Honorable Calvin K.Y. Say

Speaker, House of Representatives

Twenty-Second State Legislature

Regular Session of 2003

State of Hawaii

Sir:

Your Committee on Finance, to which was referred H.B. No. 200 entitled:

begs leave to report as follows:

The purpose of this bill is to appropriate funds for Executive branch operating and capital improvement costs for the fiscal biennium July 1, 2003, through June 30, 2005.

Your Committee on Finance reports that this bill stands as a clear reflection of its sincere commitment to work with the new administration. The adjustments to the administration’s budget proposal are minimal and your Committee has followed the administration’s overall direction.

It has been a difficult two months for your Committee. Your Committee heard many requests for expanded public services at its public hearings, yet the ability of the State to meet those needs with existing revenues is clearly insufficient. Clearly, additional resources are needed for:

• Our public schools and our students who deserve as many resources as we can provide;

• Our university system, if it is to achieve its goal of becoming a world-class institution;

• Our elderly, who have worked to make Hawaii what it is today, and who deserve necessary care; and

• Our rural communities, to provide necessary access to health care.

Funding is needed in all of these critical areas, but given the resources available, your Committee has little choice but to follow the Governor’s lead in imposing cuts to these vital programs. When the economic uncertainties of the near future are considered, there appear to be very few options available.

In January, the Department of Business, Economic Development, and Tourism reported that this past year was:

There were many reasons for an optimistic outlook. Civilian unemployment figures declined 6.7 percent over the first 11 months of 2001. During the same period the number of visitors from the mainland U.S. rebounded by 2.5 percent and year-to-date visitor days grew by 1.8 percent over the previous year. Inflation remained low, increasing by only 1.1 percent. Personal income projections for 2002 were a positive 2.5 percent. Construction activity in 2002 continued to increase, causing general excise tax revenues for contracting to grow 13.4 percent for the first ten months of 2002. Median prices of single-family homes and condominiums also increased significantly in 2002.

Despite these many positive indicators, other factors forecast the uncertain economic future that serves as the backdrop for your Committee’s work on this budget. Economic growth on the continental U.S. is soft and Japan has been unable to pull out of its prolonged recession. In addition, the possibility of a war with Iraq has already had an impact on our economy. As the potential for conflict with Iraq grew and Venezuelan oil supplies were disrupted, Hawaii experienced an increase in gas prices of 14 cents per gallon in the month of February. On the national level the cost of fuel rose 30 percent during the same period. These costs will be transferred to consumers through higher plane fares

and increased shipping and goods costs, which will ultimately result in a reduction in consumer spending and general fund revenues.

It is also expected that visitor arrivals from the Asia-Pacific region will drop in the coming months due to North Korea’s continued provocations that have created uncertainty in the region, and due to the belief of many Japanese that it is inappropriate to visit a country that is waging war. Reservations from international tourists, including Japan and European visitors, had fallen slightly through March in anticipation of a war with Iraq. Based on the recommendation of the House Select Committee on War Preparedness, a delegation of state government and business leaders is planning a trip to Japan within two to three weeks of a war with Iraq in an attempt to preserve Japanese tourism in Hawaii.

A similar delegation to Japan, lead by the former Governor after the September 11^th attacks, was helpful in bringing tourism back to pre-attack levels. The delegation met with government leaders, who in turn held press conferences assuring the Japanese that it would not be disrespectful to travel. Tourism levels rose to fifty percent of pre-9/11 rates within six months and to one hundred percent within a year.

It is clear that these negative factors will affect Hawaii's economy; an economy that is still recovering from the effects of the national recession that began in early 2001 and the devastating impact of the September 11^th terrorist attacks. The recent increase in the national threat level status has shown that peril still lingers over our nation. These factors have helped to create the high level of uncertainty that characterizes the current economic outlook of our State.

Hawaii's economy, however, could be in far worse shape. The fiscal discipline of previous State Legislatures has allowed Hawaii to report an optimistic economic outlook, and to be one of only two states in the nation to do so. Hawaii was recognized as the only state able to cut taxes by more than one percent last year, and is also on track to reduce general excise taxes on intermediary services (depyramiding) for the next four years. The negative economic situation that has affected all states nationally has been kept to a minimum in Hawaii as a result of prudent budgetary decisions made over the past decade.

