Chapter 10: Capital Investment, Borrowing, and Debt

Capital investment

Spending on long-term assets that provide benefits over many years

Infrastructure

Public systems like roads, water, transit, and energy networks

Infrastructure gap

Estimated shortfall in funding needed to maintain and improve infrastructure

Capital spending

Government expenditures on infrastructure, equipment, and long-term assets

Pay-as-you-go financing

Funding capital projects using current tax revenue

Pay-as-you-use financing

Borrowing to finance projects and repaying over time

Reason for borrowing

To spread costs across current and future beneficiaries

State and local debt

Total amount of money owed by governments from borrowing

Debt per capita

Total debt divided by population

Debt to GDP ratio

Measure of debt relative to the size of the economy

Debt to revenue ratio

Measure of government’s ability to repay debt

Interest to revenue ratio

Share of revenue used to pay interest, key measure of debt burden

General obligation bonds

Bonds backed by full taxing power of the government

Revenue bonds

Bonds repaid using revenue from a specific project

Default

Failure to repay bond obligations

Tax-exempt municipal bonds

Bonds whose interest is not taxed by the federal government

Effect of tax exemption

Lowers borrowing costs for governments

After-tax return formula

(1 − t)r

Break-even tax rate formula

t* = (r − s) / r

Private-activity bonds

Government-issued bonds used to finance private projects

Problems with private-activity bonds

Higher costs, inefficiency, and federal revenue loss

Tax Reform Act 1986 rule

Bond is private if over 10% private benefit and repayment

Volume caps

Limits on amount of private-activity bonds issued

Taxable bonds

Bonds without tax exemption

Build America Bonds

Taxable bonds with federal subsidy created in 2009

Infrastructure and growth

Infrastructure can increase productivity and economic output

Diminishing returns

Additional infrastructure has smaller benefits at higher levels

Measurement challenges

Difficulty in measuring infrastructure impact on growth

Capital spending trend

Declined as share of GDP since the 1960s

Reason for decline

Aging infrastructure, lower investment, competing priorities

Infrastructure policy

Government programs funding infrastructure projects

Interest costs

Payments made on government debt

Debt composition

Mostly long-term debt

Long-term debt

Debt repaid over more than one year

Short-term borrowing

Used for temporary cash flow needs

Bond

A promise to repay borrowed money with interest

Credit rating

Evaluation of bond risk by rating agencies

Tax exemption inefficiency

Federal government loses more revenue than governments save

Arbitrage

Borrowing at low rates and investing at higher rates (limited by law)

Effect of tax rates on bonds

Higher tax rates increase demand for tax-exempt bonds

Stadium financing

Government support for sports facilities using public funds

Economic issue with stadiums

Often do not generate sufficient public benefits