Budget Basics: State Debt — Is It Too Much? Do We Need More?
A series that details the fundamentals of New Jersey's budget, as well as its current budget woes
This is the fifth in a 10-part series outlining New Jersey’s fiscal fundamentals. The goal is to demystify some of the state’s financial challenges, and put them in context of the broader issues New Jersey faces. This series is also intended as a way to underscore the importance of state government in a year that will see a new governor and a new Legislature chosen by voters. Follow this link to see the.
Debt is often viewed as an undesirable aspect of public finance, but used properly it is an important and indispensable way to finance large projects that have high upfront costs and long-term benefits. Bonded debt, like a home mortgage, spreads the costs over time to more closely match the flow of benefits.
Public debt comes in several forms and each has different implications for the state budget. The most familiar is state-supported bonded debt incurred when the state sells bonds and is obligated to make annual repayment of principal and interest.
Further, there is nonbonded debt (pension liability), which represents future obligation but no immediate debt service. And there is debt issued by several authorities for which the state serves as a “conduit” entity to provide a tax-exempt mechanism to finance projects (for example, the New Jersey Health Care Facilities Financing Authority) — but the state has no legal responsibility to support the debt service.
There are also freestanding authorities, such as the New Jersey Turnpike, that issues debt, but again the state has no legal responsibility to support the debt. Municipalities, counties, and school districts issue debt, but again the state government has no legal responsibility to support the debt.
This article will focus on the state’s bonded debt — the debt most commonly associated with capital construction. New Jersey has the fourth-highest debt burden in the nation, measured either on a per capita basis or as debt as a percentage of personal income.
The New Jersey constitution states that any debt that is 1 percent of the total appropriation of the state must be submitted and approved by a majority of voters at a general election. The constitution further says that any money raised by debt issuance must be applied only to the specific object stated in the referendum. And the constitution restricts long-term debt only for capital purposes, such as roads, sewers, water facilities, prisons, and educational buildings.
Types of long-term debt
New Jersey’s long-term bonded debt consists of three broad types:
general obligations (GO) issued by the state government and approved by the voters;
appropriation debt (sometimes referred to as contract debt) issued by certain special state-created authorities (such as the State Building Authority and State Economic Development Authority), which is financed under contract with the state that provides state revenues;
appropriation debt supported by dedicated revenue (such as the Transportation Trust Fund).
The total bonded debt as of June 30, 2017 is $35 billion. The GO debt is $2 billion, and the appropriation debt is $33 billion — $15 billion supported by general state revenue; $18 billion supported by dedicated revenue, principally the gasoline tax.
General obligation debt must be approved by the voters, while appropriation debt is generally approved only by the Legislature and the governor — no voter approval needed. GO debt has the full faith and credit of the state’s taxing power, while appropriation debt is subject to annual appropriations by the Legislature. Wall Street and the investment community view GO debt as more secure than appropriation debt, since the Legislature could decide (it never has) not to appropriate funds for appropriation debt — whereas GO debt is a constitutional obligation.
One could write an entire thesis about how appropriation debt originated and advanced, but suffice it to say that most of New Jersey’s debt (94 percent) has been approved and sold in that method. In short, dating back to the 1970s, the state created several authorities (determined by the Supreme Court not to be the state government) to issue debt without voter approval. New Jersey is not alone in the creation of this device to issue debt, but most people would agree it was done to avoid voter approval.
In most instances the state has used this device for proper long-term capital purposes, but in three instances the state used appropriation debt to balance the operating budget a no-no in the world of public finance and clearly unconstitutional. Specifically, in 1997 $2.6 billion in nonrefundable bonds were sold to fund the pension system. And in 2004 and 2005 much smaller amounts were sold to support general state operations.Finally, the Supreme Court woke up and ruled in Lance v. McGreevey (2005) that the constitution really meant what is said: no issuance of debt for operating purposes, albeit curiously it said it was OK for the last issuance in 2005. Further, a constitutional amendment was recently approved that further limits the Legislature and the governor from enacting certain future appropriation debt. However, recent actions by the State Capitol Joint Management Commission to approve bonds for renovation of the State House seem to have circumvented the aim of the constitutional amendment — but a Superior Court judge concluded that since the bonds had already been sold no action could be taken!
Where has the state expended this $35 billion in bond money? Seventy percent (70 percent) of all bonded debt was issued for local school construction (state bond money to help school districts) and for transportation (Transportation Trust Fund). A myriad of smaller amount have been authorized for open-space acquisition, higher education facilities, water supply, sewer construction, and public buildings.
Debt service payments
Each time the state issues debt (sells bonds) to finance projects it commits to paying annual debt service — principal and interest. Such monies are budgeted annually in the General Fund.
The total debt service in the current budget is $4 billion which is 11.5 percent of the state budget. Most rating agencies and other public finance experts opine that such a percentage is very high.
Since 1991, the state has annually issued Tax and Revenue Anticipation Notes to fund timing imbalances in the state budget’s cash flow. These are necessary, as tax revenues tend to spike in December-April as final income and corporate tax returns are due, but expenditures are more evenly spread throughout the year. All such notes must mature before the end of the year; therefore, the state never has a balance payable on the balance sheet at the end of the year. This has been a good discipline, since many states roll over such debt into the following year because their cash flow has not been properly managed.
In fiscal year 2017 the state issued $1.7 billion of such notes; in some years the borrowings have been as high as $2.6 billion.
The issuance of debt is essential if the state is to invest in needed infrastructure improvements. Issuing appropriation debt rather than GO debt is not automatically inappropriate, albeit the state pays an interest premium for such debt.
The majority of debt, including appropriation debt, has been for critical projects: school construction, water and sewer infrastructure, open-space acquisition, road and transit projects — truly worthy projects and clearly capital in nature. Unfortunately, in three instances the state issued debt essentially to balance the budget rather than increase taxes or reduce programs. For example, in the fiscal 2018 budget, $426 million will be paid for debt service on the original $2.6 billion pension bond. The amount will increase to $506 million in fiscal 2022 because of the way the debt service schedule is structured. The total amount of debt service paid in the last 15 years of these 30-year bonds will be in excess of $6.5 billion. This is not the proper use of bond funds, demonstrating how bonds can be abused.
Further, significant amounts of bond financing will be needed over the next 10 years. According to a report issued in 2017 by the American Society of Civil Engineers, the New Jersey infrastructure can be characterized as anything from discouraging to alarming; NJ has received an overall grade of D+, with grades ranging from a high of B- for solid waste to D- for transit.
Further, the projected need for additional financing is estimated by the State Budget Crisis Task Force, a group co-chaired by former Fed Chairman Paul Volcker, to exceed $135 billion over the next 10 years.
Recent increases in the gasoline tax will help finance the transportation needs, but significant needs have also been identified for drinking water, wastewater treatment, stormwater management, and dams. These projects cannot be ignored, and New Jersey must develop a viable long-range capital plan to address these mounting needs.