State Sen. Tommy Tucker, R-Union, wants to curb a government funding mechanism popular among elected officials because it does not require them to gain voter approval to raise taxes.

Tucker is the primary sponsor of Senate Bill 129. All new state debt incurred after July 1 through so-called “special indebtedness” programs would be capped at 25 percent of the amount of the state’s general obligation bonds. The cap would not affect current special indebtedness, which now equals about 40 percent of the general obligation debt.

“What that means is that … the ability for this legislature and future legislatures to use [special indebtedness] as a vehicle to add money to the state credit without the consent of voters will be halted” at the 25 percent level of the general obligation debt, Tucker said.

Certificates of participation may be the best known of the three types of special indebtedness permitted under the State Capital Facilities Finance Act that SB 129 would limit to the 25 percent threshold. Lease purchase revenue bonds and limited obligation bonds are the others.

State Treasurer Janet Cowell’s office said she endorses special indebtedness.

“The treasurer supports the position contained in the 2013 Debt Affordability study that recommends that the state consider the authorization of general obligation debt as the preferred, but not necessarily the only, method to provide debt financing for the state’s capital needs,” said Julia Vail, deputy director of communications in the Treasurer’s Office.

“There are circumstances … including consideration of the types of projects being financed or the necessity to move quickly, or other factors, that actually result in special indebtedness being the more efficient vehicle overall,” Vail said.

All three credit rating agencies give North Carolina a “AAA” bond rating, the highest possible, on general obligation debt, which typically provides the lowest cost financing, Vail said. The state had $4.4 billion in general obligation debt as of Feb. 28, according to Treasurer’s Office data.

Special indebtedness is rated one step below the “AAA” rating. As of Feb. 28, the state had $551.8 million in certificates of participation, and more than $2 billion in the other two special indebtedness categories.

Traditionally, governments use general obligation bonds to finance big-ticket projects. They promise bond purchasers that they will back the bonds with the full faith and credit of their taxing power. The governments often dedicate a portion of a property tax to repay the bonds. A referendum on the debt must gain voter approval before bonds can be issued.

State and local governments use special indebtedness to avoid debt ceilings. A certificate of participation, for example, uses a third-party financing authority to sell the certificates to investors to raise money that pays for a government project. In return, the investors receive a share of the lease payments made by the government to the issuing authority.

Special indebtedness is paid with state general appropriations. It is not linked to a specific tax, so it carries a higher interest rate and costs more than a general obligation bond to repay. It does not require voter approval.

Despite criticism of special indebtedness financing under the State Capital Facilities Finance Act because taxpayers don’t vote on it, Tucker does not believe it can be banned.

“I would say to eliminate COPs altogether would require a constitutional amendment. That is the cleanest way to do it,” Tucker said. “I don’t think there is favorable support for that at this time.”

Another concern is that financial markets would react negatively to a ban as a signal that the state may be unwilling to pay special indebtedness with general appropriations. Bondholders could then experience a drop in value of their investments.

“So we reached a compromise with other members and with the Treasury and with bond counsel that if we cap it at 25 percent of the GO (general obligation) debt it would not interrupt any of those priorities that they have,” Tucker said.

State general obligation bonds and special indebtedness totaled $7 billion as of Feb. 28, according to the Treasurer’s Office, “and we’ll pay over $706 million in principal and interest” on that this year, Tucker said.

Jeanette Doran, executive director and general counsel of the North Carolina Institute for Constitutional Law, is among critics of government use of special indebtedness. She cites Article 5, Section 3 of the state constitution as her rationale. It states:

“The General Assembly shall have no power to contract debts secured by a pledge of the faith and credit of the State, unless approved by a majority of the qualified voters of the State who vote thereon.”

“I do think as a practical matter and at least arguably as a legal matter it is a pledge of the security of the state and should require voter approval,” Doran said of certificates of participation and other special indebtedness.

Government won’t let itself default, “and I think lenders and investors know that,” she said.

“So although it doesn’t technically, expressly obligate the government to use taxing power to make debt service payments, everybody involved knows government is going to do what it has to do to make debt service payments, even if that means raising taxes,” she said.

However, she concedes, there is a state Supreme Court precedent that allows use of certificates of participation. That case was Wayne County Citizens Association v. Wayne County Board of Commissioners.

The taxpayers group unsuccessfully sued Wayne County over its financing of a new four-story county court and administrative office building, and a five-story jail. The county entered into a $7.5 million installment purchase contract with First Union Securities.

The Supreme Court decision stated there was no merit in the argument that the county may expend tax revenues in future years to pay off the debt.

“Unlike general obligation bonds, wherein the taxing power of the governmental unit is pledged, in installment purchase contracts, only the property improved is pledged. The possibility that appropriations which might include income from tax revenues will be used to repay the indebtedness under the contract is not a constitutionally significant factor,” the decision stated.

“I do think it would be ripe for the court to reconsider” that 1991 ruling, Doran said. “We need to be very careful that the aim of the constitution, which is empowering the voters to limit public debt, is not circumvented by crafty financiers and bond counsel.”

Dan E. Way (@danway_carolina) is an associate editor of Carolina Journal.