from: http://www.azcentral.com/arizonarepublic/news/articles/0504bonding04.html

Napolitano budget plan saves services, increases state debt
Robbie Sherwood
The Arizona Republic
May. 4, 2003 12:00 AM

Gov. Janet Napolitano believes she has found a way to break the shackles binding Arizona to its worst budget crisis ever.

Borrow money. Lots of it.

Napolitano's budget strategy would take advantage of low interest rates to borrow more than a billion dollars in fiscal 2004. Her plan would prevent cuts to public education, health care, social services and prisons and still wipe out the state's $1 billion deficit.

To her critics, it's an audacious approach that could lead to even bigger deficits during the next few years. To Napolitano, it's an investment that will benefit most Arizonans.

"If we don't invest in Arizona, we incur greater expense down the road," she said. "If you cut substance-abuse treatment, what happens to those people? We end up dealing with them either in the criminal-justice system, in the homeless system or in the behavioral health system. And for our economy, this is a time to invest in universities, not cut their budgets."

Napolitano would borrow $75 million on future state Lottery proceeds. Another $250 million against the equity on state properties. And she and legislative leaders have agreed to borrow more than $500 million to pay for school construction and repairs.

The governor's 2004 budget calls for $6.7 billion in expenditures, compared with the $6.2 billion proposed by Republican leaders. Overall, she would borrow about $550 million more than the Republicans.

GOP legislators balk

"She just wants to borrow money," said Senate President Ken Bennett, R-Prescott. "Her budget digs the hole about twice as big in 12 months."

Bennett and other Republican leaders have said the Legislature is shackled by outside mandates that tie up more than two-thirds of the state budget. The mandates include court orders, federal government requirements and costly initiatives approved by Arizona voters. The situation has made it almost impossible to balance the budget, the legislative leaders say, and could get worse if new statewide initiatives tie up more of the budget.

Napolitano's plan offers a way out, albeit one considered unacceptable by legislative leaders. About half of the borrowing she proposes involves day-to-day government expenses instead of buildings that will outlast the term of the loans. That approach, Bennett said, is like "buying groceries with your credit card."

House Majority Leader Eddie Farnsworth, R-Gilbert, calls Napolitano's proposal a dangerous mirage and a prelude to a tax increase. The economy is just not going to bounce back fast enough in fiscal 2005 to sustain the spending in Napolitano's plan, Farnsworth said.

Business experts split

The debate over Napolitano's approach to borrowing is considered crucial. If she is right, she offers a relatively painless way out of the budget crisis that potentially could make life better for thousands of Arizonans. If wrong, Arizona's fiscal ills could get much worse.

Experts in the business community are split over the wisdom of her plan.

A group of 20 top Arizona executives sent a letter late last month to Napolitano and legislative leaders urging them to take advantage of low interest rates and use debt to avoid making cuts that might restrain future economic growth.

The group included the presidents and chief executives of three major banks and some of the state's largest employers. But they urged lawmakers to be prudent and not to use debt for operating expenses.

Bonding for buildings

Wells Fargo Bank Arizona President Gerrit van Huisstede, one of the letter's authors, disagrees with conservatives who say paying cash for buildings like schools is wiser than borrowing the money.

"When you buy a house, do you first save up enough money to buy the house?" van Huisstede said. "Bonding helps level out the payment stream, so those who move here later also help pay for the building that was put here for them also. But I'm not supportive of creating long-term debt to fund operating expenses."

Nearly every state government borrows money for capital projects: in other words, for buildings and highways. Officials at the National Conference of State Legislatures don't know how many other states have used debt to pay for day-to-day costs like salaries and utility bills, but they said it is "very rare."

Oregon's logic

One state that does is Oregon.

Facing a budget crisis similar to Arizona's, Oregon voters earlier this year rejected a tax increase, forcing the layoffs of 600 teachers and a shortened school year. That didn't balance their budget, however. Oregon leaders have now taken out a $775 million loan to provide enough cash to balance their $11 billion, two-year budget, said John Radford, Oregon controller.

The insured loan will take 10 years to pay off but will be used to pay for salaries and services, not bricks and mortar, Radford said.

"We see this as a temporary cash-flow problem," Radford said. "I understand we are expanding the debt out to 10 years, but to me it's a reasonable way to get us through this. As long as we are also reducing spending, borrowing money to survive and paying it back in better times is OK."

But how much debt is too much?

Farnsworth and other Republicans have worried that overborrowing will drag down Arizona's bond rating (the state's credit risk score), which is now a respectable AA-, making future loans more expensive. A lower bond rating can also give the nation's investors the perception that Arizona's fiscal house is not in order.

Napolitano said Wall Street financiers have assured her that her plan could be adopted with no damage to Arizona's credit rating because state government here has largely avoided debt. On the key credit-scoring measure of ratio of debt to income, Arizona ranks 27th out of 50 states.

Bob Kurtter, an analyst at Moody's Investor's Service in New York City, does not want to speculate on Arizona's credit rating until he sees which budget plan actually passes into law. But he does not support borrowing money to pay for day-to-day expenses.

"It's a sign of fiscal stress and credit weakness when a state has to resort to deficit financing to sustain current spending," Kurtter said. "There can be a cost when a bond rating goes down. And even if there's no dollar cost, there's a kind of public perceptual cost."

Revenue a key factor

Napolitano disputes the notion that her budget would automatically require a tax increase to maintain. Then again, she doesn't say it won't. Instead, she defers to her Citizens Fiscal Review Commission, whose recommendations on what to do with the tax code will be released in October.

"They may recommend that we close some tax loopholes and exemptions, or that some tax rates be decreased, I don't know," Napolitano said. "My job right now is to balance the 2004 budget and do it in such a way that it's good for the long-term health of our state."

Napolitano's prediction for revenue growth is 3.7 percent for next year (which is about $100 million more optimistic than her legislative counterparts).

Revenue would have to balloon by nearly 12 percent in 2005 to sustain her budget, a jump most local economists say is unlikely.

Farnsworth believes it's more likely the state would be facing another $1 billion deficit with no more accounting tricks or special government funds left to fill the hole.

"She would set us up in 2005 to have to pass a huge tax increase," Farnsworth said. "The economy can't sustain the type of debt in the budget she's proposing."

Cut debt, cut services

In contrast, the Legislative plan now struggling to pick up votes from rank-and-file members would leave the state with a more manageable $360 million deficit in 2005, but it features deep cuts to the state's social service network.

For Farnsworth, one of the most fiscally conservative members of his caucus, any debt is too much. But he's willing to stray from his pay-as-you-go credo, if need be, provided the loan buys an asset like a building that will still be around once the loan is paid off in 15 years.

Meanwhile, the legislative budget plan has its share of debt as well. Lawmakers, with Napolitano's blessing, would borrow $530 million to build and repair schools rather than paying cash.

Like a home-equity loan

However, Napolitano's plan would go further. Much of the debt in it is akin to taking a home-equity loan on your property for cash, although it's labeled as "asset sale and lease back."

The state holds more than $1 billion in debt-free properties - nearly half are prisons - and Napolitano would borrow $250 million while still leasing the buildings. She would use the same method to borrow $4 million, but with state aircraft as collateral. She would also refinance loans on some state buildings to save $12 million in lower interest costs.

And, in exchange for a one-time sweep of $128 million from the state's vehicle license tax on other state expenses, Napolitano would give the Department of Transportation an extra $190 million in borrowing capacity to finish road projects.

Reporter Jonathan Higuera contributed to this article. Reach the reporter at Robbie.Sherwood@arizonarepublic.com or (602) 444-8146.

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