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Employ Debt For Capital Projects

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By Lowell L. Kalapa

(Released on 6/22/08)

Earlier this session, a proposal was thrown in the hopper to use $75 million in income tax credits to encourage the undergrounding of utility lines presumably along the Leeward Coast of Oahu where downed utility lines have hampered traffic in and out of the Waianae Coast.

While the sponsor of the bill may have thought that the tax credits would be a great incentive to get the utility companies to put the utility lines underground, some sound public finance principles would have been ignored. As has been opined about tax credits in past commentaries, tax credits lack accountability. Once they are adopted or enacted, there is very little oversight. The taxpayer neither knows how much in credits have been claimed nor for that matter who claimed them.

However, in the case of this proposal another good public finance principle would be violated by using cash for a capital improvement that will serve several generations of taxpayers or consumers. That is because the tax credits would be a hit against current revenues. In the case of the proposal, the work, and therefore the claims for the credits, would have to be done over a five-year period, putting an extra burden on current taxpayers for those years when the credits could be claimed.

However, because the benefit of having the utility lines underground will benefit many generations of taxpayers, it is for this reason that government issues debt or bonds in order to pay for capital improvement projects, such as schools, roads, and office buildings, rather than paying for those improvements with current taxes or cash. By stretching the repayment of those bonds over a 20 or 30-year period, those current and future taxpayers, who will use the facility over the period of its lifetime, will help pay for the facility.

Conversely, debt should not be used to pay for goods and services that will be consumed immediately, such as payroll or utilities, as those will be consumed or used by the current generation of taxpayers. If debt were used to pay these costs, future taxpayers would be asked to pay for a benefit they did not receive.

Although some might think having government go into debt is a bad thing, the borrowing of money and incurring debt is just one more tool that government has to insure the appropriate and equitable way of financing public infrastructure. And while repayment of public debt incurs interest charges, over time and with inflation, the debt, including the interest, will be much less than if government had used current resources or cash.

One must also remember that over time inflation will also drive the cost of constructing the facility even higher than if it had been done 30 years earlier. Thus, incurring debt and building facilities now and paying for them over time is a far more efficient and equitable way of paying for public infrastructure.

So how does government borrow those funds and what kind of oversight is there to borrowing that money? While the governor and the administration can propose which capital improvement projects will be funded, it is the legislature that has the final say as to which will be funded and what the means of financing will be. The means of financing can take a variety of forms including federal funds but rarely if ever is cash used to finance capital improvement projects.

There are three types of bond funds that may be used. There are general obligation bonds for projects that are not expected to produce any kind of revenue. These would include schools or state office buildings. The full faith and credit of the state are pledged to repay the bonds and, in fact, those bonds are considered a “first charge” against the state revenues and must be repaid before any other expense of state government.

Then there are reimbursable general obligation bonds which are used when it is assumed that there will be some revenue from the project like a parking lot at the university. Should the revenues of the project prove to be insufficient, then government must put up revenues from the general fund to cover the cost of repayment. This has happened only once or twice in the history of the state.

Finally, there are revenue bonds that are issued largely for projects that are funded out of special funds like highways and airports as the enterprise becomes solely responsible for the repayment of the bonds. If revenues fall short of meeting the repayment schedule, then the taxes or fees of the special fund must be raised to cover the cost.

Thus, debt and issuance of bonds are just other, more appropriate, ways to finance public infrastructure.

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui News, West Hawaii Today, Garden Isle News, and the HawaiiReporter.com.

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