Md.'s growing debt

Our view: Gov. O'Malley's spending proposal moves the state toward sustainability, but a growing reliance on bond issues is worrisome

January 27, 2011

The nonpartisan analysis of Gov. Martin O'Malley's budget proposal backs up his most important claim, that his plan does more than balance the budget through one-time transfers, found money and other gimmicks and makes real progress toward finally aligning Maryland's revenue with its spending. Mr. O'Malley and the Department of Legislative Services disagree about exactly how big the persistent gap between revenues and expenditures is — he says the structural deficit is $1.4 billion, the department says $1.6 billion — but either way, the governor's proposal permanently addresses at least a third of that. Compared to how the state has operated for most of the last decade, this is progress.

Still, a closer look reveals some disturbing findings and underscores just how hard it is going to be for the state to put its fiscal house permanently in order.

Getting a true read on what's going on in this budget proposal is difficult because the billions Maryland received from the federal government's stimulus program during the last two years distorts easy comparisons. But factoring out such confounding factors, the area of state expenditures that is growing faster than any other is debt service. Maryland will spend $886 million next year to pay off general obligation bonds. Add bonds backed by the transportation trust fund, and next year's debt service will top $1 billion for the first time, and part of the reason is that the state is effectively taking on debt to backfill its general fund.

Unlike the federal government, the state is not allowed to borrow money to balance its operating budget, but the administration has found a legal way to do more or less the same thing. Here's how it works: The state has set up dedicated revenue streams to pay for certain programs. The real estate transfer tax, for example, funds Program Open Space; the so-called flush tax supports the Bay Restoration Fund, which finances sewage system upgrades, and so on. Governor O'Malley, and governors before him, have raided those special funds in troubled times to pay for general operations, such as education, health care, state police and other essential government functions. But rather than putting those programs on hold while their funds were being raided, Mr. O'Malley, with the legislature's consent, has taken on more debt by issuing general obligation bonds and used the proceeds to preserve more land, continue building the Inter-County Connector, replace the Medevac helicopter fleet, and so on.

Those are, legally speaking, capital expenditures, but ones the state would otherwise have paid for with cash. In all, the governor will have increased the state's debt in this way by more than $1 billion since the 2009-2010 budget year.

It's not clear that all this additional debt will cause problems in the long run. The $925 million in general obligation bonds that the O'Malley administration plans to issue in the coming fiscal year is exactly at the limit recommended by the state's Capital Debt Affordability Committee. That panel, chaired by state Treasurer Nancy K. Kopp, estimates affordable debt levels based on two criteria: Debt should be no more than 3 percent of Marylanders' personal income, and debt service payments should total no more than 8 percent of revenues. Issuing debt at this level for the next several years would not violate either standard, though it will come very close on the latter.

That means that another economic downturn, or even slower than expected growth, could force the state to pull back on its capital program, and given the practice of using debt to effectively support operating expenses, that would have ripple effects throughout the budget. Even if the committee's assumptions prove correct, skating so close to the limit robs the state of the flexibility to take on new projects.

The three major bond rating agencies are divided on how important Maryland's increasing debt is, with one characterizing Maryland's debt burden as high, one as moderate, and one as low. But their reaction to the practice will be critical; a change in the state's AAA bond rating would not only be a blow to state pride but would also cost millions from the higher interest rates we would have to pay.

The one element of Mr. O'Malley's proposal most likely to work in Maryland's favor as far as the bond rating agencies is concerned is the reform he is seeking to state employee pensions and retiree health care programs. All three rating agencies have expressed concern about the state's unfunded pension and health care liabilities, which top $30 billion. The governor's plan calls for a combination of lower benefits and higher contributions from workers for their pensions; higher health copays; and a requirement that retirees enroll in the Medicare prescription drug benefit. This would help the state return to adequate levels of funding within a decade.

That's important, but it doesn't help much with our short-term budget problems. The state will save more than $100 million next year if the reforms are enacted, but in the future, those savings will be plowed back into the system to make up for prior underfunding.

For all the legitimately difficult cuts the governor has asked the legislature to approve — including about $100 million in reductions for schools and libraries, the elimination of about 1,000 filled state jobs, and decreases in funding for programs like utility bill assistance for the poor — Maryland still has a long way to go before its finances can truly be considered sound. Mr. O'Malley said this budget was the most painful he has ever produced, but it is only the prelude to decisions that will be even tougher.

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