BORROWING TROUBLE

BORROWING TROUBLE

TOM BENDER
November 1993

We're told that time-payment, pay-as-you-go, or credit buying, has benefits that justify the cost. We are able to have use of what we're buying while we pay for it instead of having to wait until we've saved the money for its purchase. Some truth there.....maybe. But lets look down the road a bit, at the end of that situation, or better yet, a few purchases later.

After fifteen years, we've bought and financed five cars, let's say, and given ourselves the same rationale each time. But if we compare a financed end situation to a cash scenario, where we'd gone without, or driven a junker, or shared while we saved to buy just the first one, we'd see very significant differences!

After the first purchase, we're not going without a vehicle in either scenario. Debt financing ends up with possible use benefit during the first vehicle's life, but with five vehicles interest pay ments. Pay-as-you-go ends up with possible partial inconvenience during the first vehicle's life, but with interest payments gained on savings for 12 years instead of financing charges paid out for fifteen years!

We only benefit from credit or debt financing the first time we use it. On subsequent purchases financing is a major expense (often doubling the total cost of purchases) that we're trapped into with no real benefit, because payments on the original debt prevent us from saving for subsequent purchases.

We can also see that if we adopt a pay-as-you-go pattern generally, the savings generated quickly allow us to immediately pay cash for purchases rather than having to wait until we've saved up the cost. This eliminates even the original justification and value of debt financing.

These alternatives represent major differences in cumulative costs. Look at our personal expenditure patterns as a whole, including car and home payments, credit card purchases, etc. Added up, we're talking a cost difference amounting to maybe ten years of net income. And this translates into perhaps fifteen years of our total pretax income! A pretty heavy price for sloppy thinking.

In the public realm, debt-financing such as bonded capital improvements results in our paying double what those improvements would otherwise cost. Debt financing in the public realm is one of perhaps a half-dozen baseline reasons our public expenditures have become unaffordable.

A city needs a new $10 million sewage treatment plant and votes in a 30 year bond issue to pay for it. No one mentions that the actual total cost to pay off the bonds is probably $20 million, not $10 million. A few years later the city needs a new school, then a new hospital, then street improvements, then a new landfill or water treatment plant. Because of the $10 million finance charges on the first debt, it can't revenue-finance the subsequent needs, and has to bond-finance them, and successive ones also.

The reality is that capital investments are a consistent ongoing process of every city, county, state or national government. The government that plans ahead sees roughly what improvements will be needed, and when. Then they get those needs queued up so that each can be financed in turn out of current revenues. Improvements are obtained at half the cost and with freedom of action that the debt-financing entity has lost.

Many higher education systems, for example, now have an ongoing budget item for construction. Campus A gets a new physics building this year, campus B gets a new gym next year, and Campus C gets some new dormitories two years later, all financed out of current revenues.

Proponents of public debt-financing point to low interest costs, and talk about inflation resulting in "lower cost of repayment dollars". Interest rates on loans, however, already include a projection for anticipated inflation in addition to interest rates for the lender. And all ex penditures, as well as income, in later inflationary years have to be paid for in those worth-less dollars.

The length of most public capital improvement bonds is long enough that interest represents a higher proportion of repayment costs than on personal loans, and means that more old loans are hav ing to be pay for each year instead of paying cash for current expenditures.

Looked at in aggregate, by examining the financial records of typical public bodies over a forty or fifty year period, we can clearly see:

* Consistent patterns and levels of continuing capital expenditures, virtually all debt financed after the first occurrence of debt financing.

* Repayment demands each year of twenty to thirty years of old debts, not just current ones.

* Total debt service on old debts each year running about as high as current expenditures (excluding their commitments to future debt costs).

Aggregate patterns of expenditures, and real world records demonstrate clearly that revenue financing instead of debt financing would consistently achieve the same series of improvements - but for half the cost.

Revenue financing vs. debt or bond issue financing means big bucks. State and local governments in Oregon alone currently issue somewhat over a billion dollars of bonds per year. In rough figures, this debt load results in an equal amount of debt service costs per year. A billion dollars a year for one small state may not buy a trip to the moon, but it can help us accomplish many needed goals.

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There are a number of actions which can help ensure us the freedom to choose affordable ways of purchasing:

* Require ballot information on the total cost of bond issues to encourage us to support rev enue-financed alternatives.

* Enact state statutes which require or encourage revenue financing for public capital improvements.

* Enact legislation to protect state and local jurisdictions from being forced into debt financ ing to pay for federally mandated projects.

* Eliminate tax-deductability of corporate and personal debt service.

* Develop alternative auto financing institutions based on saving rather than repeated borrowing.

1. See "Hidden Costs of Housing", RAIN MAGAZINE, Mar-Apr 1984