WPRI Report:

THE EXPLODING USE OF DEBT TO FINANCE
GOVERNMENT IN WISCONSIN (Continued)

By Christian Schneider

BONDING USED TO BALANCE THE OPERATING BUDGET

One of the newer uses of debt at the state level is to utilize bonding as a budgetary tool, to be used to patch up revenue shortages to the state’s general fund. Not only does this increase the state’s bonding level and push tough decisions into the future, it also creates structural problems, as bond revenues are one-time in nature.

Numerous strategies have been utilized in recent budgets to incur long-term debt to solve short-term programs. Each of them worsens the state’s structural deficit and forces the government into a difficult position in the future.

Transportation Bonding To Benefit The General Fund

Bonding has traditionally been used for building and infrastructure. By issuing debt for capital projects, the state obtains the use of a tangible asset.

However, in recent years, the state has greatly expanded the purposes for which it accumulates debt. This has led to debt being used for ongoing general government operations, as opposed to capital projects. This not only increases the total cost of paying for ongoing appropriations, it also causes significant budget problems in the future. These phenomena are demonstrated by the recent use of transportation bonding to shift funds to general-purpose appropriations.

As Table 5 below shows, between 2003 and 2007, the governor and legislature transferred a total of $1.1 billion out of the transportation fund to pay for general-purpose programs, and backfilled those transfers with $815.5 million in new bonding:

In the 2003-05 budget, the governor proposed shifting funds out of the transportation fund and into the general fund. Since transportation projects traditionally have been an appropriate use for debt issuance, Governor Doyle backfilled the hole that transfer created in the transportation fund with more bonding. As a result, bonding was extended to highway rehabilitation, which has traditionally been considered a day-to-day operation and financed with gas tax and vehicle registration revenues.

The shift of funds out of the transportation fund in the 2003-05 budget consisted of $400 million to pay for the state’s shared revenue program, which aids local government expenditures, and $100 million to school districts. When the budget moved through the legislative process, the legislature agreed to these funds transfers. When the final budget became law, $675 million had been transferred out of the transportation fund and replaced by $565.5 million in bonding.

Of this $565.5 million in new transportation revenue bonding, $483.9 million was authorized for state highway rehabilitation, which had never before used bonding.[i] Whereas rehabilitation had always been funding on a cash basis, it would now be funded by bonding for the 2003-05 biennium—to allow the cash that it had normally used to be shifted to the general fund.

The 2005-07 budget initiated a similar fund shift. While the legislature agreed to much of the governor’s proposal, Governor Doyle utilized a creative line-item veto that transferred $427 million out of the transportation fund for general fund use. This fund shift was accompanied by a $250 million bonding increase for the transportation fund to backfill the transfer out of the fund.

As demonstrated in Table 5 above, the replacement of transportation with bonding revenue has left the transportation fund with a $330.4 million loss over the previous four years (once $43.9 million in debt service is accounted for). This loss to the account has prompted Governor Doyle to propose gas tax and vehicle registration fee increases in his 2007-09 budget to make up for the lost revenue.[ii]

Wisconsin began issuing bonding for highway projects in 1969, when the Constitution was amended to allow the state to issue debt. Before the amendment, municipalities and counties were able to issue debt for road construction, and the state oftentimes would pay the debt service on those bonds. Prior to 1984, Wisconsin issued transportation bonds as GO debt, with revenues from gas taxes and vehicle registration fees pledged for repayment. In 1984, state government began issuing transportation bonds as non-GO revenue bonds, instead supported by specific transportation-related revenues. As a result, these new bonds didn’t carry the state’s moral obligation pledge. Following the initial transportation revenue bond issue in 1984, the amount of these bonds outstanding quickly escalated. Chart 6 details the growth in transportation revenue bonds outstanding, as compared to inflation:

The state’s experience with transportation bonds mirrors the increased use of GO bonds. The following table shows that the use of bonding has grown faster than revenues to the transportation fund. Most notably, debt service has increased significantly in the past six years. In 2002-03, debt service increased from 7% of gross revenues to 11.8% in 2006-07, due in most part to bonds issued to fill a hole left by transfers from the transportation fund to the general fund. The number dipped in 2005-06 due to debt service on transportation bonds being paid from the general fund, rather than the transportation fund.

