Author: Tony Rassias - Bureau of Accounts
This article reviews another area of fiscal stress using data from both Category Five and Category Six of the Division of Local Services’ (DLS) Municipal Finance Trend Dashboard. It focuses on the municipal debt burden, recommends and suggests ways to reduce this stress, and highlights categories from the Dashboard that can be used to compare neighboring or like communities.
Total Long-Term Debt Outstanding
Cities and towns may authorize indebtedness by a two-thirds vote of approval from their respective legislative bodies. Three particular General Laws are most often referenced: G.L. c. 44, § 7 (within the debt limit), G.L. c. 44, § 8, outside the debt limit, and G.L. c. 70B (outside the debt limit for certain school construction projects).
Long-term debt involves loans with (1) a maturity date of 12 months or more, (2) an instrument (bond) in which the issuer promises to repay principal and interest to the buyer by a specified future date determined by a debt schedule, and (3) a promise to complete payment by the date of maturity (maturity date). Outstanding measures the total dollar amount of principal that must be paid on debt.
As shown below, statewide long-term debt outstanding has grown and accelerated annually over the past five fiscal years.
From FY2017 to FY2021, 169 communities increased total authorized debt by $4.4 billion (51%) including 33 between $10 million and $25 million, 24 between $25 million and $50 million, 15 between $50 million and $100 million, and 11 greater than $100 million.
Fiscal Stress from Rising Debt
An increase in the level of debt outstanding requires additional budgeted funds for principal and interest to service the debt. Principal and interest are fixed costs that must be provided for according to their debt schedule which may continue for the next 30 years or longer. Fiscal stress appears when debt service has impacted the operating budget to where normal public services are affected.
Under Proposition 2 ½, municipalities can ask the voters for a debt exclusion which allows for additional property taxes to be levied in an amount equal to the debt service payments associated with the project. This takes pressure off of the budget since there is a dedicated revenue source for the debt service.
Before authorizing additional debt, be certain that it's affordable in the budget, transparent to the public, planned well by the local financial team, and is guided by a formal debt policy. Our March 1st, 2018 City & Town publication has further information on how local governments can benefit from a debt affordability study to help policymakers manage debt, thereby enhancing a community’s credit rating.
Debt Repayment
As shown below, statewide long-term debt outstanding since FY2017 has grown at a faster rate than general fund revenues.
For the 169 communities that increased their authorized debt by $4.4 billion (51%) from FY2017 to FY2021, their total general fund revenues increased by only $2.3 billion (16%).
Fiscal Stress from Debt Rising Faster than Receipts
A municipality’s general fund revenues are usually the primary source for repayment of debt service over the long term. To pay the cost of additional debt, cities and towns must maintain a sufficient, consistent, and dependable revenue stream to cover the cost. In some instances, municipalities have made a policy decision to have debt service become a larger share of the budget in recognition of capital backlogs. In the proper manner, this can be a prudent decision that helps a municipality undertake additional capital investment.
Cities and towns should regularly review their ability to afford debt based on standard policies that measure metrics such as debt service as a percent of budget, outstanding debt as a percent of assessed value and debt service per capita. Maintaining consistent levels of debt per adopted policies is a best practice that municipalities should follow.
As previously noted, an alternative approach is a debt exclusion. Many communities have excluded their debt service from the provisions of Prop 2½ allowing additional tax revenue to be raised to pay the debt service until the debt is retired. For FY2022, debt exclusions added $629.8 million in additional tax levy authority to 287 cities and towns. A debt exclusion requires a two-thirds vote of the board of selectmen, or town or city council (with the mayor’s approval if required by law) to be placed on a ballot. A majority vote of the electorate is required for approval.
