Often state and local governments borrow money for capital projects when the economy is good and there is plenty of money for debt service. But when the economy crashes, officials get timid about debt, tightening the purse strings on new borrowing and spending. The problem with that is that economic downturns are the best time to borrow and spend on capital projects because they create jobs. A new set of recommendations from the Washington Commission on State Debt would take a step toward addressing a structural problem in the state’s constitution that makes it harder to borrow for job creating projects when times are tough.
First, a bit of background on how we do debt in Washington. In the first place, almost everyone in politics is paranoid about too much debt. Remember the big debt ceiling debacle over the summer in Washington DC? Politicians respond to the word debt because they think of public debt like a huge credit card that the government uses irresponsibly. Republicans and the press have made debt bashing de rigueur for politicians at all levels, and now even Democrats parrot the government-as-shopaholic meme.
But the truth is that debt is an important tool to get big things done. Virtually every big capital project in the private sector relies heavily on borrowed money. And if you have a mortgage, college loans, or even short-term credit card debt you’ll understand that using credit can be an important way to achieve an otherwise impossible end. The same is true for state and local governments. Debt allows cities, counties, and transit agencies access to cash now to create improvements that will generate benefits to tax payers over time. More after the jump.
Our Constitution has enshrined debt limits at the state and local level mainly because of the fear of government going wild with its ability to borrow. Without debt limits, the cupidity of local politicians pander for reelection would allow them to run up all kinds of debt that we couldn’t pay off.
To prevent that, Article 8, section 1 of the Washington State Constitution limits annual debt service payments, both principal and interest payments, to nine percent of the average of the previous three years of general state revenues. And debt fears mean that legislators have statutorily kept the limit below the Constitutional debt limit.
But think about it for a minute. If the debt service—like monthly credit card or mortgage payments—is tied to revenue, what happens when the economy goes into the tank?
When times are bad, revenues go down, limiting the amount of debt service the state can pay. That means just at the time big spending on infrastructure projects would be helpful to create jobs and spur the economy, the limit kicks in choking off the ability of state government to make prudent investments.
The Commissions recommendations to address this problem are smart and sensible and much needed.
The Commission recommends amending the Constitution to smooth the level of bond capacity over time by 1) calculating average general state revenue over a six year period instead of the existing three year period, 2) adding the state property tax to the definition of general state revenue, and 3) decreasing the debt limit percentage from nine percent to eight and three-quarters percent.
It’s modest but these changes in the way the debt limit is calculated would give the legislature a better footing to borrow for job creating capital improvements. It doesn’t blow the lid off the debt limit, but it makes an adjustment so the limit isn’t so jagged over time. Increasing the number of years from 3 to 6 and factoring in state tax revenue will help.
Lots of important kinds of debt aren’t covered by the state debt limit. Local debt, for example, is tied to a percentage of assessed property evaluation and transportation debt is connected to gas tax revenue. And, generally speaking, revenue bonds are limited only by the revenue use to generate the debt service, like sales or use taxes.
The Commission’s recommendations are, maybe, a first tentative step toward what could be the abolition of debt limits at the state and local level. We don’t need constitutional or statutory debt limits; they tend to be based more on politics than practicality, on fear rather than planning for the future. Infrastructure investments to support Transit Oriented Development would, in the long term, benefit from a loosening and end of debt limits.
The best debt limit we have is the bond market—that is, the people who lend state and local government money. If state and local government manage finances well, lenders and investors will line up to loan us money at reasonable rates. If we do stupid things that crash our economy (like continually failing to pass an income tax) the lenders will increase the interest they charge us or not lend to us at all. The best debt limit is the one that comes from having good credit, which means sensible spending but also fair and progressive revenues.
The Debt Commission will approve the final recommendations this Wednesday, November 30 in Olympia.
Here it is Europe is about to go to having wheelbarrows of Euros pay for basics… and you guys wanna increase debt?
