How to Reduce the Public Debt

I

COMBINED debt service charges on the grand total of over-all public debt of this country are more than $3,000,000,000 annually, or one sixth of all governmental (national, state, and local) expenditures. In thousands of instances the present cost of caring for previous debts takes 33 1/3 cents out of every tax dollar, and in many cases the debt charge runs as high as 50 cents. Many a citizen must wonder how public debt grew so large with so little opposition. Here is one reason.

Public debt springs from two sources: (1) the construction of public improvements such as schools, hospitals, state houses, city halls, courthouses, streets, sewers, highways, waterworks, and so forth; (2) ‘deficit borrowing,’ failure of a governing body to meet current operating expenses from current cash receipts. The first type of debt usually can be justified as creating a definite asset value behind the loan, with continuing benefits for the next twenty to forty years. Often the taxpayer has a chance to vote on these issues, but he usually is powerless against deficit borrowing. The latter debt comes to public attention as a fait accompli; the money is already owed, and all that can then be done is to find the best way of carrying the burden. This second type of debt is dangerous, usually unnecessary, and always unfair to the citizen of to-morrow. It benefits the taxpayer in the current year only, creates no new asset value, and burdens the taxpayer of to-morrow not only with the principal on the debt but with excessive interest charges as well.

Debt caused by deficit borrowing has reached astounding heights. At least one third to one half of all public debt has been created by the accumulation of annual operating deficits, or by the extension of maturing obligations beyond the useful life of the public improvement for which the money was originally borrowed. The Federal debt alone has increased from one to four billion dollars a year in the past seven years as a result of unbalanced budgets. Direct state debt in the form of deficit funding increased 183 per cent from 1930 to 1937. Many cities can blame deficit funding for one third to one half of their total debts.

This trend, if continued, must lead eventually to bankruptcy, repudiation, chaos. Fortunately, during this same period, many cities and some states have been quietly initiating constructive financial programmes. Some through necessity, and others through foresight, have returned to time-tested economic principles and are setting worthy examples for other political subdivisions as well as our national government to follow. By adopting a ‘pay-as-you-go’ policy, they are achieving the following results: —

(1) Elimination of further deficit funding;

(2) Orderly annual retirement of existing debt;

(3) Lower total interest charges each year as the debt decreases;

(4) Restoration of sound credit which will enable necessary future financing of required new improvements at low interest rates.

II

An encouraging illustration can be found in New Jersey. Although one of the wealthiest states in the Union, its municipal credit from 1932 to 1934 fell extremely low. One out of every five of its municipalities was in default. A number of its cities were paying employees in scrip or were behind in pay rolls. Many could not borrow, and such cities as had bank credit were paying the top interest rate of 6 per cent. Their bonds were selling at from 40 to 80 cents on the dollar.

While various factors contributed to this collapse of municipal credit, the basic cause was failure to keep current operations on a cash basis. For budget purposes, New Jersey municipalities had long been allowed to anticipate 100 per cent collection of the current tax levy and to overestimate receipts from miscellaneous revenues. Annual operating deficits accumulated rapidly. Customarily these deficits were financed by the issuance of tax-anticipation and tax-revenue notes. By 1934, floating debts included overdue tax notes, delinquent state, county, and school district taxes, unpaid bills, and, in many cases, defaulted principal and interest on funded debt. Floating indebtedness constituted 15 to 50 per cent of the gross indebtedness outstanding December 31, 1933, of the majority of New Jersey cities. The schedule at the foot of this page shows typical cases.

In 1934 the New Jersey Legislature, recognizing this emergency, enacted Chapter 60, known as the ‘Cash Basis Act.’ The Act was permissive and not mandatory, yet within two years a majority of all the large cities in New Jersey took advantage of its provisions. It permitted any municipality operating thereunder to fund its current floating indebtedness by issuance of serial bonds maturing from one to twenty years in the future. But if a city elected to do this, it was required thereafter to operate on a cash basis with balanced budget. In estimating the receipts from taxes and miscellaneous revenues a city could anticipate no greater percentage of collection than that achieved during the preceding year. How the Act restored the credit of New Jersey municipalities and thereby reduced interest costs can best be illustrated by specific examples.

DEBT AS OF DECEMBER 31, 1933

East Orange, endeavoring to dispose of $160,000 of improvement bonds on a 6 per cent basis in January 1934, received no bids, as its outstanding bonds were then selling on a 6.50 per cent basis. However, acting under Chapter 60 six months later, it sold $2,700,000 of bonds on a 4.375 per cent basis, an improvement in interest rate of over 30 per cent in six months. This saving encouraged other cities to put their finances in order.

