Investigative report by Mark Flatten,
Goldwater Institute 

Full Faith and Credit

The usual way for governments to go into debt is to issue bonds that are repaid through some type of taxes or fees. Usually the interest paid on government bonds is not taxed, making them attractive to investors who buy them on the open market. That allows governments to pay lower rates to borrow money.

Government bonds often amount to a full pledge of taxpayers’ wealth. The debt becomes the first lien on any money that is pledged to repay it, regardless of the consequences to taxpayers or the agencies that borrow the money. Standard language in bond documents tied to land values requires property taxes to increase to whatever level is necessary to make the annual principal and interest payments. As in Lee’s case, if one property owner goes broke, the cost is simply shifted to those who remain.

Similar guarantees are made when sales taxes or other fees are pledged to back bonds. Debt service is the first claim to the money. Anything left over is what can be used to run the rest of government. If money falls short, either taxes must be raised or services must be cut.

Jobing.com Arena

That is happening in Glendale, which has pledged so much of its sales taxes and other revenues that would normally fund day-to-day operations toward debt payments that bond rating agencies are raising fears the city may not be able to meet all of its obligations.

About a fourth of the money Glendale takes in for general operations goes to pay debt. In addition, the city is paying the National Hockey League $25 million a year to keep the Phoenix Coyotes playing at the Jobing.com arena, built with $180 million in bonds that were supposed to be paid for with stadium rent payments.

But the Coyotes went bankrupt in 2009. Since then, Glendale officials have struggled to keep the team playing there, last year offering to issue $100 million in new bonds to help finance the purchase of the team from the NHL by a private investor. That deal fell through when the Goldwater Institute raised concerns that it would violate state constitutional prohibitions against using public funds to subsidize a private business.

Glendale is paying a heavy price. Last year Moody’s Investors Service downgraded the city’s bonds, citing its high debt burden and “high leverage” of the city’s operating fund that pays for general city services like police and fire protection.

In some instances, bonds issued either directly through Glendale or through special districts created by the city are backed by second and third liens on sales taxes and other revenues normally reserved for operational spending, essentially meaning the same money is being used to back two or three different sets of bonds.

“Of continued concern, Moody’s notes that the amount of debt service supported by the general fund is substantial, reflective of management’s decision to highly leverage the city’s primary operating resources,” the report stated.

Glendale’s debt was downgraded again in January, and the outlook was changed from stable to negative, with Moody’s continuing to raise concerns that so much operating revenue was pledged to repay bonds.

Analysts for the ratings agency warned city officials faced tough choices to deal with the debt:

“The outlook also reflects budgetary pressures over the near-term that may require politically challenging revenue raising measures or cuts to city services,” the most recent report warned.

Diane Goke, chief financial officer for the city, said Glendale has not had to resort to tax increases or cuts in services through the sour economy of the last few years. However, as the council prepares the budget for next fiscal year, “all options are on the table,” she said.

Glendale did commit a large portion of its sales tax revenues to economic development projects, such as the arena and other projects in the area, when times were good, Goke said. When the economy tanked, those revenues declined sharply, creating pressure on the general fund, she said. When the economy was strong, Glendale also set up a fund balance, essentially a reserve account, of $72 million that it has used to bridge gaps as sales taxes have declined, Goke said.

That balance is down to less than $12 million.

“We do face some challenges ahead,” Goke said. “We do have some debt. The council has some really tough decisions to make, but in the past they have made some really tough decisions and done what they need to do. Given what we know now, would we do it all over again? I can’t answer that question. But we do certainly have some challenges ahead of us. We’re going to weather those challenges.”

Rating the Risk

Bond ratings reflect the risk to investors, not the risk to taxpayers, said David Jacobson, a communications strategist in the public finance group at Moody’s. So high ratings mean there is great certainty that the government that issues the bonds will be able to repay them. Part of that equation is the expectation that governments will do what is necessary to make their debt payments, even if it means raising taxes or cutting services, he said. Some governments, including Glendale, commit multiple sources of revenue to a bond issue to drive up the rating.

“We’re not in the prescriptive business,” Jacobson said. “We’re kind of agnostic as to how they do it. If they do it by raising taxes, and it works, that’s fine. If they do it by cutting expenses, that works; or some combination of the two.”

