Public Debt and the Quest for Efficiency

All government debt is not the same. Pension debt starves government of the people and tools it needs, but creative borrowing for infrastructure can save more money than it costs.
by | February 20, 2013

How much debt should cities and states carry and for what purposes? The question goes beyond the direct impact on the taxpayers of pension funding shortfalls, rising entitlement costs, unmet infrastructure needs or declining sales tax revenues due to Internet shopping. Governments mired in crushing debt don't have the flexibility to find ways to deliver better, more efficient services.

A recent event hosted by The Century Foundation raised this question in addressing the major fiscal and operational hurdles faced by state and local governments and how they might be mitigated. The panel I moderated focused on the troubling recent report by former New York Lt. Gov. Richard Ravitch and former Federal Reserve Chairman Paul Volcker, which examined unsustainable trends in public-sector pensions, health benefits and revenues.

Pension deficits in most places actually are greater than projected since public retirement funds across the nation typically assume a rate of return around 7 percent, a figure that isn't realistic over the long term of booms and recessions. And even when the funds do achieve that rate of return, public officials in many places still must make annual catch-up payments from operating revenues. In New York City alone, this number exceeds $10 billion a year -- funds that might otherwise have gone to reduce class sizes, increase the number of police patrol officers or improve human services responses. Instead, this money is redirected to pay retirement obligations for past employees.

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In short, the public workforce is being cannibalized as layoffs of current workers become necessary to support retired ones. This in turn challenges the community's quality of life and economic health, straining residents' employment prospects; their reduced spending power affects the property values that generate the very taxes funding public employees' salaries as well as their pensions. Residents in many places already are paying for current and retired public workforces in almost the same proportions.

The number of state and local government employees has been cut by more than 600,000 since June 2009, leaving governments struggling to keep up with legally obligated and necessary work. Undoubtedly, government workforces could become more efficient, but at some point the reductions in certain categories, such as police officers, will reach a critical tipping point, and it already has in many cities.

It there is one place where public officials should consider taking on more debt, however, it is in an area crucial to the country's economic health: addressing our $1.18 trillion infrastructure deficit, the unfunded portion of the $2.2 trillion needed over the next five years to build and rebuild roads, bridges, water systems and the like and respond to related federal mandates. Ravitch, one of the country's most astute observers of public fiscal matters, called attention to a need for better financing of infrastructure that is deteriorating or badly needing improvements, including the use of tools such as tolls or tax increment financing. To Ravitch, all debt is not equal, and he endorses borrowing for infrastructure so long as there is a way to pay for it.

Now certainly is the time public officials should look at repairing their infrastructure. Historically low interest rates -- for both tax-exempt and taxable debt -- provide an opportunity to inject necessary capital much more affordably. Much of our infrastructure that is most in need of repair is deteriorating at a rate that far exceeds current interest rates. This means, for example, that not repairing a bridge for the next four years might incur an annual cost three times higher than borrowing for repairs would, taking into account the rate of deterioration as well as the increasing cost of materials.

Examining these different aspects of public debt provides a number of lessons: Realistic and transparent accounting, with capital and operating budgets well separated, will give both credit-rating agencies and taxpayers more confidence. Clearly understanding the risks of badly balanced public-pension and retiree health funds will help as well, preventing distributions out of those funds into general budgets in good times and leading to needed reforms for new public employees. And officials who starve their capital budgets to help get past bad times really are engaging in another form of accumulating deficits. In this latter category, more use of alternate financing structures, revenue sources and public-private partnerships can amount to a prudent investment.

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