First published in The New York World
December 23, 2011
BY Pei Shan Hoe
Bonds borrowed against income tax receipts fueled state borrowing binge, with bills now coming due
Gov. Andrew Cuomo sold his recent tax overhaul as a move that would net New York $1.9 billion in revenue — the bulk of it from personal income taxes. This, he said, would go toward narrowing the state’s almost–$3.5 billion deficit for the coming fiscal year.
Yet any new money generated by the restructuring of personal income tax rates will not go to the state treasury. Instead, those funds will be delivered to bondholders to pay back past debts. And while the state constitution requires that voters approve state borrowing, the bonds tied to state tax revenue are issued through quasi-public authorities and get virtually no public scrutiny.
This year, about $9 billion in New Yorkers’ income tax withholding payments — one dollar out of every four — has been set aside to pay back bonds issued to pay for “state needs.” Over the last decade, these funds have helped build roads, mental health facilities and affordable housing.
More problematically, they have also enabled legislators to steer hundreds of millions of dollars in grants to businesses and nonprofits. Those debts keep coming. This week, Empire State Development is issuing $828 million in new bonds, including $60 million for Albany’s Sematech computer chip center and $69 million for Restore New York Communities, the Senate Republican majority’s jobs program.
The borrowing binge began in 2002, when Albany legislative leaders, with the support of then-governor George Pataki, authorized five state authorities to issue Personal Income Tax (PIT) revenue bonds. Financial institutions underwrite the bonds for sale to investors. The bond sales generate up-front cash for public projects, and investors get repaid over a period of years with funds set aside from the state’s income tax collections.
Since then, the New York State Environmental Facilities Corp., Dormitory Authority, Housing Finance Agency, Thruway Authority and Urban Development Corp. (doing business as the Empire State Development Corp.) have issued nearly $29 billion in these bonds. Almost $23 billion remains to be repaid to investors.Typically, bonds from state authorities are paid back through streams of revenue generated by the projects themselves. Thruway Authority roads generate tolls.Hospitals and universities (including Columbia University, home of The New York World) borrow funds through the Dormitory Authority to construct new facilities, then use patient fees or tuition revenue to reimburse the state authority.
But in the case of personal income tax bonds, the guaranteed payment is an up-front claim on automatic withholding from workers’ paychecks. State law specifies that 25 percent of New York State’s PIT revenues be deposited into a pledged revenue bond tax fund, held in joint custody by the state Comptroller and the Commissioner of Taxation and Finance. The money collected from income taxes must first go toward covering the debt service from these bonds before paying for anything else needed by the state. PIT collections continue accumulating in the bond tax fund until the fund reaches $6 billion, or 25 percent of PIT collections, whichever is greater.
In fiscal year 2011, New York State took in about $36 billion in personal income tax payments — equal to roughly 59 percent of the state’s tax receipts — and set aside about $9 billion for debt service. Next year, slightly more than $2 billion in debt service payments will come due. The rest of the funds provide a cushion to assure investors they will get paid as promised.
New York’s borrowing against future revenue isn’t unique — Washington, D.C., sells similar bonds, and many cities budget for anticipated future taxes to be collected from big development projects — but it is the only state that has systematically pledged its personal income tax revenues to investors, and its dependence on these bonds is only growing. The state budget office projects the volume of outstanding PIT bonds will jump from $17 billion in 2009-’10 to almost $27 billion in 2013-’14. By 2005, just three years after they were first issued, the level of PIT borrowing surpassed that of the state’s own “general obligation” bonds.
The income tax bonds have surpassed the state’s own debt in another important way: they are scored triple-A by the ratings agencies Standard & Poor’s and Moody’s Investors Service. The state’s general obligation debt is a lower AA. That’s because legislators have discretion about whether to budget funds for state debt payments — and there’s always a chance that they could choose to default, much as Congress threatens to. In contrast, by law, New York State taxpayers’ contributions to the PIT bond fund are automatic.
“They can’t appropriate that money to anything else,” said David Hitchcock, a senior director at Standard & Poor’s which has consistently rated PIT bonds AAA. “The law is written such that there is no reason not to appropriate, so it is assured that money will go first toward debt service.” In its review of the latest PIT bonds issued by the state’s Dormitory Authority, S&P declared that New York’s PIT bonds “will continue to be the primary vehicle for new capital needs,” thanks to their unconventional secured revenue stream and huge base of contributors.
Investors have eagerly bought up these bonds, even though yields are relatively low. The average yield to maturity for 10-year PIT bonds is 2.27 percent, compared to 2.79 percent for 10-year New York State–issued general obligation bonds. The last two issues from Empire State Development were heavily sought after, with Bank of America Merrill Lynch winning both bids totaling $700.3 million. Forbes did not call PIT bonds “sleep well munis” for no reason. These bonds are particularly popular investments for institutions, retirees and insurance companies.
“Public authority backdoor borrowing”
But the very features that make PIT bonds so reliable for investors also undermine accountability to the public. Under the New York constitution, voters must in most cases approve debt issued by the state. But like other bonds issued by authorities, PIT bonds declare to investors that they are “not a debt of the State” and do not have the “full faith and credit pledge” of state debt. As a result, voters have no say on more than $9 out of every $10 New York State borrows.
As State Comptroller Thomas DiNapoli noted in a 2010 report on deficit financing, PIT bonds issuance is “public authority backdoor borrowing, in which public authorities are used to issue debt for the State’s purposes, bypassing voter approval.”
