Assessing the Affordability of State Debt
State governments commonly issue debt to finance the construction of roads, schools, and other investments in infrastructure that are important for economic growth and competitiveness. While borrowing funds can facilitate these investments, there is also a danger in allowing debt to grow unchecked. If debt service is too high, it can crowd out other public spending or else necessitate burdensome taxes or fees. Policymakers thus must carefully balance a state's capital needs with efforts to keep debt levels affordable.
This report highlights some considerations faced by policymakers or analysts when gauging state debt affordability, including how to define state debt and which metrics and approaches to use to assess state debt burdens. The report, which uses illustrative data from the New England states, concludes with recommendations to help guide future affordability assessments. These include improving transparency surrounding the various forms of state debt, examining alternative definitions of debt and multiple debt burden ratios, and timing affordability analyses to inform capital planning.
Key Findings
- Debt affordability refers to a state’s ability to repay all of its obligations without negatively impacting the provision of ongoing public services or raising taxes to anticompetitive levels.
- The first challenge in assessing affordability is to determine what constitutes state debt. Debt supported by state taxes is usually the most relevant measure for budget discussions, however, analysts also should consider broader measures of debt to accurately capture the overall burden borne by residents and businesses.
- Once debt is defined, different ratios are used to indicate the burden that it places on state resources. Because all commonly used ratios have strengths and weaknesses, analysts should consider multiple ratios when assessing affordability.
- Policy makers typically employ either debt ceilings or benchmarking when determining what values correspond to an affordable level of debt. Care should be exercised when using debt ceilings (which can be arbitrary) or benchmarking to other places (given each state’s unique experience).
- Debt burdens in New England vary widely and by ratio considered. Massachusetts and Connecticut host relatively high debt burdens across all ratios.
- Regular debt affordability studies can promote transparency and provide guidance to policymakers weighing decisions about state debt.