Fiscal Notes, June 2001, Page 2

June 2001

On this page:
Boom Without the Bust
Feds Rule
Pharmaceutical Reprieve

On Page 1:
Conservation Vacation
From our Readers
From the Comptroller: Budget Warning
Comptroller News

Texas stats -- Fiscal and economic data

En español: Notas Fiscales de junio 2001

Texas commercial construction
not repeating past mistakes
Boom Without the Bust

The Texas economy may be slowing, but it hasn't stalled. New commercial construction around the state indicates that few expect the current slowdown to be a reprise of the bust of the 1980s.
Since 1998, the Texas construction industry has been the fastest growing sector of the state's economy. In 1998, the industry posted a job growth rate of 7.7 percent, compared with 6.4 percent in 1999 and a predicted 5.2 percent for 2000.
Industry growth should continue, but at slower rates over the next few years. The Winter 2001 Texas Economic Update from the Texas Comptroller of Public Accounts forecasts construction job growth of 1.7 percent in 2001, 1.3 percent in 2002 and 1.6 percent in 2003.
A slower pace than the late 1990s could be a blessing, because it will alleviate a labor shortage that has created difficulties for the industry.
A cushion of oil
In Houston, construction has been strong for about four years, and the forecast for the rest of 2001 is good. Bill Gilmer, vice president and senior economist for the Houston branch of the Federal Reserve Bank of Dallas, says Houston's construction is in line with property sales and rentals, and the city can expect to skip much of the slowdown the rest of the nation may experience in the coming months.
Gilmer says the petrochemical industry will suffer as oil and gas prices rise, but other energy sectors such as exploration will benefit.
"I don't see Houston slowing down much," he says.
Barton Smith, the director of the University of Houston's Institute for Regional Forecasting, agrees. Smith says commercial development in Houston is slowing due to concerns about the economy and extra space still left from overbuilding in the 1980s, but he expects the slowdown to last no more than 12 months.
"The current economic woes of the nation are giving everyone the jitters, but as those fears abate, things will pick up," he says.
He also predicts the national economy will be better by the end of 2001, but says Houston will be hit less hard by the slowdown than many parts of the country because 48 percent of its economy is energy-based.
"Energy is cushioning the blow," he says, but the non-energy part of the Houston economy will slow with the rest of the country.
It's not 1986
Smith says the 1980s left Houston with so much space to absorb, the city did not need to start building again until 1997. With continued job growth, more space will be needed.
"Houston's building activity is just coming back," he says.
Smith and Gilmer both say overbuilding is not an issue for Houston in the short term because of strong job growth in the last five years and because lenders employ more conservative lending practices than they did 17 years ago.
In the 1980s, Smith says nearly half of the more than 80 million square feet of office space that came onto the Houston market in 1984 was built on speculation. In January 2001, The Houston Business Journal reported that of the city's 4.7 million square feet of office space under construction, 83 percent was pre-leased or committed.
Vacancy--so what?
In Dallas, construction has resulted in high vacancy rates, but area brokers are not concerned the city is overbuilt.
"I don't see any cause for alarm," says Scott Byrne, executive vice president for the North Texas Commercial Association of Realtors.
CB Richard Ellis, a real estate services firm based in Los Angeles, reported the Dallas office market had the highest vacancy rates in the country in the fourth quarter of 2000, with more than 4.1 million square feet of space still under construction. Dallas posted an overall vacancy rate of 15.1 percent.
Reagan Dixon, vice president and chief operating officer of Cawley Wilcox Cos., says that at the end of first quarter of 2001, about 7.3 million square feet of space was under construction in Dallas, 30 to 40 percent of which was pre-leased.
"I think overbuilding is a misnomer because we had such great absorption in 2000," Dixon says. He admits that in the first quarter of 2001 more tenants moved out of Dallas commercial space than moved in--resulting in an additional 192,000 square feet of vacant space.
