FEATURE
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QC
FINANCING
Not All Debt is Bad
Look at risk associated with debt, and choose projects carefully by Robert Inzer
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his is the fourth and last article in a series discussing managing risk and what you as an elected official should know. In prior articles, we provided an overview of risks your city may incur and ways to protect your city. We’ve addressed the need for reserves to fund immediate costs incurred through hurricanes and other unexpected expenditures. We’ve addressed liability concerns and how to protect your city. The last article covered the risks associated with investing surplus funds and how your city can mitigate these risks through oversight, review of performance and participation in professionally managed pooled programs. This article will discuss risks associated with debt. How much debt is appropriate for your city? What are the advantages and disadvantages of internal funding of projects versus funding projects through bond proceeds? And, what are the opportunities for your city to mitigate risk during the debt issuance process and the management of this debt once issued? In conversations over the years with city commissioners, I’ve heard them advocate for issuing debt and also be opposed to incurring any debt. Debt is not good or bad. It is a tool, and like all tools, it can be used effectively or can be abused. There are advantages and disadvantages to funding a project through debt. By issuing debt and building the project today, you are enhancing the quality of life in your community by making the improvements available to your citizens sooner. You are also not subjecting the project to inflationary risks of deferring construction until adequate internal reserves can be accumulated to build it. Issuing debt also ensures that future citizens who have access and use the project will pay for it. Pay as you go financing may take many years to accumulate 40 QUALITY CITIES | FIRST QUARTER 2022
the needed resources to fund a project, and yesterday’s citizens that paid taxes to build the project may or may not be tomorrow’s users. Debt spreads the costs out over the future so that future users will be paying for the project. As an example, consider an expansion to your sewer system. If you are building an expansion of your treatment facility to potentially accommodate future growth, then issuing debt ensures those future users will be paying for that facility in their sewer bills. One of the main disadvantages is debt reduces future flexibility. A portion of your future budgets will be fixed, and if there is a need to reduce future budgetary expenditures, it will be more difficult since debt repayment of the bonded debt is not optional. Another disadvantage is that future taxpayers have no voice in the project or the repayment of the debt. Lastly, you are paying interest on the borrowed funds. We are currently in a period of exceptionally low interest rates, with interest rates on municipal bonds being around 2%, which is below the rate of inflation for the past 10 years. Under Florida law, all capital expenditures are eligible for debt financing. The fact that they are eligible does not suggest that they should be financed through debt. A fiscally prudent city provides for a balance between pay-as-you-go financing and debt financing. As a general rule, cities that are growing rapidly have large capital programs and will generally have a higher debt level than mature, fully built-out cities that are maintaining their infrastructure. The Florida Constitution and Florida Statutes limit local governments in what you can pledge for security for your debt. Unlike the private sector, cities cannot pledge assets as security for
