There’s no reason for a state or county to borrow money when it is running a budget surplus and interest rates are rising. But that’s what many states and counties want to do. As economist Chris Edwards notes,
This year, four states have bond issues on the ballot and there are usually hundreds of local ones. Voters in Arlington County, Virginia, for example, will decide on six bonds for schools, transit, parks, and other items.
When higher state and local taxes are on the ballot, voters usually reject them. But, inconsistently, voters usually support bonds by large margins—often around 75–25—as in Arlington in recent years. Voters may not realize that general obligation bonds are equivalent to taxes. When they are issued, it results in higher taxes down the road than otherwise to pay the principal and interest.
Bond issues are particularly unjustified this year because most states have large budget surpluses. State and local tax revenues soared 10 percent in 2021 and may grow another 7 percent in 2022. In addition, the federal government showered the states with $1 trillion in pandemic‐related aid followed by hundreds of billions more aid in the 2021 infrastructure bill. Governments should be paying down debt right now, rather than issuing more debt.
In general, state and local governments should minimize or eliminate debt, as I argue here. Governments can fund their infrastructure on a pay‐as‐you‐go basis, meaning with ongoing taxes, fees, and charges. Some of the most frugal states in the nation issue very little debt.
Financing infrastructure with general obligation debt incurs interest costs and creates unneeded budget risks. This year, interest rates are rising, so it is a particularly bad time for governments to increase borrowing. State and local debt issuance also generates billions of dollars of fees for Wall Street middlemen, which is pure waste for the overall economy because pay‐as‐you‐go funding would avoid it.
New Mexico is asking voters to approve $19 million in debt for libraries and $215 million for schools and colleges. If the spending is really needed, couldn’t the state have included it in its $25 billion regular budget? After all, the state currently has a budget surplus of $2.5 billion. Similarly, Rhode Island is asking voters to approve $50 million in debt for environmental and recreational projects, yet the state has a $900 million budget surplus.
It is imprudent for states to impose costs on future residents when the costs can be paid now. Debt provides no free lunch. Rather than borrowing, policymakers should sequence their major projects and allocate a portion of ongoing tax revenues for construction and renovation.
This kind of borrowing may have made sense last year, when interest rates on municipal bonds were very low. But not now. Since the beginning of this year, interest rates on municipal bonds have risen by about 3%, massively increasing the cost of repaying a 30-year bond. The interest rate on a typical Baa quality bond rose from 2% in January to 5% in October. The interest rate on a typical A quality bond rose from 1.6% in January to 4.6% in October. That higher interest rate increases the cost of repaying a 30 year bond by around 60%.
Moreover, by the time bonds are issued after voter approval of these bond issues, interest rates could easily rise by 1% or more.
