- Special Projects
Officials at the Honolulu Authority for Rapid Transportation had known for months the city’s rail project was headed for serious financial trouble but didn’t fully share that knowledge with the public until last December.
For at least two years HART’s directors received regular updates on the growing shortfall in General Excise Tax surcharge revenues. Two months ago, during an executive session, the board discussed how it planned to lobby state lawmakers to extend the tax past its scheduled expiration date in 2022.
With barely two miles of railroad guideway built, major construction contracts yet to be bid and potential cost overruns and shortfalls estimated as high as $910 million, HART says the current special tax surcharge won’t generate anywhere near enough money to pay for the city’s share of construction or the municipal subsidies needed to operate an integrated rail and bus system that have been estimated to be nearly $6 billion over the next 15 years.
Any extensions of the system, such as to the University of Hawaii at Manoa campus, will also need the higher taxes.
To underscore its argument, HART officials announced a week before Christmas that GET surcharge revenues were $41 million short of what they had expected to receive, and with additional costs blamed on lawsuits that delayed construction and missteps by the administration of former mayor Mufi Hannemann in jumping the gun on construction, those deficits could continue to increase.
That disclosure appears to have caught taxpayers and lawmakers off guard and surprised some at just how soon HART would come asking for more money.
Gov. David Ige still isn’t convinced the money is needed, at least not yet. Ige tasked his budget director, Wes Machida, with finding out just how desperate the city is for more cash, including getting detailed cost estimate information that Honolulu officials are loathe to share because they believe it will taint the bidding process.
Machida recently told Civil Beat that the administration is apprehensive about guaranteeing a surcharge extension so early on in the project. He said there are a lot of unanswered questions about the railroad’s financial outlook, especially as it relates to the estimated $910 million deficit. Until the city can placate those concerns, Machida said it will be hard for the administration to support a continuation of the GET surcharge.
“If it’s extended indefinitely those are dollars that can’t be used for other programs,” Machida said. “We just want to be sure that it’s being used in the best way possible and that there’s a need for it.”
Now, the subject of a surcharge extension is reverberating from Honolulu’s City Council chamber to the corridors of Hawaii’s State Capitol, the epicenter for any legislation permitting a continuation of the special tax surcharge that began in 2007 to generate funds earmarked solely for the city’s rail project.
A bill to extend the tax for 25 years is already moving through the state Senate, and a hearing is scheduled Wednesday in the Senate Ways and Means Committee.
What lawmakers face in deciding whether to pour additional billions into city coffers is a numbers game of gigantic proportions and its potential economic impact on taxpayers. But where Honolulu’s rail project is concerned the numbers are confusing and don’t always seem to add up.
Determining the real surcharge deficit will be a math test for both the Legislature and City Council. Depending upon how surcharge revenues are calculated projections can show anything from a shortfall to a surplus. It all boils down to the numbers and mathematical formulas used and how they are explained.
Surcharge projections have been off base since the beginning. Now that city officials are asking for more money, the question for lawmakers is whether they can rely on the accuracy of new estimates of project revenue streams for another 25 years or more.
HART officials, however, maintain they are being transparent, and stand by their projections.
Surcharge revenues are the lifeblood of the city’s 20-mile rail system and were a key part of the sales pitch used to obtain $1.55 billion in federal funding for a project originally estimated to cost $5.26 billion – a price tag that could now easily exceed $6 billion or more.
Not only were these revenues earmarked for construction costs, but more importantly, for repaying debt incurred to provide sufficient cashflow to pay contractors’ bills before the system began earning money on its own.
Most major infrastructure projects funded through taxes collected over a period of time reach a point during peak construction when costs exceed revenues and additional money must be raised to pay contractors on time. The City Council is now wary about issuing debt until they have an extension of the GET surcharge secured.
City officials were warned four years ago that their GET surcharge calculations might be off-base.
When the tax surcharge collections began in 2007 city officials — who managed the project for several years before HART was created — knew future borrowing would be needed and included the cost of repaying loans in their budget, believing the surcharge would provide all the money needed during the 15 years the tax would be collected.
