Testimony of
Raymond D. Horton, President
Citizens Budget Commission

Debt Affordability Hearing
Wednesday, June 3, 1998
10:00 AM

Good morning. I am Raymond D. Horton, President of the Citizens Budget Commission. The Commission is a private, nonprofit civic organization founded in 1932. Our mission is to promote better financial management and service delivery by the City of New York and the State of New York.

I am pleased to be here for three reasons:

1. The Commission believes strongly that the affordability of future debt service costs is a major public policy issue that has not been given sufficient attention by political leaders. The mandated statement and this mandated hearing are a valuable opportunity to help increase public awareness about this issue.

2. The Commission is concerned that the conceptual framework and supporting data used by the Budget Director in his statement do not present a complete picture of local indebtedness. Relying on this inadequate framework may mislead the public about the political judgments made by the City’s elected leaders in deciding on the future level of indebtedness. This hearing provides an opportunity for us to suggest a more complete method for assessing affordability.

3. Using a more appropriate method for assessing affordability reveals that future levels of indebtedness planned by the Mayor may be affordable by reasonable criteria; however, if local economic growth is stymied by a national recession or other factors in the next few years, then current policy may lead to debt service burdens that come dangerously close to being "unaffordable." Therefore, it is desirable to identify alternatives to the planned levels of borrowing in order to avoid economically harmful future tax increases or service cuts made necessary by these adverse circumstances.

In the next few minutes I will elaborate on each of these points.

ACCOUNTABILITY AND HONESTY IN DECIDING ON DEBT LEVELS

Designers of state and local governmental institutions have long recognized the fiscal temptation that debt represents. Borrowing is a way to pass costs on to future taxpayers, and those in office at any given time can avoid accountability for spending by incurring debt. Accordingly, framers of many state constitutions, including that of the State of New York, sought to put limits on borrowing. The intention is typically to prohibit borrowing for the operating expenses that pay for currently consumed services and to limit borrowing for long-term capital investments to a level that is "affordable" and to terms that correspond to the useful life of the project. The CBC endorses these principles.

The guidance provided by the New York State Constitution for affordability of debt service is the requirement that outstanding general obligation (GO) debt of the City of New York not exceed 10 percent of the five-year average of property values in the City. The concept is that debt levels should be linked to the scale of the City’s economic base.

In recent history the City’s leaders have found it necessary to deviate from this basic principle on two major occasions. The first was the fiscal crisis of 1975. A combination of the severe local economic impact of national recession in the early 1970s and poor financial management practices by the City created a situation in which the City became increasingly and heavily dependent on short-term borrowing (which is not subject to the Constitutional debt limit) to finance operating expenses. Eventually, responsible financial institutions would no longer provide the short-term loans. The longer-term solution to this crisis involved creation of the Municipal Assistance Corporation, a State agency empowered to issue bonds on behalf of the City. Its debt is outside the Constitutional limit and is repaid with sales tax revenues. Nonetheless, the City in its financial statements appropriately includes MAC debt service as part of its debt service obligations, because these expenses are supported from the same economic base as GO debt. We taxpayers pay both GO and MAC debt service.

The second occasion was the creation of the Transitional Finance Authority in 1997. A combination of a decline in property values caused by the local economic downturn in the late 1980s and early 1990s, an ambitious capital program, and previous reliance on imprudent refundings to achieve short-term operating budget reductions placed the City in the position of exhausting its ability to incur GO debt in fiscal year 1998. To avoid the need to suspend the capital program, the State Legislature created the Transitional Finance Authority (TFA). It is authorized to issue debt for the City’s capital program and repay the bonds with revenue from the municipal income tax. Its total debt is limited to $7.5 billion and is intended to help the City for a fixed and limited time period. As the name implies, the TFA is transitional and a better, long-term solution is needed. The City of New York still has no long-term debt policy.

While the TFA’s debt is outside the State Constitutional limit, the City’s accounting and budgeting practices initially recognized that its debt service, like MAC’s and GO debt service, should be taken into account in making judgments about affordability. Appropriately, the City initially reported TFA, MAC and GO debt service together in its financial documents.

Regrettably, in the latest Executive Budget presentation the Mayor has reversed earlier decisions and made a less than complete presentation of the City’s debt service obligations. This new reporting format is misleading for the public and should be changed. Taxpayers should be made aware of the full future costs of debt, and their knowledge should guide judgments about affordability.

