“Local Funds”: State Money Outside The Treasury New Report Addresses Little-Known State Funds

Local funds give agencies greater operating flexibility. But because they are largely exempt from the state’s usual budgeting and reporting mechanisms, they can pose various challenges concerning transparency, efficiency, and oversight.

Regarding transparency, Associate Deputy Comptroller Phillip Ashley explains, “Local funds are typically not part of state budget deliberations, not part of the financial information we report to the Legislature and generally not part of our accounting system. In comparison to normal state funds, the Comptroller’s office has little information on funds held outside the Treasury.”

Until recently, Texas had no single, readily available source for basic information on these local funds — even for how many exist or how much money they hold.

A new biennial report, however, first issued by the Legislative Budget Board (LBB) in 2019, sheds some light on these funds and will provide vital information next year as the Legislature convenes.

Local Fund Basics

Most state revenue is held in the state’s Treasury and appropriated by the Legislature every two years during the normal budgeting process.

But certain state agencies and institutions of higher education are authorized to keep funds in accounts outside the state Treasury, where they are not subject to appropriation by the Legislature.

Those may include bonds and trust funds, college tuition, pensions, endowments, and funds for general operations.

The money may be held by the investment arm of the Comptroller’s office, the Texas Treasury Safekeeping Trust Co. (TTSTC), or in private financial institutions.

Local funds must be created specifically by statute. “When a bill gets passed to create a fund or account and exempt it in that session’s funds consolidation bill, it needs to clearly state whether it’s in the Treasury or not,” says Rob Coleman, CPA’s director of fiscal management. “New money coming in goes to state general revenue unless a bill explicitly directs it elsewhere.”

The Comptroller’s 2017 article described four types of local funds: operating, custodial, bond and trust funds, categories prescribed in the Comptroller’s annual financial reporting guidance for state agencies and institutions of higher education.

Although most funds are held in investments, some are in cash or have a cash-equivalent value. In 2017, the LBB estimated local operating funds — used for “daily operations,” as the agency defines them — comprised 76 percent of the value of all state cash and cash-equivalent funds held outside the Treasury in 2015.

The Debate Over Local Funds

Agencies can spend money from local funds with less red tape. They may possess specialized knowledge of their programs or activities, making them better equipped for certain spending decisions. The management of pension funds is a good example, Ashley says.

“For the bulk of funds outside the Treasury, I think it’s logical and makes good sense to do it that way,” he says. “For example, it would be impractical to try to manage the complex investment activities of a pension fund via the appropriations process, and the Legislature has other means of providing oversight for pensions, including dedicated committees to review pension issues.”

But not all local funds are comparable to pensions — particularly those used for daily operations, which the LBB describes as “similar to funds provided through the appropriations process.”

The Texas Constitution grants the Legislature the sole power of the purse, or “the power to set policy priorities via spending decisions,” says Ashley. “When money is moved outside the Treasury, it takes it out of the appropriations process and out of the usual prioritization process.”

Local funds can be a challenge for the Comptroller’s office as well.

As the state’s chief financial officer, the Comptroller’s job is to provide lawmakers with accurate information on state revenues, spending, and available account balances to guide their decisions.

The Comptroller’s State of Texas Annual Cash Report, published each November, provides fiscal year beginning and ending balance information and revenue and expenditure activity for funds held in the Treasury.

The Comptroller’s office also helps provide important oversight of funds within the Treasury through an audit program that periodically reviews agency expenditures to ensure payroll, purchase, procurement, and travel expenditures comply with state law.

But the Comptroller often can’t provide the same oversight for local funds because, in many cases, the funds are kept on deposit with a separate financial institution, and their day-to-day activity doesn’t flow through the state’s accounting systems.

In addition, the Comptroller’s expenditure audit program is authorized only to audit activity occurring within the Treasury.

Funds outside the Treasury also are off-limits for revenue certification, the constitutionally required process by which the Comptroller provides lawmakers with an estimate of state revenue so they can write the biennial budget. “Texas is a pay-as-you-go state,” says Ashley. “The budget has to be within available revenue as certified by the Comptroller. But that only includes funds in the Treasury.”

House Bill 3745, approved in 2019, provides a recent example affecting the $1.7 billion Texas Emissions Reduction Plan (TERP) account in the Treasury.

