Public Finance

LOCAL INDEBTEDNESS

BOOK V, CHAPTER VIII

§ 1. The rapid increase in the debts of local governing bodies has been noted in an earlier chapter as likely to give rise to serious financial difficulties in the future. A national debt, whatever be its evils, is open and conspicuous; it is under the control of the government of the whole people, and is based on the total wealth of the country. It, moreover, has usually been incurred for objects of general interest, the ultimate value of which can be measured, and its treatment can be effected by public opinion guided by judicious criticism. In all these respects local indebtedness is less favourably placed. Instead of the single State, there are many bodies of very different character and importance, and with altogether diverse requirements. Each distinct administration borrows on the security of its special revenue, which may be adversely affected by local conditions. The expenditure of the innumerable loans is very hard to follow, and intelligent criticism is almost wholly wanting. Sectional interests and ignorance of financial principles have the same influence on borrowing that they have on taxation and expenditure: they tend to lower the probability of obtaining either economy or just distribution. Under such circumstances it is the more important to examine the chief features of the system of local borrowing that has spread so widely in the last fifty years.

§ 2. As regards the fact of increase, there is the most positive and convincing evidence. In 1875 the local debt of England and Wales was £92,000,000. Six years later it came to £144,000,000. By 1888 the total was £192,000,000. In 1891 it had become £201,000,000, while in 1899 it had risen to £276,000,000, showing for the period of twenty-four years an annual increase of over £7,600,000. This general growth is made up of special increases, which in such an instance as that of London are very striking. The metropolitan debt, which was only £21,000,000 in 1875, touched on £51,000,000 in 1899, showing a steady advance in the last twenty-five years.

The Irish and Scotch local debts, though insignificant in comparison with those of the English towns, are also becoming greater, and are now over £50,000,000.

Other countries show the same tendency. The debt of the French
communes (excluding Paris) has risen from £13,600,000 in 1862 to nearly £23,000,000 in 1869, and to £30,300,000 in 1878. In 1891 it exceeded £54,000,000; at the end of 1900 it was £59,670,000. The Parisian debt is by itself a formidable sum. In 1870 it was £59,000,000. In March 1890 the various debts of the French capital were £75,000,000, and at the close of 1900 they were £94,350,000.

Many of the Italian
communes are also increasing their debts. At the close of 1896 the total due by them was over £48,000,000, though this amount was small compared with the debt of the central government.

A great development of local (and particularly urban) debt is also to be found in the United States. As Professor Adams has pointed out,
*38 the great creation of municipal debts was after the opening of the Civil War. He estimates the total indebtedness of the smaller divisions in 1860 at $100,000,000, of which over one half was due by towns having over 7,500 inhabitants. Ten years later (1870) this liability came to $515,800,000, in 1880 it had further increased to $822,100,000, while in 1890 it had grown to $906,200,000.
*39

§ 3. The causes of this general movement are not difficult to trace. Local, like national, borrowing is dependent on the existence of favouring conditions; and these are to be found, first in the greater power conceded to local bodies, or rather in the extension of their administrative functions during the 19th century. Another cause is the far larger amount of disposable wealth seeking investment, and the natural desire of its holders to get good security, and this is undoubtedly afforded by most public bodies. Thirdly, the needs of city life call for the creation of works involving much capital outlay. Drainage, water-supply, lighting and transport agencies, have, at the lowest, a semipublic character, that has led to their being in many instances placed under the suitable regulative body, which had to employ its credit in order to procure the required funds. It is in this last respect that local and national debts present the greatest contrast, though some of the latter have been created in the same way.
*40 Defenders of the modern system of local borrowing point to the valuable estate formed by its use. Waterworks, gasworks, tramway lines, and market buildings may all be looked on as sources of revenue, which, after meeting their liabilities, will in some cases give a surplus for other objects. The element of truth contained in this mode of regarding debt has been already considered, but it is here desirable to indicate the qualifications to which it is subject. Granting the superiority of ‘reproductive’ over ‘unproductive’ debt, it does not follow that the former is in itself desirable. That public property, if revenue-yielding, is an asset to be set off against liability has been already explained. Whether either item should be preserved in the financial system is a distinct and separate question. Thus the various municipal industries are obviously a great aid in meeting the local debt charge, which, however, except for them would hardly have existed. The real point at issue is the expediency, socially, economically, and financially, of the conduct of such industries by public authorities. If public is superior to private management, a financial gain may be looked for, though it by no means holds good that all profitable industries should be taken up by the public powers.
*41

There are some further considerations which tend to limit the use of borrowing for this purpose. The loan system involves the interposition of the credit of a public body between the lender of capital and the actual investment. Whether gas or water works be economically successful or not, the interest on the debt incurred for them has to be met. Such investment may prove to be profitable, but, on the other hand, it may be unsuccessful, and in the latter case the burden falls on the contributors to the particular revenue affected. It is in this undertaking of risk that the borrowing system appears to show its weakest side. Speculation is a task altogether unfit for public bodies.
*42 In another way the local revenue may suffer. The absorption of a class of industries into the public property reduces the amount of private wealth available for taxation, and it is quite possible that the loss in this way may exceed the supposed gain on the working of the industries. The burden of proof rests on those who favour the process of forming a municipal domain, and they are bound to establish (1) the strong probability that the community runs no financial risk, and (2) the superiority of their method to all alternative ones. The control of special industries, as indicated when considering the industrial domain,
*43 is a less pretentious but in many cases a more effective method.