New Brunswick was paying 6 per cent in 1934 on all of its tax-revenue notes; it has since sold Chapter 60 bonds on a basis of less than 3 per cent, one half of the former rate.

In October 1933, Jersey City’s bonds were nominally quoted at 65. In January 1936, it sold 3.75 per cent bonds maturing in one to fifteen years for a fraction above 99.

Paterson early sought the advantages offered by Chapter 60. Operating on a true cash basis for the past four years, it has reduced its net debt by $4,605,000, more than 22 per cent. This performance required courage on the part of both officials and taxpayers, but was essential, as the gross indebtedness had reached a danger point. Debt liquidation, restoration of salary cuts, increased educational costs and relief expenditures, caused a $1,570,000 rise in the annual tax levy over a four-year period. However, a continuation of this policy for another five years will reduce the annual interest requirements to approximately one half of what they were in 1933. Paterson deserves commendation for its heavy sacrifices to achieve solvency.

An even more remarkable showing has been made by Garfield, New Jersey. Its conditions had long been regarded as perilous. During 1931-1933 the city’s operating deficits ranged from $250,000 to $450,000 per annum, or about 20 per cent of each year’s tax levy. As of December 31, 1933, the gross debt was $6,535,000, of which more than half was floating debt. Garfield’s gross debt has now been reduced $1,240,000 by an average pay-off of more than $300,000 per annum. Efficient operating methods and stimulation of tax collections were rewarded by a substantial reduction in the tax rate, from $7.54 in 1934 to $4.69 in 1938.

Although Chapter 60 was enacted as an emergency and permissive measure, its benefits are so apparent that the cashbasis provision has been made mandatory under the new Bond and Budget Act of New Jersey. In that state there has been a definite halt in creation of unnecessary and improper debt arising from annual operation deficits, and each year is showing a steady reduction in existing municipal debts.

III

In creating public debt, officials should weigh rigidly these factors: (1) the necessity for each improvement; (2) the capacity of the taxpayers to meet interest and principal charges within the useful life of the improvement; (3) the cost of maintaining and operating the improvement as a useful asset; and (4) the method of financing the project so as to secure the lowest possible interest rate and to amortize the principal of the indebtedness with the least burden to present and future taxpayers. In the zeal to get money, far too little thought is given to the carrying charges and terms of repayment. Often additional debt is created and repayment fixed without reference to burdens already created by previous bond issues or without weighing the effect upon future borrowing. Instances of improper planning and later corrections of expensive mistakes are common; but a concrete typical illustration can be found in a brief résumé of the debt structure of the State of Tennessee.

Governor Browning, since taking office in January 1937, has effected a debt revision which is saving the taxpayers millions of dollars annually. Tennessee’s troubles of a year and a half ago were due primarily to poor structural planning as debt was created. Its debt was large, but by no means excessive; it could be compared to a sturdy mediæval castle to which various wings had been added here and there as necessity dictated until it looked awkward and was expensive to operate. No complete architectural plan had ever been prepared to guide state officials in creation of new debt or reduction of old debt. A clumsy array of illconceived funding arrangements existed, each fund operated individually and without relation to economical servicing of the total indebtedness. Millions of dollars were evaporating through vents in the debt structure.

At the beginning of 1937, Tennessee’s debt stood as follows: —

(1) Gross indebtedness was approximately $129,000,000.

(2) Average interest rate was high, 4.78 per cent, owing to lack of planning and timing of bond issues. For example, temporary notes were issued at 4 per cent, refunded by 4.15 per cent bonds, again refunded by 5.75 per cent bonds, and finally reissued as longterm bonds at 0 per cent, an over-all increase of 50 per cent in interest rate.

(3) Maturities were unbalanced. One third of all Tennessee bonds, as originally issued, matured in a single year.

(4) Special revenues were pledged for debt service on certain issues, while none had been allocated to others, with the result that there was excessive coverage on one third of the debt and insufficient coverage on the remaining two thirds. For example, $1,000,000 of 0 per cent funding bonds, maturing in 1941, were issued in 1932 with one cent of the gas tax pledged for servicing. Within four years this gas tax accumulated more than $1,000,000, which would have retired the entire issue in 1930, but as the bonds were non-callable the state continued to pay 6 per cent interest while it had $1,000,000 idle cash in the sinking fund. Yet on other issues, such as the $15,545,000 of General Fund Bonds, no revenues had been pledged and the state was refunding these bonds at high rates each year as they matured.

