RICK PERRY'S BUDGET HUSTLE

How the Texas Governor Created His State's Budget Crisis

He Was Warned
"As of this moment, this legislation is a staggering $23 billion short of the funds needed to pay for the promised property tax cuts over the next five years. … These are conservative estimates."
—Texas Comptroller Carole Strayhorn, warning Gov. Rick Perry about his 2006 tax reform proposal

IN HIS STATE OF THE STATE SPEECH in February, Rick Perry described the $27 billion budget shortfall confronting the Texas Legislature.

"Now, the mainstream media and big government interest groups are doing their best to convince us that we're facing a budget Armageddon," Perry said. "Texans don't believe it and they shouldn't because it's not true."

The $27 billion equaled 15 percent of the $182 billion biennial budget the Legislature had passed two years earlier. If not Armageddon, an apocalyptic loss of revenue in a low-tax state that provides bare-bones public services.

Perry's statement was even more remarkable because most of the budget shortfall was a consequence of a business-tax bill he pushed through the Legislature in a special session five years earlier.

With Perry running for president on a record of fiscal responsibility (and job creation, discussed later in this article), it's important to understand the consequences of his 2006 "business margins tax" — and to ask if the governor knew that the tax reform he proposed would undermine the state's budgets in the years that followed.

First, some background. Texas is one of nine states with no income tax. It relies on property taxes to pay for public services — notably, to pay for public education, which consumes the lion's share of property taxes.

Because there is no income tax, property taxes are high. In 2006, Perry called a special session to address property taxes. With no income tax, there are no easy fixes. Yet Perry found one. A business-margins tax he said would provide enough revenue to allow for reductions in property taxes.

It was evident at the time that the new tax would not deliver what the governor promised. The state comptroller, Carole Strayhorn, had her staff run the numbers on Perry's tax-reform proposal.

"In 2007," she wrote in a letter to Perry, "your plan is $3.4 billion short; in 2009, it is $5.4 billion short; in 2010 it is $4.9 billion short, and in 2011 it is $5 billion short. These are conservative estimates."

The comptroller warned that "no economic miracle will close the gap your plan creates. Even if every dollar of the current [2006] $8.2 billion surplus was poured into the plan, it would not cover the plan's cost for more than two years, 2007 and 2008. The gap is going to continue to grow year by year." The shortfall the bill created could only be closed by tax increases, the comptroller warned, "or massive cuts in essential public services — like public education."

"It was not only Ms. Strayhorn's letter," Houston Democratic Rep. Scott Hochberg told me. "Every official document predicting the state's financial crisis at the time predicted exactly what happened."

Hochberg, the Legislature's resident authority on public-education finance, also warned Perry that the tax bill he was promoting would not produce the revenue he promised.

"I asked the governor about this in a small meeting amongst legislators," Hochberg said. "His answer to me, I remember it as clear as day, was 'Scott, use your common sense. Don't you know that when we cut property taxes we will see such an economic boom that you will never even notice the drop in revenue?'"

Perry's response to the Democratic legislator was candid — and newsworthy. Perry admitted that he knew that the tax reform he proposed would result in a "drop in revenue."
Perry was not alone in that knowledge.

Lieutenant Governor David Dewhurst told San Antonio Express-News re-porter Garry Scharrer this past January that he, too, knew the new tax wouldn't deliver what it promised:

"Dewhurst now says that he knew that revenue projections from the revised business franchise tax 'were inflated' and told Senate members in closed-door caucus meetings at the time that the business tax would not perform as advertised 'and that we were going to create a structural funding deficit in state government.' But Dewhurst said he also believed at the time that 'we would grow out of it by now.'"

A state senator told me last month that Republican leaders in the Senate knew the tax they were supporting wouldn't provide adequate revenue, and the "grow out of it" trope was their answer to questions from skeptics.

"They knew their projections were bullshit," the senator said. "When you questioned them about it, they'd say 'we'll grow out of it.'"

That's the story. The state's Republican governor and lieutenant governor knowingly created a budget crisis.

As the state's comptroller predicted, a surplus covered some of the 2007-2008 budget shortfall. In 2009, Perry used $17 billion of President Obama's federal stimulus money to fill the funding gap for the following two years, and to cover a shortfall in the previous fiscal year's budget. (Perry angrily refused $555 million in stimulus money designated for the extension of benefits to the unemployed, protesting that the federal dollars came with strings attached.)

