Taxpayers Pay More When Politicians Avoid Voter Approval For Debt

Bypassing statewide bond referendums has cost North Carolina taxpayers an estimated $261 million in extra interest payments on state debt since 2005. That’s a key finding in a new John Locke Foundation Spotlight report.

“North Carolina voters have not seen a statewide bond referendum since 2000,” said report author Sarah Curry, JLF Director of Fiscal Policy Studies. “That doesn’t mean the state has avoided taking on new debt. Instead all debt issued since then has been done without voter approval.”

Curry is releasing her report as some N.C. legislators push a measure that would limit the amount of nonvoter-approved debt North Carolina could take on in the future. The report explains why limiting future use of nonvoter-approved debt might work better than repealing the law that created that type of debt.

State lawmakers have been able to avoid statewide bond referendums in recent years because of language in the state budget approved 10 years ago, Curry said. “The 2003 budget legislation included the State Facilities Finance Act, which opened the door to ‘special indebtedness,’ a blanket term for various forms of debt outside the traditional category of general obligation bonds.”

GO bonds require voter approval. The three forms of special indebtedness require no vote of the people. Curry’s report discusses all three: lease purchase revenue bonds, limited obligation bonds, and certificates of participation, or COPs.

“Over time COPs have become the most popular and preferred financing methods, which is attributable to the fact that they can be issued more quickly than bonds requiring a voter referendum,” she said. “By 2008 outstanding COPs amounted to almost $1 billion. The current outstanding balance tops $500 million. ”

While that dollar figure has dropped, limited obligation bonds have taken on a larger role. The state’s outstanding debt from this type of special indebtedness is $2 billion.

Overall, the portion of state government’s total debt that lacks voter approval continues to climb. “Special indebtedness made up about 18 percent of North Carolina’s outstanding debt five years ago, but the figure now tops 40 percent,” Curry said. “The state treasurer’s latest North Carolina Debt Affordability Study projects that percentage will grow to 46 percent by 2017.”

While COPs and the other forms of special indebtedness prove more convenient for politicians, they also lead to more costs for taxpayers, Curry said. “General obligation debt traditionally has a very low interest rate because it is secured by the full faith, credit, and taxing power of the state,” she said. “Special indebtedness is repaid by an annual debt service appropriation from the state’s General Fund, which means a higher interest rate than voter-approved debt.”

Even a slight difference in interest rates can make a big difference, Curry said. “The interest rate penalty increases the cost of projects being financed and over time amounts to a significant portion of the debt.”

For example, Curry estimated the cost to taxpayers from 2005 to 2011 of an additional 0.25 percentage points on the interest rate of nonvoter-approved debt. Each year, the estimated additional interest topped $10 million, peaking at more than $64 million in 2008. For the entire period, the special indebtedness is estimated to have cost taxpayers an extra $261 million.

Lawmakers have taken steps to scale back nonvoter-approved debt, canceling $232 million in special indebtedness in 2011. The cancellation included all special indebtedness authorized in 2010.

Some legislators want to repeal the 10-year-old law that created special indebtedness. Curry’s report documents potential problems with that option.

“The removal of these debt vehicles would be viewed negatively by the financial markets and could send investors a signal that North Carolina no longer endorses appropriation funding for debt-financed projects,” she said. “This domino contagion would negatively affect the value of the outstanding special indebtedness held by investors and possibly lower the state’s bond ratings or trigger other unintended consequences.”

Senate Bill 129 would take a different approach. It would limit future use of nonvoter-approved debt. “This bill does not eliminate special indebtedness altogether but limits the amount North Carolina may have outstanding at any one time,” Curry said. “Special indebtedness makes up about 40 percent of North Carolina’s total outstanding debt, but the bill would cap the percentage at 25 percent.”

That means North Carolina could no longer rely on nonvoter-approved debt until that type of debt drops below 25 percent of the state’s total debt burden, Curry said. “In essence, there is a chance for a temporary moratorium on special indebtedness,” she said. “Given the fact that this nonvoter-approved debt leads to higher interest costs, this change could save taxpayers valuable dollars.”