Fiscal Brief New York City Independent Budget Office

INTRODUCTION

On November 4, 1997, New Yorkers will vote on the School Facility Health and Safety Bond Act of 1997. The Act would authorize the state to borrow up to $2.4 billion through the issuance of bonds to fund capital projects related to the construction, expansion, and modernization of public school facilities. Projects that could be funded under the Act are defined to include those addressing serious health and safety needs, expanding physical capacity, enhancing accessibility for people with disabilities, addressing emergency facilities situations, correcting environmental problems, and supporting educational technology.

The Independent Budget Office has prepared this fiscal brief to enhance public understanding of the pending bond act. In accordance with our mandate to provide objective and impartial analysis to the public regarding fiscal and budgetary issues facing New York City, the fiscal brief contains no recommendations.

The IBO's principal findings and conclusions are as follows: School facility needs are particularly great in New York City. Exacerbating these needs, the number of students attending public schools in the city has surged by nearly 20,000 each year since 1990 and a substantial amount of school maintenance has been deferred in recent years. To address its most pressing needs, the city has planned to spend $4.8 billion for school facility improvements in its five-year (1995-1999) capital budget plan. Despite this planned investment, unmet needs are expected to far exceed available resources. Apart from identifying the total amount of money that can be borrowed and listing general categories of public school capital improvement projects that can be funded with bond proceeds, the Act is not accompanied by other implementation details. This lack of detail effectively separates the decision to borrow funds, which will be submitted to the voters, from the equally important decision of how the state will spend the proceeds, even in a broad manner. A broad set of guidelines for spending proceeds, which usually exists prior to a bond referendum and informs the voters' decision, has not yet been established. The fiscal effect of the Act and New York City's share of the benefits are uncertain because of this lack of detail. If the Act passes, New York State taxpayers would likely incur costs of about $5 billion in principal and interest payments to repay funds borrowed. As they do for other state expenditures, city taxpayers would contribute significantly to these repayments. New York State has more than doubled the amount of money owed to bond holders in the last ten years. Consequently, debt service (principal and interest costs on outstanding bonds) has grown at a rate of 8.9 percent per year-more than double the 3.6 percent growth of revenues collected by the state. Debt service is expected to continue to grow by nearly 7 percent annually through 2002. Such rapid growth, absent comparable revenue increases, will make balancing the state's budget increasingly difficult. The use of bonds-as opposed to pay-as-you-go financing-is appropriate because it ensures that the costs of public improvements are borne by the beneficiaries of those investments.

Background

New York State's operating budget for the current fiscal year is $67 billion, of which $11 billion has been appropriated for state aid to school districts. New York City's share of school aid is $3.9 billion, or 35.5 percent of the total. Some of this state aid money is used to support school construction and facility improvements throughout the state. Through a specific appropriation known as building aid, the state reimburses school districts for a portion of debt service costs incurred to finance capital projects. The current year state budget includes $775 million for building aid, of which $210 million is earmarked for New York City.

The School Facility Health and Safety Bond Act of 1997 represents a departure from the traditional form of state support for elementary and secondary education. In addition to providing localities with building aid to help them defray debt service costs associated with school capital improvements, the state would borrow up to $2.4 billion which it would in turn provide to local school districts for their school facility needs. IBO assumes the borrowed money would be repaid directly by the state out of its operating budget over 35 years. Bond proceeds could be used to construct, expand, and modernize public school facilities, ensure safe school buildings, promote the health and safety of school children, and provide for educational technology throughout the state.

IBO has evaluated the Act based on five key criteria that we believe New York City voters should consider in determining whether to vote for the Act. These include:

• The need for school capital improvements in the city and the potential contribution that the funds provided through the Act could make toward meeting that need,
• The definition and structure of the Act itself,
• The fiscal impact of the Act,
• The effect on the state's long-term fiscal health, and
• Other ways to address school facility needs.

The Need for School Improvements

There is clearly a need for school facility improvement throughout New York State, although estimates of the magnitude of the problem vary considerably. The federal General Accounting Office (GAO) reported in 1996 that 67 percent of schools in New York State were operating with at least one major building feature that was inadequate. Building features included in the study were roofs, floors, foundations, windows, plumbing, heating, electrical, and emergency systems. Ninety percent of the schools in the state reported some structural or systems deficiencies.

