Rhode Island Releases Robust Debt Affordability Analysis

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In May, Rhode Island released a new debt affordability study, a policy tool that analyzes a state’s ability to repay its debt liabilities. The state is one of 29 that regularly examine how much debt it can prudently issue, according to research by The Pew Charitable Trusts. This year’s study marks a new approach to evaluating the state’s debt and is notable because it:

• Analyzes the debt of quasi-public agencies such as the Rhode Island Turnpike and Bridge Authority.
• Incorporates both state and municipal pension obligations into its analysis, making Rhode Island the only state to do so.
• Examines the debt of every municipality and many special districts—over 100 entities altogether.   

Debt affordability studies are valuable because policymakers can use the data they contain to make informed decisions about borrowing. They examine a state’s outstanding and projected debt relative to a self-imposed affordability cap, often expressed as a ratio such as debt service to revenues. When policymakers know how much they can afford to borrow, they have a fuller understanding of available resources and where money can best be put to use. A robust study can also help policymakers assess risk over the long term, should revenue fall short of expectations or economic conditions decline. A debt affordability study can therefore help inform infrastructure planning, capital budgeting, and project prioritization.    

In years past, Rhode Island analyzed its debt annually in a section of its capital budget. Seeing room for improvement, lawmakers included a provision in the 2017 budget that tasked the state’s Public Finance Management Board with producing a debt affordability study at least every two years. They also mandated that the study include recommended limits for issuers of public debt, including the state, quasi-public agencies, and municipalities.

“There is a growing recognition that ratings agencies and other market participants are looking at liabilities in a more holistic way than they used to,” said Seth Magaziner, Rhode Island’s general treasurer. “Limiting the study to traditional tax-supported debt wasn’t comprehensive enough.”

Rhode Island’s decision to include the quasi-public agencies’ debt in its study stemmed partly from the fact that their collective debt was more than double that of the state’s primary government debt: about $5 billion at the close of fiscal year 2016, against just under $2 billion for the primary government.

Although the quasi-public agencies’ debt liabilities are generally not the direct responsibility of the state—they are backed mainly by revenue earned by each agency—that does not mean the state avoids all responsibility. “Sometimes even when public debt is not explicitly backed by taxpayer funds, taxpayers can find themselves liable for the cost of debt when the original revenue stream becomes insufficient to cover the cost of debt service,” the 2017 study notes. This is what happened with 38 Studios, a video game company that issued $75 million in bonds through Rhode Island Economic Development Corp. before going out of business, ultimately costing the state millions.

“If I’m an average citizen and I owe a dollar for public debt service, I don’t care if it’s issued by the state or by my city or by my water authority or by my sewer authority. I just want to know how much I’m on the hook for,” Magaziner said. He added that public authority debt often receives less scrutiny, in Rhode Island and nationally, than state and local debt does.

Rhode Island’s study also collected data on local government debt and created guidelines that municipalities can use to make prudent borrowing decisions. The state included municipal pensions in its analysis because they affect an entity’s ability to pay down debt, as in the case of Central Falls. This city, Rhode Island’s smallest, declared bankruptcy in 2011. The city’s pension and retiree health care benefit funds faced an $80 million shortfall, eclipsing its annual budget of $17 million, resulting in property tax hikes and pension cuts.

“Bonded debt in isolation—it doesn’t really tell you very much. Whether a municipality should be issuing more debt or less debt, you have to look at the other liabilities to really make that judgment,” Magaziner said.  

The 2017 study compared each municipality’s debt and pension liability against two data points: its total property value and total personal income. At the state and municipal level, it included ratios that some credit ratings agencies use to compare the sum of debt service and pension liabilities to general fund revenues and state personal income.

The study also established debt affordability levels for the state and each quasi-public agency and municipality. “The public debt burden that is affordable for the population of one community might be higher or lower than the affordable level for a community located elsewhere,” the report notes.

To establish affordability levels for municipalities, officials examined the debt held by a given municipality as well as that of any special districts whose boundaries overlap the municipality, and analyzed that total debt relative to the underlying population’s ability to repay it, as expressed by income and property value. To set targets for municipalities, the state also used nonbinding criteria from credit rating agencies connecting their liability levels to both A and AA ratings. 

Rhode Island may not have finished expanding its affordability analysis. Magaziner said his office may add other post-employment benefits to its next study, to be published in 2019.

Pew’s research has found that taking a broad look at a state’s liabilities can help policymakers gain a fuller understanding of their state’s financial obligations and make better-informed decisions about future issuances. Rhode Island’s new debt affordability study has helped advance those goals.   

“It’s impacting our work as policymakers. We are forecasting state debt affordability using new ratios, including pension liabilities,” Magaziner said. “We’ve been asked to weigh in on municipal debt affordability in a number of communities. Having the study out provides a good guidepost for cities and towns.”

Mary Murphy is a director and Adam Levin is a senior associate in The Pew Charitable Trusts’ project on states’ fiscal health.