This summary indicates, but by no means exhausts, the complications which combined to raise Tennessee’s costs and hurt its credit. Idle cash which would not be needed for years could not be used to pay bonds of short maturities. The state lost money because it had to pay more for its borrowings than it could get for its deposits. And it faced the dire prospect of refunding an estimated total of $60,000,000, with probable interest costs of $20,000,000 to $25,000,000.

In May 1937, the Tennessee Legislature passed an act to reorganize this jerrybuilt debt structure, to the end that existing revenues pledged for only a portion of the debt could be utilized to service the entire state indebtedness. To do this without breaking contractual pledges or obligations on the existing bonds was a delicate matter, and the method by which it was accomplished has been called a unique achievement in public finance.

Under authority of the Debt Reorganization Act, the state issued Sinking Fund Retirement Certificates in an amount equal to the outstanding noncallable bonds in the hands of the public. These certificates were non-negotiable and did not increase the net debt of the state, as they were turned over to a newly created Board of Liquidation to be held in sinking funds for all outstanding issues. The certificates matured either on or prior to the date of maturity of the bond issues for which they were pledged. In this way all existing assets in the old sinking funds were released, and the then existing pledges of future revenues were transferred to benefit the entire debt. No contractual obligations were broken.

The Act also authorized the state to issue Consolidated Bonds to replace the callable bonds and also some $31,000,000 which the state owed to the counties for monies spent on state highways. The Sinking Fund Retirement Certificates and Consolidated Bonds, in addition to being direct obligations of the state, were secured by pledges of revenues annually exceeding 150 per cent of the debt service requirements. Excess revenues over and above interest and principal charges immediately became available for necessary current expenses.

The benefits of this reorganization programme can be summarized as follows : —

(1) Total state indebtedness is now served with less money than formerly was pledged for only a portion of the debt.

(2) Prompt payment of interest and principal as it matures is assured.

(3) The necessity of refunding some $60,000,000 of debt with extended maturities has been eliminated, with a saving of some $20,000,000 in interest.

(4) Both idle cash and future revenues can be utilized to advantage.

(5) From $500,000 to $1,000,000 can be released annually to the Highway Department for new construction.

(6) The general fund has been relieved from service expenditure to the extent of $1,500,000 per annum.

(7) Total debt can now be rapidly retired; there will be a reduction of $57,000,000 by the end of 1944 and an additional reduction of $49,000,000 by the end of 1951, or a total retirement of more than 80 per cent of the total debt within fourteen years.

Governor Browning has thus remodeled Tennessee’s financial house by cutting out obstructing partitions, closing the vents, and installing a modern heating system which burns less coal but gives more heat. To-day Tennessee commands the lowest interest rate in its history.

IV

What has been accomplished by the New Jersey municipalities and by Tennessee can be matched by many other cities and states. Kentucky during the past two years has reduced the interest rate on all of its outstanding warrants from 5 per cent to 3 per cent and has cut in half the outstanding principal indebtedness, which at the beginning of 1936 amounted to over $25,000,000. Mississippi this year refunded on advantageous terms over $20,000,000 of road indebtedness which was created in 1936. At the same time it provided for an enlarged road programme to be financed on terms far less costly to the taxpayers than those called for in the original financing, which was done under legislation of two years ago. North Dakota is reducing its outstanding debt by substantial amounts, thus saving interest to future taxpayers. Texas is now conducting a study of $200,000,000 of road indebtedness with a view to stopping leakage in the tax dollar. Indeed, reforms to effect tax savings can never be completely successful unless programmes of correction and prevention are put into operation to stop the hidden leaks which, out of sight and out of mind, drip dollars every minute of every day of the year, for interest takes no holidays.

While the excessive price which the Tennessee Valley Authority recently paid for one mule created a wave of indignation, how infinitesimal are like trifles compared with the heavy losses which all of us suffer as a result of unnecessary debt and clumsy financing of legitimate capital improvements.

Our whole capitalist economy and civilization depend upon caution in creating, skill in carrying, and honor in discharging public debt. Many American municipalities and states have been lax in at least one of these particulars. All too often the lapse from highest financial conduct and rating has been caused, not by dishonesty, but by lack of experience and shrewdness in planning the handling of large sums. As long as this field for effective reform exists, the taxpayer need not despair, provided he is certain that his community and state are awake to the importance of debt revision. His job is to make sure that his public servants are really searching for the hidden waste in the tax dollar.