§ 4. But though the policy of using public credit in a systematic way for the establishment of profit-giving industries should not be hastily adopted, and, if attempted, should be kept within comparatively narrow limits, there nevertheless remains a legitimate field for local borrowing. The needs of any modern community are such as to make increased expenditure unavoidable, and that expenditure is largely devoted to the supply of educational, sanitary, and social requirements. Schoolhouses, baths, drainage, libraries, and museums have to be provided by heavy immediate outlay, and as under the circumstances they cannot directly yield a revenue, it falls within the province of the public power to take them in hand.
*44 The economic conditions impose the necessity of getting such works done quickly, as otherwise the earlier expenditure would be for a long time useless. Loans are accordingly the only available means; for taxation must be kept within bounds, so as not to swell up the net revenue of a single year. The burden is by this contrivance distributed over the time during which the works are of service, or at least over a fairly long period.

A great deal of modern local debt has been incurred for such objects, some of which,
e.g. waterworks, pass imperceptibly into the strictly reproductive part of local expenditure. In the case of London, for example, almost the whole of its liabilities has been so created. Paris in like manner borrowed for the ‘improvements’ of the second Empire, and to repair the damage of the war of 1870-1.

This process of anticipating revenue has greater justification in the case of a local than in that of the central government. The former deals with a smaller revenue, on which any extraordinary outlay will have greater effect, and it is restricted in its taxing powers, while the national government can more easily distribute its outlay from year to year, and possesses full control over its means of revenue. As a general rule, therefore, it is true that loans are a convenient, indeed an indispensable, part of the financial machinery of the smaller bodies.

§ 5. The forms or classes of local borrowing may next be considered, and here also its difference from that of the State is noteworthy. The absence of sovereign power brings the town or district more nearly on a level with the industrial or trading company, while its necessary subordination to the central government makes control and regulation by the latter expedient. Just as local expenditure and taxation need the watchful care, and at times the restraining hand, of the sovereign,
*45 so does local borrowing. There is, besides, a financial benefit in the interposition of state credit to assist the smaller subdivisions. Local loans, therefore, fall into two classes, viz. (1) those raised directly by the borrowers, and (2) those obtained by advances from the State. The former until recently gave evidence of the undeveloped character of local credit. Mortgage loans or floating obligations were the usual forms. Now, however, the funding system is making rapid way, and nearly every important town has its consolidated stock, modelled on the type of the national debt. Corporation stocks form a distinct class of securities in the money market, and command a good price. This higher organisation has the great advantages of procuring loans on better terms, and of bringing the amount of borrowing before the public. So long as the debt of a town or district is broken up into several separate kinds its real amount is hard to ascertain, and it may be increased without attracting notice.

Local stock is sometimes redeemable by annual drawings (like the French 3 per cents.), or, more often, it is automatically worked off by a sinking fund, the established method in the second class of loans—those provided by the instrumentality of the State. For very small divisions the issue of separate stock would be impossible, and any ordinary loan could only be obtained at a high rate of interest. The central government can, without inconvenience, make advances in such cases, and arrange for repayment by instalments at suitable times. In Great Britain the Treasury acts as the intermediary, and makes the advances from capital, which is really a part of the national debt.
*46 Belgium also has a special fund for this purpose, and in Germany the fund for invalids—one of the assets of the Imperial treasury—has lent more than £10,000,000 to the
Gemeinden. The convenience of thus providing local bodies with advances on reasonable terms is very great, while at the same time it enables the central government to exercise effective supervision over the borrowing so conducted.

