Opponents of a bill passed on Nov. 5 to reduce the state’s sales tax fear it could be the straw that breaks the camel’s back and destroys South Dakota’s AAA bond rating – a charge that supporters of the bill deny.

The measure would eliminate the state sales tax on groceries, but opponents say the vague language could extend the impact to other goods and services. That uncertainty prompted the state’s Legislative Research Council to offer a rough estimate of the state government’s potential revenue losses from the measure, which it said would range from $134 million to $646 million annually.

This would compound the budget impact of a temporary, across-the-board reduction in the state sales tax from 4.5% to 4.2%. This reduction was enacted in 2023 and is set to expire in 2027. The cost of this decision is estimated to be over $100 million annually while it is in effect. The state’s total budget is about $7 billion.

Republican Matt Michels helped the state earn its AAA rating when he served as lieutenant governor to Gov. Dennis Daugaard from 2011 to 2019. Michels said the budget hole created by the ballot measure and the resulting fight to eliminate it in the Legislature could lead to a rating downgrade.

“Money runs away from instability,” Michels said.

Impact of food tax vote could be between $134 million and $646 million, lawmakers said

On the other side of the debate, Augustana University economics professor and Democratic Sioux Falls state senator Reynold Nesiba supports the ballot proposal and is not concerned about its potential impact on the bond’s credit rating.

“Democrats care about fiscal responsibility, but we also care about the state’s obligations to South Dakota families,” he said. “Forcing people to pay a tax before they eat is just wrong.”

Nesiba said if the measure passes, lawmakers should respect the measure’s limited intent to eliminate state sales taxes on groceries. He said raising general state sales taxes to 4.5% would give credit rating agencies little cause for concern.

An independent expert, Donald BoydCo-director of the State and Local Government Finance Project at the Center for Policy Research at the University at Albany in New York, said in an emailed statement that passing a tax cut without a plan to finance it could affect credit rating agencies’ opinion of the state.

“If everything else remains unchanged, that would be negative in the eyes of the rating agencies,” Boyd said. “Whether it is negative enough to affect the credit rating is another question.”

Explanation of bond ratings

One way for the government to finance public projects is to sell bonds to investors and then pay back the money over time with interest.

Agencies such as S&P Global rate bond issuers based on their creditworthiness, with the highest AAA rating going to those with the strongest repayment capacity. Governments with better ratings can get lower interest rates on their bonds, resulting in lower debt payments.

South Dakota Upgrade from AA+ to AAA occurred under Republican Governor Dennis Daugaard in 2015 and 2016, when all three major rating agencies made the change. The agencies attributed the upgrade to the state’s healthy savings, conservative budget approach, long-term financial planning and fully funded pension fund for state employees.

“We knew we would save taxpayers a lot of money,” Daugaard said.

The ratings also benefit the state’s administrative units, such as school districts. School districts in South Dakota have saved over According to Nancy Van Der Weide, spokeswoman for the South Dakota Department of Education, $33 million in interest has accrued since the upgrade on new construction, land purchases and debt restructuring.

Seventeen States have a AAA rating. Ratings are non-political; South Dakota’s Democratic-leaning neighbor Minnesota has a AAA rating thanks to its large and diverse economy and healthy savings and earnings. Nebraska and Iowa are South Dakota’s other AAA-rated neighbors.

Complicating factors

Republican Rep. Tony Venhuizen of Sioux Falls is Daugaard’s son-in-law and served as his chief of staff. He is concerned about the impact of the sales tax vote on the state’s credit rating.

“Cutting one of our most reliable sources of revenue through a public vote without a plan to pay for the lost revenue does not look good to these credit agencies,” he said.

Nathan Sanderson, executive director of the South Dakota Retailers Association, is part of a coalition opposing the ballot measure and served as Daugaard’s director of policy and operations when the higher credit rating was reached.

He said his former boss was able to overcome the skepticism of credit rating agencies that suggested South Dakota relied on a single revenue source for most of its income: the sales tax.

“Daugaard has shown that even though we only have a sales tax, we are really, really fiscally responsible,” Sanderson said. “Someone with limited income can get a large loan at a low interest rate if they live within their means, build solid savings and pay their bills on time.”