Brokers dealing in the bonds are well aware of their back-room origins. James Lebenthal, president of Lebenthal & Company and perhaps the nation’s best-known municipal bond salesman, told The New York World that, as much as he was attracted as an investor to these bonds, he disapproved of their trampling of voters’ rights. “PIT bonds are appropriation bonds that divert the monies needed for other debt services,” he said. “The ratings agencies are fine with them, and I am fine with them, but I hate the hypocrisy. There’s a certain ill intent in weaseling their way around the constitution.”
Charles Brecher, executive vice president and director of research for the Citizens Budget Commission, advises that all bonds issued or backed by New York State — including the personal income tax bonds — should be created as debts of the state as defined in the constitution. But he also acknowledged meaningful advantages in bypassing New York’s voters, who have in the past rejected ballot measures authorizing bonds for essential state infrastructure such as sewage treatment plants, prisons and mass transit. “Both PIT and other appropriation-backed bonds are funding projects that may not have gotten approval otherwise,” he observed, “which raises the question: is voter approval the best test?”
So it falls to the state legislature to decide how the authorities spend the funds generated through bond sales. However, the details of how borrowed funds may be spent on capital projects are often decided in clandestine agreements between the leadership of the state Senate and Assembly, with the governor. The Senate and Assembly majorities then each allocate the funds to specific projects, and the governor signs the capital budget package.
Among the projects funded this way are grants to private businesses and nonprofit organizations, many directed by legislators to recipients in their home districts. Since 2002, the Dormitory Authority has issued nearly $864 million in PIT debt for economic development and housing projects, while Empire State Development has issued more than $1.95 billion.
Budget office spokesperson Morris Peters confirmed that legislative leaders and the governor negotiate which specific projects and programs get funded by money borrowed through issuing PIT bonds. When asked how exactly these are determined and whether legislators pushed for specific grant recipients, he said, “Of course certain legislators would advocate for projects in their own districts.”
Groups that use such funds to provide important public services caution against dismissing PIT borrowing for the authorities’ capital projects as mere legislative pork. “It’s essential that we preserve the state’s ability to borrow in order to invest in New York’s social and economic infrastructure,” noted Ted Houghton, executive director of Supportive Housing Network of New York, whose more than 200 members statewide house and treat people coping with mental illness, substance abuse and other special needs. Members have received grants from the Community Capital Assistance Program and New York State Economic Development Assistance Program, both of which are paid for with PIT bond revenues, and may be eligible for PIT-financed grants from the state Office of Mental Health. “Investing in permanent supportive housing for these vulnerable populations dramatically reduces this emergency spending, saving far more in taxpayer dollars than what the bonds cost the state.”
Even when the state’s capital dollars are well spent, they are not necessarily evenly distributed. A 2006 report by the Institute for Competitive State Government on the legislature’s capital projects financed through the Dormitory Authority and Empire State Development Corp. found that the state spent $29 per New York City resident on projects located in the city, in contrast to $59 for every Long Island resident, $156 per resident of the Hudson Valley and $356 in the Albany area.
Restore New York, the Senate jobs program receiving a new cash infusion through this week’s Empire State Development bond issue, has awarded only about 5 percent of its $303 million in grants to recipients in New York City. By contrast the $241 million New York State Capital Assistance Program, created by the state Assembly in 2008 and financed through several bonds issued by the Dormitory Authority, has spent about one-third of its funds on projects in New York City, while Assembly grants under the Community Capital Assistance Program are about evenly split between the city and the rest of the state. (The city is home to 42 percent of the state’s population.)
The question now is whether New York State can continue to issue debt for such projects while continuing to pay back bondholders for funds borrowed years in the past. Across-the-board tax cuts mean that revenues will be lower than they otherwise would have been. The state budget office projects a steady decline in the “debt coverage ratio,” the difference between the amount of money collected from taxpayers and the amount owed in payments to bondholders. In 2009, the PIT bond fund had a comfortable $5.30 for every dollar due in debt service. By 2014, it will be down to $3.70.
In this climate budget hawks caution about the perils of handing legislators a blank check. (By law, New York State has a $100 billion limit on “state-supported debt,” though some borrowing is not counted toward the total.) Edmund J. McMahon, a senior fellow at the Manhattan Institute for Policy Research, warned of increased borrowing without voter approvalback in 2001, just as state leaders contemplated creating the PIT bonds system. “Debt has grown and what has grown the fastest? PIT,” said McMahon recently. The net effect of the recent income tax restructuring is that income tax revenues will in the future be more heavily weighted at the top, noted McMahon, and these highest earners are the people whose incomes can have a net swing of 30 to 40 percent in a single year.
While a collapse in tax collections is unlikely, the possibility of serious dips in revenue or spikes in spending needs still needs to be considered, suggests former Assemblymember Richard Brodsky, who chaired the Committee on Corporations, Authorities and Commissions. “If things were to go wrong — for example, if the economy suffers, or demands for services go out of whack — the statute essentially gives bondholders a priority over taxpayers and citizens.”
Former Lieutenant Governor Richard Ravitch noted that the state needs to spend to maintain its aging infrastructure, which “is not a bad thing,” and emphasized the need for a balanced approach. “There are some things the state has to do, and maybe the constitutional limitations are a little archaic in the world that we live in now. But on the other hand, if the state pledges all of its income tax revenue as payment to debt then there will be nothing left to pay for everything else,” he said. “That’s why we have to strike the right median, and that’s why there’s a debt cap.”
Finding a balance between meeting essential state needs and curbing profligate and politically motivated spending may be close to impossible when so little information and input is available to the public about how the money raised through authorities’ debt is actually spent. Said McMahon, “There is great irony in New York State where, on one hand, you have one of nation’s strongest constitutional restrictions on state debt on paper, but we now have one of the nation’s least disciplined and least transparent debt issuance policies.”
Additional reporting by Merritt Duncan