Congress is now considering legislation to authorize the District to fund its accumulated operating deficits by borrowing on the private bond market. As a homerule principle, it is clear that the District government should have this authority. As an economic proposition, however, the District should give serious consideration to whether such borrowing is prudent.
The increase in interest rates in the country over the last several years calls for closer examination of borrowing proposals. Borrowing, which may have been the conventional wisdom five years ago, may now be of questionable merit. It is likely that, even its tax-exempt status, the District will pay at least 10 percent interest on any private borrowing it now makes. Borrowing to finance an operating deficit may be even costlier. At 10 percent interest, current proposals to borrow to fund $200 million of accumulated deficits will cost $21.2 million each year for the next 30 years and the total amount repaid will be $636.5 million.
On the other hand, rather than borrowing the necessary $200 millon, we could accumulate the funds in a short period of time out of current revenue with no increase in any single year's cost and with very substantial long-term savings. The high interest rates make this option practical. Again assuming a 10 percent interest rate, by accumulating from revenue each year an amount equal to the projected debt service, we could fund the entire deficit without any borrowing in just seven years. The annual cost would be less than $150 million (rather than $636.5 million) because the deficit would be completely paid in seven years (rather than 30 years). Since the accumulating amount could be invested on the open market, rather than the tax-exempt market, we could expect a higher than 10 percent return, reducing the period of time necessary to fund the deficit.
The difference to the financial position of the District makes it clearly advantageous to accumulate rather than borrow. At the end of seven years we would have the previous deficit fully funded and no further obligations. If we borrow, at the end of the same seven years, we will still owe $188 million and have an obligation to pay $21.2 million annually for an additional two decades. h
We could even determine to fund the deficit fully in a shorter period than seven years at very little increase in annual cost of $11 million -- which is just half of the proposed annual debt service cost we will obligate ourselves to by long-term borrowing -- we could fund the deficit in just five years.
More important than eliminating the cash deficit, the financial reputation of the District would be greatly improved by funding the deficit without borrowing. If our first entry into the private financial markets is to fund operating deficits, it can only highlight our financial problems. On the other hand, if we demonstrate what we can balance our operating position without resort to borrowing, we would be demonstrating financial strength. This would in the long run reduce our interest costs on future capital borrowing.
The question is, can we accomplish solving the deficit problem by accumulation, rather than borrowing? I think that the answer is definitely yes. As discussed above, if the deficit is funded in seven years, no additional amount would be necessary to be budgeted annually over what we will be required to pay in debt service on the borrowing, and only a small increase would be required if the period is reduced to five years. Even funding the full amount in only four years would increase the annual cost above borrowing by approximately $22 million, which is small relative to the total budget. The savings program recently instituted by the mayor to balance the current 1981 budget proposes to reduce spending in six months by some $30 million. This is considerably greater than the extra accumulation necessary to wipe out the deficit in four years. Without cutting expenditures, a temporary tax surcharge of these amounts would hardly be felt. The extra amount necessary to fund the deficit in four years is less than 2 percent of our total tax revenues and less than 10 percent of either our property or income taxes alone.
The more pressing question is whether we can meet the city's cash-flow requirements during the accumulation period. An agreement from Congress to allow the District to continue short-term borrowing from the U.S. Treasury during the period would obviate this risk. This would have no direct cost to the Treasury. It should certainly be in the federal government's interest to solve the accumulated deficit problem within a very limited time, rather than carrying the weight of borrowing into the next century.