Staying Within the Debt Capacity

I am following up on an earlier post discussing the capital budget recommendations of the Governor and the Commonwealth’s debt capacity. Jim Bacon’s recent post discussing Secretary of Finance Aubrey Layne’s worries about increasing debt also dealt with this general issue.

Guided by Secretary Layne, the Governor’s introduced budget was relatively conservative in its capital provisions and the authorization of $568.4 million in additional tax-supported debt. As predicted in the earlier post, the General Assembly came under a lot of pressure to add to the package and responded accordingly.  The final budget bill, signed by the Governor in early May, authorized the issuance of an additional $1.1 billion in state-supported debt.

The major projects added by the legislature were the replacement of Central State Hospital ($315 million), a top priority of the Governor; “renewal” of Alderman Library at UVa ($132.5 million); and demolition and replacement of Daniel Gym at Virginia State University ($82.9 million). Also included in the introduced and final total packages was $248 million, primarily for Virginia Tech, which was tied to the Amazon deal.  Including the authorizations provided by the 2018 General Assembly, the 2018-2020 Appropriation Act authorized the issuance of an additional $2.1 billion in tax-supported debt.

As discussed in the earlier post, the Commonwealth abides by a voluntary limit on the amount of its general fund revenues that will be committed to debt service. That limit is an average of no more than 5 percent of projected general fund revenues over a ten-year period. The Debt Capacity Advisory Committee (DCAC) projected last December that up to $1.34 billion in additional debt could be authorized in this biennium with the state remaining within its debt capacity limits. With the General Assembly authorizing an additional $1.1 billion, it appears that the legislature stayed within the limit.

There are some hidden costs for which additional debt will need to be authorized in the future, but which were not included in the debt capacity calculations this year. The first such future cost is related to the General Assembly’s penchant for under-funding the capital pools. Some clarification is needed here. The majority of the tax-related debt projects are consolidated into one Central Agency “pool” project. There is an appropriation and bond authorization for the total pool, but the estimated costs for the individual projects are not broken out in the Appropriation Act. The spreading of the total funding among the various individual agency projects is done administratively later by the Department of Planning and Budget, after consultation with the money committee staffs and staff from the Department of General Services.

For the 2019 pool, the General Assembly authorized $694.3 million in a combination of new funding and funding left over from previously completed projects. However, the estimated costs of all the projects in that pool are higher. Estimates for all the authorized projects are not publicly available and the estimated costs for the others are preliminary, based on the agencies’ budget requests in 2018 and 2019. Nevertheless, even with that preliminary data, it is estimated that the funding authorized in the pool is at least $65.3 million less than will be needed. Underfunding the pools is not new for the General Assembly. The Department of General  Services estimated that, as of March 31 of this year, the 2016 pool will need, at some point, an additional $105 million, due to initial underfunding and cost increases.

Another hidden cost that must be addressed later is that for any furnishings and equipment that are not an integral part of a building. The legislature has a policy of not including this equipment funding in the initial authorization of pool projects, but providing it later when the project is nearing completion. For the sake of comparison, the Appropriation Act just signed into law authorizes $106 million in bonds for equipment of projects approved in previous years.

The administration and G.A. will have more room in debt capacity next year. The calculations used by the DCAC in December to project the debt capacity limits did not include the effects of conforming the state’s tax laws to the major changes in the federal income tax code. Because the G.A. did adopt conforming legislation, the state’s general fund revenues will be higher than the projections used in the debt capacity calculations. Of course, the G.A. stipulated that the additional revenue should be deposited into a separate fund and used for tax reform. It will be interesting to see how all this plays out next fall and winter.

Will the DCAC include this additional revenue in its debt capacity limits? It seems that it should, given that the additional revenue will come from income taxes, the primary source of the general fund. Will the administration increase its capital outlay budget request to take advantage of this resultant increase in debt capacity or will it exercise the restraint urged this spring by Secretary Layne? Will the G.A. take advantage of this increase in debt capacity to authorize more new projects, although it has said that the additional general fund revenue from the federal tax changes should go back to the taxpayers? These are just some of the questions that the fall legislative elections will influence.

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7 responses to “Staying Within the Debt Capacity

  1. Really Excellent commentary and I can see that you take pains to simplify it so average folks can understand it!

    I trust Layne but I do worry that it appears that they judge how much capacity they have and they promptly use it close to the limits.

    Also – these are separate pots of money from VRS pensions and VDOT money, right? They have separate dedicated revenue streams.

    Does VDOT’s debt count towards the State’s debt or is it separate?

    • Steve has addressed the VRS question very well.

      As for VDOT, some of the transportation debt is included in the debt capacity model and limits. Tax-supported debt includes all debt supported by statewide, generally applied taxes and fees. Furthermore, the legislation authorizing transportation debt (other than for toll roads) pledges the general fund as a back-up source of debt service. Accordingly, the transportation revenue, primarily gas taxes, that is deposited into the Transportation Trust Fund, and the debt service paid out of that fund are included in the Commonwealth’s debt capacity model.

      Between FY 2009 and FY 2018, the Commonwealth authorized $10.97 billion in tax-supported debt. Of that amount, approximately $2.7 billion, or 25 percent, was for VDOT projects. As of June 30, 2018, the amount of authorized and unissued tax-supported debt related to VDOT was $1.2 billion. These numbers do not include any debt issued for toll roads.