The State Education Department (SED) estimates statewide school facility needs at $15 billion for the 1995-1999 period, equally divided between the city and the rest of the state. For the city, SED accepts the New York City Board of Education's (BOE) $7.5 billion five-year estimate (discussed more fully below) as the minimum amount required to address its most serious health and safety needs.

New York City's Need

With enrollment growing at nearly 20,000 students annually since 1990 and years of deferred maintenance compounding poor conditions, BOE is facing major facilities challenges to repair, upgrade, and expand its capital stock. According to a recent report by the Citizen's Budget Commission (CBC), by 1996 fully 54 percent of the city's more than 1,000 schools were over capacity and six out of ten students were attending these crowded schools.¹ CBC also concluded that the condition of school buildings was deteriorating due to maintenance cuts of 11 percent per square foot in inflation-adjusted dollars during 1990-1996 period.

In 1993, BOE released its Ten Year Facilities Needs Assessment Plan, which estimated the costs of expanding capacity, modernizing, and upgrading all buildings to meet improved technology standards, and returning all facilities to good condition. Although the plan's estimates should be interpreted as upper-bound projections of the city's need, they do provide a sense of magnitude of the problem at hand.

The plan estimated BOE's total facility needs at more than $25 billion for the ten-year period. The investment required just to address new needs for space was estimated at $13 billion. Rehabilitation work on facilities that had suffered from long periods of deferred maintenance added another $8 billion to the total. In response to this assessment and in recognition that capital resources were limited, BOE proposed a $7.5 billion capital plan for 1995-1999 to address only the most serious facility repair and expansion issues.

In response to these pressing needs, the city has committed $4.8 billion in capital funds to be spent over this five-year period. Despite the city's planned investment, unmet needs far exceed available resources. For example, the plan shows that all of the committed funds could be spent on just one need: the 424 schools that require complete modernization and repair. It is evident that even if the city receives a substantial portion of bond act proceeds, some of its need would still go unmet.

Bond Act Details

Although the Act outlines broad categories of school projects to be financed with bond proceeds, it provides no substantive implementation guidelines. In the absence of such guidelines, the following questions arise:

• How would projects be selected?
• Would localities be obligated to maintain currently planned levels of capital spending?
• How does the level of detail in the Act compare with previous bond acts?

Project Selection

The Act does not specify a process by which projects would be selected for funding. Ideally, funding would be distributed on the basis of need, with the highest priority projects funded regardless of location. Less desirable would be a process in which political considerations are allowed to overwhelm actual needs.

It is important to emphasize that in the absence of a clearly defined process, any discussion of methods for selecting projects is only speculative. Several other states, however, have established needs-based methods for identifying and prioritizing projects based on such diverse factors as: imminent threats to health and safety; the number of students enrolled above facility capacity; building age, size, and condition; and local priorities.

Maintaining Current Funding

The Act does not specify whether school districts would be required to maintain local effort and use the new state funds to finance only additional education projects, or whether the funds could simply replace local financing for projects that would have been undertaken anyway. Similarly, there are no assurances that the state would maintain its currently planned level of funding for building aid through its operating budget. Finally, it is also unknown if the money would be used to fund entire projects or if local governments would be required to pay for a portion of cost. If localities were required to make a local contribution in order to receive bond proceeds, additional funds could be leveraged.

Comparison with Previous Bond Acts

Over the last 25 years, the level of implementation detail accompanying bond acts has been fairly consistent. Unlike previous bond acts, however, the School Facility Health and Safety Bond Act of 1997 is not accompanied by any implementation provisions apart from authorizing the state legislature to make bond proceeds available for broad categories of capital projects for public schools.

Enacted legislation accompanying nine out of eleven previous bond acts since 1974 typically allocated, and sometimes appropriated, proceeds on the basis of broad project categories and, in some cases, on geography. These allocations were, however, usually subject to annual appropriations and legislative terms and conditions. Furthermore, many of these acts (labeled medium in Figure 1 below) also provided direction to state agencies and subsequent legislatures on how bond proceeds should be spent. These acts usually balanced objective project selection criteria with significant executive agency discretion.

