The constitutionality of the new law authorizing state debt without voter approval is about to be reviewed by the New Jersey Supreme Court. At issue is whether the state can issue these bonds because of the COVID-19 emergency, and if the proceeds can be used as revenue to balance the budget. This is not normally permitted.
Assuming the court will rule in favor of allowing the state to borrow for revenue purposes, how much debt should be issued and what are the related policy implications?
How much debt should we issue?
The least amount possible. For every $1 billion of debt the state issues, there is a minimum of $50 million in debt service that will be added to the budget annually for up to 35 years, starting two to three after authorizing the debt. In addition, the debt will be sold to private investors as taxable bonds, resulting in higher interest rates than those of our usual tax-exempt bonds.
Even with normal revenue growth or new revenues, that increase in debt service will likely force cuts, crowd out additional spending on existing programs or prevent the funding of new programs. This means that while the debt we issue now can avert short-term fiscal and programmatic pain, it will limit future spending choices for several decades.
How much debt do we need to issue?
It depends. If upheld by the court, the law permits the state to issue bonds to add revenue to the budget. These can be long-term or permanent bonds or short-term (1- to 3-year) notes that are either paid off over several years or converted to long-term bonds at a later date.
We should defer permanent financing decisions as long as possible because of the uncertainty of how much we will need. State and local revenues, the unpredictable trajectory of the coronavirus, individual behaviors, federal aid and the state of the economy are all uncertainties at this point. The longer we wait, the more certainty we will have.
We should not issue permanent debt until after the close of the fiscal 2021 budget. Current data can help the state determine any projected cash shortfalls for the extended fiscal year 2020. The state should fill that gap with short-term notes, using the Federal Reserve Board’s Municipal Liquidity Facility, if necessary, and timed to meet the facility’s rules.
How does this affect the fiscal 2021 budget?
The fiscal 2021 budget will determine the difference between revenues we can anticipate and the amount we decide to spend, with new debt filling the gap.
Unfortunately, the pandemic is not our only current challenge. Government spending must also respond to issues such as climate change, structural racism, changing demographics — on top of our usual list of insufficiently funded programs. While our needs and wants are boundless, our political capacity to develop sound and timely policies is bound by limits of time, attention and money.
There is no best way to make budget decisions. For fiscal 2021, budget priorities should focus on practical austerity. We need to fund essentials. These include social-service programs that support our most vulnerable populations, public education, stable property tax relief for low- and moderate-income property owners and state-funded health care programs.
Also essential, would be seeking out and implementing prudent cost savings. These may involve renegotiating supplier and employee contracts or deferring spending on programs that address non-essential needs.
Before deciding how much debt to assume, we should consider the size of the projected deficit and all the state’s potential revenue sources. We must maximize all available federal aid to offset pandemic costs. Additional steps could be temporary revenue enhancements such as short-term taxes or fee increases. Only then should the discussion move to borrowing, keeping in mind the long-term costs described above.
What else about that long-term debt?
The law calls for a special legislative commission to approve the borrowing, leaving the administration to manage the details. In this case, the details in fine print relate to the terms and conditions surrounding the new debt.
These include the maturity schedule detailing the amount of principal and interest paid back each year, the number of years until the bonds are repaid and the conditions accompanying their issuance, such as the ability to refinance at a lower cost. These underlying numbers play a critical role in determining how much future taxpayers will pay for the benefits we reap today and the impact of these loans on budgets over the life of the bonds.
To date, these details have been the province of the administration without any requirement to consult with or advise the Legislature or inform the public of their implications. This opaque past practice is worthy of legislative review and change.
In addition, bond-rating agencies and financial markets are watching us. Our debt rating already ranks among the lowest in the country. That means our borrowing costs are higher than most other states. The more money we pay into debt service means the less money there is for anything else.
What can we learn from history?
New Jersey has a long and unfortunate history when it comes to debt. The New Jersey Policy Perspective 2016 report, the Notorious Nine highlights many of them. Two are relevant today. First are the 1996 Pension Obligation Bonds that included a 35-year maturity schedule, no refinancing option and a backloaded repayment schedule that imposed higher costs on taxpayers after that administration ended.
Second was the 2004 funding of the budget deficit with debt. While the state Supreme Court declared it unconstitutional, it allowed the one-time financing since recalling the debt was impractical. However, it directed the state never to do it again.
Since then, other bonds have been quietly issued and refinanced through the Economic Development Authority and other agencies. Some of these bonds include decades-long deferred principal payments and other exotic provisions that require future legislators and governors to continue to pay for improvements after the useful life of the benefits has expired.
To avoid continuing along this unfortunate path, the administration’s report to the commission should include issuance details. Before the state incurs additional debt, all parties need to agree on a process that will provide acceptable transparency and oversight. We should know the true cost over time. This type of full disclosure can create a valuable precedent and nudge us along the road to financial sustainability.
In the end
The fiscal challenges facing legislators and the governor are grave. They must make smart and informed choices that meet our immediate needs and limit the amount of pain imposed on recipients of crucial state services. They need to consider that our spending desires already exceed our capacity to pay for them. Any revenue-generating plan that includes debt must address the long-term interests of current and future taxpayers and serve as part of a cohesive state plan for long-term fiscal sustainability.
This is the most difficult challenge our current officials have ever faced, second only to the public health issues of the pandemic. We can’t afford to mess this one up.