If 2000 is any indication, though, Dallas may not have to worry about the recent dip. CB Richard Ellis indicates the 2000 fourth quarter rate was a decline from the third quarter rate of 15.33 percent and from the 1999 fourth quarter rate of 17.8 percent. Also, the Dallas-Fort Worth area led the nation in job creation in 2000 by adding nearly 103,000 jobs. Dixon says that job creation will continue to promote absorption.
Dixon says the national economic slowdown will be reflected in Dallas' market, but he is not worried about Dallas' prospects.
"We're still a prime area," he says. In addition to job creation, the city boasts the busiest airport in the country, affordable land, comparatively low cost for space and a Central time zone attractive for communicating during business hours from coast to coast.
In January 2001, Dallas' first-class office space leased for $24.92 per square foot--more than Houston, at $22.03; San Antonio, at $19.59; and El Paso, at $15.50--but less than many major cities around the country. In Texas, only Austin rents, $30.97 in January 2001, were higher. And Dixon expects Dallas' rates to decline.
It's about perspective
Austin commercial construction took a hit in the first quarter of 2001, but industry watchers in the area say the bump does not signal a recession for the city.
"I would term it a return to normalcy," says Charles Betts, executive director of the Downtown Austin Alliance, a nonprofit dedicated to redevelopment of Austin's central business district.
Betts says the city has been in a protracted boom, due largely to the city's high-tech sector. The high-tech industry is constricting somewhat, but demand for space in the city is still high.
At the end of 2000, CB Richard Ellis reported that 170,648 square feet of new construction was completed in Austin in the fourth quarter of 2000, with 92 percent of it pre-leased. Average rent rates dropped from $26.91 in the third quarter to $25.66 in the fourth quarter, but that was still $2.49 higher than the fourth quarter of 1999, and Ellis analysts foresaw continued demand. Indeed, the average January 2001 rate rose.
Also in January 2001, several Austin high-tech companies announced layoffs, including Dell Computer Corp., Motorola, Vignette Corp. and Multilayer Technology Inc. The layoffs were followed by the announcement that some companies were putting expansion plans on hold indefinitely.
The most glaring example was Intel. In March, the high-tech company announced it was halting construction on a 10-story downtown building, with the shell of only six stories erected. Computer Services Corp. also elected to build only two of the three downtown office buildings it originally planned.
Moody's Investors Service and Merrill Lynch Research labeled Austin risky.
Frank Niendorff, president of NAI/Commercial Industrial Properties Cos., says that despite such high-profile reversals, Austin is in good shape.
"Right now, if a [developer's] project is not financed, it probably for the foreseeable future won't get financed," he says.
But, he notes, a number of projects in all categories of commercial real estate--office, industrial, retail and multi-family--are still moving forward in Austin. Some companies are still growing and hiring, and a company that wants to expand its operations and can demonstrate its stability will still have access to financing.
"The national perception is that Austin has a problem, but the reality is our vacancy rates are not that high," he says.
Niendorff points out that the city has had vacancy rates of only 3 to 6 percent for a couple of years, so an adjustment that brings more balance to supply and demand is not a crisis.
Niendorff expects about 2.7 million feet of new office space to come onto the market by June 2001. On January 1, 2001, about half of that space was pre-leased. Niendorff says some of those leases may fall through, but the city's vacancy will likely rise to no more than 10 percent, still less than Dallas or Houston.
Niendorff attributes the city's higher rents partly to demand for space and partly to higher construction costs in Austin. Austin is a city with strong environmental regulations, and that can make building more difficult than in other parts of the state.
"In order to have enough building supply, you have to go through an inordinately difficult permitting process," he says.
The process can lead to delays and higher expenses.
No worries
The bottom line for commercial real estate in Texas is that construction is slowing from the last few boom years, but real estate brokers and analysts at the Comptroller's office say there is little cause for alarm. Thanks to more conservative lending and developing practices and continued job growth, commercial supply will be more in line with demand.
Suzanne Staton