In addition, only one act, the Energy Conservation Through Improved Transportation Bond Act of 1979, was accompanied by legislation containing a high level of detail. It identified and scheduled a significant portion of funds for specific projects. At the other end of the spectrum, one other act, the Economic Action Program Bond Act for New York State of 1977, was not accompanied by enacted implementation provisions, as is the case with the pending bond act.

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Figure 1.
General Obligation Bond Propositions
Subject to Voter Approval Since 1974 (Dollars in millions)

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Year	Issue	Outcome	Amount	% Favor	Detail
1997	School Facility Health and Safety	pending	$2,400	---	low
1996	Clean Water/Clean Air	pass	$1,750	57	medium
1996	Jobs for a New New York	fail	$800	44	medium
1996	Environmental Quality	pass	$1,975	48	medium
1996	Accelerated Capacity and Transportation Improvements for the Nineties	pass	$3,000	55	medium
1996	21st Century Environmental Quality	pass	$1,450	67	medium
1996	Rebuild New York Through Infrastructure Renewal	pass	$1,250	53	medium
1996	Improved Security Through Development Correctional Facilities	fail	$500	49	medium
1996	Energy Conservation Through Improved Transportation	pass	$500	55	high
1996	Economic Action Program	fail	$750	38	low
1996	Low Rent Housing	fail	$250	36	medium
1996	Rail Preservation	pass	$750	65	medium

SOURCE: Independent Budget Office.

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Without implementation detail, the pending bond act separates the decision to incur debt from the equally important decision of how the state will spend bond proceeds even in a broad manner. A broad set of guidelines for spending proceeds, when it exists, provides a context for the voters' decision to incur debt. In the case of the Act, broad guidelines have not yet been enacted.

It should be noted that less detail does provide greater flexibility; and greater flexibility can, in turn, allow for decision-making that may be more responsive to local needs and less driven by a centralized process.

Fiscal Impact

Because of the lack of definition in the Act, the profile of year-to-year cashflows and total costs are uncertain. Assuming a six-year disbursement schedule of 30-year bonds issued at 5.5 percent, estimated annual debt service costs would range from $28 million to $165 million over a 35-year period beginning in fiscal year 2000. IBO has assumed that in return, an average of $400 million would be disbursed annually over six years to finance school construction. Our assumption of a relatively short six-year disbursement schedule reflects the immediacy of the need. We assume a 30-year bond issue term because the state's local finance law establishes a period of probable usefulness for educational facilities at 30 years.² The interest rate reflects a conservative estimate of the borrowing costs faced by the state in the capital markets. Based on our assumptions, the total cost of the Act, if passed, would be $5.0 billion ($2.4 billion in principal and $2.6 billion in interest).

It is still unknown how much of the $2.4 billion in bond act proceeds would be spent on projects in the city. City taxpayers, however, would surely contribute significantly to repaying the bonds because economic activity in New York City is the source of roughly 45 percent of state general fund revenues.

State Fiscal Health

Given the potential budget impact of the Act, full consideration requires an assessment of the following aspects of the state's fiscal health:

• The burden imposed by existing state debt,
• The relationship of the Act to the state's overall capital spending plan, and
• Potential for out-year state budget gaps.

Existing Debt Burden

The state incurs debt to finance capital needs in two ways, general obligation (G.O.) borrowing and public authority borrowing. Under the state constitution, there is no limit to the amount of G.O. debt the state may incur, but new borrowing must be approved by voters. Public authority debt, created in the mid-1960s by the state legislature, does not require voter approval.³ The Act proposes to authorize new G.O. debt, and thus voter approval is required. Although some public authority debt has specific revenue sources devoted to servicing the related bonds, and thus is considered very secure, it frequently carries a higher interest cost than G.O. debt, which is backed by the full faith and credit of the state. Because the Act proposes G.O. borrowing, its cost is likely to be less than it would be as public authority debt.

As shown in Figure 2, total state debt has increased significantly, growing by 37.4 percent from $21.9 billion in 1992 to $30.1 billion in 1996. This followed a nearly 100 percent increase between 1988 and 1992. Much of this increase was in the form of non-voter approved public authority debt. Since it first became possible to issue public authority debt, 83 percent of state debt has been of this form.

