COPs Evade Debt Limits

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COPs Evade Debt Limits

by Barry Poulson, February 12, 2003

To: House Finance Committee
From: Barry W. Poulson
Professor of Economics
University of Colorado
Re: HB 1256

I wish to register my opposition to House Bill 1256. I am not able to testify before you today, and have asked Stephen Raher, Senior Policy Analyst with the Coloardo Criminal Justice Reform Coalition to read this statement for me.

The State Constitution imposes restrictions on government borrowing and spending. Under the Colorado Constitution, all general revenue bonds require voter approval.

In normal bond financing, the government borrows money (the bond), uses the money to build something (i.e., a prison), and promises to pay the bond off through general tax revenues..

A "Certificate of Participation" or COP is a tricky type of financing which was invented, according to Investopedia.com, so that governments can evade "restrictions on the amount of debt that they can incur."

With a COP, the state doesn't sell a general revenue bond. Rather, a spin-off government agency (created purely for the COP) builds the prison, and then "leases" the prison to the government. The special agency sells "Certificates of Participation" which entitle the investor to a share of the lease revenues. The money from the sale of the COPs is used to build the prison.

Technically, the special agency, (whose only revenue is its lease income from the prison), has the financial obligation to the COP-holders; the general revenues of the state are not formally obligated to pay back the bond.

As a practical matter, however, any state which lets a COP program fail financially, would have its bond rating severely downgraded by the bond rating companies such as Moody's. The rating downgrade would significantly increase the state’s cost of borrowing. So practically speaking, the state does its best to make sure that COP's never get into financial trouble, so the net result is the same as with a normal bond: the taxpayers must shell out enough money in taxes so that the COP stays financially healthy.

Unfortunately, the Colorado Supreme Court is extremely hostile to our State Constitution's restrictions on government spending and borrowing. The court has interpreted the Constitution to allow governments to use Certificates of participation (COPs) without a popular vote.

The whole thing amounts to an elaborate sham so that state (or municipal or county) governments can borrow money without asking for voter permission. The potential for abuse of this form of financing can be amply demonstrated at all levels of government in Colorado. Increased reliance upon COPs has exposed government in Colorado to increased vulnerability to default on this form of debt. The losses that result from this default would then be passed on to taxpayers. It is time to stop this circumvention of the Constitution and rely upon the will of the voters in determining when governments can incur debt.

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