Tuesday, November 14, 2006

Debt and taxes: does the city debt matter?

I suppose I ought to make some comment on the city budget out yesterday.. yet honestly it is what it is. There is no secret at this point that the city has this little debt problem. By any measure the debt owed by the city, especially if you were to measure it per capita for even better on a per household basis, is just off the chart for a major American city. Something has to give at some point.

So what some economists smarter than me have pointed out.

Huh? My own opinion is that debt will be the ultimate undoing of the city. Debt and pension payments are displacing ever more of the city's budget. Not much hope of refinancing any debt to generate even a few million, not much left to sell (like the water authority) and the peak of debt payments have been pushed out into the not too distant future. So the worst is yet to come.

Does it matter? To be fair, the so what, is my own paraphrasing of an issue I overlook. A question is whether the city's massive debt is already capitalized into the cost of city housing. In other words, does the market take into account that the debt is out there and 'knows' it will eventually have to be paid by increased taxes on city residents? If true then the price of housing in the city is lower than it would be if there were not this massive debt-in-waiting out there. Basically you are buying a relatively inexpensive home in the city, but at the same time taking on the future tax liability that is known to be out there.

It may not be the best example, but if you think of the debt like some other negative externality, bad air or something, it might be easier to understand. You can buy a cheap home near a waste dump, but you are partially paying for that property by future health care costs you will incur by living so close to it. In other words, the bad air/land is capitalized into the value of nearby housing... There is no free lunch.

Is this the case for the city of Pittsburgh? This is undoubtedly a factor in local real estate prices in one way or another. The mere fact that city finances are bad has to be priced into the market. I do wonder whether the city debt is entirely priced into city housing for several reasons. The large number of abandoned, vacant, tax delinquent, or otherwise unused real estate probably calls into the question how much debt is can be priced into their market values. (market failure?) In a real sense there are a lot of properties in the region that may have negative fair market values. Some markets have a hard time with negative prices. Time consistency may be a problem here, especially since the eventual payoff of the city debt is an ethereal date we will likely never reach.

This is an issue that may be operating in many cities, but like so many things we are just a much more extreme example such that we will 'test' this hypothesis sooner than elsewhere. Then there are some interesting questions of what happens if property tax reform moves municipal tax bases away from property taxes into something else. What other asset could the city debt be capitalized into? It would be difficult to capitalize long term debt into income taxes because it's so easy to move out from under that burden. Land by definition can't move and so is the default reservoir of this future liability. The underutilization of land may call that into question to a degree. I could go on but you get the picture.

As I said, this thought was not my own though I wish it was. I withhold attribution for now since I am not sure the author wants to enter the blogosphere.

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