from Dateline (February 5, 2004)
State Bonds: What are they? How do
they work?
by Valerie Orleans
When California voters go to vote March 3,
they will be faced with many different bond measures, including
Proposition 55, the 2004 school bond measure. John Erickson, chair
and professor of finance, answers some of the most commonly asked
questions about state bonds.
Q: |
What are bonds and what
are they used for? |
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A: |
Bonds issued by states and municipalities
(often called “municipal” bonds) are generally
used by states to finance capital outlay projects or acquire
land. With capital outlay, this could include using monies
to finance construction or renovation of buildings or other
infrastructure. These are usually long-term expenditures.
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Q: |
Why do states use bonds?
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A:
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Bonds generally allow the state
to acquire assets or develop building programs that it could
not afford on a “pay as you go” basis. Perhaps
one analogy would be to look at your mortgage. When people
purchase a home, they usually don’t have all the money
needed to finance such an acquisition. So, they take out a
loan to secure a down payment. The understanding is that the
loan will be repaid over the years with interest. Basically
the state is doing the same thing but on a larger scale –
they’re taking out a loan to finance a project or series
of projects.
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Q: |
Have bonds been used to
support educational goals before? |
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A: |
Yes, actually there is a long
history of using bonds to support education. In 1962, Prop
1a authorized bonds for the expansion of the UC, CSU and California
Community College systems. In Orange County, they funded the
construction of UCI, Cal State Fullerton and new community
college campuses.
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Q: |
Why not just add additional
taxes? |
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A: |
People and businesses tend to
be averse to additional taxes since California is already
a high-tax state, and taxes can have negative consequences.
Moreover, once you institute a tax, you’re frequently
going to continue to pay – even if the original reasons
for the tax no longer exist. For capital investments, bonds
are superior because the funds they make available are typically
targeted for specific expenditures that most agree need to
be made. And since the types of projects that bonds tend to
fund have long-term benefits, the costs are spread out over
time. Generally speaking, bonds should not be used to meet
ongoing operating costs. |
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Q: |
What are the types of programs
that might be considered for bonds? |
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A:
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Historically, some of the projects
that tend to be funded with bond money include education,
corrections, veterans’ facilities, housing, transportation,
state and local parks, natural resources and, in California,
expenses related to seismic retrofitting. |
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Q: |
So, with interest, what
do bonds cost? |
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A:
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It depends on the interest rate
at the time the bond is secured. Right now, interest rates
are low so many feel that this is a good time to use bonds
to secure funding. In addition, because state bonds are tax
deductible under federal law, the interest on state bonds
is lower than on the bonds issued by other entities with similar
risk. |
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Q: |
You hear about general obligation
bonds and revenue bonds. What’s the difference? |
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A:
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Revenue bonds tend to fund specific
programs or projects that will eventually bring in revenue
– such as the building of toll roads, water and sewage
facilities, airports, etc. The idea is that the money provided
to these programs will eventually be repaid through fees and
charges to the facility users. General obligation bonds are
backed by taxing authority of the issuer, not by a revenue
stream created by the project being financed. |
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Q: |
Are there alternatives to
using bonds? |
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A:
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Well, the state could use a
larger share of its annual general fund revenues to fund building
or renovation. Of course, that also would necessitate cutbacks
in other areas. If there is only so much money available at
any given point, you either raise taxes, cut services and
programs, or you do both. Nevertheless, whether you use bonds
or general fund revenues, the taxpayer foots the bill if the
bond is a general obligation bond. The taxpayer obligation
is just postponed to pay over a longer period of time. |
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Q: |
Why are there so many propositions
on the March ballot? |
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A:
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Our state is deeply in debt.
Many of the propositions on the ballot are working to address
these problems. It’s likely that we won’t experience
any real “recovery” for at least three to four
years. And we need funding now or we will experience severe
cuts in services for the poor, health care and education –
many programs that are vital to the success of the state.
It is hoped that by keeping taxes lower, businesses will be
encouraged to stay or move to California, thus stimulating
the economy. If our economy can improve, it will help our
debt situation.. |
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