I-1033: Debt and Taxes

Eyman's initiative could mean a bad credit rating for Washington.
This post is 6 in the series: I-1033: Eyman's Permanent Recession

Debt and Taxes HamletIt caught my attention when I heard State Treasurer Jim McIntire saying he won’t be supporting I-1033 because he is concerned that if it passes, it could hurt Washington State’s bond rating, increasing costs for the state to borrow money.

My dad has an annoying saying about borrowing and debt: “Neither a borrower or a lender be.” The quote is from Shakespeare’s Hamlet and is given as sage advice by another father, Polonius to his son Laertes. I’ve never liked the quote because I have always been a fan of the creative use of public financing options, especially bonds. I wrote about Qualified Energy Efficiency Bonds (QECBs) and a proposal in Washington’s last legislative session as great opportunities to use public financing, or public debt, as a tool to create large scale energy efficiencies for cities and schools.

In spite of what Polonius and my dad say, debt is a good thing if it is managed well. The positive term for debt is ‘leverage’ and when the state seeks a loan it is often through bonds. Leverage means making tax dollars go further. Just like a homeowner wouldn’t necessarily pay cash to put an addition on the house, a state often won’t pay cash for big capital projects.

Like an addition, capital projects usually add value to the state’s equity. Large drainage projects, building schools or investing in energy efficiencies are examples of projects that are financed through the sale of bonds, or leveraged, rather than paid for outright. The idea is that tax the improvements would generate more value, in revenue or savings, to make the cost of borrowing worth it.

What is a bond rating anyway and why would a lower one be so damaging to the state?

A bond rating for a state is a lot like a credit rating for a person. Moody’s Investment Service, Fitch, and Standard and Poor are the three major bond rating agencies. Instead of a three digit number used for rating people, they rate states with a range of scores from AAA all the way down to CCC, with AAA being the top rating (sometimes, like grades in school, a plus or a minus is added).  Like an individual borrower, if the state’s books are in good order and there is a strong reserve and money coming in the door, the score will be higher and the interest rate will be lower. If things are unstable with future revenues uncertain, the rating will drop and the cost to borrow increases.

After Colorado passed a similar initiative, rating agencies downgraded Colorado’s credit rating. While Colorado does not issue general obligation bonds, they do issue financial instruments called certificates of participation which also are rated by the agencies—and when the state’s credit rating lost ground, the buying power of those instruments took a hit.

But why would the Eyman initiative wreak havoc on Washington’s bond rating?

In a nutshell, it reduces investors’ confidence that the state will repay its obligations. Lenders like certainty and stability; but since a spending cap creates uncertainty about the state’s ability to pay for basic services and infrastructure, it makes some investors will worry that the state could default on their bond payments. That uncertainty drives up the interest rate that bond buyers demand—just the way banks charge higher mortgage rates for people who don’t have a steady income.

California’s budget chaos is a case in point of what happens when bonding becomes expensive because of budget problems. The Fitch rating service, this summer, downgraded California from an A- rating to a BBB. That simple change could cost as much as $7.5 billion in increased interest payments over a 30 year period.

Eyman’s initiative could force Washington to take a place in line behind states like California and Colorado at the payday loan store, where borrowing money to build new energy efficient schools and upgrade old ones, for example, would cost more because of higher interest rates. For energy-efficiency loans, a higher interest rate would consume some of the savings on heat and power—making it even more difficult to use those savings to pay back the loan.

So the initiative’s stated purpose, saving money for taxpayers, would be undermined by the higher borrowing costs created by the initiative itself. Ironically, like Eyman’s two other initiatives ultimately enacted by the Democratic legislature and governors, 1033 would harm the very people it claims to help. In the case of I-1033 any tax dollars saved by tax payers could end up getting shifted to paying the higher costs of borrowing money.  Or the state could have to forgo borrowing all together, creating a backlog in new school construction.

So when deciding whether to be or not to be for I-1033, voters should consider Washington’s credit rating as one of many .

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Comments

  1. Michelle says:

    “…And borrowing dulls the edge of husbandry.”But, as you say, when debt is “managed well,” then its leverage can actually be a positive thing in the long run, enabling one “to thine own self be true” indeed.How about considering this for leverage: Give back any of the money saved from those green upgrades, to those people who want to be able to afford tix for this national treasure. Satisfaction guaranteed! :-)

  2. Michelle says:

    Alas, the Internet itself doth play tricks on us…Hopefully this time it will linketh up correctly.

  3. Michelle says:

    Arrrgh, a pesky lot we haveth here amongst us! Never thee mind. We shall outwit its mangy machinations with this:http://wiki.answers.com/Q/What_does_Shakespeare's_to_thine_own_self_be_true_mean

  4. Michelle says:

    Here’s some more information about I-1033.(h/t to Alan Durning’s public FB page. Maybe someday I’ll join FB, too. Cool stuff!)

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