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Before the governor and legislators release their versions of the state budget, a very important source of information is needed — a comprehensive assessment of the state’s debt status.  Each year the Treasurer’s office releases a Debt Affordability Study, which outlines the state’s debt management, ability to issue new debt for capital needs, and updates on rating agencies’ perceptions of the state’s debt condition.

This study is one of the pillars when creating a sound and responsible state budget.  The state is responsible for multiple capital structures and also must use tax dollars to pay interest on outstanding debt.  Lawmakers must have a clear picture of the state’s current debt and know how much more they can access without compromising the state’s AAA ratings.

Last week in the State of the State address, Gov. McCrory laid out some of his plans for the upcoming legislative session.  Not surprisingly, he suggested issuing bonds to pay for transportation projects, and he elaborated on his previously stated objective of improving outdated state infrastructure.  What needs to be addressed is whether these requests are realistic.  Specifically he wants to issue $1.2 billion in bonds to "jump-start" transportation projects and $1.4 billion to renovate "crumbling" buildings or to tear down buildings that cannot be saved.

The metric used to calculate the state’s debt capacity is debt service as a percentage of general tax revenues.  According to the most recent study,

…the State’s General Fund has debt capacity of nearly $700 million in each of the next 10 years. The ratio of debt service to revenues peaks at 3.66%, in the current fiscal year, notably below the 4.00% target.

…transportation debt service to revenues is projected to peak at 3.69% in this fiscal year versus the limit of 6%. Transportation debt capacity equals approximately $1.044 billion in the current fiscal year and totals approximately $1.136 billion through 2019.

On a combined basis, the General Fund and Transportation Fund’s debt service is projected to peak at approximately 3.67% of combined revenues this year.

While I agree with the Governor that roads and bridges need to be improved and there are multiple state buildings that are not safe for state employees, his proposed method of financing might not be as simple as he thinks.  Issuing a large amount of debt this year or early next year would solidify the state’s commitment to infrastructure improvements and also give lawmakers a feather in their cap when running for re-election in 2016.  On the other hand, what if North Carolina experiences a natural disaster or an economic downturn where there is a large budget shortfall?  Maybe the state needs to have some debt capacity available for unexpected circumstances.  As a practical matter, when the state issues bonds, there is a time lag between the bond being authorized and when it is issued.  Instead of pledging all available debt capacity in one year, why not issue smaller amounts each year and work on these projects incrementally?

The state does not have the capacity to issue all $2.6 billion of McCrory’s desired bonds this year without losing our AAA bond rating and limiting our ability to respond to emergencies it the future.  While General Obligation bonds would be an inexpensive way to fix state infrastructure and roads, we cannot afford to issue all $2.6 billion this year. 

While the discussion of these bond offerings are sure to garner much attention in the upcoming months, there are other items of great importance raised by this study that the legislature should take into consideration.  (1) There needs to be stronger language restricting any government entity from entering into a financial arrangement that creates debt or debt-like obligations for the state.  (2) The state needs to continue its priority of maintaining budget reserves.  (3) General obligation bonds should be the preferred method to finance debt for the State’s capital needs. (4) The state should not issue back-up pledges of State appropriations to provide support for debt issued by other entities.

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