SENATE BILL NO. 161 An Act relating to interest rates and calculation of interest under certain judgments and decrees and on refunds of certain taxes, royalties, or net profit shares; and providing for an effective date. Co-chair Pearce directed that SB 161 be brought on for discussion and referenced the original bill, CSSB 161 (STA), CSSB 161 (Jud), a $39.3 fiscal note from the Alaska Court System, four zero fiscal notes, the Governor's transmittal letter, and a position paper from the Dept. of Transportation and Public Facilities. She then directed attention to two amendments. DEBORAH VOGT, Contract Attorney for the Dept. of Law, and LARRY MEYERS, Director, Division of Oil and Gas, Dept. of Revenue, came before committee. Ms. Vogt explained that the bill was introduced by the Governor to address two issues: 1. Pre-judgment and post-judgment interest in civil litigation. The current rate is 10.5%. That is dramatically out of proportion to the current market. 2. Interest on back taxes and royalties. Speaking to pre- and post-judgment interest, Ms. Vogt explained that the original bill proposed to calculate interest on judgments in accordance with the system used by federal courts: a market-rate indicator tied to sales of federal treasury bills. Interest rates on judgments would then be tied to a realistic market rate that will fluctuate over time so that the statute does not subsequently have to be amended as the market rises and falls. Since the state is frequently the defendant in litigation, it seeks the new calculation because the current 10.5% is too high. Ms. Vogt noted that the legislature amended statutes dealing with interest on back taxes and royalties in 1991, setting a rather high floating market rate of five points above the federal discount rate, with an 11% floor. The taxpayer thus pays whichever is higher. The rationale for the relatively high rate of interest is the fact that taxes and royalties are the life-blood of the state. It is thus important that payments be timely made. The high rate encourages prompt payment and provides an incentive to resolve large, outstanding disputes. Since enactment of amendments in 1991, it has been perceived that the high interest rates could provide an incentive for "people to intentionally overpay" taxes in order to take advantage of a rate of return that could not be achieved in the market. That is the reason the issue is addressed in this legislation. Ms. Vogt next directed attention to CSSB 161 (Jud) and said that it accomplishes neither of the Governor's purposes. It sets a rate for pre- and post-judgment interest of five points above the federal discount rate--the intentionally high rate chosen for taxes and royalties. That is substantially higher than the rate proposed by the Governor. It is also higher than what the state can earn on its investments. The short-term rate of return for the past twelve to twenty-four months has been "in the three to four percent neighborhood rather than the eight percent" required under CSSB 161 (Jud). The state is opposed to the floating market indicator selected by Senate Judiciary. On the tax and royalty side, CSSB 161 (Jud) no longer does what the Governor intended. It does not establish a disparate rate between underpayments and overpayments. The Governor proposed the legislation to establish a differential--an element of federal tax law and tax law in many states. The Senate Judiciary Committee removed that provision as well as the 11% floor. That substantially lowers accruing interest on large, outstanding taxes and royalties. As the legislation presently stands, the administration can no longer support it. Ms. Vogt next spoke to Amendment No. 2. She explained that current law and proposed amendments submitted by the Governor use the language "percentage points above the federal discount rate." CSSB 161 (Jud) uses "percent above." That could be construed to mean that if the discount rate is three percent, five percent of three percent is .15 percent--a tremendous difference from the original intent. Amendment No. 2 thus replaces "percent" with "percentage points above" throughout the legislation. Senator Rieger asked if constitutional issues would be raised by application of differential rates of interest. Ms. Vogt explained that legislation proposed by the Governor did not differentiate between "types of civil suits." It differentiates between underpayment and overpayment of taxes and royalties. She further acknowledged that royalties involve civil dispute. That question was addressed in 1991 when royalties were separated out of other civil litigation and "lumped together with taxes," for purposes of interest rates. Discussion followed between Senator Rieger and Mr. Meyers regarding differential rates. Mr. Meyer noted that the Internal Revenue Services and ten states use different rates for underpayment and overpayment. Rates average 15% for underpayment and 9% for overpayment. In response to an additional question from Senator Rieger, Ms. Vogt explained that AS 45.45.010 sets both the legal rate of interest and the usury rate. The legal rate is currently 10.5%. Usury statutes speak to five points above the federal discount rate. That was not changed in 1991. Those provisions were merely incorporated into the tax and royalty statute. Further discussion of the usury rate followed. Responding to a question from Co-chair Frank, Ms. Vogt advised that CSSB 161 (STA) is similar to the Governor's bill, with minor changes. In further discussion of changes within CSSB 161 (JUD), Ms. Vogt explained that the Governor proposed interest equating to the federal reserve discount rate, plus two, for overpayments. Senate Judiciary changed that to five points- -current law. For underpayments current law requires "fed plus five or 11%, whichever is higher." Co-chair Frank asked why the federal reserve discount rate was not used for pre- and post-judgment interest as well. Ms. Vogt said that the administration based judgment interest on federal treasury bills since that standard is used by the federal court system. It is currently 3.49%. She then distributed a tabulation (copy on file) listing judgment interest rates under the federal discount rate, CSSB 161 (Jud), and treasury coupons. Co-chair Pearce referenced an arrangement whereby the former attorney general lowered the interest rate on taxes owed by a taxpayer in exchange for other considerations (statute of limitations was mentioned). Noting that that action was outside of statutory authority, the Co-chair then asked if changes in the proposed bill would allow that flexibility. Ms. Vogt said that if the action was improper under current law, it would be improper under the proposed bill. Statutory amendments contained therein do not address changes in discretion for enforcement of interest provisions. As a final issue, Ms. Vogt expressed concern that provisions of CSSB 161 (Jud) may no longer be consistent with the title because the legislation is no longer confined to judgments and refunds of taxes and royalties. It also addresses underpayments of those items since it removes the 11% floor and changes the manner in which interest changes and is