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Fire Up The Economic Engine

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By Lowell L. Kalapa

(Released on 7/20/08)

A couple of weeks ago as the heads of the state and counties prepared to approve their respective operating and capital budgets for the coming year, reporters questioned the use of debt or general obligation bonds for the construction and repair of capital facilities or buildings.

For those who remember their parents talking about the federal government being in debt and leaving a legacy of debt to the next generation of taxpayers, the idea of having government go into debt conjures up those scary thoughts of government going into bankruptcy. That is the furthest thing from the truth if the debt is managed wisely and, in fact, the issuance of debt by state and local governments is a tool by which the cost of large capital facilities can be spread over a number of generations of beneficiaries.

As the economy begins to slow and the Federal Reserve Board attempts to stimulate the economy by holding down interest rates, this is the perfect time to step in and use borrowing capabilities to spur economic activity by borrowing funds at low interest rates and investing in the construction of capital facilities. Unlike the earlier slow down in construction activity in Hawaii when state officials decided to give away tax credits to spur construction and stimulate the economy, this time the state won’t have the capacity to incur such back door expenditures as there just isn’t any money to hand out in tax credits.

On the other hand, borrowing the funds through the sale of bonds would allow government to invest in public infrastructure at a time when labor and materials should be readily available. This would allow government to invest in some badly needed infrastructure at a much more reasonable cost than it would have been when it had to compete with private construction activity. And unlike private projects which take years to put together as private investors must not only provide for the planning and design of a project, but also must attract the necessary capital and investors, government can access the capital more readily with its borrowing power and can, therefore, put the spade into the ground faster than private investors seeking the money in a tight credit market.

Perhaps the best of all worlds is to create partnerships between the public and private sector by having government access the capital while allowing private developers and contractors to actually build the public infrastructure. Another type of financing tool which is extended by the federal government but issued by state or local governments is private activity bonds.

These are debt instruments where the proceeds of the bonds are used for a defined qualified purpose by an entity other than the government issuing the bonds. In other words, a private company would be the user of the proceeds of the bonds issued by government. Because the bonds are issued by government, the interest income earned on the bonds would be tax exempt as long as 95% of the proceeds are used according to guidelines laid out by the federal Internal Revenue Code.

Qualified uses of private activity bonds include facilities such as airports, harbors, mass commuting facilities, water systems, sewage facilities, solid waste disposal facilities, qualified residential rental projects, facilities for the generation of electricity or gas energy, heating or cooling facilities, qualified hazardous waste facilities, environmental enhancements and public educational facilities. While all of these qualified uses benefit the public in general, only the construction or renovation of affordable residential rental facilities comes with an added bonus, a subsidy by the federal government of 40%. So for every dollar of private activity bond proceeds used for residential rental housing facilities, the federal government will throw in another 40 cents.

Thus, with an economy beginning to show signs of weakness from the loss of nearly a million airline seats, dropping vacancies in the state’s hotel inventory, a slowing of the residential housing market, the role that state government can play in stimulating the local economy is to bring capital into the state with its borrowing power and to invest in public infrastructure. It has a variety of tools at its disposal from general obligation bonds to private activity bonds with which to keep the economy moving.

Hopefully government leaders will take the initiative and use their resources to not only stimulate the economy, but to catch up on the backlog of public infrastructure needs.

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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