As it turned out the original upbeat estimates of how much money the surcharge would produce may have been too optimistic, and were based upon calculations that may have been unrealistic.
At the time projections were first made in 2009, city officials estimated that surcharge revenues would increase at a steady rate of slightly over 5 percent each year. That rate has never been adjusted and it’s what accounts for much of the shortfall between tax money HART thought it would receive and what was actually collected.
Tax collection reports show that over the past eight years the actual amount of surcharge money collected has fluctuated substantially on both a quarterly and fiscal year basis, something that raises questions about the accuracy of the project’s initial revenue estimates.
City officials were warned four years ago that their GET surcharge calculations might be off-base.
A 2010 study of rail financing conducted by Maryland-based Infrastructure Management Group for the administration of former Gov. Linda Lingle concluded that calculations used by the city to project future surcharge revenues overstated the amount that would ultimately be collected.
The IMG report was sharply criticized by then-mayor Peter Carlisle who characterized the study as “biased” and “shoddy.” Carlisle’s criticism appears to have been focused on IMG’s estimates of the project’s total construction costs, a mistake created in large part by the city’s outright refusal to cooperate with the state consultant.
An assessment of the problems encountered by IMG, obtained by Civil Beat, indicate city officials stonewalled IMG personnel and refused to provide any information on how the municipal revenue estimates were calculated.
“The greatest difficulty that IMG faced in performing this project was the almost total refusal of the City to meet with it, to share documents…,” the assessment reported. “After spending months attempting to get the City to agree to allow [IMG] to review its [financial] models and to meet with the City’s consultants for detailed discussions…the City suddenly, and without any notice, cut off all contact and refused to even respond to emails and phone calls.”
History, however, has proved surcharge revenues projected by IMG were more accurate than those produced by the mayor’s own transportation department in preparation for Honolulu’s application to the Federal Transit Administration seeking entry into the project’s Preliminary Engineering phase, the first step to obtaining federal funding.
In fact, the FTA itself questioned aspects of city calculations. In a letter approving the start of preliminary design work the FTA said “some elements of the current financial plan may not fare well in the stress tests that FTA will apply to evaluate robustness. These elements include the projected revenue stream from the General Excise Tax … were this plan submitted today in support of a request to advance the project into final design [the second step for federal funding approval], its weaknesses would likely cause FTA to deny the request.”
Carlisle told Civil Beat he doesn’t recall city officials stonewalling IMG consultants.
Hawaii’s General Excise Tax is a 4 percent levy on the income of individuals and businesses that sell goods or provide services.
In 2005, state lawmakers authorized Honolulu to add a one-half-of-one-percent surcharge on the tax to help pay for the city’s commuter rail system and allowed the state to skim 10 percent off the top of what it collected for administrative fees.
Although the state Senate approved the bill on a 19-6 vote, several cast their votes “with reservations.”
One opponent, Republican Sen. Sam Slom, argued at the time that if the law was approved it would force taxpayers to “support a program of a train that’s going nowhere. There’s no plan. There’s no routes.There’s no schedule. There’s no technology. There’s nothing at all, but we’re in a rush to pass a tax increase,” he said.
“The greatest difficulty that IMG faced in performing this project was the almost total refusal of the City to meet with it, to share documents.” — State consultant IMG
Sen. Brian Taniguchi, a Democrat, supported the tax surcharge, but expressed reservations, saying “while many may support the idea of a light rail system, the Senate has concerns about the unknowns in the city’s plans.” And Taniguchi noted the law’s sunset clause would provide “the opportunity to evaluate the progress and management of the surcharge revenue.”
The surcharge is not limited to Honolulu because it applies to income generated by Oahu-based businesses selling goods and services on the other islands. Even contractors on the rail project itself are subject to the tax and include that in their bids.
Through last September, the point at which HART calculated its deficit, $1.346 billion in net surcharge revenue had flowed into the city’s Transit Fund from which it is disbursed to cover project and other expenses. But HART officials said this revenue was tens of millions less than they expected based upon estimates made in June 2012 when HART submitted its final application to the FTA seeking the federal money.