When the Legislature convened in January 2011, the federal stimulus money was spent, and the budget shortfall about which the comptroller warned Perry five years earlier had arrived.

Public education took the biggest hit.

I asked Hochberg about the $4 billion cut from the state's public education budget.

He said the funding gap is larger: $4.3 billion on the basic "formulas," which have always been funded. And "a billion-plus" ($1.4 billion) in "categorical funding" to public schools — funds for teacher incentives, school facilities, pre-kindergarten grants.

Thus far, 12,000 teachers have been laid off. Add to that roughly 6,000 state employees cashiered because of budget cuts, a figure that doesn't include university professors and other university employees who will lose their jobs because of the $1.2 billion cut from higher ed funding.

Medicaid payments to doctors and hospitals were cut, and the final four months of Medicaid payments in fiscal year 2012 were not funded.

There was an alternative to the austerity budget the Texas Legislature passed in June. Democrats and some Republicans proposed tapping the state's Rainy Day Fund, funded by oil and gas taxes, to cover part of the shortfall.

Perry, however, declared the $9.5 billion fund off limits. He ultimately acquiesced to demands from moderate Republicans and agreed to use $3.2 billion to cover part of the current fiscal year's deficit. But nothing for the next biennium, when the state's public schools are short $5.7 billion.

"The governor doesn't do anything on his own," Hochberg observed. "The governor was only able to do that because he had a large number of House members, particularly newly elected Tea Party House members, who were willing to say 'I'm not going to vote against the governor.'

"But, clearly, he led the parade."

When the Legislature convenes in 2013, it will face a shortfall of $10 billion to $18 billion, plus the $4.8 billion in Medicaid expenses it failed to fund this year.

JOBS FOR SALE—By now we all know what Rick Perry is selling. He collaborates with the private sector to create jobs and to attract jobs from other states. The Texas Enterprise Fund and the Emerging Technologies Fund, his creations, have had unprecedented success.

It's not as simple as Perry would have you believe.

The two big economic development funds Perry controls operate on a trickle-up economic theory. The state takes money from taxpayers and gives it to corporations to entice them to create new jobs.

Yet corporations often fail to deliver, and the governor and his staff rewrite corporations' contracts to relax their job-creation requirements.

Grants are often made to companies that would move into the state or expand their workforce without a taxpayer-funded incentive.

The governor hands over millions of dollars to corporations whose executives have contributed hundreds of thousands of dollars to his campaigns.

And Rick Perry holds all the cards. The lieutenant governor and the speaker of the House have a vote on which corporations get public money. But as a state senator explained to me, neither of them has the staff to evaluate candidates for taxpayer funding.

The same senator also said he would like to know how many times the speaker and lieutenant governor have said 'no' to Perry. There is no public record. The governor proposes and the governor disposes, in closed meetings.

And these are scarce dollars. In a low-tax and low-services state, the zero-sum-game nature of the budgetary process is painfully evident. For example, the biggest pot of economic-development dollars, the Texas Enterprise Fund, was started in 2003 by drawing $285 million from the state's Rainy Day Fund. The same Rainy Day Fund the governor this year declared off limits for the public schools.

The Enterprise Fund also withdrew $161 million from the Unemployment Compensation Trust Fund in 2009, at a time when unemployment taxes paid by businesses tripled and only 34 percent of unemployed workers received benefits.

Add to that the total funds appropriated by the Legislature, and you get close to $500 million, all of which has or will be disbursed by the governor.

Perry has been in office for more than 10 years, which has allowed him to use his authority to make political appointments to expand the constitutionally limited powers of his office. He is, in other words, a very strong weak governor.

Every statewide elected office is held by a Republican. And the Republican Party holds a supermajority in both houses of the Legislature.

This political hegemony has created a climate that discourages oversight of the Republican governor.

PUBLIC INTEREST OVERSIGHT—In the absence of official oversight, a good-government group, Texans for Public Justice (TPJ), did its own audit of the economic development funds and found that in 2009 the number of corporate grant recipients not fulfilling their obligations had increased from 42 percent to 66 percent.

TPJ also found that when companies failed to meet their contractual obligations to provide jobs, the governor's office discreetly rewrote their contracts.