I know you guys are progressive, I kinda agree much needs to be done to stimulate the economy besides 1-tune tax cuts, but this isn’t going anywhere.
You have oversimplified this post.
It’s not about “wanting to increase debt.” It’s about shifting the time we borrow to fund public projects from “good times”—when interest rates are high and the stimulating effect of government spending is lower—to “bad times”—when the cost of borrowing is lower and the stimulating effect of government spending is higher.
But I suppose if you’ve bought into the militantly anti-Keynesian neo-Conservative rhetoric no amount of government spending will make you happy.
Obviously, Joe, you agree that we need to build public infrastructure. Right now our system forces us to fund that investment by borrowing at the wrong time.
I identify as a progressive and think that government is an appropriate vehicle for solving “big” problems and for coordinating public infrastructure.
But my years on this planet have also found that governments have often spent in deficit mode in “bad times” like good Keynesians , but also, governments almost invariably fail to adhere to Keynes other principle to “save for a rainy day” when times are good. Instead, those savings are squandered as tax cuts or even more government operational spending often by the cynical machinations of the politicians that claim alternatively that deficits don’t matter or b), that deficits will be our ruin.
The thing to do, ideally, would be to tie government debt issuance limits to, say, the employment/population ratio, so that debt can be issued when employment is low but must be paid off when employment is high.
Thank you Charles, well put.
To all: I do feel public debt needs to come down in all global governments and with government debt having such a bad rep, now is not the time to push for reform. That said, we do need more infrastructure – not more bureaucracy or one-tune tax cuts. Yes, some of the W tax cuts for small business & low-income people are great but others stink raw eggs.
Joe, just so you know, my statement is primarily an indictment of Republicans who have operated on a deficits don’t matter mode and also of Democrats who enabled Republicans by spending in deficit mode (e.g. not saving) even in good times and when they were in power.
Unfortunately, our very system of money since the late 1960’s is dependent on the issuance of debt for its viability. The predicament our world is currently in was almost inevitable once this system came into being.
What to do about it remains to be seen.
Oh God, now we’ve gone from neo-Conservatism to Austrian malarkey.
Charles, In Washington State we already have a mechanism to enforce that, the Rainy Day Fund.
Zarelli want to increase the amount that has to go into it during good times. The devil is in the details but one the whole I am not opposed. Also I think it’d be a good measure onto which to attach the Debt Commissions Recommendations. Seems like a good bipartisan measure, Progressives get more spending during lean times, Conservatives get more saving during boom times.
http://www.theolympian.com/2011/10/10/1832427/time-for-new-rainy-day-fund.html?storylink=fb
Matthew, except we are funding the required reserves by grotesquely defunding essential services the Government should be providing. It is disgusting that we are not adequately funding our educational system to the point where a very large percentage of those coveted high-tech jobs are going to candidates from out of state. Our schools and universities are sliding into second rate status. We are also to the point of cutting health care for the poor. We are being constrained from making the kind of infrastructure investments to keep our state competitive. Distrust of government and the tax structure we have but have no courage to change is the crux of the problem.
There are many more reasons than just that they create jobs.
Economic downturns are also the cheapest time to get these projects done. Construction and financing costs also typically plummet during downturns, which can save the government a lot of money vs. doing the project in the heat of an economic boom.
Just about every government construction project since the recession has had bids come in way under budget, thanks to all the idle construction capacity.
Indeed.
If debt is so good for the state, we should take control of our own debt and create a state bank, and take out loans pledging tax revenue as the asset rather than issue bonds. Why let a bunch of bond holders determine our credit worthiness? And we save the cost of the bond sale, and we guarantee that we get that loan if we meet the right tax projections vs outstanding debt.
It’s a matter of who controls the money supply and if we want to control the money supply in the state, and we can’t change the current Federal debt based money, we can at least do our own issuance.
And yes, you have to collect the taxes for a year or two (rainy day fund?) Before you can loan out money but since we have a fractional lending based economy we can loan out 10 to 1 just like BOA.
