The Impact of Debt Management Policies on Borrowing Costs Incurred by U.S. State Governments

Article excerpt

ABSTRACT

This study empirically examines the impact of debt management policies on borrowing costs incurred by U.S. state governments when issuing debt in the municipal bond market. Based on positive political theory and the benefit principle of taxation, it is proposed that states that adhere to best practice debt management policies transmit signals to the credit ratings, investment community and taxpayers that the government should meet its obligations in a timely manner, resulting in lower debt costs. As a result of a multi-block multivariate regression model the implication of adhering to debt policies aimed at promoting transparency results in a borrowing cost savings in terms of true interest cost (TIC) of close to $8,000 for every $1,000,000 of debt issued (-.769, p<.10). However a comprehensive debt policy is not a significant indicator of borrowing costs. These results suggest a product of a pull push process between the economic forces of the bond market on one hand and politics on the other, pulling the administrative function toward efficiency in the former and democratic values of responsiveness and transparency in the latter. The problem lies in policies that respond to the bond market but virtually exclude any other community interest in policy making. It is recommended that openness in government and allowing taxpayers to understand government services are essential goals in ensuring responsible citizen oversight and providing taxpayers the opportunity to be less likely to propose restrictive initiatives or force dramatic political or management changes through the electoral process or bond referenda.

INTRODUCTION

Borrowing costs, or the interest rate on buying money today, is an essential factor in determining the overall fiscal burden of spending on capital improvements. Because state governments borrow millions of dollars and pay interest on those dollars for many years, even a variation in interest rates as small as 1/100 of a percent can mean a substantial savings. This has important implications for both present and future taxpayers in that over the life of a debt instrument, higher borrowing costs can mean millions of dollars in higher taxes. As a result, professional organizations (e.g. Government Finance Officers Association (GFOA), the National Association of State Budget Officers (NASBO), the American Society of Public Administration and the International City Management Association (ICMA), interested in long-term borrow ing costs have identified a body of recommended practices and policies for states to follow in the management and issuance of bond sales. Although it has previously been found that a number of economic and fiscal factors that differ substantially among states determine disparities in interest bond yields Poterba and Rueben (1999), little empirical evidence connects debt management policy and the costs of borrowing.

This study addresses the impact of debt policies and adherence to those policies on borrowing costs incurred by state governments when issuing municipal bonds to finance long term capital projects. Based on positive political theory and the benefit principle of taxation, it is proposed that states that adhere to best practice debt management policies transmit signals to the credit ratings, investment community and taxpayers that the government should meet its obligations in a timely manner, resulting in lower debt costs. This is an important question in public finance and public administration in that lack of strategies guiding debt issuing practices in credit markets is to blame for what has become the worst downturn in our economy since the Great Depression (ICMA, 2009). Importantly, Khademian (2009) makes the case that "Public administration scholars and practitioners play a vital role in forging the future of finance" (p. 596).

The paper is structured as follows: first, previous studies are reviewed followed by an examination of the theoretical framework. …