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Debt and Taxes: Recommendations for Reform

November 19, 2014

By Stephen Slivinski, Byron Schlomach, and Nick Dranias

Arizonans, through their state and local governments, are in debt to the tune of $66.5 billion. That’s over $10,000 for every man, woman, and child in the state. To put that in perspective, the average person’s income in Arizona is less than $36,000 per year.

This shocking figure includes known unfunded government financial obligations like public employee retirement plans, but it doesn’t account for every penny of debt we owe. Some of the debt incurred in Arizonans’ name is unknowable because it is not quantified. Most debt issued through quasi-governmental bodies called “Industrial Development Authorities,” for example, is not reported anywhere.

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Unpaid Balances

As Debt and Taxes: Arizona Taxpayers on the hook for $66 Billion Tab Run Up By State and Local Governments demonstrates, there is too little accountability for state and local debt. Public debt schemes in the state know no limits. Cities create municipal property corporations that borrow large amounts of money without voter approval and claim the debt is not municipal. Lease-purchase agreements, in which governments sell their buildings to private investors for cash and then rent them back,are another ruse to avoid voter approval of debt.  When local governments max-out their credit or hits the Arizona Constitution’s spending or taxing caps, they can spin off expensive programs into any number of dozens of freestanding “special districts” available to them, which are then free to borrow and spend without any constitutional limit.   

These debt schemes are not victimless. As George Lee of Prescott Valley found out after he lost his business because of unaffordable property taxes, when a special district incurs more debt than it can afford, that often means property tax bills skyrocket.

George Lee and hardworking Arizona taxpayers deserve better. There is  simply too much reliance on debt by state and local government. The state’s debt limit and debt laws in general are ineffective and need reform due to court decisions that have effectively redefined debt as not being debt. Limitations on the ability of state or local governments and its subdivisions to issue debt are needed. The steps recommended here, if taken, would likely only be the first of many steps in a comprehensive reform program to protect Arizona’s taxpayers from excessive debt, too often incurred for the wrong reasons. They can include, but not necessarily be limited to, the following:

1. Reform the state constitutional debt limit.

Arizona’s current debt limit has been effectively ruled out of existence by the state’s Supreme Court. Arguably, the $350,000 limit, established in the constitution in 1912, should be indexed either to population and inflation or state GDP. If it were so indexed, the new limit would be in the neighborhood of $230 million or $700 million, respectively. Regardless, even if indexed, the current limit falls far below the sum of all debt owed by this state’s agencies. A new constitutional definition for debt that cannot be gamed and that includes deferred payments to other units of government (rollovers) must be devised. This new definition and the newly-indexed debt limit should aim to limit future debt. But we must also bow to reality, perhaps by prescribing a gradual de-leveraging by the state.

2. Require a supermajority for creation of new state and local debt.

The issuing of debt to pay for new spending is, by definition, a claim to future revenues and an added burden on future taxpayers. If a government program or initiative were to be paid for with current revenues via a tax increase on Arizona residents, the state constitution requires a 2/3 supermajority vote in the Legislature. Yet bonds can be issued by a simple majority. Debt issues should be viewed as akin to a tax increase, and therefore should also be subject to a 2/3 supermajority requirement.

3. Forbid issuance of government-grade, tax-exempt bonds by non-elected bodies.

Various special districts have been created over the years with the ability to issue government-grade, tax-exempt bonds. Sports authorities are one example. The oversight boards of these sorts of entities are often appointed by elected officials and certain seats might be reserved to elected individuals. However, accountability is blurred and too far removed from the people who are ultimately responsible for redeeming these debt instruments – taxpayers. Though the bonds are “non-recourse,” should something happen to the ability to pay them off, taxpayers are likely to be called upon to make the debt good, if for no other reason than to protect the creditworthiness of a community. Therefore, only elected bodies, directly accountable to the people, should be able to issue debt.