The new law created a Texas Emissions Reduction Plan Trust outside the Treasury, to be managed as a local fund by the Texas Commission on Environmental Quality.

In fiscal 2022 and beyond, any new revenue coming in from the sources dedicated to the TERP account will be deposited in the Texas Emissions Reduction Plan Trust. (The balance in the original TERP account will not move and will remain available for certification.)

The loss of revenue for certification will be offset by the fact that the Legislature no longer will have to appropriate funds to cover TERP expenditures.

When the Texas Division of Emergency Management was moved to the Texas A&M University System in 2016, on the other hand, some suggested its funding be moved outside the Treasury to “make for easier processing and to align with other A&M processes that use local money,” says Coleman.

The move ultimately didn’t happen, in part due to concerns that the agency’s estimated $3.5 billion in federal funding for the biennium wouldn’t flow through the state’s financial systems, resulting in reduced information on a significant amount of funding.

According to Coleman, the struggle to balance the budget during the 2007-09 financial crisis led to far greater scrutiny of local funds. “Due to the recession, it was more important than ever for the Legislature to scrutinize every dollar and look for any opportunity to leverage the state’s revenue to the greatest extent possible,” he says.

Finally, putting increasing amounts of money into local funds can weaken Texas’ overall financial position.

Though much of the $50 billion Treasury pool is kept liquid to be available for daily operating needs, the state still reported more than $2.8 billion in interest and investment income in fiscal 2020.

Any interest or other income earned on local funds, however, usually remains outside the Treasury.

This means lower returns on the state’s pooled investments and less flexibility in consolidating funds to address daily cash flow needs.

New Reporting Requirements

According to a January 2017 LBB staff report (PDF), at the end of fiscal 2015 state agencies held about $3.6 billion in cash outside the Treasury, while public institutions of higher education held about $3.9 billion.

But those were only estimates of cash value at the fiscal year’s end, as reported in the state’s annual Comprehensive Annual Financial Report, and did not include longer-term investments.

The Legislature included a rider in the 2018-19 General Appropriations Act requiring the LBB and Comptroller’s office to compile more detailed biennial reports on state entities’ holdings in funds outside the Treasury.

With agency submissions collected by the Comptroller’s office, the LBB issued its inaugural report (PDF) in February 2019.

For each fund, agencies were asked to report the fund number and name, statutory basis, allowable uses, eligible programs, ending balances for fiscal 2016 through 2018, and estimated ending balances for 2019. (Many entities declined to provide 2019 projections.)

The rider requiring the report, however, didn’t require the inclusion of funds held by institutions of higher education, a significant sum. Furthermore, the report only offers a snapshot of fund values at a point in time.

“A periodic report on funds outside the Treasury can’t provide up-to-date and real-time information regarding fund balances, revenues, and expenditures, like we can for funds inside the Treasury,” says Ashley.

At the end of fiscal 2018, the 43 state agencies and entities listed in the report held $285.8 billion in noncash investments and $2.4 billion in cash and cash equivalents outside the Treasury.

Less allowances and liabilities, the total was $254.1 billion, of which 94 percent was held by five agencies with major investment portfolios (Exhibit 1).

Pension funds made up the majority, with the Teacher Retirement System holding 60.8 percent and Employees Retirement System another 11.8 percent.

The amount held in cash and cash equivalents (such as federal obligation investments) has decreased by more than a half-billion dollars since 2016 (Exhibit 2). The Texas Department of Insurance holds 43.2 percent of those funds.

Coleman acknowledges the report is “high level” but says, “it could be a good way to identify local funds information and how the agencies are using the balances.”

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What Happens Next?

Lawmakers will face tough choices as the 2022-23 budget process unfolds. A simple but crucial question during those negotiations will be: How much money does the state actually have?

For the Comptroller’s office, state agencies, and legislators, next year’s LBB report will help answer that more fully. The House Appropriations Committee also was charged to investigate such funds before the next legislative session begins in January.

Ultimately, most local funds are held outside the Treasury for good reasons, and Ashley notes that the Comptroller’s office generally doesn’t take a position on individual funds or pieces of legislation.

“Anyone particular fund … is too small to move the needle,” he says. “But we want to ensure the Legislature and other stakeholders stay generally informed about the amounts, differences, and distinctions between funds in the Treasury versus outside it.”