A Closer Look at S&P’s Bond Rating Downgrade of Oklahoma
July 13, 2017 - 3:15pm CDT
By William Freeland and Jonathan Small
Earlier this year, Standard & Poor’s (S&P) downgraded Oklahoma government debt a notch. According to a March 1, 2017, “ratings action” memo: “S&P Global Ratings lowered its rating on the state of Oklahoma's general obligation (GO) bonds and appropriation debt backed by the state's credit enhancement reserve fund one notch to 'AA' from 'AA+'. At the same time, we lowered our rating on the state's appropriation debt to 'AA-' from 'AA'. The outlook is stable.”
S&P cited recent revenue shortfalls, which they categorize as “persistently weak revenue collections.” Moreover, they essentially view Oklahoma as having a structural, persistent lower pattern of state revenue collections relative to the trajectory of state government spending—while treating that spending trend as somewhat sacrosanct and largely escaping their fiscal scrutiny. They also cite an underperforming economy, particularly noting the Oklahoma state economy’s focus on energy extraction, which has seen lower prices depress the state’s economic growth in recent years.
S&P’s partially stated and fully implied remedy is additional stable revenues to be raised by the state, in addition to enhancing the level of the state’s rainy day fund and an improvement in state economic performance generally.
In a new report published by OCPA, we suggest that S&P’s downgrade of Oklahoma state government debt should be considered with a healthy degree of skepticism.
S&P has a dubious track record of accuracy, objectivity, and impartiality in bond ratings. These ratings advise debt investors on the relative risk of failure to receive consistent, timely interest payments and, more drastically, loss of initial investment principal through debt default. S&P ranking of this risk often exhibits an agenda that can be difficult to detect, leaving their assessments with potential bias and questionable accuracy relative to the true underlying risk of the debt they rank.
Moreover, analysis of Oklahoma’s fiscal positions by other credible organizations, as well as a review of available data, suggest a much stronger fiscal position than S&P recognizes in their recent ratings action. Even S&P itself, in maintaining a “high, investment grade” credit ranking for Oklahoma state government debt, recognizes the state has a much stronger fiscal position than many flawed media reports and opportunistic, agenda-driven commentary by some policymakers seems to suggest.
S&P’s ratings have been substantially incorrect in the past and, worse still, they have been systematically biased. Additionally, the agency is likely overly concerned with the short-term interests of bondholders of state debt, and grossly under-appreciating the long-run potential of economic growth and the benefits of a less volatile tax regime.
Still, there is some truth in S&P’s concerns regarding Oklahoma’s recent revenue shortfalls. Public policy must address these concerns. Unfortunately, both S&P and key executive-branch officials in Oklahoma provide the wrong solution.
Oklahoma’s anemic economy, in part caused by low energy prices but more broadly due to issues in economic competitiveness, must be addressed to solve the problem of chronic revenue shortfalls. This means enhancing economic competitiveness in Oklahoma through pro-growth economic reform, not further stymieing the economy through higher taxes.
Oklahoma needs to diversify its economy by fostering substantive growth in industries outside the energy sector. This will bolster overall economic performance, increase earnings and the performance of labor markets, and reduce the impact of energy prices on Oklahoma’s economic well-being and on annual tax returns.
The only viable pathway to substantive diversification through broad, fast-paced, dynamic economic transformation is by creating a climate that offers a more competitive economic policy regime to entrepreneurs.
William Freeland is an independent public policy analyst, research economist, and data scientist with a decade of experience in public policy research and advocacy. He has worked as a research analyst and economist for the American Legislative Exchange Council (ALEC), as an economist at the Tax Foundation, and as a member of the research faculty at the George Mason University Law and Economics Center.
Jonathan Small is the president of the Oklahoma Council of Public Affairs. A Certified Public Accountant, he previously served as a budget analyst for the Oklahoma Office of State Finance, as a fiscal policy analyst and research analyst for the Oklahoma House of Representatives, and as director of government affairs for the Oklahoma Insurance Department. Small’s work includes co-authoring “Economics 101” with Dr. Arthur Laffer and Dr. Wayne Winegarden.