4. Forbid the use of debt for the purchase of non-physical capital or day-to-day operating expenses.

Bonding has traditionally been a financing mechanism for long-term, capital-intensive projects such as building roads or structures. Expenses that are routine and occur within the day-to-day business of government are traditionally paid for with current revenues. Any limitation on the ability of a government to issue debt should also expressly forbid the use of debt – which should include accounting gimmicks such as budget “rollovers” – as a means to finance day-to-day operations of state government.

5. Require that the maturity of the bond be equal to or shorter than the life of the asset being purchased or financed with the bond.

This would discourage policymakers from issuing debt to pay for activities that should be financed on a pay-as-you-go basis. For instance, issuing a 15-year bond to purchase new school busses that may only last five years would be forbidden. A fifteen-year bond could, however, finance the construction of a highway that will last in excess of fifteen years. This would guard taxpayers against paying interest on capital assets that have long since outlived their usefulness. In addition, if a bond were to be refinanced, the bond maturity date would be limited by the time left in the capital asset’s life.

6. Require certification of bond issues by the state treasurer.

Any bond issued by a state or local government – or a refinancing of an existing bond – should be certified by the state treasurer as to whether it meets the standards outlined above. This will create another layer of accountability and further guard against various levels of government trying to violate the intent of these reforms.

7. Enhance transparency of state and local debt.

It should be easy for a taxpayer to know the amount of debt issued by governmental and quasi-governmental entities that geographically cover that his address. This is not true now. The Department of Revenue produces an annual report that shows the amount of debt of school districts, cities, towns, counties, community college districts, state agencies, and some special districts. The Joint Legislative Budget Board now produces a state debt report that includes at least a nod to deferred payments to state agencies or subdivisions (rollovers). No one transparently reports unfunded pension fund actuarial balances for various levels of government. Balances of debt issued through Industrial Development Authorities aren’t even known by the Authorities themselves. This must be remedied with a comprehensive debt transparency requirement for all levels of government.

8. Require voter approval of debt issues at the local level.

All local debt and probably all state debt should be subject to voter approval. Debt should be defined to include general obligation bonds as well as revenue bonds, lease purchase, certificates of participation, and any other type of long-term debt currently defined otherwise by the courts. Citizens are ultimately responsible for debt redemption. Therefore, they should have a say in whether or not the debt is issued. Debt elections should include more information than is currently required, however. Currently, the requirement is merely to describe what is being financed. Voters should also be made aware of how much per capita debt an issuing entity is already in and how it compares to a statewide average of similar entities. A school district, for example, should be required to indicate on the ballot how it compares to other districts when it proposes additional debt.

9. Allow for the creation of dedicated sinking funds for governments already subject to expenditure limits.

A local government subject to a spending limit might be encouraged to issue debt to pay for a project that would normally fall under that limit. So, in order to prevent a spending limit from encouraging debt financing, governments should be allowed to create dedicated “sinking funds” wherein the governments can save for a large lump-sum expenditure in the future. Deposits to the funds would count toward a spending limit but large, lump-sum expenditures from such funds would not be counted toward a spending limit.

This might most easily be understood with an example. Suppose a county wants to build a $20 million building. Under the current spending limit, a cash expenditure of $20 million might serve to exceed the spending limit even though the $20 million was saved over a period of years. This proposal would count savings deposits, say $2 million per year, toward a spending limit each year. But, after 10 years, (ignoring interest earnings) the saved $20 million could be expended without counting toward the spending limit.

10. Close the spending and tax cap loopholes that encourage the creation of special districts

It is no accident that the number of special districts in Arizona has exploded from around 100 in 1980 to more than 500 today. When tax and spending caps were imposed on local government in the early 1980s, those caps excluded most special districts. As a result, cities and counties remained free to avoid hard budgetary choices by spinning off expensive programs into special districts. Fiscal responsibility will return to local government only when this shell game is stopped. One solution is to eliminate the incentive to indulge unsustainable spending through the device of special districts. This requires closing the special district loophole in the state constitution’s spending and taxing caps.

>> Read Debt and Taxes: Arizona Taxpayers on the hook for $66 Billion Tab Run Up By State and Local Governments



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