New federal statistical standards
could label rural towns urban
Feds Rule
The feds have done it again.
Before the last presidential administration left Washington, D.C., the federal Office of Management and Budget (OMB) dropped a Byzantine plan for geographic statistical definitions on the states. The definitions, based on U.S. Census Bureau data, blur the distinctions between some communities and obfuscate definitions of rural and urban areas, giving some of Texas' most rural areas urban designations. More importantly, the definitions could affect how much, if any, federal funding an area gets.
OMB creates new statistical areas called Core Based Statistical Areas that are divided into Metropolitan Statistical Areas, which include Census Bureau-designated urban areas of more than 50,000 people, and Micropolitan Statistical Areas which include Census-labeled urban clusters of between 10,000 and 50,000 people.
The new standards became official on December 27, 2000. By 2003, OMB will define statistical areas based on 2000 Census data. The standards are supposed to be used only for statistical purposes, but some federal agencies use them in determining qualifications for federal funds.
A ruckus
When the new standards were first announced in August 2000, OMB posted a map showing which counties would be Metropolitan Core Based Statistical Areas, Micropolitan Statistical Areas or neither, if 1990 census figures were used. Some of the metropolitan areas combined major cities under a single name, leaving one or more cities out of the title. Minneapolis-St.Paul, for example, would become the Minneapolis combined area.
In some of the more timid parts of the country, there were only perfunctory objections. Reaction to a proposal to call Dallas-Fort Worth the Dallas combined area, however, was not timid. The publication of the proposed statistical standards in the August 22, 2000, Federal Register brought 1,672 comments nationwide; 1,314 from Fort Worth.
"We had similar protests in other parts of the country--Minneapolis-St. Paul, Oakland-San Francisco--but nothing like the volume from Fort Worth," says Michael Ratcliffe, a Census Bureau geographer who advised OMB on the statistical areas. "I've worked on a number of Federal Register issues and never got that number; 1,300 is definitely a record."
Under the proposed plan, Tarrant County--Fort Worth--could not be a separate metropolitan area because more than 15 percent of its residents work in Dallas County. But, after the protest, OMB removed the commuter standard. In December 2000, the feds announced the region would be called the Dallas-Fort Worth-Arlington statistical area.
Ranch goes urban
In most of the United States, metropolitan and micropolitan statistical areas are designated by counties or groups of counties. In New England, they are designated by cities and towns. But this county standard can lead to some curious designations.
Kenedy County in South Texas is the third-least populous county in the state. The 2000 Census puts 414 people in a county with a land area of 1,457 square miles--about 0.28 people per square mile.
Kenedy makes up part of the King Ranch and, in 1999, the county had 108 times more cattle than people. It has only four businesses that are not farm- or ranch-related, and they all have fewer than 20 employees. There were no retail sales in Kenedy County in 1999. It is one of nine Texas counties with only one school, and that school is the smallest of the nine, with just 79 students.
Yet, according to OMB, Kenedy County is micropolitan.
In 2000, OMB applied the new statistical standards to counties using 1990 Census data. Kenedy didn't get its designation because it had a population explosion; in fact, the county had 46 fewer people in 2000 than in 1990. But the city of Kingsville, in neighboring Kleberg County, is labeled an urban cluster by the Census Bureau and Kenedy is considered an outlying county to the cluster because more than 25 percent of the county's residents commute to Kleberg.
"I'm surprised we're not considered rural," says Barbara Turcotte, Kenedy County district and county clerk. "There's no retail businesses in the county, not even a convenience store."
Turcotte also questions whether 25 percent of the population commutes to Kleberg County.
"Most of the people in Kenedy County work on ranches in the county," she says. "Some of the younger group might [go to Kleberg]."
What's rural?
Although a county like Kenedy may be included in a metropolitan or micropolitan area, that doesn't mean it is urban, the Census Bureau's Ratcliffe says. Commuting to an urban cluster "just indicates an economic link," he says. "It doesn't say anything about it being rural or urban."
The distinction is important because whether an area is rural or urban dictates the kind of federal funding that may be available. Ratcliff says the purpose of the standards is not to establish federal funding formulas, but to provide nationally consistent definitions for collecting, tabulating and publishing federal statistics.
"In other words, to make sure that when the Bureau of Labor Statistics publishes data for, say, the Houston metropolitan statistical area, it is using the same boundary as is used by the Census Bureau, the Bureau of Economic Analysis and other statistical agencies," he says.
The December 27, 2000, OMB notice of the standards for statistical areas cautions other agencies that "programs that base funding levels or eligibility on whether a county is included in metropolitan or micropolitan statistical area may not accurately address issues or problems faced by local populations."
Ratcliffe says agencies sometimes ignore OMB. An agency such as the U.S. Environmental Protection Agency may use the standards to apply air emissions policies to an entire metropolitan area, even though a more rural county in the statistical area is in compliance with the U.S. Clean Air Act. He also says decisions by policy makers can affect funding if, for example, a rural county is included in a metropolitan or micropolitan area.
"I think the tendency has been for policy makers to look [at the county] and say it is now urban," Ratcliffe says. That could lead to agencies not considering a county for a particular kind of funding, if bureaucrats assume the county doesn't need the assistance.
Why it matters
The February 2001 Texas Comptroller of Public Accounts report, Rural Texas In Transition, gives examples of why it matters how rural areas are defined.
"Both the use of county-wide statistics--which is how the numbers are collected by the federal government--and the non-metropolitan requirement can prevent otherwise eligible communities and counties from receiving aid" under an economic recovery program administered by the U.S. Forest Service, according to the report. San Jacinto County, for example, has received assistance under this program because more than 60 percent of the county is in the Sam Houston National Forest.
The county has a narrow economic base, "a high level of persistent poverty" and large numbers of residents commuting out of the county to work. But, according to the Comptroller's rural report, "under the new 2000 metropolitan definitions, San Jacinto County would have been considered part of the Houston metropolitan statistical area in 1990" and not eligible for some of the grant funds.
Communities can lose out because of the countywide statistics for income. New Waverly, in Walker County, is on the edge of the national forest. The Comptroller's rural report says it "would seem to be just the type of small community the [Forest Service] economic recovery program was designed for--non-metropolitan, less than 10,000 residents, close to a national forest and economically dependent on forest-related industries."
Wrong. New Waverly loses out because Walker County will be designated a micropolitan county with a population that doesn't earn sufficient income from forest-related industries, according to the rural report.
No relief
The new statistical standards had been in development for several years and were issued in the waning days of the previous national administration. The Office of Management and Budget is an agency of The White House.
On January 20, 2001, the first day of the new administration, White House Chief of Staff Andrew Card Jr. issued a memorandum directing department and agency heads to put a hold on all new or proposed regulations until they could be reviewed and approved or rejected.
"Emergency or other urgent situations relating to health and safety" were exempted, Card says.
Ratcliffe says, however, the statistical area standards "didn't fall under the Card memo. They're not statutes, just rules."
And they are likely to stay.
"The rules aren't going to change," Ratcliffe says. "I think we do anticipate some change in boundaries."
After OMB gets the latest data from the Census, including commuting data, boundaries will be drawn, but not before getting "input from local officials on combined areas," he says. "That's part of the change that came about as a result of Fort Worth."
Daryl Janes