An examination of those estimates, contained in documents submitted to the federal government going back six years, suggests the city, and later HART, substantially overestimated the amount of money the tax would generate and seemingly made no attempt to revise those estimates, despite different calculations in the state-commissioned financial study.
The difference was a matter of percentages, which can have an immense impact when used to estimate amounts in the millions of dollars.
HART’s projections assumed surcharge revenue would grow by 5.04 percent each year – a factor that remained unchanged from the first set of projections prepared in 2009, when the city estimated it would receive a total of $3.52 billion in surcharge revenue by 2022.
The state study projected surcharge revenues using what have proved to be more accurate percentages ranging from 3.7 percent to 4.7 percent in three different financial models – a conservative case, base case and optimistic case.
While HART estimated it would receive about $3.3 billion in surcharge money during the life of the tax, the state study projected those receipts would be between $2.96 billion and $3.16 billion, and concluded, based on the city’s estimates that surcharge revenue could come up short by $366 million to $560 million.
HART still uses the 5.04 percent surcharge growth rate, and has not yet decided if it will scale it down when revising its financial plan with the FTA this summer.
The city’s optimistic early projections could easily have been attributed to the chaotic financial markets at the time and the difficulty predicting the future under those circumstances.
This was exacerbated by the fact that in calculating GET revenues a number of components had to be considered – income generated by tourism, retail sales and other products and services subject to the tax. If a family in Iowa was losing its home to foreclosure, they wouldn’t be traveling to Hawaii on vacation.
Ironically, in a study prepared for the FTA assessing the city’s ability to pay for the rail project, and released a few months after HART’s final request for funding in June 2012, consulting firm Porter & Associates — emphasizing it had relied on documents supplied by the city — conducted a “stress test” to determine the impact of a decrease in the growth of surcharge revenues after 2012. That test was conducted using a growth rate factor of 4.3 percent – a percentage within the range utilized two years before by IMG, the state’s consultant.
Based upon its stress test, Porter concluded that if a 4.3 percent growth rate were projected from 2012 over the life of the tax, surcharge revenues would come up $123.1 million short – something that would only become apparent in 2023 and 2024 when the system was operating and a planned transfer of that projected surplus to rail operations and capital expenses would be unavailable and have to be made up by other city funds.
Following HART’s arithmetic is not always easy, because sometimes the numbers just don’t seem to add up.
Although Porter “reviewed” HART’s forecast assumptions, it did not attempt to fully validate the methodology used by the agency in making the projections, concluding “the GET surcharge forecast is in the range of what may be considered reasonable,” but cautioning that historical variations in statewide GET revenues made any projections of those revenues in the future “inherently risky.”
Porter also echoed a previous FTA report saying “by their nature, financial forecasts assume the occurrence of future events that are unlikely to occur exactly as planned. Variances between assumed and actual outcomes may occur and could be material.”
As it stands, HART expects the GET shortfall to be between $80 million and $100 million by the time the current surcharge is scheduled to expire in 2022.
While taxpayers may not have been aware of potential revenue problems — and city officials remained silent at the time — soon after HART began operations on July 1, 2011 and its board of directors got up to speed on what the city had been doing, the subject of surcharge revenues was regularly discussed.
One board member on the finance committee, banker Don Horner, frequently inquired about HART finances, according to minutes of committee meetings. Informed during a February 2013 meeting that surcharge revenues had reached about $1 billion, Horner said he believed there was a need to keep a running tally for “public consumption.”
Finance committee members were also updated on surcharge shortfalls. In May of 2013, according to meeting minutes, the committee was told the tax revenues were $30 million shy of what had been expected. In March 2014 during a discussion of HART’s monthly “Balanced Scorecard” a quarterly color-coded financial summary, Horner questioned the accuracy of the surcharge collections.
When the $41 million surcharge deficit was revealed last December, Horner said he thought the public would be concerned “about these numbers” and conceded to fellow board members that the surcharge deficit was due to “the fact our projections were two-percent wrong.”