Other states have not been so lucky. According to a report released by the National Conference of State Legislatures (NCSL), the aggregate gap between state budgets and state revenues grew by 50 percent in December and January. NCSL reported that by June 30th of this year, two-thirds of the states must reduce their budgets by nearly $26,000,000,000.

The news gets worse for state budget planners. In fiscal year 2004, state legislatures will face a minimum shortfall of $68,500,000,000. "The magnitude of next year's budget gap is startling," said NCSL President Angela Monson, a state senator from Oklahoma. "Thirty-three states estimate budget gaps in excess of five percent, with 18 of those facing gaps above ten percent. There is great cause for concern since the deficit numbers continue to grow at an alarming rate."

Sluggish revenues are a major contributor to these budget shortfalls. At least 30 states reported that revenue collections are below budget forecasts, with 12 states reporting collections below revised estimates. Thirty-seven states report that spending is exceeding budgeted levels, and all but five report escalating Medicaid and other health care costs.

State budgets are under siege. The faltering national economy, declines in the stock market, contractions in manufacturing and high-tech sectors, and soaring health care costs have combined to undermine the stability of state budgets. According to NCSL, states used rainy day funds, delayed or repealed scheduled tax cuts, tapped other state funds, delayed capital projects, and cut spending to balance their budgets. Twenty-nine states imposed across-the-board budget cuts. In the current legislative sessions, at least 24 states report that the Governor has offered tax increase proposals to help eliminate budget deficits. At least 14 states will consider raising cigarette taxes while another six will look to increase alcohol taxes.

New and continuing unfunded federal mandates are compounding these problems. State budget decision makers, including your Committee, are concerned that the proposed federal budget for next year does not meet the projected cost of the No Child Left Behind Act and special education mandates.

On September 9, 2002, Hawaii's Council on Revenues projected that the growth rate for fiscal year 2002-2003 would be 6.1 percent. The Council noted that "the recovery of the overall economy appears to be faster than expected" and that "Hawaii total personal income numbers, adjusted for inflation, remained at the average level of 2 percent growth rate through both the U.S. slowdown and the 9/11 event."

The Council's January 8, 2003, quarterly revenue estimate retained the 6.1 percent growth rate estimate. This was done despite a negative 0.4 percent state general tax revenue cumulative growth rate for the first five months of the fiscal year. The Council stated that their estimate was based on a Tax Department assessment that the December growth rate would be robust, an assessment that proved correct when December collections showed an increase of 34.7 percent from the previous year, boosting general tax collections for the first six months of the fiscal year 2002-2003, to 4.5 percent.

Unfortunately, the economic outlook has changed in the second half of fiscal year 2002-2003 as global events have affected revenue collections. Tax revenues fell 9.6 percent in January 2003 compared to the previous year, leaving the State with a 1.9 percent increase in revenue over the previous fiscal year, far short of the Council’s 6.1 percent projection.

In September 2002, the prior administration sent instructions to all the state directors for the preparation of department Fiscal Biennium 2003-2005 requests. These instructions wisely acknowledged that planning efforts must be "prudent yet relevant and accurate but flexible." In September, the administration had the foresight to acknowledge that program funding would be affected by:

• The uncertain state of our economy;

• Increasing costs of the government’s legal and social obligations;

• Public pressure to identify and remedy areas of government duplication and inefficiency; and

• In this transition year, the need to accommodate different priorities.

Even with the best efforts of the executive branch to prepare a responsible balanced budget, your Committee faced a rather abnormal budget process this session. On December 16^th, the Governor submitted the administration’s budget request, and it indicated that changes would be made. The Governor gave notice that using funds from the Hawaii Hurricane Relief Fund would not be an option, and as a result, many changes to the expenditure plan would be needed. Through discussions with the Governor’s Office, your Committee anticipated a balanced financial plan on January 14^th, nearly a month after the initial statutory deadline. In the spirit of cooperation and with an understanding that this is a new administration, your Committee was willing to give the new administration additional time.

On January 14^th, the administration presented your Committee a conceptual financial plan without an accompanying detailed expenditure plan. While the plan appeared to be balanced, your Committee noted that "the devil is in the details" and there was ample opportunity for missteps and miscues when formulating a budget. Once again, your Committee awaited indications from the Governor as to the direction the administration was heading.

