Revisiting Arizona’s Asset Sale-Leasebacks

Back in July, I wrote about a budget proposal in Arizona that involved a the sale and leaseback of dozens of state buildings to generate hundreds of millions in one-time revenue to help close a $3+ billion budget deficit. The proposal was eventually enacted in the package of budget bills signed by Governor Jan Brewer in August and is now moving forward, as discussed in this New York Times piece yesterday.

My thinking on this strategy has evolved over the last few months as the statutory language was finalized and more details became available. In the July post referenced above, I wrote that it was a sensible strategy to leverage public assets to address budget deficits and invest in long-term debt reduction or infrastructure improvements. I absolutely stand behind that comment, but like anything, there are shades of grey underneath that merit further discussion.

The first key point to elaborate is that the best and most fiscally responsible way to “spend the windfall” of a long-term (20+ year) leasing arrangement is to invest it for long-term economic benefit, such as paying down public debt (aking to paying down additional principal on a mortgage), shoring up underfunded public pensions, and investing in infrastructure. However, the fiscal and political realities todayââ?¬â?and a strong desire among policymakers to avoid raising taxes if humanly possible to avoid the political falloutââ?¬â?make it probable that some portion of a one-time revenue windfall to government will get spent on immediate needs, likely plugging budget deficits.

Chicago offers an example here, where the $3+ billion the city received from the long-term leases of the Skyway toll road, downtown parking garages and downtown parking meter system have been used for a variety of purposes involving various time-scales, including paying down public debt, setting up rainy day funds, short- and long-term investments to augment city revenues, and short-term budget fixes. In an ideal world one would wish for all long-term investments, but the real world of governing in a recession dictates otherwise. The reality is that Chicago doesn’t have a choice about balancing its budget (like states), and I’d wager that many taxpayers would (or should) prefer to see assets leased than taxes raised to accomplish that balancing act, even if not all 100% of the revenues are dedicated to long-term uses. To their credit, Chicago’s done a good job on that balancing act between short- and long-term, in my estimation.

On this point, though, Arizona’s situation would actually rank near the bottom of the fiscal responsibility meter, because they’re not talking about investing any of the proceeds into long-term budget reduction or investments. It’s all going to be spent to help close the next budget deficit, and then there will be nothing left to show for it. Put differently, all of the proceeds from a 20-year sale-leaseback will be spent in year one.

The second key point is that, as of a few months ago, I was hopeful that the state would bundle in operations and maintenance of the state buildings as part of the transaction, which would actually yield tremendous cost savings over time (given typical cost savings seen in the world of government O&M contracting more generally). That would have bumped the proposal up on the fiscal responsibility meter for meââ?¬â?a point discussed in detail in the July postââ?¬â?given that it would build in a long-term savings for the state.

Unfortunately, I’ve come to learn that the state is not likely to bundle in O&M into the sale-leaseback deals after all (and there’s no explicit statutory guidance to do so), making the proposed sale-leasebacks a pure financial transaction. And there’s definitely a strong role for sale-leaseback transactions in governmentââ?¬â?the issue is not the tool itself but how one uses it. And on that front lies my critique.

Instead of making politically difficult decisions on budget cuts, priorities, and core vs. non-core government functions, Arizona policymakers are almost abandoning fiscal responsibility and making a desperation play for quick cash. I’d give them better marks if they were bundling in O&M and generating long-term savings (and potentially a larger upfront payment?). Instead, the state will still continue to maintain the buildings the same way they do today, without the cost-savings and efficiencies that the private-sector could bring in a long-term, performance-based maintenance contracting situation.

Similarly, I’d give them better marks if they were using some portion of the proceeds to pay down state debt, invest in short-/long-term annuities to generate supplemental revenues over a longer timeframe, highway expansions/maintenance or something with a shelf life exceeding 365 days. Instead, it’s “bye-bye, cash” in year one.

At the end of the day though, note that I said Arizona policymakers “almost” abandoned fiscal responsibility. No one will argue that this is a desperation play. But as an Arizona taxpayer, I would still much rather see this desperation play than see my taxes raised or see us take on more bonded debt, IOUs and the like. Taxes and debt will only dig the hole deeper, and I’ll take a sale-leaseback over those approaches any day. So while I do need to retract my July comment that this strategy was “sensible,” I will say that sale-leasebacks offer a last firewall of sorts against an additional $1 billion or so in tax increases that would be another blow to a fragile economy.

What would truly be “sensible” would be to actually cut the size and scope of government, which the Arizona legislature barely made any traction on this past session (and I haven’t seen any major streamlining initiatives coming from Gov. Brewer’s office either). Louisiana and Arizona are night and day on that point. Arizona pols could start immediately by revisiting the Council on Efficient Government bill that died under the weight on politics at the very end of the regular session. And Gov. Brewer could start replicating Gov. Jindal’s multi-faceted government streamlining strategy in Louisiana in a proactive attempt to get on top of the fiscal crisis.

Let’s dispense with the illusion that there’s some easy and painless way to navigate the recession and start making tough, but necessary, decisions.

Ã?” Reason Foundation’s Annual Privatization Report 2009
Ã?” Reason Foundation’s Privatization Research and Commentary

UPDATE: Of course, my comments above apply equally to Californiaââ?¬â?which just announced its own $2 billion sale-leaseback initiative this week, which looks a lot like Arizona’s. I predicted that here, and I think we’ll see more states moving in this direction.