§ 6. Repayment of local debt has to be regulated in accordance with its general features. As it is generally incurred for objects that are useful, or at least assumed to be so, the time of redemption ought to be adjusted to the duration of the utility created. Some improvements are much more speedily exhausted than others, and it cannot be well to have a debt charge which represents no present benefit. Again, local debt does not ordinarily arise from any pressing emergency. Its use is rather to get the work quickly completed, and therefore a sinking fund that will remove the charge within a definite number of years is often serviceable, since at the conclusion of the term new objects of outlay can be dealt with in the same way. The larger bodies may prefer the issue of stock, redeemable in parts or by annual sections, or even take the chance of further reductions of interest, and the power of conversion thence arising.
*47 The danger of this course lies in the possible neglect of the necessary provisions for repayment, and in the undue accumulation of debt. A sinking fund that makes repayment compulsory has decided advantages. A difficult question, however, arises in connexion with the determination of the proper period for redemption. If it is very short the immediate taxpayers suffer, while their successors in after years are free from the burden. When a longer time is fixed the pressure may fall chiefly on those who hold leases extending over the time, leaving the benefit to a reversioner who has perhaps contributed nothing to the payment of the charge.
*48 This failure in just distribution is, however, primarily a question of taxation. We have seen that local charges should be distributed on different grounds from those that regulate general taxation,
*49 and that the chief reasons for making this distinction are the predominance of the economic element in local expenditure, and the necessity of taking the several interests benefited into account. The use of loans enables a just distribution to be more closely attained, since future interests come under liability as they are realised. But at the same time their service in this respect must be subordinate to their general working. Direct taxation of reversionary property may also be desirable, though this course is limited by serious difficulties. A still better way of reaching justice is to maintain a steady policy with regard to expenditure. By so dividing outlay as to keep it in a nearly constant proportion to the rateable value of the wealth liable, it is clear that in the great bulk of cases the partition of charges between holders of property at different times will not be an unjust one, though some exceptional instances may occur. Very heavy and irregular expenditure by means of loans will be almost certain to cause serious practical grievances, which would, however, also be found if taxation were employed in the same way.

§ 7. Up to the present our attention has been chiefly directed to the urban and smaller rural divisions, and they are no doubt the most important. But the indebtedness of intermediate bodies, such as the English Counties, the French Departments, the Prussian and Italian Provinces, and on a higher scale the German and American States, deserves some notice. Special conditions have prevented the counties in the United Kingdom from coming forward as borrowers.
*50 A different reason has closed the loan market to the American States, but there are general causes for the smaller development of provincial borrowing. The works of utility for which local debt has been incurred are for the most part confined to small areas, or are of national importance. They fall either into the hands of the State or into those of the
commune. The duties of the province are such as can, generally speaking, be met out of revenue.

It would, however, be going too far to conclude that there will be no expansion of this kind of public debt in the future.
*51 In relation more particularly to transport, there is an opportunity for creating or purchasing railway lines or canals of secondary importance, as in other instances there may be one for an extension of public forests. The German States show an example of the former which is also found to a smaller extent in the French Departments. Arterial drainage or reclamation of waste land might also be carried out in the same way, and the loans for such objects should be governed by the same principles as those applicable to municipal debts. So much depends on the future course of political movement that no prediction is possible; but for finance it is sufficient to dwell on the necessity of applying the same rigid tests to all classes of borrowing, and to insist on the danger of its undue use.

§ 8. The great importance of adequate control by the central government has been already indicated, but it is desirable to again lay emphasis on the point. If expenditure and taxation cannot be safely trusted to administrators who may be led astray by ignorance and prejudice, still less can the power of mortgaging the property of those under their rule. For this reason rigid supervision is exercised in most countries. Local bodies in the United Kingdom can borrow only by a special legislative act, or after a semi-judicial inquiry by officials of the State. In France authorisation is in like manner needed for communal and departmental loans. The American State constitutions often place limits on both State and municipal borrowing powers, and the latter are also regulated by the State legislatures. The convenience, indeed the necessity of some method of the kind is obvious; without it a numerical majority of the inhabitants of a district, perhaps possessing little monetary interest in its future condition, could burden all the holders of property and future residents with a load of debt. Heavy taxation soon brings a remedy in the impatience of the taxpayers; but borrowing is, for the time, an agreeable process whose evils are only perceived later on. Thus the creation, the amount, and the mode of repayment of debt all stand in need of due regulation by the supreme authority of the State. The method employed will of course vary with the particular circumstances, but it seems best to reduce the system to a set of general rules, limiting the amount obtained to a certain proportion of the taxable value,
*52 requiring definite reasons for the issue of each distinct loan, and providing for a sinking fund, or other effective means of repayment, within no very distant time. These conditions are all insisted on by the English Local Government Board, and they seem to be necessary for the protection of those concerned. A direct appeal to the central legislature is the proper way of dealing with exceptional cases when they arise.

The character and scale of the particular bodies concerned should, further, be taken into account. Temporary loans by a large city, repayable on demand or within a short period, must be soon met out of taxation, and they may be allowed under the same rules as those controlling the taxing power. There is no need for the same constant check as that essential in the case of small areas.

This power of regulation and its efficient exercise show the real unity of all public liabilities. Whether contracted by the State or by local administrations, they result from the use of the credit obtained through public property and the power of taxation. Their examination, therefore, must be conducted on the same principles, and their effects must be combined to form a proper estimate of the true financial position of the country.