With an outstanding debt load that has doubled since 1990, New York is one of the most indebted states in the nation. While Standard and Poor's recently upgraded New York State's bond rating, it remains one of the lower-rated states. In fact, Moody's Investor Services continues to rate New York State G.O. bonds the second lowest among the 40 states it evaluates.

Figure 2. Outstanding State Debt 1976-2000 SOURCE: Independent Budget Office; New York State Division of the Budget, 1997-98 Executive Budget; Office of the New York State Comptroller (December 1996), New York's Debt: A Profile of the State's Voter Approved and Non-Voter Approved Debt. NOTE: Projected outstanding debt in 2000 does not include the pending bond act.

As state-supported debt has grown, debt service payments have increased from $1.3 billion in 1988 to $2.8 billion in 1997, representing an average annual growth rate of 8.9 percent. Over the same period, revenues were increasing at an average rate of 3.6 percent, or less than half as fast as debt service costs. Thus, as shown in Figure 3, the amount the state has had to dedicate to repayment of debt has gradually increased as a percentage of revenues from 4.1 percent in 1988 to 6.5 percent in 1997. State debt service is expected to reach 7.6 percent of revenues in 2000.

The state currently has a $22.6 billion six-year capital plan for the 1997-2002 period. School facility projects are not included in the plan, which consists mainly of spending on transportation, public protection, higher education, housing, mental hygiene, and the environment. In fact, borrowing for school facility improvements would represent a new programmatic area for the state's capital budget. As discussed in the background section above, local school facilityimprovements are presently assisted through building aid provided as part of the state's operating budget. Authorizing new capital spending for schools commits a stream of state operating funds to debt service which, consequently, would not be available for other purposes.

Figure 3. Debt Service as a Percentage of Revenues SOURCE: Independent Budget Office; New York State Division of the Budget and Office of the New York State Comptroller (August 1997), Annual Information Statement, State of New York; New York State Division of the Budget, 1997-98 Executive Budget; Office of the New York State Comptroller (September 1997), The 1997-98 Budget: Fiscal Review and Analysis. NOTE: Revenues based on all state funds including total taxes and miscellaneous receipts.

The viability of out-year state budgets is a concern because despite recent strong revenue growth and a surplus in the current budget year, the New York State Comptroller projects out-year budget gaps-which occur when spending is greater than revenues-of $1.5 billion in 1999 and $3.4 billion in 2000, with even larger gaps possible thereafter if economic growth moderates.

Against this, we need to remember that inadequate investment in and maintenance of public infrastructure-including school facilities-can pose a threat to the state's long-term fiscal health. While increases in state debt represent additional future claims on the state's revenue base, investing in critically needed public facilities promotes growth of the state's revenue base.

Other Considerations

IBO has considered three other ways to address local school facility needs. These include:

• Increasing state building aid payments to localities,
• Funding capital improvements on a pay-as-you-go basis, and
• Enabling localities to implement non-capital solutions.

Increasing Building Aid

The state's operating budget for the current year increases school district building aid through two changes to its formula. Beginning in June 1998, the state will reimburse school districts for a greater percentage of qualified debt service. Also, payments will account for differences in costs faced by school districts in different regions. If the state increased annual building aid funding still further by an amount roughly equal to the increased state debt service costs that would be incurred under the Act, school construction needs could be addressed through (state-aided) increases in local debt rather than by increasing state debt.

The main advantage of this alternative is that it would allow the state to avoid increasing its already heavy debt load. Moreover, increased building aid would ensure that (within the constraints of the aid formula) project selection is made at the local level. Finally, since building aid is combined, or matched, with a school district contribution toward debt service, a greater total investment could be generated than with state money alone.

But this alternative would also have substantial disadvantages, especially for New York City. The city's ability to make use of increased building aid might be constrained by the city's own debt level. Debt service as a share of revenues is considerably greater for the city than for the state and is projected to rise sharply in the next several years. Moreover, the city's debt limit, set by the state's constitution, remains tight-even with recent debt limit relief provided by the state through the establishment of the Transitional Finance Authority.

