By Tim Carpenter
March 12, 2016

Gov. Sam Brownback met with House and Senate leaders one day after February tax revenue fell $53 million below expectations to discuss leveraging the state’s share of tobacco litigation settlement funds to supplement the beleaguered state treasury, sources said Saturday.

Administration officials ridiculed or dismissed initial reports Tuesday that the governor was involved in exploring the bonding of cash-flow assets, including tobacco receipts, with Brownback’s budget director making a reference to “black helicopter” theories and the governor’s spokeswoman deriding “rumors” of a deal.

Asked to respond to confirmation the governor raised the possibility in private with high-ranking Republican legislators, Brownback spokeswoman Eileen Hawley repeated no bonding agreement had been completed.

“The governor frequently seeks feedback from legislators on a wide range of topics, including options for addressing the budget,” Hawley said.

Several people at the March 2 meeting with Brownback said the governor introduced the bonding concept to the group of legislators and staff. The gathering came hours after the administration reported March 1 that last month’s tax revenue tumbled far below projections.

“It was along the lines of, ‘Here are different options,’ ” House budget chairman Ron Ryckman Jr., R-Olathe, said of the conversation with the governor. “I’m going to try to keep an open mind myself.”

Senate budget chairman Ty Masterson, R-Andover, also was at the meeting with Brownback, but said in an interview he was only privy to gossip about bonding tobacco proceeds. House Speaker Ray Merrick, R-Stilwell, and Senate President Susan Wagle, R-Wichita, were in attendance. Merrick wasn’t available; Wagle declined comment.

Unlike other states with budgetary difficulties, Kansas has never sold tobacco bonds. About 20 states have deployed some form of bonding of tobacco revenue. The most recent tobacco-backed issues involved refinancing — $1.7 billion by California and $621 million by Rhode Island — in March 2015.

Ryckman said reaction among legislators to selling rights to tobacco payments was “pretty negative,” but opinion might evolve with the state deficit hovering at $30 million and four months remaining in the fiscal year.

“What we’re not willing to look at today may be different later,” he said.

In last year’s legislative session, Republicans and Brownback closed a larger revenue shortfall with the largest tax increase in state history. The general sales tax went to 6.5 percent and the state’s cigarette tax surged. From June to December 2015, revenue didn’t match projections. More borrowing from the Kansas Department of Transportation was approved, along with other spending adjustments. When the Kansas Department of Revenue revealed the February shortfall on March 1, Brownback ordered a $17 million cut to higher education.

Freshly aware of a tax revenue problem driven by tax reform and economic malaise, Brownback met March 2 with the four GOP legislators at the Capitol. They convened at the long conference table in the governor’s office.

Brownback delved into the option of turning to tobacco-backed bonds. In general, Wall Street investors would buy the special bonds. Kansas’ treasury would get an immediate artificial revenue bump. New debt would be covered over the years by the state’s annual receipts from tobacco companies.

The transaction as outlined by administration officials could add as little as $200 million or as much as $600 million to the state’s bottom line. If Kansas lawmakers decided to take the lower figure, tobacco revenue relied upon to finance early childhood programs could be preserved. If the state maximized the influx of cash, there might be nothing left for early childhood programs.

Shannon Cotsoradis, president of Kansas Action for Children, which advocates on behalf of early childhood development programs funded with tobacco settlement money, was the first to question internal discussion in the Brownback administration about conversion of long-term revenue to quick cash. She raised the possibility of tobacco bonding during testimony to Masterson’s budget committee.

“This plan doesn’t just lack transparency. The things that have been said by the administration in the last few days have been blatantly deceptive,” Cotsoradis said upon learning of the governor’s March meeting. “Let’s remember we’re talking about the most vulnerable babies and toddlers in Kansas. Governor Brownback is pushing a plan that will bankrupt our state’s children to avoid admitting that his tax experiment has failed.”

In January, Brownback presented a budget to the 2016 Legislature designed to resolve a pending deficit. He also recommended placement of $50 million in tobacco settlement funds in the state general fund. His plan was to earmark $44 million in general tax dollars for children’s programs. That parallels a bill pending before the Senate committee led by Masterson.