The administration provided details of their revised expenditure plan in the form of seven Governor’s Messages from January 30^th to February 13^th, a span of roughly two weeks, which revised the administration's financial plan along the way. Needless to say, there were significant changes in the Governor’s budget as a result of these seven Governor’s Messages, and your Committee on Finance worked diligently on both Governor’s Message items as well as items from the original December budget transmittal.

This brings us to today. Your Committee has spent the past month analyzing the Governor’s new proposed budget and its impacts. Due to the time limitations of the 60 working days of the legislative timetable, your Committee expresses regret in not

being able to hold another round of budget briefings to fully hear the impacts of the Governor’s reductions, and to allow the real scrutiny that a public forum provides. Other issues, including both administration-sponsored and member-introduced bills required the attention and scrutiny of your Committee as well. Therefore your Committee could not, in good conscience, focus all of its attention on the budget and the impact of the Governor’s cuts despite its willingness to do so.

After nearly a decade of facing tremendous economic challenges, struggling with hard decisions, and making a concerted effort to alter attitudes and restructure our government institutions, your Committee continues its work to ensure that the State has a balanced budget. Today the State of Hawaii again finds itself challenged by demands for public services, an uncertain revenue forecast, and the continued threat of additional fallout from geopolitical events in the world.

Your Committee has tried to find other sources of revenue and expenditure reductions in hopes of minimizing the impact of the Governor’s proposed cuts. Your Committee, through its hard work, has found approximately $14,000,000 in additional general fund savings through the biennium. In the past, these savings would have been used to restore reductions in critical areas such as education, health, and our social safety net. That is not the case this year.

To give the new Governor the opportunity to set the direction for state government, a majority of the governor’s budget serves as the basis for this House Draft. Unfortunately, as the single greatest issue on all our minds is the threat of war looming on the horizon, it would be irresponsible and less than honest for your Committee to provide funding for new programs or restore funding in areas that would raise false hopes as to the role the State can play in meeting needs for public services. In fact, your Committee is proposing several reductions to the administration’s current budget proposal.

Your Committee recognizes the importance of using landfill space in the best and most practical way possible, and understands that Hawaii’s landfill space is rapidly diminishing. Your Committee appreciates the new administration’s efforts in

appropriating $2,000,000 to the State's counties for the purpose of addressing solid waste conservation in the communities. However, your Committee is concerned with the lack of information regarding this program and the lack of accountability of this proposed appropriation. Therefore, your Committee has decided to postpone the appropriation of these funds.

Your Committee also recognizes the importance of cleaning up trash and other waste in the State's communities, and further appreciates the new administration’s efforts in appropriating $300,000 in general funds toward a Community Work Day initiative. However, your Committee is again concerned with the lack of information the administration and the Department of Health were willing to provide about this request. Therefore, your Committee has decided to postpone appropriating these funds.

Finally, your Committee finds that although emergency medical services are essential for public welfare, at a time when we are looking at reducing services everywhere, it does not seem prudent to add any new services. As such, the new administration’s proposal for additional funding to increase ambulance service to a 24-hour operation in an area not identified as a priority by a 2001 Needs Assessment will be reduced to a placeholder amount in the event that additional funds become available.

The Governor also proposed the deletion of the State Health Planning and Development Agency, which would result in the elimination of eight state employees. Your Committee disagrees with this reduction because there is still a requirement under

section 323D-43, Hawaii Revised Statutes, for certificates of need to be issued, and this process provides the public the only opportunity to comment on proposals to meet health care needs.

In addition to the above concerns, your Committee has made a very difficult decision with regard to the funding for the Hawaii State Public Library System. Your Committee eliminates funding for the Kapolei Library, but offsets this by restoring half of the administration’s proposed cuts to the entire library system. The administration has indicated that adding services when current service levels are not being met would be irresponsible, and thus, your Committee has acted accordingly.

In regard to the new administration's denial of the Department of Education's $5,000,000 request for program improvements, your Committee notes that these funds were to be used to contract school safety managers, subsidize charter schools, and pay lease rent for Nanaikapono School to the Department of Hawaiian Home Lands during fiscal year 2004. Due to this reduction, the Department of Education will not be able to provide additional safety for its students or increase the subsidy to charter schools. Furthermore, your Committee recognizes that this will also restrict appropriations intended for more than 250 regular public schools, and reduce textbooks and classroom supplies for regular education.

