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Heads Up, States: Arizona Poised to Monetize Assets to Help Close Budget Deficit

Leonard Gilroy
July 29, 2009, 4:48pm

Arizona Governor Jan Brewer and legislative leaders have reportedly struck a deal to close a $3.4 billion budget gap for fiscal year 2010, and Matt Benson and J.J. Hensley at the Arizona Republic report today that recently-vetoed proposals to monetize state assets—including the House and Senate buildings—have re-emerged as a key component of the deal:

Call it a sign of desperate times: Legislators are considering selling the House and Senate buildings where they've conducted state business for more than 50 years.

Dozens of other state properties also may be sold as the state government faces its worst financial crisis in a generation, if not ever. The plan isn't to liquidate state assets, though.

Instead, officials hope to sell the properties and then lease them back over several years before assuming ownership again. The complex financial transaction would allow government services to continue without interruption while giving the state a fast infusion of as much as $735 million, according to Capitol projections. For investors, the arrangement means long-term lease payments from a stable source. [...]

State properties now being considered for sale and leaseback include the House and Senate buildings, the Phoenix and Tucson headquarters of the Arizona Department of Public Safety, the State Hospital and the state fairgrounds, according to a document obtained by The Arizona Republic. Some prison facilities also are under consideration.

In total, the list comprises 32 properties that, if built from the ground up, come with a combined replacement value in excess of $1 billion. The properties were chosen based on attractiveness to investors, buildings the state would be unlikely to walk away from, such as prisons or other facilities that provide essential government services. Only one state property thus far is targeted for outright sale: the state Agricultural Laboratory in Phoenix. [...]

Under the most recent legislative proposal, the state would seek a series of lease arrangements spanning as much as 20 years. Deals that would generate the targeted $735 million in revenue would mean state lease payments totaling $60 million to $70 million a year, according to budget analysts.

Over two decades, that would equate to at least $1.2 billion in lease payments. Once the leases had expired, the state would again take ownership of the properties.

Read the whole thing. This is a sensible strategy in my view, as discussed before here and here. In both good and bad fiscal times, it's smart policy for governments to "mine the balance sheet," identifying existing public assets it makes sense to transfer to the private sector through sales, sale-leasebacks, concessions/franchises and other arrangements and structuring the transactions in a manner that protects the public interest and improves the asset's operation and maintenance.

As discussed both here and in this 1993 Reason Foundation how-to-guide, the state receives a lump sum cash payment in these transactions, essentially turning physical capital into financial capital that can be deployed to close budget deficits and/or invested over the long term. It would also stand to capture the revenue benefits of transferring some tax-exempt property to the tax rolls (assuming that the deals do not include a perpetuation of tax-exempt status).

For sale-leasebacks of the sort that Arizona is considering, it's important to remember that these are not outright sales, and the state would not lose control of the asset (rather, it can actually gain control, as I discussed here). Properly structured transactions would build performance requirements into the contracts with penalties for noncompliance, providing a mechanism to guarantee proper (likely improved) maintenance and operation of the asset. And as we've seen with the Indiana Toll Road/Chicago Skyway-style asset leases, the state would want to incorporate provisions into the contracts that specify that the assets be returned to the state at the end of the term in top condition.

These are critical points to understand, as this sort of privatization offers a tremendous opportunity to improve the condition and maintenance of state assets. Under state operation, deferred maintenance is a chronic problem, whether you're talking about roads, buildings or otherwise. Maintenance doesn't create photo ops, and is usually one of the first things to be skimped on when budgets get tight. By guaranteeing proper maintenance via contract in a privatization initiative, you remove this obligation from the state and transfer it to a private sector operator who's on the hook financially for fulfilling it.

Arizona may be catching headlines today for its bold proposal, but there's really nothing new about this sort of sale-leaseback approach. Just this year, Louisiana policymakers included a major sale-leaseback component in its Superdome lease agreement with the New Orleans Saints, which overall is projected to save the state over $280 million through 2025. And as Reason reported here, Orange County, California raised more than $300 million through asset sales and sale-leasebacks to help recover from collapse into bankruptcy in 1995, and New York's Empire State Development Corporation generated hundreds of millions in revenues through sales and sale-leasebacks of state assets including the New York Coliseum, state mental health campuses, parking lots, armories, and state-owned golf courses.

California made some noise on bold asset sales, but Arizona seems poised to actually get it done. If these proposals ultimately pass in Arizona (which may start today in the lege), I'd predict that we'll see the concept catch fire in other states as well, given their epic, ongoing fiscal woes.

There are two other angles to this story—one in Arizona policymakers' reactions, and the other in the return of a bold prison privatization proposal—that I'll be exploring this week in separate blog posts.

» Reason Foundation's Privatization Research and Commentary


Leonard Gilroy is Director of Government Reform


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