Securitization arrangements with a prominent banking firm would require the Legislature’s approval, said Shawn Sullivan, the governor’s budget director.

Sullivan said Friday on KCUR public radio’s “Statehouse Blend” that bonding tied to tobacco payments remained a possibility if tax receipts left the state desperate for revenue. “I’m not going to deny it’s an option,” Sullivan said.

On Tuesday, Hawley had said there was “no deal or pending legislation to sell tobacco settlement money” despite rumors to the contrary. Sullivan took to Twitter on Tuesday to mock reporting of Cotsoradis’ disclosure of a possible tobacco bond deal raising $400 million. His post to social media: “Why are there black helicopters circling my office? Are they here to drop off this secret deal?”

Neither Hawley nor Sullivan mentioned at that time Brownback’s recent closed-door conversation on the topic with GOP legislative leaders.

Documents emerged Thursday showing officials with the Kansas Development Finance Authority, which handles state bond transactions, met in October with investment bankers at Citigroup Global Markets regarding securitization of the state’s payments from tobacco companies. Sullivan and Tim Shallenburger, KDFA’s executive director and Brownback’s legislative liaison, were at that meeting with Citigroup. The company has been involved in 59 tobacco bond transactions.

Last year, Kansas was a significant player in the bond market. State lawmakers and Brownback agreed to borrow $1 billion to bolster the Kansas Public Employee Retirement System. The state Department of Transportation unilaterally issued $400 million in bonds in December. The state also completed $300 million in bonding for the National Bio- and Agro-Defense Facility in Manhattan.

Sen. Jim Denning, R-Overland Park, said the state’s mounting debt and revenue problems reflected factors that ought to have been expected and others correctly described as unpredictable.

A 2012 tax reform bill signed by Brownback went beyond legislative intent and granted a state income tax exemption to owners of 330,000 businesses, Denning said. The law cut too deeply into the state’s revenue stream, he said. Weakness in aviation was known, but the depth of trouble in agriculture and the oil and gas sectors was a shock.

Brownback has vowed to veto any bill rolling back the business tax break, which he views as a cornerstone of a program to reshape the economy based on supply-side theory. However, Denning said the Legislature likely would oppose bonding of tobacco settlement receipts if proposed by the governor.

“There’s not enough will to get that done as long as he doesn’t fix the other issues,” Denning said. “The will is gone.”

Senate Minority Leader Anthony Hensley, D-Topeka, said comments by Brownback administration officials downplaying possible sale of the tobacco revenue reflected a pattern of deception. He said a Senate bill endorsed by Masterson would shift tobacco funding into the state general fund. That could be the first step of an effort to bond out long-range revenue streams, Hensley said.

“Sam Brownback is literally mortgaging Kansas’ future to Wall Street on his way out the door,” Hensley said. “He’s spending money we don’t even have yet and making sure that taxpayers and children will be cleaning up his mess long after he is gone.”

Under the 1998 national settlement agreement, tobacco companies ended litigation by agreeing to pay 46 states for health care costs related to smoking illnesses. Kansas has received $950 million under the agreement, including $62 million in 2015.

Citigroup and other firms have contracted with at least 20 states to sell tobacco bonds that provided cash for pensions, capital improvements and working capital. States have authorized sale of more than $62 billion in tobacco bonds, with most activity prior to 2007. A 2014 report by ProPublica said outcome of those deals ranged from clear success to spectacular failure, depending on financial structure.

ProPublica cast doubt on wisdom of states choosing tobacco-backed capital appreciation bonds, or CABs, that provide additional cash up front but include huge balloon payments down the road.

New Jersey had to rescue two CABs in 2014 that were part of a 2007 deal. The CABs were obligated to pay $1.3 billion far into the future, but the state instead decided to hand over $400 million of tobacco proceeds starting in 2017. Credit agencies responded by downgrading the state’s credit, making it costlier for New Jersey to borrow.

Read more from the Topeka Capital Journal.