What’s it to Utz? – On finance and freak outs

Posted by Decaturish.com March 5, 2015
Hans Utz

Hans Utz

By Hans Utz

I realize that a conversation about municipal debt is about as riveting as a root canal, but based on what I’ve seen discussed on the topic so far I think some explaining is in order.  Bear with me…the decisions we as voters will be asked to make are extremely important, and we should be as informed as possible.

I intend to make the case that we are incorrectly worried about the city’s debt, which is well within normal boundaries.  Even if we were to substantially increase the debt, the city’s borrowing is within healthy boundaries.

Whether we wish to be taxed to increase that debt is an entirely different question that will require your vote of approval.

Background on bonds and debt

Let’s begin with a clear understanding of the numbers.  Unless I indicate otherwise, all of the numbers quoted in this article have come from the city’s most recent annual report or the school system’s most recent annual audit.  The numbers can fluctuate over the course of a year as loans are paid down and property values change, so we’ll just stick with what was audited and published most recently.  Read along in the reports if you are masochistic like that.

The total amount that both the city and schools will pay over the next 30 years for all current outstanding borrowed debt is $206 million.

The schools may ask to borrow an additional $82 million to build space for the influx of students expected over the next few years.

Those sound like huge scary numbers, but don’t freak out just yet.

First, let’s answer the question why cities borrow money to begin with.  At the very basic level, roads, bridges, and schools are very expensive, and they tend to last for many, many years.  It is fundamentally unfair to ask today’s taxpayer to fund the full cost of an incredibly expensive building when they only get to use it for a small portion of its useful life.

Borrowing money allows a city to spread the cost out over a very long period of time, so that people in the future who benefit from the road or building help contribute toward paying for it.

The breakdown

Now let’s break that $206 million down.

We need to distinguish between the amount the city has borrowed from the amount the city will pay to retire the debt.

The difference here is interest.  Let’s say you take out a $100,000 mortgage at 4.5 percent interest over 30 years.  You have borrowed $100,000, but over 30 years you will pay closer to $185,000.

In other words, it will cost you $85,000 in interest over 30 years to borrow the $100,000 in the first place.  But no one speaks about debt this way.  You don’t say you owe $185,000 on your home when you take out a $100,000 mortgage.

So let’s talk about actual issued debt, or the principal amount borrowed prior to interest.

Of that $206 million, approximately $81 million is what the city and schools expect to pay in interest.  Thus, $125 million is the amount the city and schools have actually borrowed, otherwise known as the principal.

With me so far?  Great.

One hundred twenty-five million is still a pretty big number.   Of that amount, the portion that the schools owe is $43 million and the portion the city owes is $82 million.

We can break it down even more.  Of the $82 million that the city owes, only $31 million is backed by your property taxes.  The remaining $51 million is from other sources of debt, primarily revenue bonds.  We’ll discuss these in a minute.

Most of the schools’ $43 million in debt is in what are called Certificates of Participation, or COPs for short.  They get a little complex, but in effect they act like a homeowner taking out a second mortgage.  The schools use the buildings they own as collateral to borrow the money for additional construction rather than backing the loans with the property tax digest.

The most important thing to keep in mind is that of the $43 million of school debt, only $5 million of it impacts the constitutional debt limit facing the city.

The constitutional debt limit

Decatur’s property digest, or the value of all property within the city, is worth approximately $2.5 billion. Remove the tax-exempt properties like schools, parks, etc., and the taxable digest is worth some $1.37 billion.

The Georgia state constitution allows municipalities to borrow up to 10 percent of the value of their taxable digest for property tax-backed debt (I’ll explain this in a minute).  This means Decatur could borrow up to $137 million backed by property taxes.  This sort of debt is called a general obligation bond, or GO bond for short.

Because GO bonds are backed by your property taxes (which means your tax rate goes up if the city starts to default) you have to vote to allow the city to do it.

As I mentioned earlier, Decatur currently has approximately $31 million in property tax-backed GO bonds, approved by the voters back in 2007.  The schools owe another $5 million that impacts the debt limit.  What does that mean?

It means that the city and schools have borrowed a total of $36 million against the debt limit, or about one-fourth of what the state constitution will allow us to borrow.  Decatur could borrow another $101 million before we hit the limit.

There is no mystery here.  We are way under our constitutional debt limit.

Incidentally, the constitutional debt limit is itself a conservative ceiling meant to prevent fiscally weak or irresponsible municipalities from overextending themselves.  Decatur is neither.

Property-tax backed debt v. other types of debt

With me so far?