Your Committee has great concerns with the new administration's denial of the Department of Education's $3,000,000 request for the purchase of supplies for school restrooms. Your Committee realizes that public schools have never been allocated funds to adequately supply restroom facilities, and that the new administration's proposal will further restrict the Department of Education's ability to provide such basic needs for Hawaii’s students.

Your Committee also has great concerns with the Governor’s decision to impose a five percent reduction to all program areas in the Department of Education. This reduction includes cutting from non-discretionary authorizations for Felix costs, regular instruction, and school level support. In sum, these reductions amount to over $3,000,000 per year for the biennium.

Additionally, your Committee feels trepidation due to the administration’s $580,000 reduction for public school repair and maintenance. This amounts to a twenty percent reduction to the minor repairs budget at a time when too many schools are in critical need of repair and maintenance services.

Moreover, the new administration's budget proposal leaves a $14,000,000 deficit over the next two fiscal years for funding required to fulfill the obligations of the No Child Left Behind Act. Your Committee realizes that without additional funding, the Department of Education may not be able to implement the requirements of the Act, and as a consequence, the federal government may impose penalties that can affect our entire state.

Your Committee believes that the basic health needs of Hawaii's population must be met. Those individuals who are underinsured or who live in isolated rural areas continue to live under the threat that basic health services may not be accessible when needed. One of the major concerns presented by the administration's financial plan is its lack of funding for community health centers and rural hospitals. Both types of facilities provide essential services to the public that simply are not available elsewhere.

The community health centers function as primary health care providers servicing communities consisting primarily of uninsured and underinsured clients. The impact of failure by the administration to provide funding for the health centers may result in increased use of the emergency rooms in our various hospitals, which will then serve as substitute primary care facilities for these clients, due to the lack of other options.

Community health centers provide benefits for the uninsured and underinsured patients at substantially lower costs than would be charged by hospitals. The Legislature provided funding for

this purpose in the amount of $1,650,000 from the "Rainy Day Fund" in Act 175, Session Laws of Hawaii (SLH) 2002. These funds will enable the various health centers to serve approximately 6,570 people. However, without this funding, the centers will not be able to provide health care services for their uninsured and underinsured clients, who will inevitably use higher cost emergency room services. These higher costs will then eventually pass on to all those who purchase health insurance, affecting everyone in the state.

Rural hospitals are another area of grave concern. Funding for these safety net facilities has not been provided by the new administration. These hospitals received $2,535,000 in Act 175, SLH 2002. However, to date there has been no such provision made by the new Governor, even though these facilities service areas that are either extremely remote or the only facility of its type for the entire island.

The new administration has reduced $5,336,000 in general funds for the Healthy Start purchase of service contract. The administration is proposing, instead, to use the Tobacco Settlement Special Fund to supplement funding for this program. However, this will reduce funds for the Healthy Hawaii Initiative, which was created by the Department of Health to develop chronic disease prevention programs, provide nutritional and educational programs, and offer services to promote physical activities for better health. The reduction proposed by the Governor will affect this initiative by:

• Eliminating Community Based Initiatives;

• Eliminating Public Awareness and Professional Educational Campaigns; and

• Cutting School-Based Programs in half.

Furthermore, your Committee has additional concerns because Tobacco Settlement Special Funds must be used for purposes consistent with the Attorney General’s Master Settlement Agreement (MSA). If the MSA is not properly enforced according to the terms of the agreement, the State may lose a substantial portion of its overall tobacco settlement funds.

Another result of the new administration’s budget proposal is a $1,800,000 reduction for the Residential Alternatives Community Care Program, which would have allowed more adults in need of nursing facility level of care to be served in the community. Your Committee understands that these essential services are needed most during times of economic difficulty.

The Department of Labor’s Office of Community Services (OCS) uses private providers to serve those most in need in our society, particularly the economically disadvantaged, immigrants, and refugees. Your Committee feels that any reduction to services that help disadvantaged citizens in the current economic environment is very troubling. OCS Services include:

• Legal services (Legal Aid);

• Food collection and distribution (Food Bank); and

• Disability rights (Hawaii Disability Rights Center).