Proposed change would cut cost of
prescription drugs given to convicts
Pharmaceutical Reprieve
Texas state government provides a wide variety of medical services to state prisoners. Among those are prescription drugs. In fiscal 1999, Texas spent about $28 million on drugs for state prisoners and the cost of medication is rising sharply.
The Comptroller's December 2000 e-Texas: smaller, smarter, faster government report outlines some simple administrative changes that would allow the state to take advantage of deep discounts in drug prices and save more than $25 million over the next five years. SB347 by state Sen. J. E. "Buster" Brown to implement these changes was approved by the Legislature in May 2001.
The U.S. Congress first addressed the rising cost of pharmaceuticals used in government programs by creating a Medicaid rebate program in 1990.
Drug manufacturers were required to give Medicaid the "best price" for each drug covered under the plan. Drug manufacturers, however, minimized the rebates' impact by raising their best prices, eventually increasing rather than easing the burden on federal and state providers.
Discount dose
In 1992, Congress amended the Public Health Service Act to cure this loophole. Now drug manufacturers participating in Medicaid must enter into a second agreement with the federal government to provide additional, negotiated discounts on covered drugs purchased by certain government-supported facilities.
According to the Public Hospital Pharmacy Coalition (PHPC), pharmaceutical prices available under Section 340B of the public health act are significantly lower than both wholesale and retail prices. A recent analysis of 100 popular outpatient drugs found that, on average, 340B prices are 34 percent lower than wholesale. PHPC estimates that participating hospitals have saved an average of more than $2 million annually since Congress created the drug pricing program.
Contract cure
The Texas Department of Criminal Justice (TDCJ) relies on a Correctional Managed Health Care Committee to obtain correctional health services. The committee, made up of representatives of TDCJ, the University of Texas Medical Branch at Galveston (UTMB) and the Texas Tech University Health Sciences Center administers managed health care in the state's prisons. Through contracts with the committee, TDCJ acquires medical services from UTMB, which serves about 78 percent of the prison population, and Texas Tech, which serves 22 percent.
UTMB purchases all drugs for prison health care, including those used by Texas Tech personnel. UTMB qualifies for the 340B program, yet because of certain federal accounting requirements, 340B prices are not available for prison drug purchases. For example, to receive the discount, drugs administered by Texas Tech health care professionals would have to be obtained through a direct contract with UTMB, instead of the contract with the committee.
Such administrative changes could yield substantial savings. Maria Mendez-Lewis, a Comptroller's office analyst says, "This is a good way for the state to buy drugs at lower prices. Texas prisoners will get the same quality of care, but Texas taxpayers will save money."
The pharmacy coalition estimates Texas could save about 22 percent on prison drug purchases by qualifying for the discounted prices. This would translate into a $25.4 million gain to the state by 2006.
Bruce Wright

