Promises made, promises kept? Legislators explain grocery tax cut considerations

Nov. 11—SIOUX FALLS, S.D. — After being elected to serve as the governor of South Dakota, Dennis Daugaard in 2011 made serious cuts to the budget — almost 10% across the board — in order to erase the recession-era "structural deficit" in the state coffers.

"The experience that we had in 2011 certainly was due to the recession, and what we had to do to respond as a state was very difficult," Jean Hunhoff, the Senate's current top appropriator who served in the legislature during those cuts, said. "We were never able to fully recover as we went down the road. Those lost dollars that we took away were never replaced at full value."

The current state budget situation could hardly be further from the reality a decade ago: several consecutive surpluses — including last year's surplus of $115.5 million — puts the state's reserves at over $400 million.

But some parallels to the leadup to the 2011 cuts are hard to ignore.

"We need to be looking at history," Matt Michels, who served as lieutenant governor under Daugaard, said. "And we have a relatively recent history of what happens when we cut revenues at the same time we have been relying upon federal funds."

In that vein, the Nov. 8 election carried two checks that are set to be cashed by the legislature: Gov. Kristi Noem's promise to cut the grocery tax and the expansion of Medicaid to tens of thousands of South Dakotans.

Combine those two facts with calls by state employees for raises that outpace inflation, the winding down of pandemic-era federal funds and a potential recession curtailing spending and tourism, and some legislators worry that it's all too much, too soon.

"If I were a betting man, I would say that we're in for tougher times because we've been in tough times before," Rep. Lance Koth, R-Mitchell, said. "So for me, and maybe it's because I spent 40 plus years in banking, I don't anticipate the worst, but I want to plan for it."

On the campaign trail, Noem often reiterated that the state's growth — especially the continued overperformance of sales tax collection — would be the mechanism to pay for the expected $100 million in annual cuts from a grocery carve-out.

Koth and several other legislators were clear that the grocery tax decision is not something to be made right now; after all, balancing the budget and keeping the state in a strong financial position moving forward is the major task of the legislature, and that function will not be finalized until March.

"The revenue projections continue to look good, I think we should be proud of the economic resiliency we've had. And budgets don't happen in isolation; whether we can afford spending or whether we can afford tax cuts all depends on the revenues as they come in," Rep. Will Mortenson said. "I think it's only prudent that we all reserve judgment on what we can afford until we have the best available data and that will be February."

While tax collection in the winter months will be one variable that frames these discussions, several other variables already exist, ranging from seemingly unlimited mouths to feed with the budget surplus to the key role that the grocery tax plays in keeping South Dakota financially strong and stable.

For decades, appropriators in South Dakota have seen the grocery tax as the most stable source of income for the state and an important underpinning of financial security.

The tax, while regressive, is a major reason why the state has

retained a triple-A credit rating,

which was issued in part because revenues from the "broad-based" sales tax do not fluctuate as much as income taxes or a more narrowly-targeted sales tax.

"The fact that everybody buys groceries, that does help the triple-A bond rating that we proudly hold in our state," Koth said. "I don't want to see anything happen to jeopardize that."

While the necessity of groceries is also a point made by those in favor of cutting the tax, it's difficult to overstate the importance of this bond rating, which allows schools and municipalities to borrow at low rates for large projects.

Cutting the grocery tax would not automatically lower the state's bond ratings; however, combined with a drop in federal funds and a potential recession on the horizon, cutting the grocery tax would speed up a loss of income.

"There are big dollars that are coming into the state," Sen. Jean Hunhoff, R-Yankton, said. "But those are one-time dollars. And if you're doing capital improvement projects with them, somewhere down the road, somebody's going to have to pick up payments on that."

Hunhoff made clear that she had not formed an opinion on the grocery tax cut, saying it would be "inappropriate" for an appropriator to come out on one side without full consideration of factors during the session.

In addition to nearing the sunset of a large portion of pandemic-era federal funds, the ratcheting up of interest rates by the Federal Reserve has

heightened worries of an economy-wide recession.

In South Dakota, that would likely mean a further tightening of pocketbooks, potentially lowering sales tax collection in disposable areas and affecting tourism to the state.