Lower bond ratings raise the city’s cost of borrowing money when it issues new debt and makes those bonds already trading less attractive to investors. In February, Glendale attempted to market $58 million in bonds backed by sales taxes and other general fund revenues. It only managed to sell about $8.7 million.

“The market said ‘look Glendale, you need to get some of your things in order before we’re going to go any farther,’” Goke said.

Glendale has about $1 billion in outstanding bonds.

Pay As You Go

Max Wilson, Maricopa County Supervisor

Max Wilson, chairman of the Maricopa County Board of Supervisors, said what is playing out in Glendale and other cities with heavy debt burdens shows why it is dangerous for governments to rely heavily on borrowed money.

“Debt is not free,” Wilson said. “Debt kills you. It’s not good in any economy.”

Maricopa County has had a policy since the mid-1990s of paying up front for capital improvements, such as new buildings, out of the regular operating budgets rather than issuing long-term bonds. That means for the most part if the county does not have the cash, the project does not get built, Wilson said.

The county was teetering on bankruptcy in the early 1990s, said David Smith, who was brought in as county manager to help the board of supervisors dig out of the debt and overspending that had driven it to near ruin. Since then, the board has limited the growth of county government and set money aside every year so it would not have to use bonds for most large construction projects, said Smith, who recently retired.

More than $1 billion worth of capital projects have been financed without issuing debt by Maricopa County. That includes a new $340 million court building, and almost a half-billion dollars in jail improvements that were financed by a quarter-cent per dollar sales tax approved by voters. By paying for the improvements with year-to-year revenue rather than by issuing bonds, the county saved about $350 million over the last 10 years in interest charges, according to county estimates. Paying cash for the new courthouse alone saved about $191 million.

As other levels of government have cut services and raised taxes to cope with the economic downturn, Maricopa County has remained relatively stable and this year reduced property taxes by about $22 million, Wilson said.

David Smith, Maricopa County Manager

“It’s pretty simple economics,” he said. “If you go into debt you are paying more for your money than if you don’t go into debt, and you can do more with your dollars if you do not go into debt. The people are the ones that have to pay for the debt. They’re the ones that elected us and the ones we’re serving. Nothing is accidental when it comes to money. Either you’re good money managers or you’re not.”

Arizona law actually encourages governments to go into debt because it limits how much a local government’s general operations budget can increase from year to year, an attempt to control spending. Maricopa County has issued debt for projects it would have otherwise paid cash for to avoid violating that spending limit, Smith said.

“These laws are blunt instruments,” Smith said.

Maricopa County, where about 60 percent of the state’s population lives, does owe about $134 million in bond debt, most of it left over from old issues. Per-capita debt for county government in Maricopa County is about $35. Pima County, the state’s second largest in terms of population, owes almost $1 billion on outstanding bonds, about $1,016 per person. Five Arizona counties have no debt themselves, though some have created special districts that do owe money. For instance, Yuma County has no bonded debt itself. The Yuma County Library District, technically a separate entity, owes about $48 million on bonds.

Good Debt and Bad Debt

Scottsdale Mayor Jim Lane

Not all debt is bad, said Scottsdale Mayor Jim Lane. Paying for infrastructure like water and sewer treatment plants that will be used for decades with long-term bonds makes sense, especially when the debt is repaid for through specific revenues such as water and sewer fees.

Scottsdale has about $1.15 billion in outstanding bonds. That works out to about $4,719 per resident, the most of any major Arizona city. About $350 million of that was to pay for water and sewer lines and treatment facilities, Lane said. Another $277 million is owed for nature preserve efforts in the McDowell Mountains, authorized by voters in 1995 and 2004.

“The appropriate use of debt is to build the infrastructure that the city relies upon, whether it’s streets and sidewalks, or it’s water lines and treatment facilities or a public safety building or city hall; any of your hard assets,” Lane said. “You are talking about a long-term asset. You generally match a long-term asset with long-term debt so you have an even matching the useful life of it with a steady stream of income over a longer period of time.”

It is dangerous for governments to commit general operating revenues like sales taxes to long-term debt, said Lane. That is something Scottsdale did in the past.

About two years ago Scottsdale adopted a policy of not obligating sales taxes and other money used for day-to-day operations toward debt, Lane said.