth in the economy, then the burden of taxes taken grows heavier on that economy, potentially stifling its growth. By diverting the tax revenues into a special fund, the expenditures of those dollars are not measured against the spending limit.

The other downside of earmarking revenues into a special fund to be expended only for a specified activity is that it tends to create apathy on how those funds are being expended as the money can’t be used for anything else but that activity or program. Once the funds are designated, they are pretty much off the table as far as being used for other purposes. That program no longer has to compete with other state programs and services even if those other programs and services may be of a higher priority or importance on a contemporary basis. Once out of sight, the special fund escapes the attention of lawmakers.

For example, 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 that the department could barely process half of the annual amount or $45 million a year. Even when the source of funding was switched to bonds or borrowed moneys when the state hit the financial crisis of the 1990’s, it meant that 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 last 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. These are other than the three special funds established long before statehood for the transportation programs of the state. For example, 11.7% of the 1995-1997 biennial budget appropriated by the legislature was financed from special funds other than the transportation special funds. That portion grew to more than 17.5% as of the 2013-2015 biennial budget.

As a result, when programs are moved to special fund financing, they free-up more general funds that allow 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, taxpayers - as well as lawmakers - have no clue as to the true size of government.

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