Still, several legislators underscored their faith in the Bureau of Finance and Management, the Legislative Research Council and other groups tasked with supplying legislators with the requisite information to make good decisions.

"All those are things that we have to do an analysis on, and that really occurs during the legislative session," Hunhoff said. "People get frustrated because we don't set our budget until we can get as close as possible to what we think the economy is going to do. I'm still waiting to see what's all on the horizon."

Doing some simple math, the $115 million surplus from the 2022 fiscal year — even assuming impressive growth in revenues — could disappear quickly.

For one, while an inflationary environment is helpful on the front end in increasing nominal sales tax collection, the bill always comes due in the form of the "Big Three," a name given by appropriators to three major state spending areas: education, employee compensation and healthcare providers.

Last legislative session, the Big Three received a 6% cost-of-living increase,

an increase of $104 million

in general fund spending.

This year, Eric Ollila, the executive director of the South Dakota State Employees Organization, said he is looking for at least 10%. If the legislature were to pass the same increase across all three categories, that increase would mean about $180 million in extra general fund spending.

"We're not looking for raises to keep up with inflation. We're looking for raises beyond, since that's what every career takes to survive," Ollila said. "So we want to see inflation plus since we had the last session where it was 6% and we have inflation at 8.5%."

Furthermore, while federal incentives mean that the voter-approved expansion to Medicaid is projected to save the state tens of millions over the first two years of expansion, the annual costs after that will net out to at least $20 million, a figure opponents say could be a severe underestimate. The inscription of this expansion in the state constitution means that, unlike a grocery tax cut, this spending is not optional.

Jean Hunhoff, the chair of the appropriations committee in the Senate, thinks it would be prudent not to come to rely on that short-term surplus, instead saving it for a potential cut in the federal matching ratio of state Medicaid dollars.

"We would have to pick up all that extra that they were no longer picking up," Hunhoff said. "I think we have to see how we can manage those dollars that are coming in and make sure they go into a fund to cover a Medicaid expansion group."

The decision to lower the 90% federal share would have to be made by legislators at the national level, the vast majority of whom represent states that have expanded Medicaid.

Of course, discussions of competing interests around the grocery tax cut quickly become moot if legislators feel good about a payment source that can recoup the expected $100 million or more in stable income that would disappear from the balance sheet.

Each of the gubernatorial candidates had their own ideas: for Jamie Smith, taxes levied on recreational marijuana could have made up some of the difference. With the defeat of Initiated Measure 27, that revenue source can't be counted on.

Noem, for her part, said the "permanent growth" of the state economy would pay for it, and sales tax receipt surpluses totaling

more than $75 million above expectations

in the last four months support that point.

Though they think cutting the grocery tax is on the table, several legislators have urged caution in rushing to forfeit that revenue source, especially in what is already a relatively lean state budget.

"We just have to be really careful," Rep. Jess Olson, R-Rapid City, said. "When I got in four years ago, we were bickering over $10 million on one-time issues and barely squeaking by with a 2% increase for teachers. And now we're talking about $100 million dollars in ongoing cuts."

For the right wing of the state's Republican party, the discussion of how to replace these dollars is the wrong framing. Instead of replacing the funding, legislators like Phil Jensen and Spencer Gosch think the onus should be on the government to cut back their spending.

"Some legislators feel that the government shouldn't ever have to give up or tighten its belt. Only the people," Gosch, who will not be serving in the legislature this coming term, said. "If we have an economic recession or downturn, I think the government should probably take a look at what can we do to make it easier on the people, and what do we take less from of theirs."

On the other side of the aisle, Sen. Reynold Nesiba, D-Sioux Falls, thinks a more tenable solution would be shaving one or two pennies from the sales tax, rather than cutting the entire 4.5% state share at once.

Since the full repeal did pass the House, albeit in a last-minute amendment that skirted legislative processes, the Senate is the major roadblock to Noem's agenda.

"My sense is there wasn't enough change [in the Senate] to suddenly have support for full repeal," Nesiba said. "But I think what we could have a conversation about is does it make sense for us to take off one penny or two pennies since each penny is worth about $25 million."

Jason Harward is a

Report for America

corps reporter who writes about state politics in South Dakota. Contact him at

605-301-0496

or

jharward@forumcomm.com.