      Interestingly, the debt service on VDOT projects is taking up a disproportionate share of the state’s debt capacity. As the DCAC explained, “Currently, debt service on debt paid by the TTF exceeds 5% of TTF revenues. Accordingly, to the extent the 5% measure is exceeded, capacity derived from the general fund is being utilized. This does not mean that general fund dollars are supplementing debt service payments on TTF debt; rather, it means that capacity derived from the general fund is being used to keep overall capacity for all tax-supported debt under the 5% target. “

  2. Dick, thanks for the inside look at determining Virginia’s debt capacity.

    The natural tendency of politicians (Democrat or Republican) is to spend every time and borrow every dime they can. And it appears from your post that that’s exactly what’s happening here — the General Assembly is borrowing everything it can without jeopardizing the state’s AAA credit rating.

    Question: I remember bond issues in the past that went before the voters for approval. There was a big higher-ed bond issue a decade or so ago, as I recall. Why does the list of projects you provide above ($315 million for Central State Hospital, $132.5 million for the “renewal” of UVa’s Alderman Library, etc.) not require voter approval?

  3. VRS money is kept in its own “pot” and the GA cannot get into that trust fund. What the GA can do is manipulate its annual contribution rate to allow it to spend less cash there, more cash somewhere else. The “dedicated revenue streams” for VRS in my view are the employee dollars contributed and the earnings on its investments. VDOT’s revenue streams are dedicated in law, not in the state constitution. Subject to check, I think that VDOT debt does count toward the state’s overall limits. Most of it is also tied to specific tax sources, such as tolls.

    Despite temptation, I’m waiting for the end of the full FY before taking a look at the actual impact of income tax conformity on the state’s revenue. Still have May and June revenue to see.

  4. re: when is a referenda needed? Good subject for a separate blog post!

    Works that way at local level also – some things require specific voter approval and others just votes from elected.

    same church, different pew – which things REQUIRE a public hearing and which do not?

  5. To answer the question of Jim and Larry (and any other inquiring minds) about the need for a referendum on the issuance of bonds, it is necessary to get into the weeds some. (I need to be careful how far into the weeds I go, because I can easily get in over my head.)

    The Virginia Constitution sets out the various types of long-term debt the Commonwealth may incur. To simplify matters some, I will lump the four categories into two general categories—general obligation bonds and revenue bonds.

    General obligation debt is the gold standard. With general obligation debt, the Commonwealth pledges its “full faith and credit” toward the payment of the interest and principal to the bondholders. That means that, legally, those bondholders have the first claim on any state revenues. Because they are the most secure, general obligation bonds pay the lowest interest rate. General obligation debt must be authorized by the General Assembly and then approved in a statewide referendum before it can be issued. (Generally speaking, interest on bonds issued by the state and its subdivisions is tax exempt.)

    Revenue bonds are backed by the revenue associated with the project, rather than the full faith and credit of the Commonwealth. (There are exceptions, but they are not applicable to this discussion.) They do not require approval by referendum. The tax supported debt authorized in the current Appropriation Act falls into this category.

    In order to understand why these are technically revenue bonds, it is necessary to go a little deeper. The Virginia Public Building Authority (VPBA) and the Virginia College Building Authority (VCBA) are political subdivisions created in the Code of Virginia for the purpose of “constructing, improving, furnishing, maintaining, acquiring, financing, refinancing, and operating public buildings”, with the power to issue bonds. The authorities consist of the directors of state financial agencies and other persons appointed by the Governor. The Virginia Department of the Treasury provides staff support to the authorities.

    The language in the Appropriation Act authorizes the VPBA and VCBA to issue bonds to construct, expand, repair, renovate, or maintain the various projects listed. Legally, the two authorities issue the bonds, not the Commonwealth. The “revenues” used by the authorities to pay the debt service on these bonds are appropriations provided by the General Assembly for that purpose.

    I have long considered the VPBA and VCBA the equivalent of “shell corporations” created to bypass the referendum requirement. Be that as it may, those mechanisms allowed Virginia to break out of the Harry Byrd policy of “pay as you go” and construct the infrastructure needed for a modern state. That Virginia has been responsible in the use of debt can be seen in the maintenance of its AAA bond rating and the adherence to a voluntary cap on its use of debt.

    The state does not issue general obligation bonds often. The last general obligation bond referendum was in 2002. Although the interest rates on general obligation bonds are lower than that on VPBA or VCBA bonds, the difference is marginal and not enough incentive for the General Assembly to go through the delay and trouble of having a referendum. However, the bond rating agencies have voiced concern about the Commonwealth not issuing general obligation bonds. As the DCAC put it, the growing reliance on non-general obligation debt has “has caught the attention of the bond rating agencies and in the past has resulted in comments in ratings of the Commonwealth.” The ratings agencies complain that Virginia is not utilizing its AAA-rated general obligation capacity to the extent that other AAA-rated states do. The response of Virginia officials has been that those other states do not have a referendum requirement. Given this consistent concern expressed by the ratings agencies, I would not be surprised if a general obligation bond issuance is proposed in the near future.

    The politics of a general obligation bond issuance are interesting. First, the list of projects to be supported by the debt must be “popular” ones that would appeal to the state’s voters. That generally means the list is restricted to higher education, parks, and mental health; certainly no corrections projects would be included. Second, the list has to be balanced so that there are projects for every region of the state so that all voters feel that there is something in the package for them.

  6. That was excellent Dick. Thank You!

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