The deal was simple and neat: Waterbury, which normally manages to collect 93 percent of the taxes due it each year, was guaranteed the equivalent of a 99.25 percent collection rate--up front and in cash each year under a three-year contract. The difference between normal collection and the guaranteed rate would put a very-much-needed $7 million a year in the city's coffers. In exchange, the city handed over to the private company its outstanding liens and the right to the uncollected taxes plus any interest or fees due.
Privatizing delinquent debt is not particularly unusual. Sometimes it's as basic as a contract with a collection agency. But a growing number of localities are moving toward more sophisticated approaches that can bring greater rewards but also carry considerable risk. Some big cities bundle up their liens and have the debts sold as securities. Investors are paid back as delinquent debt and interest is collected. Or, a city may sign up with a private company that, in effect, prepays the locality for the taxes due and then makes its money by collecting back-taxes and interest.
The benefit to a locality is that it gets its overdue tax money up front and even gets paid for debts that might never be collected. But there are pitfalls. With securitization, if collections fall below expectations, the security--a bond, usually issued by a third party-- may go into default. Although the city is not legally responsible for the default, its name is associated with the bond and its reputation in the municipal bond market could be tarnished.
It would seem to be a safer bet to go with a company. But Waterbury found that approach far from danger-free.
One of the biggest risks emerged in the third year of the city's three-year contract with Angram Business Services Inc., a Florida- based company. Angram filed for bankruptcy, leaving Waterbury in the lurch. Instead of having the guaranteed $7 million shot in the arm, it found itself several million short on its $250 million fiscal 2000 budget.
Pasquale Mangini, the city of Waterbury's tax collector, says the exact impact on the budget will be clearer after an independent state audit is completed. Meanwhile, the city had to resort to layoffs, some temporary, some not. But it also lost its liens and, with that, the opportunity to collect outstanding IOUs at 18 percent interest.
Waterbury was not the only Connecticut municipality to test this form of collecting delinquent taxes. South Windsor, Seymour and Torrington also contracted with Angram. All did so under the auspices of the state.
In 1995, Connecticut created a task force to investigate the privatizing of municipal tax collection, and it set up a pilot program to test the idea. But now, state officials are not exactly pleased with the experiment. "I don't think the state looks favorably on this anymore," says Linda R. Savitsky, director of municipal finance for the Connecticut Office of Policy and Management.
Savitsky says a number of Connecticut municipalities looked at the privatization pilot, but only three opted for the model that allowed a third party to own the liens.
One was South Windsor, which also dealt with Angram in its pre- bankruptcy days. South Windsor's new town manager, Matthew Galligan, who came to the job after the contract was in place, took a hard look at the numbers and found they just didn't add up. "It was a smoke-and- mirrors deal," he says. "Yes, you get an infusion of cash the first year, but by the third year, you're losing money."
The problem Galligan spotted is that after the first year, the tax liens are gone. Thus, in the succeeding years, the town loses the revenue that it could have gained by collecting the back-taxes with 18 percent interest. In its contracts, Angram guaranteed the municipalities a 99 percent or better tax-collection rate. But Galligan says that in general, most local governments can achieve such high rates on their own. South Windsor collects about 98.4 percent of taxes in the year they're due, but what is left outstanding is earning the city 18 percent interest, and most of that is collected within five years, with interest. "At some point," he says, "no matter what, we're going to get all of our taxes."
State data support that conclusion. "If you look at real estate taxes," Savitsky says, "I'd say that 99 percent of local governments in the state eventually collect all their taxes."
In Connecticut, local governments have 15 years to collect the taxes. So, by giving up their tax liens, local governments give up an important asset, Galligan says.
Galligan was a member of the state task force that had been created to examine the idea of privatizing tax collection, and he sought to sway other municipalities from adopting the approach. Galligan created a model that showed how much potential revenue South Windsor lost over the three years of the contract by giving up its tax liens. The state made the information available to other local governments so they could also weigh the financial pros and cons of privatization.
Seymour, a town of just under 15,000, also dealt with Angram and even with its contract completed before the bankruptcy, sees more cons than pros. "It looked good for a couple of years," says Robert Anderson, the town's tax collector. "But no one looked long-term, such as what would happen after the contract expired."
Angram's president, Joseph T. Whelihan, doesn't dispute the claim by local governments that they could be financially better off if they didn't sell liens or privatize. But he points out that if local governments can't collect the taxes, they'll never earn that 18 percent interest.
Angram's approach was to borrow money, usually at about a 12 percent interest rate, to pay the locality its up-front cash. The company then repaid the loan with cash collected from delinquent taxpayers. Since tax liens carry an 18 percent interest rate in Connecticut, there was room for a 6 percent profit, minus administration costs.
Considering that many local governments could do the same thing and get the borrowed money at an even lower interest rate, Whelihan admits that he can see why, once municipalities hire him and understand how he operates, they begin thinking they could do better without him. "They shouldn't need me after three years," he says. This is because during the term of the contract, Angram puts in place a software system that is designed to help local governments better administer their tax-collection process and increase their tax-collection rates.
Angram's bankruptcy aside, is some form of privatized tax collection a sound idea?
"Private firms are generally more efficient at providing many services than are state and local governments," says E.S. Savas, director of the Privatization Research Organization at Baruch College. The problem in Connecticut "isn't with privatization per se," he says. "It seems to be with how they did the contracts."
As Savas sees it, had these Connecticut municipalities been more careful about the company they contracted with and how they wrote their contracts, they might have had a positive experience. Angram's need to borrow money to pay the municipalities up front should have indicated to the local governments that they were not dealing with a financially sound firm. Moreover, these local governments should have been more careful in writing the contracts and gotten themselves a better deal. A better deal might even have required that Angram give them a portion of the interest and fees earned from delinquent taxes.
Officials with all three Connecticut municipalities and those with the state now say that short-term thinking is what lured these local governments into experimenting with privatization and that they are cured of the desire to do so again.
The city of Torrington is an interesting case in counterpoint. It has used a private tax collector since 1931. The right to privatize this function dates back to its charter from the 1920s and Torrington officials say that they are quite happy with the process. "I would never, ever say that privatization doesn't work for the city of Torrington," says Mayor Mary Jane Gryniuk. But she thinks the city's system works because, with the exception of the three years that Angram held the contract, the city has always had a local firm act as tax collector. The current collector, R. Thomas Crovo, is the nephew of Raymond B. Crovo, who was the city's private tax collector in the 1960s.
Crovo got the city's contract in 1999 after the city's contract with Angram expired. And Gryniuk says it was only when Angram had the contract that the city was unhappy with its private tax collector.
It's true that local governments, by privatizing, could lose potential revenue by forgoing the collection of liens at 18 percent interest, but she sees benefits to privatization. The contract for tax collection costs Torrington about $165,000 and the private collector hauls in about $40 million in back-taxes. "That's a bargain," Gryniuk says. "I can count on recovering 100 percent of my taxes. Yes, we don't gain the extra income from interest, but we have less risk, fewer headaches and guaranteed revenue."