Specifically, the latest Executive Budget does not show debt service obligations of the TFA as part of regular City expenses and eliminates the portion of the personal income tax revenues devoted to this purpose as regular tax revenue. Declaring the TFA a "covered organization" rather than a part of the City’s obligations misleads the public about our future indebtedness and its implications for the operating budget. The same reporting concepts that have long applied to MAC should be applied to TFA. The Executive Budget in effect hides from citizens debt service expenses that grow from $17 million in fiscal year 1998 to $560 million in fiscal year 2002.

Another misleading presentation of debt service information is found in the chart on page 58 of the "Budget Summary" document used in the public presentation of the Executive Budget. It shows that debt service is less burdensome now than was the case in the early 1980s and that debt will not grow in the future. However, the data for years after fiscal year 1985 do not include debt service for the Water and Sewer Finance Authority (WSFA), which was created in that year to finance these types of investments; in contrast, the data shown for years before 1986 include all GO debt service used for these purposes–a comparison of apples and oranges that misleads the public. Similarly, as noted above, the figures shown for the projected years through 2007 exclude the TFA debt service, yet this is a major mechanism for financing in these years. Projected debt service burdens pictured in the chart are "flat" only because of the decision not to include the rapidly growing TFA debt service.

We at CBC hope that future budget presentations of debt service are complete. New Yorkers, including lenders, deserve no less.

AN APPROPRIATE FRAMEWORK FOR ASSESSING AFFORDABILITY

These distortions of data point to the need for a clear and consistent framework for assessing the affordability of debt and debt service. The CBC suggests the following guidelines:

1. Affordability should be assessed in terms of a relationship between debt service expenses and the size of the local economic base. An appropriate measure is a ratio of debt service to the value of economic activity, and hence the tax base, in the city. This indicates the share of the economic base required to support local public debt.

2. The numerator in the ratio should (a) measure debt service obligations as opposed to only outstanding debt, and (b) include debt service related to all local debt that must be supported from the local economic base.

The Budget Director’s statement follows the first of these guidelines. Measures are presented showing both outstanding debt and debt service.

In contrast, the Budget Director’s statement does not follow the second guideline. The figures do not include all relevant debt service and therefore understate future debt service burdens. Unlike the Mayor’s Executive Budget presentation, these statements do include TFA debt service. However, other important debt service obligations, notably those of the WFA and Health and Hospitals Corporation (HHC) are excluded.

The case for including these obligations when assessing affordability is strong and straightforward. It was recently summarized by the Independent Budget Office in its analysis:

For purposes of assessing the burden on the local economy, it matters less whether the city or some state-created local public entity issues the debt. What matters more are facts concerning (i) the correlation between taxpayers and those who pay the fees to support the enterprise, (ii) ownership and operational control of the public assets supporting the public service, (iii) political control of the entity’s governing body, (iv) the nature of the public service itself and whether it, at one time, was performed directly by the city, and (v) the extent to which the city relies on the entity’s debt to fund a portion of the city’s capital program.

Applying these criteria leads to a conclusion that WFA and HHC debt should be considered in assessing affordability. In future statements and other public reporting, the Mayor and the Budget Director should include the obligations of these entities.

3. The denominator in the ratio should be a measure of the value of local economic activity.

The Budget Director’s statement generally follows this guideline. Appropriate measures include the value of real property and the value of personal income. Both these measures are used in the statement.

However, measures of tax revenues and total revenues, which also are included in the Budget Director’s statement, should not be relied upon as a primary gauge of the economic base. Revenues can change due to policy changes, such as shifts in levels of intergovernmental aid (for total revenues) or increases or decreases in taxes (for tax revenues). Debt should not be viewed as more affordable because local tax increases are enacted, or as less affordable because local tax cuts are enacted. Economic activity, not revenues, should guide decisions about affordability.

 

A WARNING ABOUT THE AFFORDABILITY OF CURRENT POLICIES

The CBC has followed the above guidelines to prepare alternative measures of debt service and debt affordability. This information is summarized in Figures 1 and 2.

These more meaningful indicators point to four conclusions:

1. Debt service obligations are, and will be, larger than indicated in the Budget Director’s statement.

Total relevant debt service is $3,859 million in fiscal year 1998 and grows to $5,169 million in fiscal year 2002. In the latter year the sum is fully $992 million larger than the largest amount reflected in the Budget Director’s statement.