The Debt Limit
G.L. c. 44, § 10 requires that debt authorized by cities and towns for certain capital purposes under primarily G.L. c. 44, § 7 cannot in total exceed 5% of their most recent equalized valuation (EQV), or exceed 10% of the EQV if approved by the Massachusetts Municipal Finance Oversight Board (MFOB). G.L. c. 44, § 8 authorizes debt outside the 5% limit for other capital purposes and G.L. c. 70B authorizes debt outside the limit provided the school project has been approved by the Massachusetts School Building Authority. EQVs are determined biennially by the DLS Bureau of Local Assessment and statistically represent total assessed property values at 100% of full and fair cash value (FFCV). They are considered a preferred proxy to FFCV as a measure of community wealth.
Fiscal Stress from Approaching or Reaching the Debt Limit
Fiscal stress appears when the 5% of EQV debt authorization limit is being approached (between 4% and 5% of EQV) or has been reached and additional infrastructure repairs or capital assets continue in demand. Fiscal stress may also appear if a school building project does not receive MSBA reimbursement approval. In that case, not only is the full cost of the project inside the 5% of EQV debt limit, but it also means the community must fund 100% of the project, which could place stress on the operating budget. From FY2017 to FY2021, although total debt for several communities exceeded 5% of EQV, their authorizations included amounts inside and outside the debt limit. None exceeded their authorization limit.
Recommendations
Financial advisors, bond or local counsel can assist the local treasurer decide the proper borrowing citation. G.L. c. 44, § 8 currently includes 24 clauses with purposes a city or town may authorize borrowing above the 5% debt limit. If your community cannot receive MSBA reimbursement approval, be sure that the cost of the project is transparent to the taxpayers and is still affordable.
Subject to MFOB approval, a city or town may authorize debt otherwise subject to the 5% of EQV limit up to 10% of EQV. If needed, contact the Public Finance section of the Bureau of Accounts or the Municipal Finance Oversight Board in the Office of the State Auditor for more details.
Using Dashboard Metrics
DLS Dashboard Categories 5 and 6 include data and metrics that allow communities to compare themselves to neighboring communities either contiguous to or however alike to themselves. Municipal analysts and investors in municipal debt review multiple measurements in an audit report, Comprehensive Annual Financial Report or CAFR, or bond prospectus to identify trends in community wealth and debt burden. Reviewing multiple measurements is recommended because one single measure may not provide an accurate depiction.
Below are common measurements that can be found in Dashboard Categories 5 and 6 and from where the data is received.
Debt as a % of Property Value
This ratio measures community wealth by comparing long-term debt outstanding from the municipal year-end report, the Schedule A, to the EQV.
Debt Per Capita
This ratio measures debt burden by comparing long-term debt outstanding to the United States Census Bureau’s community population total determined either by decennial count or an interim year estimation. Specific reports may apply local census data obtained for street listings and voting purposes. For clarification, ratios using a population total should footnote which population total is being used. Although debt per capita captures the debt burden per resident, it does not capture the affordability of the debt.
Debt Per Capita as % of Personal Income Per Capita
This ratio incorporates an affordability of debt component (personal income per capita) into an assessment of community wealth (debt per capita). It compares the relationship between long-term debt outstanding to personal Income reported to the Massachusetts Department of Revenue on annual income tax returns. The Government Accounting Standards Board has described the personal income component as a most appropriate base to develop a ratio of total debt.
Conclusion
Municipal debt is an important tool for city and town governments to finance the purchase of expensive capital assets and to construct and maintain municipally owned infrastructure. However, debt cannot become overburdensome to either the community’s property tax paying population or to the budget. Capital purchasing and/or improvements should ideally be planned with its priorities analyzed and reviewed by a capital planning committee seeking to coordinate community planning with debt affordability and aiming to present its recommendations to municipal leaders and to the public.
For more information and assistance, contact the DLS Financial Management Resource Bureau for capital budgeting and planning guidance and the State House Notes Program of the Bureau of Accounts for further borrowing guidance.
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City & Town is brought to you by:
Editor: Dan Bertrand
Editorial Board: Marcia Bohinc, Linda Bradley, Sean Cronin, Emily Izzo, Lisa Krzywicki and Tony Rassias
| Date published: | March 2, 2023 |
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