Municipal Borrowing Trends in the Fourth District
One distinct characteristic of the recent slow recovery has been financial strain of state and, especially, local governments. State and local tax revenue dropped 8.4 percent in 2009, capping a record-setting five consecutive quarters of declines in income and sales taxes. While revenues from income and sales taxes have slowly climbed back to pre-recession levels, depreciated property values are now working into the assessment process. The first quarter of 2012 recorded the sixth consecutive drop in local property tax revenues. (These figures are from the Rockefeller Institute, 2010 and 2011.) State and local government payrolls have been cut by 3.5 percent nationally since their 2008 peak.
What does this strain imply for municipal borrowing? Are state and local governments canceling or postponing capital projects because they fear taking on new interest payments? We examined the issuance of municipal bonds for public improvements in Fourth District states going back to 2006. Borrowing activity in Kentucky, Ohio, Pennsylvania, and West Virginia actually increased in 2009 and 2010 as municipalities took advantage of the Build America Bonds program. But borrowing dropped precipitously as the program expired, and time will tell if the decline reflects the Build America Bonds program pulling forward spending that would otherwise have taken place in 2012, or whether it reflects the new normal level of municipal borrowing.
Plotting the quarterly borrowing for Ohio, Pennsylvania, and Kentucky shows that there was no distinct slowdown during the recession or immediately afterward. Rather, the pace of borrowing slowed in 2011. Most of the funds in the public improvements category are for municipal capital projects such as police stations, fire equipment, and library renovations. The debt service is paid from the same general funds that support the shrinking local government payrolls. Schools, transportation, utilities, and ten smaller categories are tracked separately.
In the third quarter of 2006, Philadelphia issued a large quantity of bonds, totaling $1.8 billion. This issuance, which was outside the Fourth District, creates the early spike in Pennsylvania’s moving average.
If the bond issuances are categorized by their taxable status, it is clear that 2009 and 2010 saw an unusual volume of federally-taxable municipal bonds. The cause of the surge was the American Recovery and Reinvestment Act.
The interest paid on most municipal bonds is exempt from federal income taxes. High-income households own most municipal bonds, and they are willing to accept a lower interest rate from municipalities because the payments are not taxed. As part of the American Recovery and Reinvestment Act, however, the federal government offered to directly subsidize interest payments on taxable “Build America” municipal bonds. This was intended to raise municipal bond yields and make them attractive to middle-income households and foreign investors, who do not have large income tax liabilities. Replacing the implicit subsidy of tax exemption with a federal expenditure subsidy is a strategy public finance professional have discussed for decades. The Build America Bonds program was the first large-scale implementation of this approach. The high volume of federally taxable bonds in the Fourth District shows that the program had widespread participation in the region.
As with other stimulus programs, there is a question of whether the short-term subsidies pull forward economic activity that would have been smoothed over the subsequent months and years. If we compare the annual debt issuance and new debt service incurred during the pre-recession period (2006:Q1-2007:Q3) to that in the post-recession period (2009:Q3-2012:Q2), we find that the results are mixed. Two states have issued more bonds per year, and taken on more new interest payments, after the recession than before, while two states have posted lower numbers. So far, it appears that the Build America Bonds rush in Ohio and Kentucky offset the subsequent drop in activity. If Philadelphia were excluded from the analysis, the Pennsylvania figures would be almost equal before and after the recession.
|Pre-Recession (2006:Q1–2007:Q3)||Post-Recession (2009:Q3–2012:Q2)|
|Issuance||New coupon payments||Issuance||New coupon payments|
Note: Coupon payments are for the first 12 months.
Sources: Bloomberg; authors’ calculations.
What do the data above reveal about the spending of state and local governments in tightened post-recession fiscal circumstances? The answer—for now—is that it is too soon to tell. Over the next few quarters, we will see whether the recent dip in new state and local government borrowing represents a new normal or whether borrowing will return to a pre-recession pace.