Washington State is facing a budget shortfall of $4.6 billion through 2023, just one of the many shockwaves from the COVID-induced recession that has crimped the budgets of families and governments alike. A shortfall that size means that in January 2021 the new legislature will be spending most of its time cutting services and hunting for new revenue.
The problem, which is hardly unique to Washington, could in theory be addressed by the federal government. But that’s not likely. Although the feds can borrow money at extremely low interest rates and use it to plug budget holes or invest in jobs programs—both of which would serve to ease the recession—there is little reason to believe the Republican-controlled US Senate is interested in major new stimulus spending for state and local economic recovery. Federal money for climate protection is even less likely.
So, what can a state like Washington do in the absence of federal leadership?
It could unlock direct investment in the state economy over the next ten years, providing near term stimulus and mitigating economic risk in the long term by building out much-needed climate infrastructure.
Rather than muddle through what may prove to be a slow (and highly inequitable) recovery, a promising new idea has emerged. It could unlock upwards of $16 billion for direct investment in the state economy over the next ten years, spending that would provide stimulus in the near term and mitigate economic risk in the long term by building out the state’s much-needed climate infrastructure. The idea would have Washington take advantage of the seemingly insatiable demand for sustainable investment products to issue its own debt, in a sense replicating at a small scale what the federal government could do for the nation. The idea, first floated by proponents of Washington Strong and now backed by a growing number of state legislators, is for the incoming legislature to avoid painful cuts by directing the treasurer to issue economic “recovery bonds” and then investing the proceeds into resilient infrastructure, prioritizing projects that would jumpstart employment and local spending or cover important budget items that the state budget may not be able to pay for.
For those uninitiated in government finance, here’s a quick primer on how bonding works. The state sells bonds (i.e. debt) to investors; the investors pay for the bonds upfront; and then the state repays the debt over time with interest. Investors win by making a steady, if modest, return on a secure investment while the state gets money when it’s needed—like in the doldrums of a recession—that it can slowly repay when times are better.
State-level recovery bonds are an attractive option right now for several reasons: they can inject money into the economy when the state needs it, because interest rates are incredibly low, they are an inexpensive way to jumpstart the economy. As a bonus, spending from recovery bonds could be directed to take care of long-overdue priorities like replacing salmon-blocking culverts (which the state has been legally ordered to do, but can’t pay for) and restoring unhealthy forests that are prone to wildfire. Spending of this sort would benefit the environment in obvious ways, while also putting people to work in every corner of the state. It has the potential to be a big win.
But even cheap money isn’t free, and it’s important to peer under the hood of the recovery bond proposal to understand how the mechanics work.
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The first component to inspect is the repayment mechanism. In this proposal, the state would repay the bonds by tapping into a new revenue source, a tax on the carbon emissions from burning fossil fuels and a few types of polluting industry activity. That’s right, the engine of the recovery bond is a carbon tax. And if you’re now rolling your eyes about the political prospects of another carbon pricing proposal in Washington—it’s an idea that has proved unpopular with state voters recently—that’s understandable. It was my first reaction too.
Yet there is good reason to think that this time is different. The state economy needs stimulus spending, at a time when other options are very limited and carbon tax-based bonds are well suited for economic recovery. They have the advantage of bringing in revenue quickly, right when we need it badly, because investors pay for the bonds earlier than the repayment revenue trickles in. Plus, issuing bonds provides a degree of long-term certainty that is very difficult for other policies to achieve. Because the state must repay its debt on the bonds, even a climate-unfriendly future legislature could not easily weaken the carbon tax that drives the program.
The second system to examine is the complicated-looking system of bond issuance. Generally speaking, there are a couple of types of bonds. General obligations bonds, sometimes called GO bonds, are backed by what is known as “the full faith and credit” of the state. That means investors who buy the bonds can rest assured that the state is legally pledged to repay the debt with interest. In a state like Washington with an excellent credit rating, these bonds are very secure investments, so they typically have low interest rates. From an investor’s perspective, they are low risk but also low reward.
The recovery bonds are a bit different. These bonds would be considered “special tax obligation bonds” that are backed solely by a dedicated revenue stream, a carbon tax in this case, rather than by the state’s credit. In normal times, that lack of security means higher interest rates (a better return for investors and a higher cost for the state). But two preliminary analyses of the proposal, one from the state Treasurer’s office and one from Goldman Sachs, indicate that the recovery bonds would likely be highly rated and, because they would be certified as green, popular with investors as well. In other words, they would likely carry interest rates not much higher than general obligation bonds. (If interest rates do rise in the future, the program of ongoing bond issuance would by then have an established, and hopefully successful, track record for investors to evaluate.) Plus, because recovery bonds are special tax obligation bonds, they are not constrained by Washington’s constitutional limit on debt. That means, according to the Attorney General’s office, they require only a simple majority in the legislature to pass and, critically, they would enable additional financing capacity, above and beyond any other sources of revenue for the state.
The Washington Strong proposal would dedicate 100 percent of the carbon tax revenue, whether bonded or not, to be used for climate change mitigation and adaptation.
Recovery bonds would be constrained in other ways though. The Washington Strong proposal would dedicate 100 percent of the carbon tax revenue, whether bonded or not, to be used for climate change mitigation and adaptation. It is not a slush fund for the government; the funds can’t be used for highway expansions or state agency bloat. They would instead be directed to shoring up the finances of struggling low- and moderate-income households (for which a variety of mechanisms are available) or investing in decarbonization projects that drive economic activity. It could mean opening up salmon habitat by removing stream-blocking culverts and repairing a century of forest mismanagement to prevent wildfires. And it could mean important new investments for cities and towns too, like energy efficiency and HVAC upgrades for schools and hospitals; installing broadband in rural and underserved areas to enable trip reduction and economic diversity; next-generation wastewater treatment plants that generate their own energy; and much more. These are the investments that would move Washington’s decarbonization strategies from plans on paper to working reality.
Like the rest of the country, Washington’s economy was derailed by the events of 2020. Unemployment spiked, renters and homeowners alike are facing a looming eviction crisis, and now the resurging virus threatens even more harm. Yet even in the face of these reversals, it is entirely possible for states like Washington to take control of their own fortunes—and they don’t need to wait for the federal government to do it.