As I said earlier, Decatur owes about $31 million in property tax-backed debt.  But the city does have some $51 million in other forms of issued debt, of which the largest portion is in revenue-backed bonds.

This may sound scary. It is not.

Cities have many sources of revenue other than property tax.  In particular, Decatur receives a portion of DeKalb County’s Homestead Option Sales Tax (aka ‘HOST’), of which a portion can be applied toward capital improvements.  This revenue source tends to be stable, which means it can be used to borrow money and pay off what are called revenue bonds.

You don’t usually have to vote on these bonds because they are not backed by your property taxes even if the city defaults on the debt.

Let me say that again: the property taxpayers of Decatur do not have to pay off revenue bonds if the revenue sources collapse.  The bondholders incur that risk of default.

This means revenue bonds are usually more expensive because the interest rates are higher, due to the additional risk.  But right now, debt is unbelievably cheap, and so the interest rates are quite reasonable. Decatur also has very high scores from the bond rating agencies, which helps further reduce the costs of borrowing.

I would strongly recommend that Decatur take advantage of cheap debt while it lasts.  This protects the taxpayers, allows the city to access the capital it needs to grow responsibly, and keeps us away from bumping up against constitutional property tax-backed debt limits.

Funny, that.  It appears that this is exactly what the city has done.  Anyone who suggests that Decatur is on a path to an unsustainable future of debt is being hyperbolic.

Decatur’s options

This is a tricky topic, but freak-outs are unhelpful, especially from people who should know better.  The voters deserve an honest, lucid, and fact-based discussion of the finances in order to help them determine their vote.

With that, let’s discuss this additional $82 million of property tax-backed debt that the schools want for future needs.

Eighty-two million is a lot of money.  It is nearly four times Decatur’s operating budget.  It would be two and a half times as much GO debt as the city currently holds.  But even if the city borrowed the full $82 million, Decatur would still be $19 million below its available limit.  So, again, let’s not debt fret just yet.

A reasonable person may ask: why can’t we just use the revenue bonds to pay for the schools?  Well, it would be nice if we could.  But the state constitution specifically calls out the list of things on which municipalities may use the HOST, and you guessed it: schools don’t make the cut.  Check out Article IX, Section II, Paragraph III of the state constitution if you enjoy abuse.

So, to summarize:

Total debt including estimated interest for city and schools $206 million
Debt principal (not including interest) $125 million
City portion of debt $82 million
Debt that impacts the constitutional limit $36 million
Constitutional debt limit (10 percent of taxable digest) $137 million
Available property-tax-based debt before limit is reached $101 million
Property-tax debt (GO bond) needed by schools $82 million
Available debt capacity even if schools receive the full $82M $19 million

Debt and the impact on your taxes

Although the city has the capacity to issue property tax-backed debt, it does not automatically mean that it should.  Specifically, GO bond debt has the potential to increase your taxes.   In this case, the schools estimate it would require an additional 2.98 mills to pay the $82 million down over 25 years.

Quickly, the ‘millage’, or ‘mill’, is the tax you pay per $1000 of your home’s value.  For a longer discussion, I’m referring you to Wikipedia.  (The journalist gods are grumbling, and they can go hang.  The explanation is solid.)  The higher the millage rate, the higher your taxes.

In total, Decatur property taxpayers currently pay about 43 mills each year for city taxes, county taxes, and school taxes.  This means they pay about $43 per $1,000 of their home’s value after certain deductions.  If you are interested in calculating your property tax, Decatur maintains a helpful website.

An increase of 2.98 mills on a base of 43 mills means that schools are asking for a tax increase of around 7 percent.

But we can break it down further.  The portion of your property taxes applied to the Decatur schools is 20.5 mills.  That means the 2.98 mills the schools may ask for is a tax increase of approximately 15 percent over what they currently receive.

That’s a sizeable increase.

So are we in a bad place with debt?  No, not at all.  Not even a little bit.  Not even if the schools do get an additional $82 million in capital.  We should stay vigilant, of course, but we are operating well within our capacity.

The question is whether we think the schools need the capital sufficiently enough for us to willingly to increase our overall property tax by 7 percent.  That is a big conversation that we must have as a community.  We’ll grapple with some of the policy considerations of that question in a future column.

By now you’ve passed the aspirin and reached for the whisky.  I don’t blame you.

Hans Utz has lived in and around Atlanta for 25 years and formerly served as the Deputy COO of the City of Atlanta.  He writes about local and national politics. He and his family currently reside in Decatur.

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