The debt service on the replacement bonds continues to grow. In the proposed 2007-09 budget, it is estimated that debt service on these bonds will cost the state $175.9 million. By the time the $815.5 million in replacement bonds are repaid, Wisconsin taxpayers will have paid an additional $1.1 billion in debt service on the bonds.[iii]

The one-time nature of these fund transfers have exacerbated the state’s structural deficit, which is the disparity between future anticipated revenues and funds needed to satisfy future obligations. Since revenue transferred from the transportation fund is not an ongoing funding source, the governor and legislature have several options in the next budget to make up the loss in available funds for ongoing appropriations (such as school aids and shared revenue). They may cut spending to these programs, which is politically unpopular and therefore difficult to do. They may raise taxes or fees to fill the hole. Or they may continue to use budgeting maneuvers to cover over the hole, such as using the transportation fund to pay for general purpose programs (as has been proposed in the 2007-09 budget).

Refunding Bonds

Recently, bonding has been used to refinance the state’s debt service on previously issued bonds. Through “refunding bonds,” the state can replace an old stream of debt service payments with a new stream in order to take advantage of lower interest rates (“economic refunding”), or the state can issue new bonds to stretch debt service payments out into the future, with savings realized in earlier years (“structural refunding”).

In January 2004, the Wisconsin Legislative Fiscal Bureau indicated that the state’s Medical Assistance (MA) Fund would be short $310 million, due to federal revenues the state budgeted for, but wouldn’t receive. As a result, the governor and legislature had to act quickly to make sure MA had enough funds to operate.

Their answer to fund a large portion of this deficit was to issue $175 million in new structural refunding bonds, which allowed the state to retire debt service on previously issued bonds. The remaining funding—the $175 million in general purpose revenue saved by not having to pay debt service on the old bonds—was shifted to the MA fund. Thus, the new bonding, along with other fiscal maneuvering, allowed the governor and legislature to fully fund MA benefits.

Despite the success in funding MA, there are downsides to the use of refunding bonds as a budgetary band-aid. As estimated by the Fiscal Bureau at the time of the restructuring, interest on the new bonds would be $46.1 million higher than if the original bonds had been paid off on schedule. Furthermore, the Fiscal Bureau estimated that general fund principal and interest payments were $52.3 million higher in 2005-06 and $30.2 million in 2006-07 with the new bonds.[iv]

Thus, the use of refunding bonds had a negative effect on future budgets. First, the new bonds will cost the state more money in the future. The short-term relief the state received from not having to pay $175 million in general fund debt service payments cost the state $82.5 million in the next biennium. Since the relief from the refunding bonds was one-time in nature, more revenue was needed in the next budget to fill the hole left by the refunding mechanism. As a result, the state’s structural deficit grew.

Appropriation Bonds

Not all bonding is necessarily detrimental to the state’s economic condition. Facing large budget deficits and declining state revenues, Governor Jim Doyle in 2003 proposed what he called “appropriation bonds” for the purpose of refinancing the state’s unfunded pension liability and accumulated sick leave conversion programs.

Under the Wisconsin Retirement System (WRS), employers are obligated to pay to fund the future retirement obligations being generated by current employees. At the time, the state’s actuarial analysis forecast an 8% yearly interest rate required to fund the growing unfunded pension liability. The projections showed that the state would need to pay over $2 billion into the system over a 28-year period, $1.3 billion of which was interest.

In 2003, interest rates for borrowing were less than the projected 8% interest necessary to fund the state’s unfunded pension and health care liability. In the 2003-05 biennial budget, Governor Doyle requested $750 million in what he called “appropriation bonds” to pay off the unfunded pension liability. In theory, this would allow the state to fully fund pensions and pay a lower interest rate than the 8% required if the funds were to be paid over the full term. Such an arrangement could have saved the state money over a 30-year period, as it would be paying a lower interest rate on the bonds it issued.

However, the state structured the bonds in such a way that no debt service payments would be made in the 2003-05 biennium. This allowed the state to keep the $70 million it would have had to pay to the pension fund in the state’s general fund.

While issuing the bonds allowed Governor Doyle to spend that $70 million in the two year 2003-05 budget cycle to fill the budget deficit, it causes some fiscal problems for the state. The $70 million retained in the state’s general fund represented a one-time funding fix for the state operating budget. When continuing programs are funded with one-time money, it creates a structural deficit for the next biennium. In subsequent biennia, the government either has to raise taxes, cut spending, or hope tax revenues grow enough to make up for that $70 million hole. A state’s structural deficit is one of the primary benchmarks used by credit rating agencies to determine the value of a state’s bonds. The higher a state’s structural deficit, the more likely they will earn a lower credit rating.

Aside from the structural operating budget problem, the creation of appropriation bonds set a potentially troublesome precedent for the use of debt for budget relief. These bonds are nearly identical to GO bonds, but have been issued in such a way as to allow them to be used for a general government operation.

