COPs: Bad Boy, Bad Boy
In North Carolina, state and local governments are prohibited from borrowing money without the approval of a majority of the people who choose to vote on the question. So why does the recently adopted budget for the fiscal year 2008-09 include more than $850 million in borrowing that will never undergo the scrutiny of voters?
Governmental entities usually borrow money by issuing general obligation bonds. These bonds are secured by the “full faith and credit” of the State, which means that taxes will be used to repay the debt, even if taxes have to be raised in order to make certain the creditors are paid. All such general obligation bond issues must be approved by the electorate.
Under the state constitution, some exceptions are allowed with respect to approval by the voters. These exceptions are for the following purposes:
· to fund or refund a valid existing debt;
· to supply an unforeseen deficiency in the revenue;
· to borrow in anticipation of the collection of taxes due and payable within the current fiscal year to an amount not exceeding 50 per cent of such taxes;
· to suppress riots or insurrections, or to repel invasions;
· to meet emergencies immediately threatening the public health or safety, as conclusively determined in writing by the Governor; and
· for any other lawful purpose, to the extent of two-thirds of the amount by which the State's outstanding indebtedness shall have been reduced during the next preceding biennium.
In 2002, the General Assembly of North Carolina found a way to get around the pesky business of getting the approval of the people before issuing bonds that had to be paid off by the state’s taxpayers. It was called the State Capital Facilities Finance Act (Article 9 of Chapter 142).
In adopting this legislation, the General Assembly found that there was a continuing need for more capital facilities in North Carolina, noting many of these will continue to be provided on a "pay‑as‑you‑go" basis by direct appropriations (other capital facilities, however, would still be funded by the issuance of general obligation bonds).
But lawmakers claimed that there was a need for alternative financing methods to facilitate providing capital facilities by some means other than direct appropriations and the issuance of general obligation bonds, so conveniently, they created such an alternative - Certificates of Participation (COPs).
According to legislators, COPs would provide financing flexibility to the state and permit the state to take advantage of “changing financial and economic environments.”
A Certificate of Participation is a financial document that is employed when a governmental entity creates a bond issue. Instead of paying interest on the bonds or guaranteeing a face value at the conclusion of a capital project, the investor (the bond buyer) receives a return based on revenues associated with the capital project, such as an annual government appropriation. A referendum is not required in order float a COPS bond issue because the full faith and credit of the state is not pledged. As John Hood, president of the John Locke Foundation, pointed out, “In practice, there is essentially no difference. No investor in a COP has ever initiated foreclosure and ended up owning, say, a broom closet in a state prison. COP buyers lend money, and taxpayers pay it back. That’s a public debt.”
There is, of course, no language in the statute indicating that COPs is a way to get around having to allow the people to vote on bond issues, though many believe this was precisely the reason for going down this road. But COPs are repaid at a higher interest rate, since the bonds are not technically backed by the full faith and credit provision of the Constitution. So why would the state or a local government want to pay a higher interest rate? For them, it’s worth the price for avoiding the potentially messy process of asking the voters for approval.
Some defenders of COPs contend that it's a timing issue, since this type of borrowing can be expedited more quickly than the traditional referendum bond. No doubt this is true, but it could also be said that government could do almost anything more quickly if it did not have to consult the voters. The question is - is it necessary? Current leaders in the state House of Representatives admit some COPs capital projects funded by the 2008-2009 budget would not break ground for years, allowing ample time for a referendum on these projects.
More likely, lawmakers worry that voters might reject some of the proposed projects.
On July 3, House Speaker Joe Hackney and Senate leader Marc Basnight announced that the legislative budget conference had agreed on issuing $857 in new debt, including $750 million in new COPs and $107 million in “two-thirds bonds”, a previously unused scheme that allows the government to reissue two-thirds of the amount of previously repaid bonds, also without voter approval. In addition, the budget reduces planned tax cuts from $50 million to $29 million.
In defending the new bond issues, the legislative leaders turned to their old, well-worn justification: job creation. They claimed that the new debt would create 20,000 jobs in the construction industry and generate $85 million in taxes and other income for the state treasury. As Hood points out, however, legislative leaders took no note of the private spending that would be displaced by the higher debt service or the private jobs that might be sustained by this private spending. “The question doesn’t seem to have occurred to Basnight and Hackney, operating under the assumptions that borrowing is income and that opportunity cost doesn’t exist," Hood notes. "Public debts for infrastructure are justified only if the benefits from using the infrastructure to carry out legitimate government functions…exceed the full cost of the debt, including principle and interest over the life of the loan.”
Additionally, wouldn't those same jobs be created if the projects were funded by a voter-approved general obligation bond?
If legislators were sincerely seeking some new alternative and innovative financing mechanism for the changing financial and economic environments, it would have been more noble - and more transparent - for them to propose amending the state Constitution, carving out an exception for COPs.
Oh, but, wait, that’s no good. Amending the constitution would require a vote of the people!
Read more in Scott Mooneyham's column,"Voter Debt Dodge Continues, Southern Pines Pilot.
Updated July 29, 2008.
