DALLAS – Three weeks into its new fiscal year, Kansas is facing a “good news-bad news” state finance scenario.

The good news is that the Sunflower State closed out its 2017 fiscal year with revenues running above forecast – albeit a reduced forecast -- and prospects for a balanced budget in the current year look promising.

The bad news is that a state Supreme Court hearing could lead to a special session of the legislature to provide as much as $839 million more for school funding over the next two years.

The court will hear oral arguments in the school finance case Gannon v. Kansas on Tuesday to determine if lawmakers provided sufficient funding for the next two fiscal years per the state’s constitution.

Under Senate Bill 19 approved by the 2017 legislature, K-12 public schools will receive about $195 million more in this budget year and about $290 million more in the following year.

For fiscal 2017, that brings state K-12 spending to $7.5 billion, including $4 billion from the state General Fund, up from 2016's $7.3 billion, of which $3.9 billion is from the General Fund.

While the state contends that SB 19 satisfied the court’s February order to increase school funding, the justices said the upcoming hearing is needed to determine if the amount is adequate.

Based on Kansas State Board of Education estimates, school districts are asking the court to provide $893 million more over two years.

In a 2005 ruling on school funding, the Supreme Court ordered the state to increase funding by more than $800 million over a number of years. While the state did raise school funding in response to the order, lawmakers reduced the funding when revenues slumped after the 2007-08 recession.

If the court overturns the legislature’s formula again, lawmakers may be called into a special session sometime this summer or fall to add additional funding.

That could require new taxing measures after an historic regular session in which lawmakers overturned Gov. Sam Brownback’s veto of a bill raising $1.2 billion through income tax increases. The measure effectively ended the controversial tax cuts Brownback urged fellow Republicans to pass in 2012, including a tax exemption for most businesses.

Brownback referred to the tax cuts as an “experiment” meant to show that lower taxes would improve the state’s economy. The economy remained flat and revenues fell.

In the wake of the tax cuts, Kansas ran revenue shortfalls that required a variety of one-time measures, including deep spending reductions and reliance on debt to balance the budget.

To counter the chronic shortfalls, state officials repeatedly lowered revenue estimates in hopes that the income would match the lower targets.

In November 2015, less than five months into the fiscal year, Kansas revenue estimates were lowered by $159 million, a move that required spending cuts, including a $48 million transfer from the Kansas Department of Transportation to the general fund.

At the same time, revenue estimates for the 2017 fiscal year that ended June 30 were lowered by $194 million.

In April 2016, the Consensus Revenue Estimate, prepared by a panel of university economists, legislative researchers and officials in the governor's administration, was again lowered by about $94 million for the 2016 fiscal year and by about $135 million for fiscal year 2017.

When the 2017 legislative session began in January, one-third of the seats were held by new lawmakers, many of whom opposed Brownback’s austerity measures to support tax cuts for business. Polling done mid-session showed that two-thirds of Kansas voters disapproved of the Brownback tax plan.

Kansas was not alone among the states in facing mid-year budget adjustments. This year, 25 states have faced or have addressed revenue shortfalls. More states expected mid-year revenue shortfalls than in any year since 2010, according to the National Association of State Budget Officers.

“The mid-year revenue shortfalls and resulting budget problems — some of which are due to state policymakers’ own ill-advised tax policy choices — that states are facing in 2017 appear to be the first signs of continuing problems,” the Washington-based Center on Budget and Policy Priorities noted in a March 30 report. “More than half the states lack the revenue needed to maintain services at existing levels in 2018. All told, two-thirds of the states are facing or have addressed revenue shortfalls this year, next year, or both.”

When the 2017 fiscal year ended June 30, the Kansas Department of Revenue could report that the state had actually exceeded the lowered estimates for the year by 1.26% and that the annual revenues exceeded those of fiscal year 2016 by $58.6 million, or 1.02%. Had June revenues not run $76 million or 13.5% over estimates, the fiscal year revenues would have been down slightly.

“Kansas will be climbing out of the Brownback experiment for years,” said Duane Goosen, senior fellow at the Kansas Center for Economic Growth and former state budget director. “The override vote did not fix all problems, but at least everyone can take a breath. Our political energy can now focus on the future rather than on crisis management.”

With the new revenue-generating tax increases, the state is now expected to have positive ending balances in the 2018 and 2019 fiscal years.

Despite the new revenue, the state's bond ratings aren't out of danger. S&P Global Ratings, which has a negative outlook on Kansas’ AA-minus rating, pointed to the school funding case as one factor that could affect the agency’s credit opinion.

“Uncertainties remain regarding the full cost of adequately funding K-12 education, even though the budget includes a plan to address underfunding of its schools as required by the court ruling in February, subject to the court's review,” analysts Oladunni Ososami and David Hitchcock noted in a July 5 report.

Moreover, the analysts noted that the $15.6 billion budget approved by lawmakers and signed into law by Brownback on June 25 remains problematic.

“The higher anticipated revenue, particularly from income taxes, is being neutralized in the biennium by the elimination of proposed one-time bridge funding from the securitization of tobacco proceeds,” the analysts wrote. The new budget’s elimination of bonds backed by tobacco settlement proceeds essentially removed about $440 million in one-time revenues, they said.

“We view the income tax increase as a more sustainable way to fund the state's ongoing appropriation, which may ease budget pressures in future years, all other things held constant,” they wrote. “However, the state still intends to fund its remaining budget gap primarily through transfers from its highway fund, resulting in slowdowns in the state's long-term highway capital plan and underfunding of actuarial annual pension contributions.

“While the enacted budget eliminates some of the pension funding deferrals, the state still intends to defer some of its payments in 2019, which will be repaid through layered amortization beginning in fiscal 2020, increasing out-year costs,” analysts wrote. “In addition, the budget continues to underfund the state's pension system on an actuarial basis.”

In December, Fitch Ratings downgraded $2 billion of KDOT bonds to AA-minus from AA-plus, citing the ongoing fund transfers to the general fund. The outlook returned to stable.

In 2015, the state issued $1 billion of pension obligation bonds to reduce the unfunded liability while protecting the general fund.

At the time of the bond sale, Moody’s Investors Service cautioned that the debt did little to resolve the state’s pension problem.

"Although the (pension obligation bonds) fit into a plan to achieve full pension funding by 2033, adding $1 billion of debt to do it represents a riskier strategy than the simpler alternative of making larger annual pension contributions," Moody's said.

When the legislature overrode Brownback’s veto of the income tax increase, Moody’s restored its outlook on the state’s Aa2 rating to stable from negative, saying the new revenues, representing 10% of the budget, “go a long way toward solving the state’s budget challenges.” The outlook had been negative since May 3, 2016.

“Kansas has the economic capacity to balance its budget, service its above-average debt burden, and make progress on funding its large net pension liabilities,” Moody’s analyst Dan Seymour wrote.

“The state’s chronic budget imbalances, repeated raids on its highway fund, and deferrals of scheduled pension contributions were essentially policy choices, not acts of desperation driven by economic hardship or fundamental inability to generate enough revenues to meet its obligations.”

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