Debt Limits' End

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

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 DEBT’S LEGAL LIMITS ................................................. 1251

C. LOCAL DEBT’S LEGAL LIMITS’ HISTORY ................................. 1256

III. DEBT LIMITS LAW’S 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

COMM’N 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