The Capital Budget
Secretary, Administration & Finance
September 29, 2003
Six months ago, I announced a sweeping review of all state capital projects and related debt financing. The initial phase of our review is now complete, and our findings have broad implications for the future.
What is the capital budget?
The Commonwealth has two related, but separate budgets:
- annual operating budget initially filed by the Governor and subject to legislative approval
- multi-year capital budget that prioritizes legislatively approved bond authorizations, but is not subject to legislative approval itself.
Not all states have capital budgets. In Massachusetts, we historically have separated investment-like and consumption-like spending. Our capital budget, generally speaking, creates assets with future benefits, like buildings and roads. The operating budget, in contrast, primarily allocates money to current consumption (services, maintenance, and so on).
Basically, the capital budget matches debt to construction projects, while the operating budget matches state revenues (like taxes and fees) to consumption. The state constitution requires a balanced operating budget. There is no similar legal constraint on the capital budget; rather, financial markets dictate how much debt is "too much".
Unsustainable debt trend
We are burdened by one of the highest debt loads in the country. Massachusetts ranks second behind Connecticut and Hawaii, respectively, in debt as measured in both per capita and percent of personal income terms. 
Our "direct" debt, primarily General Obligation (or GO), has grown about twice as fast as the state's operating budget since fiscal 1999. But worse still, significant "off-balance sheet" obligations have pushed debt growth on a compound annual basis to nearly 9% in recent years. In addition, the Commonwealth carries substantial "pseudo-debt" promises, including school building assistance and CAT/Turnpike agreements.
When added up, we have about $23 billion in tax-supported debt at the state level. This includes GO and Special Obligation (SO) debt, grant anticipation notes, contract bonds (MCCA, Foxborough, Devens, etc.), and appropriation-based debt (Route 3, UMass "Star Store", Saltonstall, SBA, etc.). It must be noted that we also have billions in unfunded liabilities for health and pension costs.
Payments on total tax supported debt account for $2.1 billion in fiscal 2004, or more than 9% of the operating budget. Since fiscal 1999, these payments have increased at a 5.9% compound annual growth rate, well ahead of the growth in the state expenditures.
To state the obvious: if the state's economy expands at about 3% per year, we cannot sustain debt that grows twice as fast. In fact, outstanding debt growth must be cut substantially during the 2004-08 timeframe in order to preserve our credit rating and stop the increasing pressure of debt service on the state's operating budget.
The administrative "cap"
The problem of exploding debt is not new to Massachusetts. Back in 1991, the Weld Administration imposed an annual limit, which came to be known as the capital "cap", on the issuance of GO debt. Unfortunately, the integrity of this process later broke down, as various schemes, like the financing for Route 3 North, circumvented the limit.
These "off-balance sheet" deals are no longer acceptable. Our policy is strict adherence to the administrative cap in FY04 and in all future years.
Wall Street supports this position. Last week Moody's placed $437 million in off-balance sheet debt for Route 3 and a UMass Dartmouth arts building on credit watch. This is the fiscal equivalent of getting a speeding ticket. Other deals, such as the Saltonstall building, remain highly vulnerable. The days of "creative" non-GO debt issuance are over.
Debt trends can only be reduced over a long time horizon. We plan no increase in the administrative cap through 2008. As a result of holding the cap flat, today's $16 billion of outstanding direct debt will still increase to $17.3 billion by the end of fiscal 2008, a 1.6% compound annual growth rate. This is partly due to previous administration practices of "balloon payment" financings that, as a matter of policy, we will no longer support. This prudent approach will reduce the debt burden as a percentage of personal income, albeit slowly.
The FY04 cap is $1.278 billion, of which approximately $1.2 billion will be borrowed. Subsequent year caps, in billions, are as follows:
|Fiscal Year ($Billions)
While the FY04 limit of $1.278 billion is slightly above the "official" FY03 cap of $1.225 billion, the overall amount of actual capital spending in FY04 will decline. This is because approximately $162 million of FY03 spending was "outside" the set cap limit. As I mentioned earlier, no further spending outside the cap will be permitted.
