Smart debt: Municipal borrowing must match the assets it buys and the
city's ability to pay
The Calgary Herald
March 5, 2004
By Casey Vander Ploeg
From the 1950s to the 1970s, borrowing was an important source of infrastructure financing
for most cities. Beginning in the mid-1980s, however, many cities embarked on a structured
program to reduce debt, especially tax-supported debt (debt supported by the tax base.)
Some cities even pursued the goal of eliminating tax-supported debt altogether. To be sure,
this may have been necessary due to relatively high debt levels. But other forces were also
at work. There was a general reluctance by cities to borrow at the high interest rates of the
1980s and the roller-coaster ride of financial markets since then has made debt instruments
less attractive.
Reinforcing all of this has been the emergence of a strong public reaction against federal
and provincial deficits and debt, which spilled over onto municipal governments.
However, the fact remains there are good reasons for cities to assume modest levels of taxsupported debt.
First, unlike federal and provincial budgets, city budgets are very capital-intensive. There is
a big difference between borrowing for large, one-time capital projects that provide
economic benefits for decades down the road and continual borrowing to cover the payroll
or some other structural operating shortfall.
In other words, municipal debt is much like a mortgage on a home. The debt is offset by an
asset. Much federal and provincial debt is like credit card debt -- debt that has been taken
on to fund consumption yesterday, but has no asset to show for it today.
Second, a completely debt-free city should not be the ultimate goal of municipal fiscal
policy, regardless of how well it plays with the public.
This is especially the case if the tradeoff is an underfunded stock of infrastructure. The payas-you-go approach (building only the infrastructure for which you have money right now)
is arguably better for a city fiscally, but it may not contribute to the overall health of that
city, which certainly has to encompass more than the balance sheet.
One of the reasons why infrastructure has become such a large issue is that many cities
began following a policy heavily tilted toward the pay-as-you-go approach.
Changing from debt financing to complete pay-as-you-go is not an easy task. At the same
time that capital reserves and current revenues are needed to finance infrastructure, funds
are still tied up to service yesterday's debt. As debt is repaid, only small incremental
increases in pay-as-you-go funding become available from the reduced debt charges.
As a result, many cities lowered their investment in infrastructure until sufficient reserves
and pay-as-you-go dollars became available.
In short, a heavy assault on debt is one reason why infrastructure deficits have appeared in
our cities.
To be sure, cities must ensure that their debt levels are sustainable and can be tolerated
within the operating budget.
This speaks to a new innovative approach to debt that cities are now beginning to consider.
That approach is often called "smart debt."
Smart debt recognizes that borrowing is a valid form of infrastructure financing and sets out
broad parameters on how cities should borrow. Typically, the idea comprises four
components.
First, smart debt recognizes that not all capital projects are equally well suited for taxsupported debt financing. Appropriate candidates include large projects involving substantial
sums that also provide well-defined benefits to the community.
Such projects are one-time or non-recurring in nature, have long asset lives and can also
leverage additional financing elsewhere.
Second, smart debt identifies a sustainable level of borrowing or some notion of optimal
debt relative to future operating budgets and anticipated growth. In other words, smart
debt requires cities to work through the subjective question of their tolerance for debt.
For example, in February 2002, Calgary implemented a new capital financing policy that
allows for up to $70 million in new tax-supported borrowing annually for the next five years.
But strict limits have been set -- the cost of servicing all tax-supported debt may not exceed
10 per cent of tax-supported expenditures.
Another example is Edmonton, which in October of 2002, approved a new debt policy. Total
debt charges in that city are not to exceed 10 per cent of city revenues and debt charges for
tax-supported debt are capped at 6.5 per cent of the tax levy. Debt-financed projects must
be worth at least $10 million, have an asset life of at least 15 years, and must fit into
approved capital plans.
Third, smart debt sets out policies regarding debt structure and amortization. Such policies
speak to the use of serial or sinking fund debt, and structured, retractable, bullet or regular
amortized debt. Each carries varying costs and implications.
Further, debt amortization terms (e.g., 10, 20, 30 years) are not set arbitrarily or with the
sole consideration being lowest cost. Rather, amortization terms reflect the life of the asset.
Amortization terms today tend to be in the 10- to 20-year range, but in the past they have
stretched out as long as 30 years.
Finally, smart debt recognizes that debt only finances infrastructure, but the debt itself must
be funded. Before issuing debt, cities draw up a comprehensive repayment plan.
For example, Calgary implemented a one-time special property tax levy of 1.7 per cent in
1998, which has been earmarked to fund certain borrowings. Edmonton did the same with a
special one per cent tax levy.
The fact is that a city can borrow a certain amount each year against an operating budget
that tends to grow as well. If borrowing proceeds at a slightly slower pace than even the
most modest of growth in operating revenues, then the costs of servicing debt relative to
the budget do not rise and debt can be used effectively over time. This may have the
potential to arrest at least some of the infrastructure funding shortfall.
But at the same time, it needs to be stressed again that infrastructure deficits are both
large and represent an ongoing shortfall.
It is unrealistic to assume that financing the entire infrastructure deficit with sizable and
ever-increasing amounts of debt can solve the problem in the long-term, even if debt
capacity exists.
While debt is certainly part of the answer, it is not the answer.
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