2. If favorable economic trends continue, then debt service burdens will grow, but they will not reach levels that clearly should be judged unaffordable.

The data in Figure 2 indicate that, if the Administration’s economic assumptions prove valid, debt service will grow from 1.5 percent of personal income and 5.1 percent of property values in fiscal year 1998 to 1.7 and 6.1 percent, respectively, in fiscal year 2002. While the 2002 figure relating to personal income is a significant increase, the CBC does not judge it "unaffordable."

We agree with the Budget Director that affordability is a judgment about balancing capital needs with competing concerns including other government operating expenses and private consumption. However, this does not mean that any judgment made by a public official is a sound one. For example, experience from the fiscal crisis of the mid-1970s teaches that debt can be too high to permit a city to continue operating and obtaining access to credit markets. Our estimate is that in 1976 and 1977 debt service equaled about 3.3 percent of personal income—a level which resulted from poor prior judgments about the use of debt, and that in many respects defined the nature of the fiscal crisis.

The projected figure for fiscal year 2002 does not reach fiscal crisis levels, but is higher than has been the case for most of the 1990s. While debt service will place a growing drain on municipal resources that might otherwise be available for tax cuts or service improvements, the burden is not unaffordable by any clear criteria. In a 1989 report, A Review of the New York City Ten-Year Capital Plan and in a 1990 report, Toward an Affordable Capital Program, the CBC suggested that a meaningful threshold for raising concern about affordability was when debt service exceeded 2.0 percent of personal income. The projections suggest this threshold will not be crossed by 2002, but the projected ratio will be at a level close to that of the early 1980s when the City had great difficulty balancing its budget and had not fully regained access to public credit markets.

3. If the local economy experiences a slowdown or contraction in the coming financial plan period, then debt service obligations will grow even closer to a level judged unaffordable.

If, instead of the strong revenue growth projected by the Mayor in his Financial Plan, the local economy experienced in 2000-2002 the slowed growth following the recession of the early 1990s, then debt service in 2002 would approach 1.8 percent of personal income. While still below the 2.0 percent threshold, this is a sign of potential danger. Also troubling is the relationship between debt service and property values, another gauge of the value of economic activity in the city. According to the Mayor’s projections of assessed value, debt service will reach 6.1 percent of that figure in 2002. That ratio is larger than the figure in 1976 at the peak of the fiscal crisis. While income may be a better indicator of the value of economic activity than property values, the sharp increase in the property value ratio since 1990 should generate concern about the growth in debt service expenses.

4. In light of the risks associated with current policy leading to significant increases in debt service, the City should develop options that are more fiscally prudent.

Because of the risk of slowed economic growth, the City should develop and implement actions that would make debt service more affordable in the future. We suggest these three actions.

a. Use the surplus arising this fiscal year to retire outstanding debt or to fund capital projects on a "pay-as-you-go" basis. These uses of the surplus would reduce future years’ debt service obligations. In contrast, current policy in the Mayor’s Executive Budget calls for applying the surplus to pay next year’s debt service—a disguised form of applying the surplus to help fund an increase in next year’s operating expenses.

b. Review the proposed four-year capital plan to identify projects that may be unnecessary or can be deferred without economic harm. Planned capital commitments in coming years should be lowered in order to reduce the necessary borrowing. A leaner capital program may be necessary to achieve an affordable debt policy, and the Mayor should require the Budget Director and his Commissioners to review their capital programs to achieve this reduction.

c. Better maintain existing capital assets in order to reduce future capital investment needs. The City has a poor record of maintaining its fixed assets. The 1989 charter amendments recognized this and sought to increase accountability for maintenance by requiring annual estimates of maintenance needs and the percent of needs funded to be published by the Office of Management and Budget. Regrettably, the publication of this information has not changed notably the City’s neglectful practices. The latest data, for fiscal year 1997, show that less than one-fifth the needed maintenance was funded among at least eight major agencies—Correction (19 percent), Sanitation (17 percent), Board of Education (15 percent), Police (10 percent), Parks (10 percent), libraries (7 percent) and Fire (5 percent). Better maintenance policies in the operating budget would reduce future capital needs.

Thank you for this opportunity to testify. I hope the Mayor and Budget Director find these comments and suggestions helpful in crafting an affordable debt policy for New Yorkers.

Figure 1

Figure 2

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