But even though GET projections didn’t meet reality, HART Executive Director and CEO Dan Grabauskas said in an interview it was hard to be too concerned about the lag.
The GET shortfall, even at $41 million, is only a fraction of the total project cost. Before construction bids came in much higher than anticipated, he said, the project’s more than $600 million contingency would have easily covered the shortfall. There was no need for alarm bells.
“It was something we monitored,” Grabauskas said. “But in the parlance of auditors it wasn’t material.”
HART defends its estimates, saying the percentage of increase in projected surcharge revenue was accurate in 2012 and remains accurate today because it was based upon historical statewide total GET revenues collected over a 30-year period.
Diane Arakaki, HART’s chief financial officer, told Civil Beat the agency calculates its budget projections by increasing actual quarterly surcharge collections by 5.04 percent to estimate tax receipts for the similar quarter in the following year.
Arakaki says collections for the first three months of fiscal year 2012 (July-September of 2011) would be increased by 5.04 percent to project the surcharge receipts in the same quarter of fiscal year 2013.
However, HART’s method of predicting what it will receive is not always on target.
For example, in the third quarter of fiscal year 2013 (January-March 2013) actual surcharge collections totaled $55.3 million. HART’s formula increased that amount by 5.04 percent to $58.1 million, using this revenue estimate for the third quarter of fiscal year 2014.
Although the city has the financial capacity and borrowing power to pay for building the rail system, it is uncertain how city fathers expected to pay for running it.
Actual collections for the third quarter of fiscal year 2014, however, were $61.6 million, 6 percent more than even HART estimated. Yet, on a chart outlining surcharge deficits for HART directors last December, the budgeted amount for the quarter was $54 million.
But following HART’s arithmetic is not always easy, which can be confusing to the public, because sometimes the numbers just don’t seem to add up.
For instance, last December HART officials told directors that between March 2012 and September 2014 they had expected to receive $528 million in surcharge revenues and had included that in their budget. Yet, using HART’s own formula as described by Arakaki for projecting revenues, that amount should have been $492 million.
Using that math, and considering actual collections during that period were $487 million, HART’s $41 million surcharge revenue deficit shrinks to $5 million, much less severe.
However, the surcharge situation has changed since the $41 million deficit was announced. Surcharge collections for the second quarter of the 2015 fiscal year ended Dec. 31 totaled $57.8 million, more than HART expected.
HART’s hand in the high-stakes poker game with state lawmakers may prove to be no bluff. The outcome will have significant ramifications on city finances for decades. Part of the strategy behind building the railroad was to unify a public transit system now dependent upon buses sharing increasingly crowded roadways.
Besides needing enough money to complete construction of the railroad, HART will require additional tens of millions of dollars for railroad operations and maintenance alone — costs estimated to be somewhere around $1.6 billion through 2030 and that doesn’t include expenses of operating an integrated bus system – or potentially extending the length of the railroad.
Since GET surcharge revenues are restricted to railroad construction and operating costs, any financial planning had to include other sources of revenue. Although HART had expected a surplus of surcharge money when the tax ended in 2022, something that is now unlikely, those extra funds would come nowhere near defraying the expected operating and maintenance costs.
Rail passenger fares through 2030 were projected to be just $497 million, hundreds of millions short of the project becoming financially self-sustaining.
Combining rail revenues with the estimated $1.66 billion in bus system revenue and another $267 million HART expected to squeeze out of the federal government – somebody had to come up with the additional $5.87 billion needed to cover the estimated total $8.4 billion needed to keep everything running for 15 years.
That somebody was the City and County of Honolulu, and although the city has the financial capacity and borrowing power to pay for building the rail system, it is uncertain how city fathers expected to pay for running it.
Almost from the beginning, HART appeared to be coveting a tax surcharge extension. As early as 2012 the subject was included on a list of “future issues that will need to be addressed” contained in HART’s first annual business plan.
While HART officials publicly express their belief that Honolulu’s rail system will be completed on time and within budget, the looming cost overruns, for whatever reason, seemingly justify growing concerns about the project’s financial viability and how unanticipated expenses will be paid.