Long Term Borrowing is the Best Way to Finance Major City Facility Investments

The Palo Alto City Council is beginning to discuss long-term financing options for major new facilities including the Public Safety building and Municipal Service Center renovation. This post explains the reasons why long-term borrowing is appropriate for these investments.

First, let’s start with a bit of background. The Infrastructure Blue Ribbon Commission (IBRC) on which I served identified three buckets of infrastructure need—keep up, catch up and new facilities. For the keep up financing so that we do not fall behind again, the IBRC recommended that the City make room in the annual city budget for $2.2 million in additional infrastructure funding and that has been done for the new budget.

For the catch up facilities (projects on a backlog list) we recommended that the City could work these off as funds became available or bundle some or all of them into new long-term borrowing.
The IBRC report then recommended that major project financing should be done by borrowing. That could take the form of bond issues or certificates of participation (COPs) that would be borrowing repaid out of the General Fund.

There are two major reasons for long-term borrowing for major facilities like the Public Safety facility or recently for our libraries. One is that these projects have large construction costs that need to be financed currently. The related and second reason is that the benefits occur over many years into the future and borrowing allows future beneficiaries to share in paying for the projects. It is a better matching of costs and benefits than to have past residents take money away from city services to pay for projects that will benefit future generations.

I think the discussion in other threads that the city should have been saving money for these projects is out of line with how cities finance major facilities and would poorly match benefits and costs as well as avoid a public vote. The IBRC did recommend creating a reserve to smooth out the annual keep up funding.

I favor bond financing for long-term borrowing for the three reasons cited in the report. First, General Obligation bonds are normally cheaper than COPs. When we completed the IBRC report, the average interest rate on G.O. bonds was nearly 1% lower than for COPs and that could mean substantial interest savings. The second reason is that a G.O. bond requires voter approval and, therefore, allows residents a direct voice in project approval. Ultimately since residents will pay for and benefit from these investments, they should have a voting voice in my opinion.

The third reason is that city COP borrowing still requires a dedicated source of funds for repayment, which is not easily identified given the struggles that all cities face with slow growing revenue sources and long-term retirement benefit challenges so it likely that the city would need a new revenue source to repay any COP borrowing.

Finally, this post is about financing choices, which should come into play only after projects are determined to be worthwhile and in the public interest for future investment. And the post does not offer an opinion on the current proposal to share costs of financing the Public Safety facility through approval of a private development proposal. But it does offer an opinion as to the best way to finance the City’s ultimate share of these costs.