With discussions about possible defaults in Greece and Puerto Rico, it is important to consider what debt really means in the United States, especially at the federal level, and in the state of New Jersey.
The federal and state governments issue bonds to finance several purposes of their governments. Total debt issued by state and local agencies in the United States is $3.9 trillion. The total federal debt “held by the public” is $13 trillion.
Each level of government sells debt in a different manner, but the federal government issues debt for an entirely different reason than state and local governments, including New Jersey.
New Jersey debt
The state of New Jersey’s bonded debt consists of two types: general obligation debt (GO) and appropriation debt — sometimes referred to as contract debt.
General obligation debt must be approved by the voters, while appropriation debt is generally approved only by the Legislature and governor. GO debt has the full faith and credit of the state’s taxing power, while appropriation debt is subject to annual appropriation by the Legislature. Wall Street views GO debt as more secure than appropriation debt, since the Legislature could decide not to appropriate funds for contract debt — whereas GO debt is a constitutional obligation.
One could write an entire treatise about how appropriation (contract) debt originated, but suffice it to say that most debt (92 percent) of the state has been sold via this method. Some would argue that appropriation debt originated as a method to circumvent the constitutional requirement to have voter approval — and they would be correct. However, the debt clause of the constitution was amended by a vote of the people in 2008 and now generally limits the Legislature from enacting such future appropriation debt.
The debt issued by counties, municipalities, and school districts and other locally created authorities is not the debt of the state. Furthermore, several state authorities finance capital projects with bonds secured by their revenue, such as the NJ Turnpike Authority. This debt is also not debt of the state.
The New Jersey Constitution restricts long-term debt for capital purposes only, such as roads, bridges, sewer and water facilities, prisons, K-12 and higher-education facilities, and so on. Some states, including New Jersey, have “slipped” and issued debt for operating purposes — a big no-no in public finance and a violation of the New Jersey Constitution.
For example, in 1997, New Jersey sold $2.8 billion for pension costs; in fiscal years 2003, 2004, and 2005, additional amounts of debt were again sold for operating purposes. Finally, the New Jersey Supreme Court woke up and in Lance v. McGreevey (July 2004) opined that the 1947 constitution really meant what it said — no issuance of debt for operating purposes — albeit curiously enough they said it was OK for the current year (2005)!
New Jersey‘s total bonded debt (GO and appropriation) is $35 billion. It is the fourth-highest debt per capita among all states. The total annual debt service payment is $3.6 billion in the fiscal year 2016 budget — almost 11 percent of the total budget — again one of the highest in the nation.
Seventy percent of outstanding debt is for either transportation or for local school construction. A myriad of smaller amounts were sold for open space, higher education facilities, water supply, and environmental cleanup.
In addition to bonded debt, New Jersey — like other states– has nonbonded obligations — the two largest being for pension and retirement health benefits ($90 billion). Unlike bonded debt that requires annual payments to meet annual obligations – these costs represent obligations to be paid over the life time of a retiree, albeit pension commitments do require annual contributions to have sufficient funds to make lifetime payments.
The federal government issues debt to fund its entire budget; no distinction is made between capital or operating purposes, as is the custom for states. Debt is issued for Medicare and Medicaid, the purchase of aircraft carriers and tanks, the FBI and CIA — and all other functions of the federal government.
For more years than not, the federal government has had budget deficits (expenditures exceeding revenues) that in turn are funded by selling bonds and notes. There are various nuances as to what constitutes total federal debt. The “debt held by the public” (the accumulation of annual budget deficits) is one number. In addition, there are IOUs that the federal treasury owes to the Social Security Trust, since this trust fund has had a surplus for many years and “loaned” this surplus to the federal budget to reduce market borrowing — but it must be repaid when the cash is needed to make benefit payments.
If one includes these IOUs the “total federal debt” is $17 trillion — and is projected to increase to $26 trillion by 2024. In addition there is “hidden nonbonded debt” — specifically, the unfunded liability for future Social Security and Medicare obligations totaling $50 trillion.
Complicated? You said it – especially in the federal world.
Is debt bad public policy? Not necessarily.
As with most public-policy issues, there are many views about debt creation. Most state debt is for important critical infrastructure. Unlike the federal government, however, state governments do not have the entire taxing power of the country to support an “infinite” amount of debt. More important, the capital market itself, if not state constitutions, automatically limits how much debt states can issue — thank goodness.
In my judgment, while New Jersey’s bonded debt is high compared with other states, it is generally manageable — and the majority has been issued for important infrastructure purposes. However, the nonbonded debt, specifically the unfunded pension liability, is a very serious matter — and needs to be addressed as quickly as possible.
At the federal level the discussion is different because of its size and use — to support the entire budget. The budgetary tradeoffs between defense and safety-net programs — such as Medicare, Medicaid, and Social Security — and decisions concerning overall tax policy, have an obvious impact on how much debt the federal government can afford and issue in the future.
Can we issue an unlimited amount of federal debt? In my opinion, certainly not. The answer, however, is much more complicated than a certain number. Those who say just balance the budget are just not realistic. It will not happen since the needs are just too expansive and growing, especially as the population ages.
But we must reach a realistic political compromise. We must reform the tax code to make it fairer and to raise more money; alter defense policy; and bend downward the growth curve in safety-net programs. These actions are necessary so federal debt is maintained at a reasonable level vis-a-vis the economic wealth of our nation.
Richard F. Keevey is a senior policy fellow at the Bloustein School of Planning and Policy and a lecturer at the Woodrow Wilson School, Princeton University. He was the state budget director and comptroller for two New Jersey governors — political parties — the deputy undersecretary of defense for finance, and the chief financial officer at HUD.
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