Operating budget impact
The link between the capital and operating budgets is debt service (principal and interest). Like a homeowner with a mortgage, our consumption spending is constrained by how much debt we have. Even under the flat capital spending plan of $1.25 billion annually, debt service will increase on the operating budget:
|Fiscal Year ($Billions)
|% projected budget
As a percent of projected personal income, our debt burden will slowly diminish. Fiscal discipline will be required for many years.
No more business as usual
In addition to excessive debt growth, the capital planning process in recent years has suffered from a lack of rigor and coordination. Capital has increasingly been used as a "safe harbor" from reductions in operating budgets. Return on investment analysis was rarely, if ever, done. Projects were not prioritized according to any objective criteria.
We seek a new, invigorated process, but this will necessarily take time. A first step is to establish clear, objective criteria for all programs and significant projects:
FIX IT FIRST
- Is there an immediate health or safety concern?
- Will preventative maintenance now avoid a future major expenditure?
- Does a part of our core infrastructure require replacement or renovation?
- Will future operating costs be reduced?
- What is the projected return on investment?
- Will other capital sources like the federal government be leveraged?
PUBLIC POLICY RATIONALE
- Will investment support a smart growth policy?
- Will tangible beneficial programmatic outcomes be generated? If so, for how long?
- Will investment improve the operation of state government?
Whenever practical, we also seek the best-demonstrated methods of procurement and development.
For example, design-build construction will be emphasized if it can save us money. In technology, we will adopt open standards to make systems more interoperable, and open source software, when available, to reduce licensing, programming and maintenance costs. A new coordinated and strategic approach will link PWED (public works economic development), CDAG (community development action grants), transit-oriented development, brownfield, and open space programs to better achieve smart growth objectives.
All potential FY04 projects are reviewed using the above criteria. We also apply an additional requirement: all existing liabilities must be met, and all clearly committed projects with a legal or high cost barrier to cancellation will continue.
Of the $1.278 billion FY04 cap, we have completed review of $1.100 billion of projects, and they are officially approved. These approved projects are:
|Description ($ in millions)
||Approved FY 2004 capital projects
|Transportation (roads, bridges, etc.)
|Housing, including Affordable Housing Trust
|State buildings and properties
|Hospitals and related facilities
|State and community colleges
|University of Massachusetts
|TOTAL APPROVED for FY04
With $1.1 billion of the $1.278 billion cap approved, there still remains $178 million available for new projects in FY04.
Currently the Commonwealth lacks the resources to start a number of large projects all at the same time, including new courthouses and jails. These endeavors require additional review to insure that the scope is appropriate, that a clear link to operating budget impact is made, and that other assumed changes or reforms are firmly in place.
In addition to new projects, and as previously announced by Governor Romney, $100 million will be allocated for new Chapter 90 grants. The overwhelming majority of such new projects will be paid for in future capital budgets.
I should note that many important projects remain outside the state's capital budget. The MBTA's Greenbush line, for example, is part of the MBTA's own capital plan, not the Commonwealth's. The Governor's stated support for Greenbush is consistent with the capital policy outlined here.
Fiscal 2005 planning underway
Releasing a capital budget midway through a fiscal year is obviously not optimal. Unfortunately, the prior condition of capital planning gave us no alternative. But FY05 will be different.
We intend to issue a preliminary FY05 capital budget along with the Governor's annual FY05 operating budget recommendation in January 2004, followed by a final FY05 capital budget in the Spring of 2004. For the first time, we will explicitly link the capital and operating budgets. We will also impose more rigorous definitions of capital expenditure to insure that future generations are, in fact, paying for long-term assets, not yesterday's consumption.
- New FY04 capital spending limitation, or cap, of $1.278 billion
- Freeze 2005-2008 caps at $1.25 billion
- Fully funds all pre-committed projects and related liabilities and establishes new criteria for project evaluation
- Direct debt is projected grow from $16 billion to $17.3 billion by the end of fiscal 2008, or 1.6% compound annual growth rate
 Moody's Investor Services, "2003 State Debt Medians"