Debt Limits' End

Author:Nadav Shoked
Position::Associate Professor of Law, Northwestern University Pritzker School of Law
Pages:1239-1298
SUMMARY

Debt is a major tool funding American local governments. Local governments are, however, severely constrained in their ability to rely on this vital tool. For over a century now, state constitutions and statutes have strictly curbed local governments' power to issue debt. The effectiveness of these legal restrictions has often been questioned, but the rationale for their existence has not been... (see full summary)

 
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1239
Debt Limits’ End
Nadav Shoked*
ABSTRACT: Debt is a major tool funding American local governments.
Local governments are, however, severely constrained in their ability to rely
on this vital tool. For over a century now, state constitutions and statutes
have strictly curbed local governments’ power to issue debt. The effectiveness
of these legal restrictions has often been questioned, but the rationale for their
existence has not been doubted. This Article presents the first systematic
appraisal of the justifications offered for the limits state laws place on local
indebtedness. It finds all the varied normative accounts lawmakers and
commentators provide glaringly lacking. Even the most prevalent
explanation—portraying debt limits as alleviating the inter-generational
conflict between current residents who borrow money and spend it, and future
residents who must repay the loans—is inconsistent with the economics of
public finances and the laws of local government. After exposing the flaws of
this and all other normative ends heretofore assigned to debt limits, the Article
uncovers the sole end that may be attributed to them. Debt limits, it establishes,
institute a degree of inter-municipal equity in access to credit, ensuring that
one municipality does not deplete credit markets to the detriment of other
municipalities located within the same state. But although debt limits do
thereby serve an end, that lone normative benefit they generate is found to be
of meager proportions. The limits therefore often represent unwarranted,
costly—and deleterious—legal interferences in local finances. This Article’s
novel analysis should hence lead, if not to debt limits’ abolition, then at least
to their redesign so that their form corresponds to their inescapably limited end
identified here.
I. INTRODUCTION ........................................................................... 1240
*Associate Professor of Law, Northwestern University Pritzker School of Law. For
invaluable comments on drafts of this Article, and for fruitful conversations about the ideas they
incorporated, I am grateful to Michelle Wilde Anderson, Kenneth Ayot te, David Dana, Matthew
Fisher, Gerald Frug, Amnon Lehavi, Max Schanzenbach, and Richard Schragger. I also benefitted
from the input of participants at the faculty workshop at Northwestern University School of Law,
at the Law and Economics Workshop at the Hebrew University Law School, and at the Big Ten
Junior Scholars Conference. Finally, I am thankful to Jack Licata and Jonathan Saltz who provided
exceptional assistance in research.
1240 IOWA LAW REVIEW [Vol. 102:1239
II. DEBT LIMITS LAW ....................................................................... 1246
A. LOCAL DEBT ......................................................................... 1246
B. LOCAL DEBTS LEGAL LIMITS ................................................. 1251
C. LOCAL DEBTS LEGAL LIMITS HISTORY ................................. 1256
III. DEBT LIMITS LAWS NORMATIVE ENDS ....................................... 1258
A. DEBT LIMITS AS MEASURES TO PROTECT MUNICIPALITIES AND
LENDERS JOINT INTERESTS .................................................... 1259
1. The Argument ........................................................... 1259
2. The Argument’s Flaw ................................................ 1261
B. DEBT LIMITS AS MEASURES TO PROTECT RESIDENTS ............... 1263
1. The Argument ........................................................... 1263
2. The Argument’s Flaw ................................................ 1265
C. DEBT LIMITS AS MEASURES TO PROTECT FUTURE
RESIDENTS ............................................................................ 1267
1. The Argument ........................................................... 1267
2. The Argument’s Flaw ................................................ 1269
D. DEBT LIMITS AS MEASURES TO PROTECT THE FEDERAL
GOVERNMENT ....................................................................... 1273
1. The Argument ........................................................... 1273
2. The Argument’s Flaw ................................................ 1274
E. DEBT LIMITS AS MEASURES TO PROTECT THE STATE