compounded. Current law tracks the federal rate quarterly and is compounded quarterly. CSSB 161 (Jud) tracks annually and is compounded annually. Discussion followed between Co-chair Frank and Ms. Vogt regarding pre- and post-judgment interest. Ms. Vogt explained that, under current law, interest accrues from the date a suit is filed. Under both Senate Committee Substitutes, interest would accrue from the date of injury. Both the original bill and CSSB 161 (STA) set the interest rate as of the initial event (the date of injury or the date on which a suit is filed). That rate remains in effect until the date of judgment, at which time a new post- judgment rate is set and continues until payment of the judgment. Under the Senate Judiciary version, the rate changes. Ms. Vogt advised that the court system staff would speak to that impact. In response to further comments by Senator Frank regarding interest rates and inflation, Ms. Vogt said that the administration seeks to find "that number" which neither benefits nor penalizes the party "who didn't have the money who was supposed to have the money." It is not the intent to make pre- and post-judgment interest either a benefit or penalty to the litigant. It should provide neither an incentive to settle nor incentive to drag out a lawsuit in the hope that interest will continue to accrue at an unusually high rate. The administration believes that the treasury coupon rate is close. Five points above the federal discount rate is too high. Co-chair Frank noted that the treasury rate generally reflects the market while the federal discount rate may be used to effect the market. Senator Rieger voiced support for two separate rates of interest. He noted that in commercial transactions, the value of possession of the cash is much higher. In commercial transactions the five percent premium is probably necessary as an inducement to avoid dragging out the case. Ms. Vogt advised that the original bill and both Senate versions leave in current law provisions that allow parties to contract for different rates. That is likely to cover commercial litigation and is different from the default rate set in statutes. Mr. Meyers noted that refunds from the treasury currently earn between 3 and 4%. Those refunds are presently paid out at 11%. Lack of fluctuation and variance of the two rates is costing the state a considerable amount. The administration is proposing to do no different than banks which use different types of rates. Since the 11% floor was established in 1991, the state collected over $1.7 billion in settlements. The interest rate was a primary motivator in reaching agreements. Mr. Meyer expressed concern that if rates are too low, there will be no incentive for parties to "get together." The floating floor is intended to provide inducement. The department has over $3 billion in interest, relating to outstanding settlements, on the books. In response to questions from Senator Rieger, Mr. Meyer advised of "provisions for failure to file or failure to pay of 5% a month, not to exceed 25%." There are thus penalties in addition to interest. Penalties only arise in instances relating to filing and compliance in payment of tax returns. They do not apply to settlements whereby taxpayers have filed and paid what they believe they owe, and the amount is in dispute. Penalties are not imposed in those instances. Co-chair Frank inquired regarding overpayments following 1991 interest rate changes. Mr. Meyers said for the period commencing July 1, 1991, and ending March 15, 1992, the state paid out $8.8 million. For the same period through 1993, a total of $22 million was paid. From July 1, 1993, to March 15, 1994, payments total $65 million. In one instance for which the department "paid out a refund of the tax of $31 million, interest was $8 million." On that $8 million in interest, the state treasury earned $2 million. The taxpayer earned 11% on the refund which sat in the state treasury for two years, and the interest payment cost the state $6 million. CHRIS CHRISTENSEN, General Counsel, Alaska Court System, next came before committee. He explained that CSSB 161 (Jud) establishes an immediate effective date for the legislation. At the request of the Court System, CSSB 161 (STA) provided a delayed effective date of sections relating to court judgments. Mr. Christensen directed attention to proposed Amendment No. 1 and explained that it changes the effective date for judgment interest to January 1, 1995. At the present time, court system computers cannot perform the interest calculations required by the bill. They will have to be reprogrammed, associated forms and booklets provided to litigants will have to be revised, and personnel will have to receive additional training. A six-month window would be helpful. Reviewing the amendment, Mr. Christensen noted need to change the January 1, 1995, date to January 2, 1995. He said that would be in keeping with a further change within CSSB 161 (Jud), requiring that the interest rate change on January 2 of every year. Mr. Christensen further remarked that additional changes made by Senate Judiciary have the effect of doubling personal services costs on the fiscal note from $7.4 per year to $19.5. Proposed Amendment No. 1 would reduce the note by approximately $10.0 for FY 95 since new interest rates would only be in effect for half of the fiscal year. The Senate State Affairs bill calls for two interest calculations: one for pre-judgment interest and one for post-judgment interest. CSSB 161 (Jud) calls for the interest rate to be recalculated every year for ongoing cases. An individual who is injured and files suit two years thereafter and receives a judgment three years hence is entitled to pre-judgment interest for five years. The specific rate will be different for each of the five years. Further if payment on the judgment is not made for approximately three years, post-judgment interest will also be different for each year. In a number of cases, instead of performing two interest calculations, the court system will perform six or eight or ten. That translates into extra clerical time. The court system presently makes approximately 10,000 calculations annually. Most are small claims cases, however it takes equally as long to calculate interest on small amounts as it does for larger cases. Further, the court system is responsible for recalculating figures presented by attorneys. If this is not done, and an incorrect interest figure is applied, the state may be liable for the difference. Co-chair Pearce queried members concerning disposition of the bill. Co-chair Frank voiced a preference for the original bill. Senator Rieger acknowledged that he also was more comfortable with the original version. Senator Sharp termed the Senate Judiciary version "too fat" because of provisions allowing for 5 points over the federal discount rate. That more than doubles the market interest rate for the past several years. He voiced a preference for the Senate State Affairs bill. Co-chair Pearce asked that Senators Rieger and Sharp work on an alternate draft to bring back to the next meeting. SB 161 was thus HELD in subcommittee.