No state official, appointed or elected, it seemed, was working to ensure that the taxpayer was getting a reasonable return on the $368 billion the governor had handed out at the time TPJ's report was released.

Beyond the sloppy stewardship of taxpayer dollars, many of Perry's grants make little sense.

Consider $600,000 paid to the Cabela's sporting-goods chain for a commitment of 400 new jobs in two new superstores. And the promise of "new hotels, entertainment parks, restaurants and complementary retail stores … expected to total over $250 million and create an additional 2,000 Texas jobs," according to documents obtained by TPJ.

Cabela's is not Disney. It created 241 jobs, with average annual salaries of $23,000. The hotels, restaurants, and various retail outlets never materialized. The state recovered $177,288, or 44 percent of the grant.

"It's a slippery slope when you fund retail," said Don Baylor, a policy analyst at the non-profit Center for Public Policy Priorities. "Because retail always follows where rooftops are." In other words, where there are consumers, Cabela's and other retailers need no incentive.

Other grants were made to corporations expanding facilities they are unlikely to abandon.

Motiva Enterprises, for example, is a joint venture of Shell Oil and the Saudi-Arabian oil company Aramco. In 2006, Texas awarded Motiva $2 million on the promise of 300 jobs it would create through a $3.2 billion project to make its Port Arthur refinery the largest in the nation.

With a producing refinery on Port Arthur's Sabine-Neches Waterway, Motiva was unlikely to take its $3.2 billion expansion project to another state.

Nor was Motiva so illiquid that it could not have expanded its refinery without $2 million from the public treasury. In the quarter in which Motiva's $2 million check was cut, Shell reported $6.3 billion in earnings.

Taxpayers in Texas also wrote checks to mortgage bankers, while the bankers booked huge profits on the subprime home-loans that foundered the economy in 2007.

Countrywide Home Loans got $20 million in 2004, on a commitment of 7,500 jobs. It created 3,876. Then the bottom fell out of the housing market, Countrywide was charged with defrauding its clients, and was acquired by Bank of America. It has agreed to return 40 percent of its $20 million. By July 2011, the Countrywide loan portfolio, underwritten in part by Texas taxpayers, had cost Bank of America more than 50 percent of its share value.

Texas taxpayers also gave Washington Mutual $15 million in 2005, to open a new $50 million facility in San Antonio. At the time the deal was announced, WaMu had $300 billion in assets, $188 billion in deposits, and 43,000 employees. It was also in the process of dumping its 30-year-fixed-rate mortgage portfolio to clear the books for high-risk subprime loans.

"Those were really negative investments," Baylor said. "You financed toxic financial products that sucked equity and wealth out of hundreds of thousands of people, not only in Texas, but nationwide."

WaMu also consistently missed its job targets. TPJ found that the governor's office amended its contract, allowing aggregated part-time jobs to count as full-time jobs.

Other grants fail to pass the smell test.

Bill White, Perry's opponent in the 2010 general election, criticized an $8.5 million grant to Caterpillar Inc. to build an engine plant in Seguin. Perry's office responded that White was desperate because he was trailing in the polls.
Perhaps.

But Peter M. Holt owns the Caterpillar sales outlets in Texas and had donated $424,000 to Perry's campaigns. The decision to locate the plant in Texas, according to a company press release obtained by White, was made before Caterpillar's grant was awarded.

Sanderson Farms got $500,000 in exchange for a commitment to build a $7 million chicken hatchery and processing plant in Waco. Sanderson Farms CEO Joe Sanderson had contributed $165,000 to Perry's campaign.

Close ties between political donors and development grants are not isolated incidents. Texas Observer Editor Dave Mann found that executives and employees of 20 companies that received a combined $174.2 million had donated $2.2 million to Perry, and to the Republican Governors Association he chaired until he began his run for the presidency.

In the 2011 legislative session, Democratic Senator Kirk Watson and Republican Senator John Carona passed a bill that provides some transparency in the grant process. Control of the funds remains firmly in Perry's hands.

Don't look for the pace of the grants to slow. A week before Perry flew to South Carolina to announce that he's in the race, his office announced a $300,000 grant to Office Depot.

The company might need the help. Two days before winning the scratch-off lottery in Texas, Office Depot posted a quarterly loss of $29 million.

Correction: the original version of this article incorrectly stated the amount of stimulus money refused by Perry as $555 billion. It is $555 million.