GOVERNMENT ........................................................................ 1275
1. The Argument ........................................................... 1275
2. The Argument’s Flaw ................................................ 1278
F. DEBT LIMITS AS MEASURES TO PROTECT OTHER
MUNICIPALITIES .................................................................... 1285
1. The Argument ........................................................... 1285
2. The Argument’s Limits ............................................. 1289
IV. DEBT LIMITS LAW REFORMED ..................................................... 1291
A. REDRAFTING DEBT LIMITS ..................................................... 1292
B. REINTERPRETING DEBT LIMITS .............................................. 1294
V. CONCLUSION .............................................................................. 1297
I. INTRODUCTION
In a capitalist economy, few financial activities are more routine—yet
vital—than the lending and borrowing of money.1 Accordingly, the law might
regulate the form of loans issued and the practices of those involved in the
1. E.g., CHRISTINE DESAN, MAKING MONEY: COIN, CURRENCY, AND THE COMING OF
CAPITALISM 2–6 (2014) (relating capitalism’s advent to a decision to facilitate lending).
2017] DEBT LIMITS’ END 1241
lending market,2 but it does not directly limit market participants’ freedom
to procure debt.3 If Jane desires to assume a debt, she need only find a willing
lender. The same is true if Jane Corp. entertains such a desire: as a
corporation, Jane Corp. might be subject to reporting obligations,4 but the
law will not challenge Jane Corp.’s ability to proceed.5 The market, not the
law, determines who shall qualify for a loan.6 This basic truism of American
law is abrogated, however, in one exceptional case. The law may assume an
indifferent posture towards Jane or Jane Corp.’s credit desires, but when the
City of Jane fancies a loan, the law aggressively intercedes. In all states but one,
arduous constraints will be placed along the City of Jane’s path toward credit.7
The City might be flat-out prohibited from borrowing funds beyond a certain
amount; it might be required to attain resident approval for the move—
perhaps by a supermajority—in a referendum; it might even be subjected to
both these restrictions concurrently.8 The law thus treats local governments
strikingly differently from individuals or corporations, by placing on their
debt—and only on their debt—limits.
These limits’ unique nature is further accentuated by yet another key
contrast contained within the current law. The law not only treats city debt
obligations differently from individual or corporate debt obligations; it also
separates city debt obligations from other city obligations. Hence, if, for
example, the City of Jane desires a new football stadium, it will be, as noted,
constrained in its ability to issue debt to fund construction.9 At the same time,
it will not be constrained in its ability to fund construction through a budget
allocation;10 to grant tax subsidies to the privately-owned football team
constructing the stadium;11 to lease to the team, for a fraction of its value, the
2. For example, secured loans are regulated. U.C.C. § 9-109 (AM. LAW INST. & UNIF. LAW
COMMN 2015). States’ usury laws limit interest rates. E.g., CAL. CONST. art. XV, § 1.
3. Inevitably, however, the regulation of loans and lending practices leads to the pricing
out of certain borrowers from the market, and thus indirectly limits the freedom to procure debt.
4. The Securities and Exchange Commission monitors publicly-traded corporations. See
15 U.S.C. § 78d (2012).
5. Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate
Governance, 154 U. PA. L. REV. 1209, 1216–17 (2006). Commercial banks are an exception: they
are subject to capital requirements enforcing assets to liabilities ratios. 12 C.F.R. § 324.1 (2016).
Banks’ unique treatment is revisited infra note 136 and accompanying text.
6. The law may do the opposit e: e.g., it prohibits lenders from denying mortgages because
of applicants’ race. 42 U.S.C. § 3605 (2012).
7. See infra notes 76–88 and accompanying text.
8. See infra notes 76–88 and accompanying text.
9. See infra Part II.B.
1 0. Government funds can only be spent for a “public purpose” and thus seemingly cannot aid
private endeavors. However, courts rendered the requirement inconsequential by deferring to
legislatures’ determination respecting aid’s public purpose. Richard Briffault, Foreword, The Disfavored
Constitution: State Fiscal Limits and State Constitutional Law, 34 RUTGERS L.J. 907, 914 (2003).
11. For example, as part of the stadium plan Inglewood approved for the NF L’s St. Louis
Rams—as they were relocating to Los Angeles—public support was provided through $100

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