Bonds are not the answer.
BTW Lincoln issued fiat based currency to fund the Civil war when faced with a 30% rate from the bankers.
The other side of the coin is appointing people of high honor to run these projects and to have them negotiate in the public interest for the best deal possible.
At the levels of public infrastructure most vendors are desperate to do deals. Do we have people in power who represent the public?
The history of the last two decades says no…we have people who are crooks and charlatans who are willing to run up debt using any false excuse they can lay claim to…all the while ensconcing it in a cloak of golden words!
[ot]
Fortunately, none of these people are major players in anything to do with public transit projects in the State of Washington in general, or the Puget Sound Region in particular. Whatever mistakes and shortcomings hinder this particular endeavor here are within the power of the voters to deal with.
Mark Dublin
As we saw when Sound Transit had to be reformed because during the 90s they squandered billions with no payback.
For all the reasons given to increase the debt limit, or to spend during a down economy, I didn’t hear one word about building good projects. Apparently the nature of the spending isn’t important enough to be a factor, so any project will do.
Business doesn’t operate that way, in the best or worst of times. Projects need to have a reasonable cost/benefit relationship. You don’t buy new plant or equipment that drive your cost of production up through the roof. You certainly wouldn’t mortgage the company to buy that really cute machine that makes widgets for 3 times the current widget cost.
So why do transit supporters think they are immune from good solid business sense?
Roger is envisioning more tunnels, otherwise, why would he have picked the photo he did? They aren’t penciling out folks. Not even close, and probably never will around Seattle.
Go into more debt for a lousy project? Forget about it!
Well, you have to look at why it has been so difficult to get good transit in Seattle. In Chicago the streets go straight for ten miles without hills/lakes/canals/cliffs. So it’s easy to build a bus grid and el’s. It’s not so easy to build a grid for Queen Anne and Beacon Hill. Also, the streets are so narrow it’s hard to commandeer two lanes for transit-only; e.g., it wouldn’t work on Market Street going up Phinney Ridge which is three lanes and no room for widening, and it probably wouldn’t work on 23rd. So we’ve avoided doing anything because of these obstacles. Subways avoid all of that. Suddenly there’s no more dilemma about fitting into the NE 45th or NE 40th right of way, or turning at intersections to reach Fremont and Ballard: you just go diagonally. So there’s an argument that tunnels are more important in Seattle than in other places.
I think there’s a lot of sense in the basic proposal. I don’t know how we force government to save in the good times and borrow in the bad but I definitely think the national conversation about government spending is way out of whack.
To that issue I recommend this article:
http://hir.harvard.edu/debt-deficits-and-modern-monetary-theory
The first half is pretty heavy going, but the second half is fairly succinct and it’s a very important perspective on the nature of our national debt. While it doesn’t apply to state government if the Feds put enough politics aside to embrace this vision of monetary theory the states would benefit. This is definitely the time to be pursuing public works.
As for the concerns over the value of the projects, that is why planning must be ongoing and not unalterably tied to specific funding sources–though identifying probable sources is useful as a conversations starter. If the plans are ready then we can act when the right funding source becomes apparent. This is why NYC got so much of the New Deal funding; Robert Moses was shovel-ready while everyone else scrambled to take advantage of the windfall.
Furthermore the question of project value speaks to the question of a transit system’s purpose. Certainly transit systems contribute directly to economic growth, but that’s not the only reason for having a transit system. I think having a strong and precise purpose for transit is vital to its planning and implementation.
It’s a basic principle that businesses shouldn’t borrow while times are good. If your business is well run, you will be making enough money to finance your growth internally. Then, when the economy sours, you can borrow to pay for necessary improvements and pay the loan back when the economy recovers. The reason we have a bad economy now is that back when the economy was humming along, too many businesses borrowed to finance their growth when they should have been using their profits to finance their expansion. Now that the economy is tight, those companies don’t have cash to service their debt.
