Local Debt Limitations Primer
By Liz Green-Taylor
During the recent recession, many local governments struggled with borrowing to cover new and ongoing needs and with paying off debt already on the books. A variety of factors affect a local jurisdiction’s ability to borrow money, including revenues, credit history, and credit ratings from the national bond ratings organizations. Governments at both the state and local levels have recently experienced credit ratings downgrades, which may deter bond investors and raise interest rates.
However, regardless of revenues, history, and ratings, the state limits the borrowing power of even the most credit-worthy local governments. Those limitations, both constitutional and statutory, are based on a percentage of the assessed valuation of the taxable properties within each jurisdiction. When the Bond Users Clearinghouse produces our general-obligation (GO) debt reports each year, we use the data provided to us by each local government and the statutory debt limitations for each type of jurisdiction to calculate how much of the jurisdiction’s debt limitation is currently being used. This, in turn, tells us how much more debt a jurisdiction is allowed to take on.
Definition of “Debt”
For present purposes, debt is defined as “borrowed money payable from taxes”(1). Keep this in mind when considering various categories of debt and how they relate to local government debt capacity.
Constitutional Debt Limits
The state constitution limits the debt each unit of government is allowed to carry based on a percentage of the assessed valuation of the taxable properties within the jurisdiction. The formula is uniform for all jurisdiction types but allows two exceptions — one for cities and towns and one for school districts.
Debt that is not voter-approved is limited to 1.5 percent of assessed valuation for all local jurisdiction types. When debt has been approved by three-fifths of the voters, total allowable debt increases to 5 percent of assessed valuation.
Cities and towns are allowed an additional 5 percent, provided the extra 5 percent is voter-approved and is used to supply the city or town with jurisdiction-owned and operated water, lighting, and sewer services.
School districts are also allowed an additional 5 percent for capital outlays, providing the extra 5 percent is voter approved. Capital outlays include expenses for buildings, facilities, and major equipment.
Statutory debt limits
While constitutional debt limits represent the maximum debt a jurisdiction would ever be allowed, statutory debt limits are usually set at a much lower level based on the Legislature’s perception of what is a safe and reasonable amount for each jurisdiction type to carry.
When setting debt limits for each jurisdiction type, the Legislature also takes into consideration the cumulative debt impacts of overlapping taxing districts on local communities.
Not only do the percentages of assessed valuation allowed as debt vary from one jurisdiction type to another, but often the ratio between non-voted and voter-approved debt also varies. For example, up to 60 percent of county debt may be in the form of non-voted (councilmanic) debt, but only 7.5 percent of a school district’s total debt can be non-voted.
Statutory debt limits for cities are a higher percentage of their constitutional debt limits — 75 percent — than those of other jurisdiction types. Counties, school districts, and hospital districts may use up to 50 percent of their constitutional limits, ports may use up to 15 percent, and library districts may use up to 10 percent.
What counts against debt capacity?
Under current statutes, only general-obligation (GO) debt counts against a jurisdiction’s debt capacity. GO debt pledges the “full faith and credit” of the jurisdiction to pay off the debt. In other words, any and all of a jurisdiction’s taxes, revenues, and other sources of money may be used to pay off the debt.
GO debt includes bonds and notes, whether or not they are voter approved. It also includes most long-term financial obligations, such as lease/purchase contracts. Routine recurring financial obligations do not count against debt limits. In addition to routine operational obligations such as rent and payroll, pension obligations and compensated absences (owed to jurisdictional employees for sick or vacation leave) do not count against debt limits; they don’t meet the “borrowed money” portion of the debt definition.
If a jurisdiction participates in bonds issued by the Office of the State Treasurer as “Certificates of Participation” through the LOCAL program, those debts also count against debt capacity. This program aggregates small purchases by several jurisdictions into a single bond to create volume savings on issuance costs. Certificates of Participation typically finance purchases of equipment such as school buses or fire engines that are too small to individually warrant the costs of issuing a bond, but for which conventional bank financing is prohibitively expensive.
What doesn’t count and why?
Two main categories of debt do not count against debt capacity: revenue and special assessment debt. Revenue debt is debt — bonds or notes, mainly — for which the jurisdiction has pledged a specific stream of revenue. Examples include debt for jurisdiction-owned water and sewer systems, for which the fees paid by system users are pledged to pay off the debt.