Your Committee expresses grave concerns with the Governor’s $55,927 reduction per year to the Department of Defense’s Office of Veteran Services. Your Committee recognizes that a majority of this reduction, $37,577, will be taken out of repairs, maintenance, and supplies for the Hawaii State Veterans Cemetery. This reduction in funding will cause the conditions of the Veterans Cemetery to deteriorate. At a time when our nation is on the brink of war, your Committee regrets that the tremendous service that our veterans have provided cannot be adequately addressed.

Your Committee acknowledges the University of Hawaii’s goal of becoming a world-class university and an economic engine for the State of Hawaii. Notwithstanding, your Committee understands the harsh realities of the five percent budget cut proposed by the new administration and how it will impact the University’s ability to achieve its goals. Your Committee is also aware that the approved Board of Regents budget called for an increase of $99,000,000 in fiscal year 2004, and an increase of $117,000,000 in fiscal year 2005, and that none of the requests have been granted by the new administration. In sum, the Governor has proposed over $3,000,000 in cuts to the base of the University of Hawaii’s budget.

Your Committee has concerns with the administration’s decision to withdraw the $2,000,000 biennium request for critical Information Technology services. These services would establish the necessary security and integrity that would allow the State’s networks and communications to operate at adequate levels.

The new administration has reduced general funds for the Department of Land and Natural Resources by $872,704. Your Committee realizes the potential risks of damage to Hawaii’s natural ecosystems, and the delays in maintenance and repair of state parks that will occur as a result of these reductions.

Recognizing that the new Governor has made a commitment to place native Hawaiians who are on the waiting list on land within five years, your Committee has concerns with the fact that the administration’s budget proposal does not appear to address this commitment. In fact, general fund resources have been reduced by the new administration.

Acknowledging the importance of maximizing state revenue potential, your Committee has concerns with payroll turnover savings for the Department of Taxation, as proposed by the Governor. Considering the fact that it has been demonstrated that additional tax auditors and collectors would generate millions of dollars in additional revenue, your Committee finds that it may not be fiscally prudent to impose restrictions on filling revenue-generating positions that are temporarily vacant.

In the previous biennium, approximately $1,000,000,000 in general obligation (G.O.) bonds was appropriated in the Executive Branch's CIP budget. Of this amount, your Committee notes that as of December 2002, approximately $603,000,000 remains in project funding that has not been released or project funding that has been released but not been encumbered. This is over $600,000,000 that has not filtered through the State's economy.

Being mindful of the ever-rising cost of debt service, and the uncertainties facing the economy, your Committee feels that the fiscally responsible thing to do at this time is to limit the amount of future bond issuances to control the State's debt.

The amount of G.O. bonds appropriated in this bill totals approximately $340,500,000. This total, along with the balances remaining from the previous biennium, comes to over $940,000,000 in projects that are to be initiated. Your Committee feels that this should be sufficient to make progress on improving and developing public facilities, and to support the construction industry, while at the same time controlling debt service.

Your Committee understands that the Governor’s reductions will be painful. Given the uncertain fiscal situation of the State and the potential for geopolitical chaos, your Committee has prepared a biennium budget that reflects this ominous state of affairs.

Your Committee would have liked to avoid the reductions proposed in this biennium budget. However, the current uncertain fiscal future has made it essential to err on the side of caution. Should revenue forecasts remain the same or improve, the Committee will be the first to call for restoration of essential funding for the Department of Education, the University of Hawaii, and the preservation of the social safety net.

Your Committee has hopes that war will be avoided, tourism will fully recover, our economy will grow, and that all the citizens of Hawaii will have the opportunity to live in healthy and safe communities.

While your Committee prepares for the worst and does not offer false hope, it remains committed to the values of our Hawaii: opportunity, fairness, and the spirit of aloha. It is with hope, conviction, and a steadfast sense of responsibility, that your Committee stands ready to meet the challenge, and looks forward to working with the Senate and the new administration to ultimately create a budget that will be balanced, while preserving what makes Hawaii special.

As affirmed by the record of votes of the members of your Committee on Finance that is attached to this report, your Committee is in accord with the intent and purpose of H.B. No. 200, as amended herein, and recommends that it pass Second Reading in the form attached hereto as H.B. No. 200, H.D. 1, and be placed on the calendar for Third Reading.