These new bonds were technically considered revenue bonds, yet are structured to be repaid by an annual appropriation from the general fund. This was done to dodge the constitutional requirement that debt be issued essentially for capital projects. Since revenue bonds are not considered public debt of the state, they may be issued for any purpose. Because repayment of the appropriation bonds was structured to require an annual general fund appropriation by the legislature, these new bonds were considered revenue bonds, and therefore weren’t considered public debt of the state.

However, the state applied its moral obligation to these bonds, which is generally reserved for GO bonds. The moral obligation pledge has been applied to revenue bonds in the past, but only in specific and targeted instances. Essentially, the administration tried to set up a new type of bonding that had all the characteristics of general fund-supported GO bonding, without the limit on the uses for them.

At the time the plan went to the legislature for examination, the Legislative Fiscal Bureau questioned the appropriateness of this broad expansion of bonding authority. In a memo to the Joint Committee on Finance, they noted that “using general fund revenues to pay off revenue obligation bonds or GPR funding to pay the appropriation bonds authorized under the bill could establish a precedent for the state’s debt programs.” They further warned that “such borrowing programs that use state general fund revenues to support debt that is not constitutionally limited in its use or amount, could be statutorily expanded to support bonds that could be issued for any state government operating function or expense.”[v] However, the legislature chose not to heed the warning and proceeded to approve the governor’s proposal.

In essence, the state has now devised a way to use general fund-supported debt for general government programs, a practice that has been specifically forbidden by the constitution. When a new funding crisis exists, it would be entirely possible for the state to issue general fund-supported borrowing to plug the hole—leaving future generations to pick up the tab.

Thus, while appropriation bonds will serve the purpose of saving the state money in the long term, they were used in a manner that exacerbated the state’s structural deficit. In this case, greater long-term savings were sacrificed for a short-term budgetary band-aid—a theme common when debt is used as a budgetary tool.

Tobacco Securitization

In the 2001-03 biennial budget, Governor Scott McCallum faced a significant shortfall in state revenues. In order to fill the hole caused by lagging state revenue, the governor proposed “securitizing” the stream of revenue state government was set to receive from the multi-state tobacco master settlement agreement. In essence, the state would take a large, one-time lump sum payment rather than payments that were scheduled to be paid by the tobacco companies over a 30-year time period.

Aside from merely filling a budget hole, supporters of securitization argued that it would be wise to maximize revenue from the tobacco settlement while it was still available. They argued there would be no guarantee the tobacco funds would be available, given possible litigation and other circumstances. Furthermore, the McCallum administration had to make the choice between securitizing the tobacco funds or raising taxes.

At the time of Wisconsin’s proposal, several other local and state governments had utilized securitization for various needs. Some used it to get around the constitutional limits on debt issuance they were up against, while others used the proceeds for capital projects. Still others used securitization bond revenues to set up health care endowments or rainy day funds.[vi]

The one-time lump sum payment was achieved by setting up a nonstock corporation to issue revenue bonds on behalf of the state. In April 2002, the Badger Tobacco Asset Securitization Corporation issued $1.59 billion worth of revenue bonds, $1.275 billion of which were available to the State of Wisconsin to balance the budget. The debt service on the bonds is paid with the yearly revenue from the tobacco company payments. It is anticipated that the bonds may actually be paid off sooner than expected, which would then allow the state to reclaim the settlement payments as early as 2018.[vii] As of December 2006, the Corporation still had $1.46 billion in bonds outstanding.

While the revenue bonds issued to finance securitization may have been self-funding, the decision to take the lump sum amount to balance the state budget had other ramifications. The use of one-time money to support ongoing government operations created a hole in the next budget that required new revenue to fill.

CONSEQUENCES

Increased utilization of bonding allows the state to defer many short-term budgetary decisions, but carries some significant consequences for the future.

Increased Debt Service Costs

Increased bonding necessitates increased debt service payments. In the case of most general obligation and transportation bonding those debt service payments are paid with tax and fee revenue collected from citizens of the state. As noted, when the state issues bonds, it commits taxpayers to paying debt service on those bonds for between ten and thirty years into the future.

In good economic times increasing debt service is not as big as a problem, since the growth in state tax collections allows for more flexibility in spending decisions. More money in the state’s treasury makes it easier to pay for increased debt service.

However, when the economy slows down and tax collections begin to recede, debt service becomes a real problem. Even though the state has less money to spend, debt service payments are non-negotiable and must be paid.

In fact, because debt service puts such a squeeze on the general fund in a slowing economy, it provides incentives to lawmakers to use even more bonding to fill the remaining hole. In this sense, the process becomes cyclical—too much bonding shrinks the general fund, which forces more bonding to fund programs that can’t be paid for with existing revenues.