The same principles should apply to government borrowing. Back in the mid 1990s when the Asian economies went sour, the Clinton government loosened credit to allow for American companies and consumers to borrow more easily. Then after 9/11 more credit was pumped into the economy. But eventually all the borrowing combined with the tax cuts created a house of (credit) cards that eventually collapsed.
“Now that the economy is tight, those companies don’t have cash to service their debt.”
Except that it isn’t. Companies have a record amount of cash, and banks are sitting on their reserves investing them in Treasuries because it’s risk-free profit. You may be right in general that one shouldn’t borrow in good times, and many homeowners shouldn’t have taken out second mortgages, but that’s not the only thing happening in the economy.
The companies that are sitting on buckets of cash are likely the ones that didn’t heavily leverage during the good times and subsequently surviving and benefiting during the hard times.
Of course the companies with cash aren’t the ones that were highly leveraged. But the greater point is that this is a consumer-leverage driven slump, not a business-leverage driven slump. Companies aren’t producing because people aren’t buying, not because the companies can’t afford to produce. (And the banks have found an easy way to make profits without making loans.)
I agree with the thrust of this, and with what GuyOnBeaconHill just said a few hours ago. But I’d like to expand on it a bit.
It’s true that debt is more valuable during bad times than good, and that it’s an important finance tool for really big things that need to be done all at once, like a rail investment, bridges and tunnels. But during the bubble years we went hog wild with debt in Washington for transportation purposes of all sorts because of a perceived political benefit of promising voters faster results from their tax investments. And the sea of debt we’re left with is the barrier we face to borrowing now; more so than debt capacity calculations.
On the highway side, the entire 14.5 cent gas tax increase last decade was bonded. In a few years we will spend 74% of gas tax dollars statewide to pay for debt service. On the transit side, as a region we’ve chosen bonding to be able to get simultaneous improvements done in all subareas, rather than by focusing the entire region’s pay-as-you-go resources on each segment and having a little patience to get the system built over time. What that means is that half (or more) of transportation dollars go to pay the finance community for debt over the life of projects. And that means of course that only half as much money is spent for transportation. If inflation is high, you get some of that back in deferred inflation, but under the current economy it’s like putting the money in the fireplace just to get projects a few years sooner for political reasons.
Adding to that: the very fact of accelerating spending on big transportation projects requires exceeding the construction capacity of local firms (while bond revenues are being spent) and shrinking them again after the spending spree is over. And that results in extreme inflation in construction prices to import those people and resources from other regions. Even less gets done than would have otherwise with a more level spending program.
So I’d say the more important policy would be to restrict use of debt during the good times to those things where debt is truly needed. We should not be using debt for routing activities, and certainly not for fixing potholes. And if we count on the bond market to regulate that, as was suggested at the end of the article, we’ll just repeat the same experience in the future if we ever recover from the mess we’ve made so far. That’s not learning anything from the experience we’re having now, in my opinion.
Oops- my spell checker intervened – the word ‘routing’ in the last paragraph was supposed to be ‘routine.’
That’s what happens when you neglect transit for so many years: it causes a big pent-up demand with a big price tag to get through the backlog. ST2 is the best thing this region has seen in forty years. Even if it’s not expanded beyond that, it hits the largest transit needs. It would have been better to build it in 1972, and add an inexpensive extension in the 1990s to the areas it didn’t go — although people would have lived different places if it had existed, so maybe we wouldn’t need those extensions. (It went to Lake City and Renton because Southcenter-Kent-Federal Way, Northgate and Lynnwood weren’t as developed yet, so subsequent development would have gravitated toward Lake City and Renton.) But that’s all science fiction. The reality was, it was ST1 and 2 or nothing. And ST2 is better than nothing. I agree that some roads were overbuilt during the bubble, but we’d have to talk about which roads rather than blanket condemning them all.