In a previous article I suggested New Jersey does poor planning and budgeting for its capital investments. It follows an ad hoc process whereby the state makes decisions based on the cause of the day. One day it is $300 million for State House renovations; another day it is water projects and another day it is vocational and community colleges and K-12 safety projects.
I recommended the state reinvigorate its existing Capital Planning and Budgeting Commission as the vehicle to orchestrate a meaningful process so future bond authorizations and other capital investments be undertaken in a systematic and planned environment.
Nothing is simple in the world of public finance, so some clarification about debt is needed. The total amount of state bonded debt supported by state revenues as of June 30, 2017 — the last year of audited state records —is $35 billion. In addition, there are debt-related obligations not supported by state revenues such as tobacco settlement bonds and other unamortized bond premiums; these total $11 billion and have no taxpayer impact. There are non-bonded obligations, including net pension liabilities and retirement health obligations; these total $155 billion. These costs are a concern to taxpayers and addressed in the budget, but are not bonded debt.
NJ debt, the big picture
Debt is often viewed as an undesirable aspect of public finance but, used properly, it is an important way to finance large projects that have high up-front costs and long-term benefits. Bonded debt, like a home mortgage, spreads the costs over time to more closely match the flow of benefits.
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. Furthermore, 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, educational buildings.
Over a number of years, with favorable interpretations by the Supreme Court, other mechanisms, including appropriation debt, were approved for debt issuance without voter approval. Let’s take a quick look at the debt situation.
New Jersey‘s long term bonded debt consists of three broad types:
(1) General obligations (GO) issued by the state government and approved by the voters;
(2) Appropriation debt (sometimes referred to as contract debt) issued by certain special state-created authorities — without voter approval (e.g., the State Building Authority and the State Economic Development Authority) and which is financed under contract with the state which provides state revenues to pay the debt service;
(3) Appropriation debt supported by dedicated revenue — think Transportation Trust Fund) — issued without voter approval, albeit voters have approved the dedication of gasoline revenue to support these bonds.
The total bonded debt as of June 30, 2017 is $35 billion. The GO debt is $2 billion. Appropriation debt is $33 billion — $15.6 billion supported by general state revenue, and $17.4 billion supported by dedicated revenue, principally the gasoline tax.
General obligation debt is approved by the voters while appropriation debt is generally approved only by the Legislature and the governor, with 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 since the Legislature could decide — although it never has — not to appropriate funds for appropriation debt whereas GO debt has a constitutional guarantee.
One could write an entire thesis about how appropriation debt originated and advanced, but suffice to say that most of New Jersey’s debt (94 percent) has been approved by that method. In short, dating back to the 1970’s, 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.
Where has bond money been spent?
Seventy-one percent of all debt has been issued for local school construction ($9.7billion), or for transportation projects ($15 billion). A myriad of smaller amounts has been authorized for open space acquisition, higher education facilities, water supply, sewer construction, and public buildings.
When the state sells bonds, it commits to paying annual debt service. This principal and interest is in the annual state budget, and for the proposed financial year 2019 budget it’s $4.2 billion, 11 percent of the state budget. Most rating agencies and other public finance exerts 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 budget’s annual cash flow. These are necessary because tax revenues tend to spike in December-April as final income and corporate tax returns are received, but expenditures are more evenly spread throughout the year. All such notes mature before the end of the year; therefore, the state never has a debt payable on the balance sheet at the end of the year. This is excellent discipline as many states roll over such debt into the following year. In FY 2017 the state issued $1.7 billion of such notes; in some years the borrowings have been as high as $2.6 billion.
Most debt has been for critical projects — school construction, water and sewer, open space acquisition, roads and transit projects — 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, including issuing bonds for pension payments.
The issuance of debt is essential to invest in needed infrastructure improvements. According to a report issued in 2017 by the American Society of Civil Engineers, New Jersey’s infrastructure can be characterized as anything from discouraging to alarming. The state received an overall grade of D+, with grades ranging from a high of B- for solid waste to D- for transit.
Furthermore, the need for additional financing was estimated by the State Budget Crisis Task Force, a group co-chaired by former FED chairman Paul Volcker, at $135 billion and growing.
Recent increases in the gasoline tax will help finance the transportation needs, but significant needs have been identified for drinking water, wastewater treatment, stormwater management, buildings and dams. These projects cannot be ignored but New Jersey must utilize a viable long-range capital planning and budgeting process to address these mounting needs. Should we sell more bonds for the $135 billion — but how does one plan for that?