Special assessment debt may be paid off by collecting property taxes assessed only on the specific parcels that benefit from a financed project. A typical example is taxes assessed on an individual neighborhood for the installation of street lights or sidewalks.
What about government loans?
The GO survey includes loans from state or federal agencies in the category of revenue debt. These loans are exempt from being counted against statutory municipal debt limits under RCW 39.69.020. In addition, they are most often used for construction or upgrades of facilities, such as water and sewer facilities, that have fee revenues with which to pay off the debt. Examples include loans from the state Public Works Trust Fund or the U.S. Department of Agriculture Rural Development programs.
The government loan exemption, adopted in 1987, applies only to the calculation of statutory debt limits. To the extent that government loans constitute actual revenue debt, they are also exempt from the calculation of constitutional debt limits(2). However, not all government loans have user fee revenues pledged. Any government loans without pledged revenues still count against constitutional debt limits.
This can result in an unintended situation in which a jurisdiction with a large number of government loans that do not have pledged revenues can be in compliance with its statutory limitation, but in violation of its constitutional limitation. This situation primarily impacts cities because of how close the city statutory 7.5 percent limit is to the constitutional 10 percent of assessed valuation limit.
What About retiree pensions?
Another frequently asked question is whether pensions owed to jurisdictional retirees should be counted against debt capacity. The bottom line is that pension obligations do not meet the court-determined definition of debt as “borrowed money payable from taxes.” Unless that definition is changed, pension obligations are not included in debt calculations in Washington.
However, those in favor of including pensions argue that pension payments can be a major factor affecting a jurisdiction’s ability to provide debt service on other general obligation debt.
This is not a minor technicality. The U.S. Securities and Exchange Commission has recently charged the State of Illinois with fraud for issuing bonds without disclosing that they would have to compete for payment in the future with pension obligations and reimbursements of funds borrowed from the state’s pension system to cover budget shortfalls.
On the other hand, because pension payments are not due and payable until after individual retirees have survived the month for which a payment is due, others argue that pension obligations cannot be accurately assessed ahead of time, and therefore should not be counted against debt capacity.
Unlike a bond for which present value and interest payable can be amortized accurately into the future, pension payments can only be roughly estimated using actuarial data (as is used in the life insurance industry). For this reason, in our state, pension obligations have traditionally been treated as an ordinary monthly obligation, similar to regular payroll and other operational expenses. This issue is not addressed in statute.
What Is the future of debt limits?
In the wake of the recession, it seems likely that debt limits will be more heavily scrutinized and controlled in order to protect against local government bond defaults and bankruptcies. Bond ratings agencies have already adjusted their practices to include more data gathering on the fiscal health of bond issuers, resulting in credit rating downgrades for many state and local governments.
For more information, including a list of current debt limits and statutory citations for all local jurisdiction types, check out our reports and databases.
1. Definition of debt determined in: State ex rel. Witter v. Yelle, 65 Wn.2d 660, 339 P.2d 319 (1965); Troy v. Yelle, 36 Wn.2d 192, 217 P.2d 337 (1950).
2. Because most of the Public Works Trust Fund loans are utility infrastructure loans in which user fees payable into special funds are pledged for repayment, these loans fall under the special fund doctrine and are considered revenue bond debt, rather than a debt of the municipality. (Municipality of Metropolitan Seattle v. Seattle, 57 Wn.2d 446, 357 P.2d 863 (1960)). As quoted in the State Auditor’s Office BARS Manual at http://www.sao.wa.gov/local/BarsManual/Documents/gaap_p3_limitindebt.pdf
This article was originally published in The GO Report 2011 and updated May 2014.
Assessed Valuation Quick Facts
The state Department of Revenue compiles assessed valuation data and publishes it each fall covering the previous year’s valuation.
Because only assessed valuation of taxable properties counts toward debt capacity, counties with large tracts of tax-exempt properties — such as state and national parks — may be at a disadvantage for both revenue and debt purposes.
Because of sudden and significant shifts in market value of properties in the last few years, county assessors have increased reassessment schedules to evaluate properties more frequently than in the past.