Indiana University SPEA Edward J. Bloustein School of Planning and Public Policy University of Pennsylvania AIR American University

Panel Paper: Do Financial Markets Impose a Penalty As States Increase Their Debt Loads?

Friday, November 13, 2015 : 8:50 AM
Pearson II (Hyatt Regency Miami)

*Names in bold indicate Presenter

Cleopatra Charles and Jongmin Shon, Rutgers University - Newark
The primary source for state and local governments financing large capital projects in the United States is borrowing from individuals and institutions such as banks, capital market funds, and other institutional investors through deficit financing i.e. bond issuance  (Lee, Johnson, and Joyce, 2012). Every year, state and local governments raise funds for bridges, tunnels, roads, schools, and other capital projects by issuing municipal bonds but there is also a danger in allowing debt to grow unchecked.  If debt service is too high it can crowd out spending for other public goods and services or cause governments to raise taxes and user fees creating an unnecessary burden for their citizens (Weiner, 2013). Drawing heavily from the article by Robbins and Simonsen (2012) this paper asks whether financial markets impose fiscal discipline on state governments that issue large amounts of debt by increasing the cost of borrowing for these states. To account for possible endogeneity between the borrowing cost i.e. true interest cost and the amount of debt outstanding we utilize a two stage least squares regression (2SLS). Using data on general obligation debt issued in the primary market by states for the period 1980-2007, our preliminary results support the findings of Robbins and Simonsen (2012). While the total amount of debt issued by state and local governments has been growing steadily over the last three decades and is well documented we find no evidence of an interest cost penalty being imposed on states that are heavily indebted.