Using State Bonds to Pay for Government Doesn’t Hurt Like Taxes, But It Can’t Last : Debt: With its AAA credit rating, California is like a once-successful businessman whose income is plummeting but whose credit line is intact.

California is going into debt at an alarming rate. Voters approved $5 billion in state bonds in June and are being asked to sign off on an another $5.3 billion next month. Such a result would more than double the amount of bond debt that California had at the end of 1989, and would represent a borrowing rate 10 times that of a decade ago.

This borrowing binge amounts to nothing less than a mortgaging of California’s future. Bond issues are not free money--they must be repaid like any other loan, with interest. Repayment of these obligations, once the bonds have been sold, will cost the state at least $4 billion a year for a generation to come. The numbers will become even more mind-boggling as additional debt is created in future years.

With its blue-chip, AAA credit rating, California is like a once-successful businessman whose income is plummeting but whose credit line is intact. As State Treasurer Tom Hayes has repeatedly pointed out, the market for California bonds is becoming saturated and, as it becomes apparent that our financial health is fading, our bond rating will drop and our borrowing costs will increase, thereby compounding an already vicious cycle. Even now, the state has a backlog of more than $10 billion in unsold bonds; Hayes urges that future sales be held to no more than $2 billion a year.

In some respects, the day of reckoning is already here. We are rapidly approaching the point where the state will be paying, largely from the general fund, as much as $5,000 a year for every California resident just to amortize bond proceeds that have already been spent. This drain on the general fund has become a prime ingredient in the yearly torturous budget process, as the Legislature and the governor strain to find any remaining discretionary funds for vital programs.

Why this massive and accelerating reliance on bond debt to finance government operations in California?

The simple answer is that revenues are falling billions of dollars short of meeting the state’s costs of even routine governmental activities, let alone public works and other special programs. The bond issues on the November ballot, for example, would finance, among other things, drug enforcement, forest conservation, veterans’ home loans and construction of schools, prisons, child-care centers and university facilities.

As the pathetic spectacle of this year’s state budget battle demonstrated, Sacramento is too factionalized to set spending priorities by anything approaching consensus, particularly as spending demands outstrip budget growth. Under the circumstances, borrowing, especially with the voters’ approval, is an easy way out for a divided Legislature and a governor unalterably opposed to new general taxes.

The same phenomenon is occurring at the local level, where officials are finding themselves increasingly short of general funds to finance programs and facilities demanded by the citizenry, especially in rapidly developing communities with inadequate infrastructure. Lacking enough conventional revenue sources, local jurisdictions are utilizing assessment districts, special tax districts and other money-raising entities to finance and carry out even the most customary of governmental activities--building roads and schools, providing police and fire services. In the process, they are collectively generating a debt of approximately $5 billion a year.

Debt financing--whether in the form of general obligation bonds backed by the full faith and credit of the issuing jurisdiction or revenue bonds supported by identified revenue sources--has become the stop-gap solution to California’s fiscal crisis. To understand this situation, it is necessary to look back to the tax revolt of the late 1970s and the adoption of the Jarvis and Gann initiatives.

Proposition 13, a constitutional amendment adopted in 1978, undercut the primary revenue source of local government by sharply reducing real-estate assessments and restricting increases in subsequent years. It also established a two-thirds vote requirement for new special taxes.

Two years later, voters, by passing Proposition 4, imposed constitutional limits on government spending at all levels, allowing only modest adjustments in future years. They further reduced, in 1988, what little discretion remained in allocating state expenditures by adopting Proposition 98, requiring roughly 40% of state general funds to go to public education. Meanwhile, federal assistance to local governments during the Reagan years was gutted and state revenues declined as a result of income-tax indexing, begun in 1982.

The effects of the tax revolt on state government were not felt directly for some time. With revenue sources other than property taxes untouched, Sacramento continued to prosper along with the state economy, although the new restrictions on local revenues rapidly brought on demands for redistributing a portion of state funds to local jurisdictions. By the mid-’80s, however, both state and local governments had begun to feel the concussive effects of the Gann time bomb, as the permitted increases in spending were overtaken by economic growth and demands for public expenditures. By the turn of the ‘90s, virtually every governmental unit in the state had reached its spending limits.

Government officials seized upon the perfect solution to this budgetary dilemma: a funding source that not only generates added funds but also is exempt from the Gann limits. Proposition 4 had specifically exempted any subsequent voter-approved bonded debt, thus allowing public officials to present to the electorate bond issues intended to finance every variety of governmental activity. For voters who had begun to feel the pinch of the shortfalls in government revenues and spending, even in the middle-class suburbs where the tax revolt was spawned, this was blessed relief.

Stop-gap measures, however, can only do so much. It is finally becoming common wisdom, among both the state’s political leadership and the electorate, that California’s public financing system should be substantially restructured. Toward that end, some initial steps have already been taken: Last June, voters loosened the Gann spending limits and adopted an increase in gasoline taxes. Actually, the tax revolt had barely subsided when voters began passing virtually every measure authorizing increased local spending, usually for targeted programs. Furthermore, polls increasingly point to voter approval of increasing general taxation and expenditure, especially to support the traditional governmental obligations.

Some analysts argue that the kind of spending enabled by bond financing is simply an investment in the economic future of the state, and thus should not be discouraged. Certainly, new roads or universities paid for by bonds indirectly stimulate economic growth, but the link gets more tenuous when it comes to new government office buildings and drug enforcement. In any case, this argument begs the fundamental question of whether there isn’t a better approach to finance government activities generally.

A number of basic changes need to be made to stabilize the financing of state and local government in California and restore a sense of order to what has become an overly ad hoc process. This requires not only reducing reliance upon bond financing, but also making it more flexible and simultaneously developing alternative revenue sources.

The constitutional provisions established by Proposition 13 must be revamped. No one suggests repealing it. But its current assessment procedures are biased in favor of longer-term owners, particularly commercial properties. Some form of split-tax roll would not only reduce this inequity, but would generate substantial additional property-tax revenues for local government. At the same time, it is critical that voters reject Proposition 136, which would require a two-thirds vote on new taxes.

Local general obligation bonds should be made subject to approval by simple majority rather than a two-thirds margin, thereby providing easier access to financing backed with tax revenues generated by the entire community. This would be a more equitable alternative to the special taxes and assessments now in such wide use.

Also, the state should be required to redistribute any surplus above its annual spending limit to local governments; local governments themselves should seek more revenues from user fees, that, like bond debt, are exempted from the Gann spending limits, as well as from Proposition 98’s provisions. At the same time, it is necessary that the radical allocation of state funds imposed by this proposition be substantially modified to allow more flexible setting of priorities.

After the November election, it is crucial that the new governor make a priority of coming to terms with the Legislature on a program for restoring a stable and responsible base to public finance in California. The voters, on our behalf and that of the future generations who are already becoming heir to the debts we are creating this year, must demand no less.