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Sat Apr 27, 2013, 09:01 AM

I need an economist or accountant to explain this to me.

How can passing a bond issue not increase taxes? As I understand it, people buy bonds and redeem them at a future date for the purchase amount plus interest. But where does the money come from to pay back the bond and the interest if not from taxes? I know it's more complicated than that, but I get really tired of hearing people say the city did something without raising taxes because they floated a bond issue.

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Reply I need an economist or accountant to explain this to me. (Original post)
mykpart Apr 2013 OP
ret5hd Apr 2013 #1
on point Apr 2013 #2
lastlib Apr 2013 #3
Yo_Mama Apr 2013 #4

Response to mykpart (Original post)

Sat Apr 27, 2013, 09:06 AM

1. Well, probably in its simplest form...

it is a bit like a person getting a mortgage. You don't (usually) get a second or third job to pay the mortgage, you look at what you can afford and pay off the mortgage with your existing income.

BTW, I am neither an economist nor an accountant.

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Response to mykpart (Original post)

Sat Apr 27, 2013, 09:07 AM

2. There are many ways

One simple way is the Bond invests in something that saves the city money / or makes the city money, like a new road that saves time / fuel / labor / shock absorbers

Another simple way is to retire an existing bond that is more expensive

Another simple way is to invest is something with a return on it that is equally long term that pays off - like a new schools for the kids - much cheaper than prisons for instance.

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Response to mykpart (Original post)

Sat Apr 27, 2013, 09:50 AM

3. Bonds can be financed from a variety of sources.

"General Obligation" bonds are paid from whatever source is available to the payer (I'm assuming in all this that we are discussing municipal bonds--which is any bond issued by a state or political subdivision, eg, city, county, water district...) The repayment is pretty much a line item in the budget, just like parks, sewers, roads, etc. But that "line item" cannot be taken out of the budget or reduced--so if the city gets into financial difficulties, they may have to forego spending on the other things to be able to pay off the bond. An "industrial revenue" bond is repaid from money raised by a specific project--other funds can't be used to pay it off. So if that project goes belly-up, bondholders would be left holding the bag; taxpayers wouldn't be on the hook for the money, unless some other provision of the bond contract (called an indenture) kicked in.

that's a short answer--there's a lot more to it. Municipal finance can be a fascinatingly complex subject.

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Response to mykpart (Original post)

Sat Apr 27, 2013, 10:03 AM

4. That's right - bond issues are future raises in taxes

You are spreading current costs over a longer term.

That having been said, there are some things for which costs should be paid over the longer term. Buildings, like schools, for example. But non-capital account bond issues are a problem - if you are just floating bonds so as not to pay recurring costs out of revenue, in the future the implication is that tax rates must increase to compensate.

The problem arises when you float long bonds for short-term purchases. It's no different than families in 2003-2007 refinancing their houses and taking cash-outs to pay off credit card and auto loans. Yes, they got cheaper interest rates, but now they shifted the cost of buying things that should have been paid from current earnings to long-term debt, and although they may have felt like they had more cash flow in the short term, over the longer term they were probably dooming themselves toward paying more overall of their incomes to pay off those purchases.

If you keep doing that, whether it's a municipality, state or federal government, sometime in the future you will end up very broke!

People who get in that situation usually stop spending and go on a personal austerity binge,, but that's hard for governments, so they raise taxes as much as they can, and in the end, it also creates an austerity binge.

Huge overhangs of debt do way on economies, no matter what the current cant is. However total debt burdens have to be looked at. If household debt is high in relation to GDP and business debt is high in relation to GDP and government debt is high in relation to GDP, the situation is very different from a country in which government debt is high in relation to GDP but household and business debt isn't - in that country you can afford to raise taxes!

But if every sector has high debt, the problem snowballs quite quickly, because future investment will be restricted due to the need to at least pay interest on the debt. Nor can you inflate your way out of it, because that means higher interest rates which raise the carrying cost of new investments and usually the new debt.

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