This is, in essence, what happened with the state’s transportation fund in the previous two budgets. Transportation funds were transferred to bolster the sagging general fund, and replaced with more transportation bonding. As a result, taxpayers will be picking up the tab for the $1.1 billion in debt service costs for the transportation bonds issued to backfill the road-building fund.

Structural Deficits

Another consequence of increased bonding is the substantial budgetary problems caused by the one-time nature of bond revenues. The use of one-time bonding revenue to plug ongoing holes in the budget further exacerbates the structural deficit, which forces higher taxes, program cuts, or even more bonding in the subsequent budget.

Table 7 details the structural deficits in recent state budgets:

Given the size of the structural deficit in Wisconsin, it is clear state government has continued to utilize strategies to push obligations off into the future. In 2006, according to the Wisconsin Taxpayers Alliance, Wisconsin was one of only three states with a Generally Accepted Accounting Principles (GAAP) deficit and, relative to population, it had the largest deficit in the nation.[viii]

Credit Ratings

State and local governments issue bonds through the municipal bond market. It is in the government’s interest to get the best rating for their bonds, as highly-rated bonds receive lower interest rates, and reduce the amount the government will have to repay in interest.

The three major bond rating firms (Moody’s Investor Service, Standard and Poor’s, and Fitch) use a number of measures when determining what rating a specific group of bonds will receive. The overriding principle in rating bonds is risk—the more probable it is that the bond issuer will repay the bonds, the better rating they are likely to get. Much of the probability of repayment is determined by the soundness of the borrower’s financial practices.

For governments, one factor used by bond agencies to measure financial practices is how the debtor manages current debt, including the per capita level of debt issued. Bond ratings consider the amount of debt outstanding and compare that amount to the revenue the government is estimated to receive. How the debt is used is also considered, as is the growth pattern in debt issued.

When Wisconsin first issued bonds directly in 1970, it received the highest possible rating by Moody’s and Standard and Poor’s for its general obligation bonds. The state’s general obligation bond rating was reduced by Standard and Poor’s in 1981 (from AAA to AA+) and by Moody’s (From Aaa to Aa) in 1982.

In recent years, Wisconsin’s general obligation bond ratings have continued to fall. In 2002, general obligation bonds received an AA- rating from Standard & Poor’s, Aa3 from Moody’s, and AA by Fitch. In March 2004, Fitch downgraded a general obligation bond issue to an AA- rating. Currently, Moody’s and Fitch rank 31 states higher than Wisconsin, and Standard & Poor’s puts 37 states ahead of Wisconsin.[ix]

In their explanations for downgrading state bond ratings, rating agencies pointed to a number of questionable budgeting practices by Wisconsin state government. Among these practices was the use of one-time revenue to plug budget holes, as was done with tobacco securitization and transportation funds (as well as numerous other lapses from various state accounts).[x]

Naturally, when the state receives a lower rating on its bonds, it must pay a higher rate of interest to repay those bonds. Thus, the increased level of bonding relative to tax receipts, coupled with the one-time use of those bond revenues will cost the state more for new bonds issued in the future.

SUMMARY

The recent tendency of Wisconsin state government to defer responsibility for fiscal decisions will likely have detrimental effects in the future. Wisconsin state government has found itself on a treadmill of fiscal procrastination, unable to slow down the growth in structural deficits. On the contrary, increased reliance on debt has worsened the state’s financial situation, the costs of which will be borne by future generations.

Increased reliance on debt has exacerbated the state’s fiscal problems in two major ways, as demonstrated in this report. First, increased debt means increased long-term costs to taxpayers. Short-term decisions made by elected officials can cost taxpayers millions in interest costs for decades. The startling increase in general fund-supported, general obligation bonding issued by Wisconsin relative to tax revenues indicate that this is taking place.

The second fiscal problem related to state debt is in some ways caused by the first. High fixed debt payments force the state to use even more debt to patch budgetary holes in tight times. As a result, even more interest costs are pushed off into the future. It is easy to see that in Wisconsin, debt begets more debt.

In good economic times, revenue growth may be able to handle the increased debt load the state has taken on. However, when the economy slows down, high state debt squeezes the state budget, as debt service must be paid before any other general fund appropriations are made. High debt service payments often serve as an excuse for elected officials to push other obligations off into the future—the other options, cutting programs or raising taxes, are often politically untenable.

The legislature can do little to affect the debt currently on the books. Yet in the future, it can employ real budgetary strategies that can slowly bring Wisconsin’s borrowing back in line with its citizens’ ability to pay.

<<--Previous Page  (1..2..3)