Breaking down the president's budget: a local government perspective.

President Bush unveiled his fiscal 2005 budget in early February, outlining the administration's priorities, namely, homeland security and the war on terror, economic growth, job creation, and education. Aside from defense and homeland security spending, discretionary programs will see an increase of only .5 percent in 2005. This limited increase will help achieve the president's goal of cutting the nation's deficit in half over the next five years. According to the Congressional Budget Office, the deficit will reach approximately $478 billion this year before falling to $258 billion over the next five years. However, the CBO numbers do not include expenditures for the wars in Iraq and Afghanistan past 2005, and they do not take into account the fiscal impact of making permanent the 2001 tax cuts, a proposal pending in Congress.

According to the Office of Management and Budget, the federal government will deliver nearly $400 billion to local and state governments in fiscal 2005, a record amount as a percentage of all federal spending (18 percent) and as a share of GDP (4 percent). However, OMB also reports that funding for capital investment has mostly remained flat since 1990, with only 2.8 percent of all federal funds going to state and local infrastructure needs. Most of the monies allocated to local and state governments are for essential services like welfare and Medicaid. Approximately half of this spending is allocated for Medicaid, which has seen a dramatic rise in costs over the past few years. Unlike many of the other spending programs that are directed to local and state governments, Medicaid is a non-discretionary budget item that can only be changed by law.

The president's budget proposal outlines what the administration would like to see move forward in the congressional appropriations process. The House and the Senate are now sorting through the 13 appropriation bills, and there is still substantial disagreement between the two chambers. While it is still early in the session, many have predicted that the shortened congressional work schedule (a product of the national election and the dynamic political scene) will make it difficult for Congress to move all bills before the June 30 deadline. As such, the fiscal 2005 budget is likely to be passed as one large bill--the omnibus bill--rather than the norm of 13 separate appropriations bills.

The following is a list of some of the proposals in the president's budget that affect local and state governments:

* Additional funding for public health and bioterrorism initiatives

* A decrease in funding for homeland security first responder programs (the formula for distributing funds has been changed from a state formula grant program to an urban area security initiative grant program)

* A $250 million decrease in firefighter grant programs

* A $1 billion increase in spending for the No Child Left Behind program

* A slight increase in transportation funding, including airport improvement grants and financing for commuter rail projects

* A $659 million cut (from $756 million to $97 million) for the COPS program, including the elimination of grants for hiring new police officers

* A $28 million increase for brownfields clean-up

SALE-LEASEBACK DEALS IN JEOPARDY

One of the most significant items in the president's budget for local and state governments is a proposal to alter the way in which the private sector enters into leasing arrangements with the public sector. The centerpiece of this proposal is to end sale-leaseback arrangements, or SILOs (sale-in, lease-out). These deals allow a state or local entity to sell an asset to a private company for cash. The company leases the asset back to the tax-exempt entity, deducting the annual depreciation costs from its federal taxes. At the end of the lease, the asset can revert back to the government for a nominal fee. The Treasury Department and the Senate Finance Committee are determined to put an end to these deals, which they contend are abusive tax shelters that cost the federal government nearly $35 billion a year in tax revenues.

The administration's proposal, as well as pending legislation in the Senate Finance Committee, is intended to alter the rules governing depreciation of assets leased to tax-exempt entities by private firms. However, the scope of the legislation has the potential to indirectly increase costs for local and state governments. In the absence of the tax incentives that encourage the private sector (the lessor) to enter into leasing agreements with the public sector (the lessee), it is reasonable to believe that the additional costs will trickle down to the party paying the bill--local and state governments. Because the proposal and the legislation do not clearly define those leases they perceive as abusive, nearly all leases entered into by the public sector, not just SILOs, could be affected. While some of the requirements are solely aimed at ending SILO transactions, others cross the line to impair traditional leasing arrangements (such as those for motor vehicles and copy machines).

The Senate's legislation, which contains five new requirements that would have to be satisfied on every lease with the public sector, is a mirror image of the administration's proposal. The most notable requirement is that lessors maintain a 20 percent equity investment throughout the term of the lease. Because of the need for a higher return on equity than on debt, this requirement will add costs to every type of lease. For leases of more than five years, the legislation would reduce the available depreciation deductions exclusively for properties leased to the public sector. As a result, the cost of leasing for local and state governments would increase because lessors will need to charge more to maintain their return on investment.

Chairman Bill Thomas of the House Ways and Means Committee dropped a similar bill in the House on March 12. His legislation, HR 3967, allows the SILO deals that have been put on hold since last fall to move forward, and also allows for a short-term lease exception to the equity requirement described above. Thomas' staff has indicated to GFOA that they would like to work with the public sector to make certain the bill does not affect traditional leasing arrangements, and we are working with staff to provide needed clarification.

Some members of Congress understand that eliminating sale-leaseback arrangements from the market would have a negative impact on local governments. Both transit authorities and local governments will see a negative revenue impact, and a solution to provide direct funding or other types of fiscal relief is being discussed to offset the impact.

CONCLUSION

The leasing legislation and other funding proposals that will move forward this year in Congress could have a significant impact on local and state government finances. These issues, along with Congressional action on the Internet access tax legislation, will be a focus of the Federal Liaison Center's 2004 work plan. For more information on the president's proposed budget, the leasing proposal, or other issues affecting local and state governments, as well as advice on how best to reach out to your representatives in Congress, please visit www.gfoa.org.

SUSAN GAFFNEY is director of GFOA's Federal Liaison Center in Washington, D.C.