Some local governments in California have drawn unwanted attention for issuing bonds that delay principal and interest payments for 20 years. These bonds, known as Capital Appreciation Bonds, push payments onto future taxpayers and can result in up to $10 being owed for every $1 borrowed.
A degree of well-deserved skepticism has emerged regarding this sort of exotic public financing tool – a tool that allows elected officials to enjoy the fruits of borrowed money while telling today’s voters not to worry about the debt.
Michigan legislators deemed appreciation bonds so dangerous that they voted to ban them in 1994.
But CABs, banned in Detroit, aren’t just a California phenomenon. Texas has increasingly turned to appreciation bonds in recent years.
Texas’ per capita state debt ranks 45th in the nation.
But, when local debt is added in, Texas’ per capita debt ranking soars to the 15th-highest in the nation. The collateral for this high local debt is local property taxes – the 14th-highest property taxes in the nation.
Local control is a sacred Texas tradition. But what happens when large bond elections are held on low turnout dates? Or when the voters lack the information they need to make informed decisions?
An example of how rapidly things can go wrong can be found in Leander Independent School District. Leander ISD found itself grappling with a burgeoning student population, with expectations that the housing stock would soar 50 percent by 2021 from a base of about 58,000. The school board borrowed heavily to finance school construction.
When the recession hit, Leander ISD faced two problems: it borrowed too much and it overbuilt.
Leander ISD could raise taxes to pay for the bonds they issued; they could try to cut back on expenses, but, since school districts typically separate their operating budgets, used mainly to pay teachers, from their capital budgets, used to build new facilities, this is very difficult; or they could declare bankruptcy and renegotiate their debt.
Unfortunately, for future taxpayers, Leander ISD chose a fourth route: they refinanced their debt, borrowing about $389 million in Capital Appreciation Bonds with repayment delayed for 20 years so as to preserve cash today and not ask local taxpayers to shoulder the burden of the school board’s overborrowing.
But, such buy-today, pay-tomorrow borrowing is not without consequence. Fitch, a bond ratings firm, downgraded Leander ISD’s debt in May, observing, “The downgrade applies to approximately $1.3 billion … ” of debt ” … secured by an unlimited ad valorem tax pledge levied against all taxable property,” with “further restructurings” likely at “very high debt levels,” with slow “amortization of principal” due to the ” … extensive use of capital appreciation bonds to minimize tax rate impacts and shift the debt burden to future taxpayers.”
This is as close to a morality play as can be found in the dry language of Wall Street – an intergenerational theft of taxpayers yet born by today’s voters and elected officials akin to America’s other underfunded promises: Social Security, Medicare, and government pensions.
By resorting to capital appreciation bonds to refinance their debt, Leander ISD will end up paying back about $9 for every $1 borrowed. From 2007 to 2011, Texas local governments issued more than $2.3 billion in CAB debt in more than 700 separate borrowings. Taxpayers will eventually pay more than $20 billion to retire this debt.
Until the Legislature bans the use of toxic financial instruments like capital appreciation bonds, Texas taxpayers should be skeptical of a political promise that, “these bonds won’t raise your taxes.”
DeVore is vice president of communications and senior fellow for the Center for Fiscal Policy with the Texas Public Policy Foundation. [email protected].
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