State traders making
tobacco funds grow
A Crop of Cash
When the 1999 Texas Legislature divided up the first proceeds of the multi-billion dollar tobacco lawsuit, lawmakers gave part of the money to the Comptroller of Public Accounts to create endowment funds. Interest from these endowments pays for a variety of health programs, including health care for the indigent.
The Comptroller's Treasury Division was managing about $1.37 billion from the tobacco settlement by December 31, 2000. Its in-house trading desk manages that part of the endowment funds invested in fixed-income items and the division has outsourced the equities portion of the portfolio to 17 external managers.
More flexibility
"When the Legislature gave us the job of managing this portion of the tobacco settlement money, we also received legal authority to invest in a wide range of investments, including corporate bonds and stocks," says Mike Doyle, director of the Treasury Division.
"We have the flexibility necessary to take advantage of investment opportunities when they arise." Doyle says. "With more investment vehicles, we actually don't add to our risk, we can reduce it because the risk can be diversified into more areas."
Following the money
About 30 percent of the tobacco settlement money the Treasury Division is responsible for is invested in fixed-income items that the division's in-house trading desk manages on its own. The remaining 70 percent is invested in equities.
About 80 percent of the equity portion of the portfolio is invested in American companies, ranging from those known for their growth potential to others purchased for their stability. The remaining 20 percent of the equity portfolio is invested in international companies.
"The foundation has been built," says Susan Anderson, the Comptroller's Chief Investment Officer. "We've created a prudent portfolio to support these endowment funds over time and into perpetuity. This is not a short-term portfolio. We have to take into consideration the long-term needs of the funds' beneficiaries."
Good trade
The Treasury Division's trading desk, has an excellent record in managing fixed-income investments.
"Since the trading desk was created in the 1980s, the desk has developed an excellent reputation," says Anderson.
During the fourth quarter of 2000--the first quarter that the fixed-income portion of the tobacco settlement portfolio was fully invested--the desk outperformed 85 percent of similar funds in the nation. The Shearson Lehman Aggregate Index, the benchmark for similar portfolios, had a 4.21 percent return, while the trading desk reached 4.8 percent.
"The trading desk staff has an amazing market sense, and they are very good at using economic data to predict market moves," says Traci Salinas of Seattle-Northwest Securities Corporation. "They're better than any highly paid chief economist on Wall Street."
"We are justifiably proud of our track record," Anderson says. "We have stock managers and brokerage firms from around the country calling us to see what we think is going to happen in the financial world. The reason is that word has gone out that we know what we're doing, and we're doing it well."
Pam Wagner

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