Furthermore, unlike commitments to bond act debt service, increases in building aid are reversible. If passed, the portion of education facility spending funded by the Act would remain relatively secure even during future periods of fiscal duress. In contrast, if building aid is increased in lieu of passing the bond act, then the portion of state-assisted facility spending at risk is much higher.

Finally, it is important to note that two of the advantages associated with increasing state building aid-local selection of projects and the use of local matching funds to generate greater total investment-would also be potentially available under the bond act.

Pay-As-You-Go Financing

The state could fund school capital improvements by paying for projects directly out of its operating budget rather than borrowing funds (the state would "pay as it goes"). Pay-as-you-go financing would avoid adding to the state's already large debt burden, but it would require the state to spend much more of its operating budget over the next few years to achieve the same level of school capital improvements supported by the Act. Under pay-as-you-go financing, annual debt service costs in the state's operating budget would not be increased, but an additional $2.4 billion for education infrastructure improvements would be disbursed directly from the state's operating budget instead of from its capital budget. The net operating budget expense over the disbursement period would be the difference between additional infrastructure spending and debt service costs avoided by not issuing school facility bonds.

In estimating the total debt service costs of the Act, IBO found that a six-year disbursement schedule for the $2.4 billion would result in total costs of $5.0 billion in principal and interest over a 35-year period. Of the latter amount, about $400 million would be payable from the operating budget over the first six years, meaning that under pay-as-you-go financing the net additional operating budget cost during the disbursement period would be $2 billion ($2.4 billion less $400 million).

Pay-as-you-go financing would, of course, result in lower operating budget costs after the disbursement period. But while the total cost of paying $2.4 billion in the next few fiscal years would be lower than the total of $5.0 billion in principal and interest payments expected to be required by the Act over the coming 35 years, in net present value terms the costs would be nearly equal.

There are two reasons to prefer bond financing of education capital expenditures to the pay-as-you-go alternative. Because pay-as-you-go financing is limited by current revenues, it is unrealistic to expect capital expenditures to occur as rapidly as with bond finance. Moreover, the rationale of bond financing for projects providing a long-term stream of benefits is well established. Bond financing ensures that the costs of public improvements are borne by the future beneficiaries of those improvements.

Non-Capital Solutions

Instead of addressing the state's school needs solely through capital investments, proposals have been made to increase the utilization of existing facilities. State legislation to support year-round schooling and double-session school days would substantially increase the capacity of existing buildings.

The potential capital savings warrant consideration of increasing the use of existing school facilities. However, increased utilization would not cover all projected needs. In particular, facility modernization and safety deficiencies can only be addressed by capital investment. Non-capital solutions for increasing the capacity of existing facilities should therefore be seen as a potential complement to, rather than substitute for, capital spending.

Proponents of increasing the use of existing capital have concluded that with extensive use of year-round schooling and double-session scheduling, the city could address facility needs with a reconfiguration of the current capital plan.⁴ These proposals would involve city-wide implementation of year-round and double-session school and closure of many existing school buildings. Other analysts contend that this politically and operationally difficult option is unlikely to occur quickly or to be implemented fully.

Conclusion

The School Facility Health and Safety Bond Act of 1997 would help meet the immediate school capital needs that exist in both New York State and New York City. Given the lack of specificity in the Act, however, it is not possible to determine how the bond proceeds would be distributed and whether they would be directed to the areas of greatest need. While the cost to state taxpayers would total about $5 billion over the next 35 years, the striking deficiencies in New York State's education infrastructure may warrant an investment considerably greater than the one proposed by the Act.

New York State's long-term fiscal health remains a concern because the state faces significant out-year budget gaps and state debt payments continue to grow at a rate more than double that of state revenue collections. Alternatives to the bond issuance do exist, but they would likely mean that the school facility improvements would be carried out over a longer period of time than if the bond act is approved.

Voters ultimately face a difficult decision between addressing a major school facility problem confronting New Yorkers and exacerbating a problematic budgetary outlook for the state.

IBO's principal education analysts are Elizabeth Lynam (212-442-8618) and Patrick Killackey (212-442-8612).