Financial Limits in Constitutions Dale Oesterle Moritz School of Law
History • Representative Democracies have an “Achilles Heel”: Insolvency (Excessive Spending Funded by Debt). • A Long History of Financial Failure. National; Regional. Old;New. Greece (EU); City of Detroit; State of Illinois; Republic of Texas; Most States Under Articles of Confederation; Most States In Canal and Railroad Days in 1830s. • Inevitable? Cyclical? Inherent? Consequences? • Solution: Financial Limits in Constitutions • They are our version of binding ourselves to resist the “Siren’s Song” (Homer’s Odyssey): We tie ourselves to the mast through the constitution, as did Odysseus, to resist the sweet music that leads sailors’ to dash their own ships on the shoals.
Ohio’s Special Place in the History of Financial Limits in Constitutions • Ohio a Leader since 1851 in • Innovation [The Completeness of the Protection] • Application of Limits [Ohio Courts Have Stood Up to Phony Structures, Misuse of Terms, and Other Tricks] • Has Long Running Experience with the Limits and is an Example for the States Worldwide Considering such Covenants • Irony: The World is Adding Limits (Spain, EU); Ohio Is Running Away from Its Own Limits.
Theory and Data Supports the 1851 Approach • Obvious Problem: Bad Faith of Elected Officials. • Risk of Corruption & Cronyism in Spending Decisions. • Traditional Solutions: Prosecutions and the Ballot Box (“throw the rascals out”) • Less Obvious Problem: Well-Intentioned, Good Faith Errors that Lead Inexorably to Excessive Spending. Economic Theory Supported by Datagives voice to the problems. • Older Theory and Data: Deficiencies of Central Planning Over Market Based Allocations of Capital. But “Market Failures.” The Cry of the Public Finance Industry. Laureate Edmund Phelps (Data: State Performance Inversely Related to Degree of Central Planning) • More Recent Theories and Data: Mismatch of Incentives of even Well-Intentioned Elected Representatives and Citizens (Public Choice Theory). The Nobel Laureates (5, including Buchanan). Phelps (Level of Government Subsidies to Private Sector Inversely Related to State Growth).
The Incentive Mismatches • Spend Now; Pay Later. • Spend Now to Benefit Constituencies that Generate Votes • Postpone Payments for Later Governments • Bring Home the Bacon • Each Rep. Seeks to Benefit Specific Constituencies from General Funds • Willing to Logroll to Trade Packages with Other Elected Officials • The Power of a Specific, Cohesive Constituency Group, The Public Finance Industry (Lobbyists, Bankers, Lawyers, Developers, Subsidized Recipients), Over the Less Cohesive, Less Knowledgeable Citizenry • Public Marketing and Spin. Rationalization: Market Failure, Job Creation, & Multiplier Exaggeration. See Harv. Prof. Robert Barro’s Data on Multipliers (usually under 1).
Incentive Mismatches • The Mismatches are Inherent (Always There), Dangerous (threaten solvency), and Not Correctable by normal political processes (the ballot box). • Confluence of Incentive Mismatches Leads to Excessive Spending, Usually Fueled by Debt, on What Should Be Private Projects.
Should Governments Be an Engine of Economic Development? • Yes, But Method Counts • Use General, Universal (Fair) Rules Including Low Taxes, with Few Special Exceptions. Spending Limited to “Public Goods.” • Do Not Use Targeted Grants (or their equivalent) to Specific People, Companies, & Industries. The Primary Current Rationalization, “Job Creation,” has no boundaries or limits.
Constitutional Solutions • Main Provisions • 1) Balanced Budget [Sinking Funds] • 2) Limits and Caps on State Debt [In All Forms] • 3) Limits on State Aid to Private Parties (Various Arrangements) • Exceptions?: Only With Voter Approval of Specific Projects. • A Plethora of Supporting Rules Necessary to the Health of the Main Provisions. See App. A
The Loophole Problem & Protections • Constant Heavy Pressure to Create and Exploit Loopholes in Constitutional Financial Limits. • The Main Prohibitions, 1,2&3, are interrelated. They Support Each Other. E.g., Weaken 3 and the Others Are of Little Import. • Each of the Main Prohibitions Has Supportive Definitions that Catch Language Tricks (E.g., state guarantees count as debt) • There are other necessary supportive rules sprinkled throughout the Constitution (e.g., the no bait and switch rule with special funds). • Also Key Is Judicial Support: Courts Must Be Willing to Look Through Form and Trickery to Essence of the Arrangement. E.g., Lease/Lease-back in Arena Deal to turn tax dollars into “rent.” Ohio’s Court is one the few courts consistently, over time willing to do this (there are a few bad cases, but only a few). See Kitchen (leases are debt) & Brand (broad definition of credit) cases.
Where Are We Now? • A Very Leaky but Floating System of Limits. • Leaks: Grant Anticipation Revenue Bonds (GARVEE); Certifications of Participation (COPs); Special Obligation Debt; Revenue Bonds; Tax Credit supported Debt; Fee Franchise Supported Debt; TIF Bonds. • New Leaks will Sink the Basic System • An Explosion of Public Subsidies for Private Business at All Levels of Government in Ohio in the last ten years. NYT: $3.2B. • New Tricks That Every Level of Government Can Use for Broad-Based Frustration of the Limits
The New Iterations of the Authority (SPV) Loophole • If The Jobs Ohio or Arena Deal Structures Hold Up, Each Provides a Gaping Loophole for Target Government Support of Private Projects at all Levels of Ohio Government • Use of SPVs (“Authorities”) to funnel Government Funds to Discretionary, Specific, Private Targets. An Enron trick. • SPVs Use Clever Tricks: “Subject to Appropriation Debt,” Privatization (Transfer of a “Franchise” on the Collection of Liquor Fees), Lease/Lease Back to Create “Rent.” • The Breech and Collapse of the System of Limits? • Previous Speaker Was Correct (A huge admission): • If Jobs Ohio Survives We Do Not Need Amendments: Public Finance Industry is Healthy Enough With Space in Loopholes. • Just Throw Out Some of the Current Provisions Limits • As Technically Useless (in a Bow to the Inevitability of Current Practice) • For “More Flexibility” At the Margin
Recommendation • Clean Up Obsolete Text on Financial Limits • Support the Existing Structure on Financial Limits with Clear Language that Catches the Latest Loopholes, Specifically those in SPVs (Authorities) • Periodic Revisions to Catch Errant Court Cases and Drafting Openings that Support New Tricks and Scams.