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Inadequacy of the funds from their own sources and federal aid is compelling state and local governments to constantly resort to various loans for covering primarily capital investments. Aggravation of the financial difficulties of state and local governments, especially after the Second World War, brought about a systematic increase in the

Table VI-17 A Comparison of State and Local Government Nonfinancial Expenditures to Gross National Product (1890—1938)  [188•2  Periods (annual average) Annual average of GNP, million dollars Ratio of total nonfinancial expenditures to GNP, per cent 1890 12,400 4.6 1909-18 40,120 6.3 1914-23 61,900 6.6 1919-28 81,200 8.2 1924-33 79,130 10.9 1929-38 69,950 14.2 189 issuance of bonds and the growth of the debt. The tendency to increase the debt on state and local loans has been observed for several decades. But its manifestations vary from period to period, reflecting the cyclical nature of the development of the capitalist economy.

p During the years of crisis (1930-31) expenditures which led to a deficit rose steeply. But in the subsequent years of the depression the expenditures were cut more rapidly than the revenue and in 1934 some of the receipts were partly used for repaying the debt. This was facilitated by federal grants which reached $1,600 million in 1934 as compared with $500 million in 1933. Notwithstanding the consequences of the depression, the level of state and local expenditures remained high in relation to the GNP which dropped sharply during the crisis. This position could not continue for long and a reduction of the ratio of expenditures to the GNP started at the beginning of the 1940s.

p In the 1920s the growth of the state and local debt outstripped the increase of the GNP almost 10 times, which pointed to an obvious discrepancy in the scale of financial operations, specifically investments and the economic activity. Morris Copeland, examining the structure, aims and consequences of state and local loans, arrives at the conclusion: “In general we have not inquired whether the borrowings governments have engaged in have been justified. But it has seemed necessary to note that there have from time to time been various instances of clearly unjustified deficits and thoroughly disorderly finance. And in some of these there has been outright corruption. Among the most extreme instances of the disorderly finance during the last 50 or 60 years are those that accompanied the Florida land boom of the 1920s; and the Coral Gables case stands out as one that was clearly characterised by corruption."  [189•1 

p The general drop in the level of employment and incomes, accompanied by the crisis reduction of prices, increased the tax burden in the 1930s. Measures to raise tax rates did not produce the expected effect and tax receipts in 1930-1934 were cut by 17 per cent. This was partly a result of failure to collect the expected taxes in a number 190 of municipalities; in 1934 it reached 20 per cent in 150 cities with a population of more than 50,000.

p Thus, all attempts of state and local authorities to balance their budgets, ensuring a minimum of expenses for current needs on the basis of their own revenue, were unsuccessful. Yet borrowing on extremely disadvantageous terms presupposed, in future, a substantial burden on their budgets, through debt and high interest repayment.

p It was becoming clear that state and local governments were unable to reasonably adjust their financial resources to the expenditures when dealing with questions even relating to the immediate future. The measures they adopted were dictated not by needs for capital investment for the future and current expenditure but by circumstances connected with spontaneous development of capitalist economy. And on the contrary, when decisions were made on big programmes, involving large outlays, it often turned out that resources for implementing them were inadequate.

p Samuel Jackson, Assistant Secretary for Metropolitan Development, characterising the existing situation in planning the financial sources of investments, writes: “... Communities delay needed improvements until crisis develops. Others permit popular or large projects to drain off all available funds. Inadequate planning also results in the poor location of public facilities and the unrealistic expenditure of public funds."  [190•1 

p The post-depression period was characterised by relatively favourable economic and financial activity. By 1944, nonfinancial receipts in state and local budgets exceeded the 1939 level by about 26 per cent, which enabled them to reduce the general debt by 15 per cent in 1946 as compared with 1939.

p However, as the economy developed and incomes of corporations and private individuals grew, a greater interest arose in buying bonds issued by state and local governments because the interest on them was exempt from federal taxes. This factor became even more pronounced after the 191 Second World War when federal tax rate increased and became more progressive.

The distribution of the state and local debt over a number of years tended towards a relatively swifter growth in state indebtedness, the result of the transfer of a number of functions from local to state governments. During the depression, states were compelled to assume a number of tasks beyond the capacity of local authorities. This process did not have an identical “feed-back” and states largely preserved duties they assumed. This notwithstanding the fact that in 1966 the debt of states was still only one-third of that of the local debt.

Table VI-18 Outstanding State and Local Debt Selectively by Years 1902—1969  [191•1  (million dollars) Fiscal years State and local State Local 1902 2,107 230 1,877 1913 4,417 379 4,035 1927 14,881 1,971 12,910 1932 19,205 2,832 16,373 1938 19,436 3,343 16,093 1946 15,917 2,353 13,564 1950 24,115 5,285 18,830 1960 69,955 18,543 51,412 1966 107,051 29,564 77,487 1968 121,158 35,666 85,492 1969 133,548 39,553 93,995

p These characteristics do not fully correspond to the situation in individual states and local government bodies but they adequately reflect the general tendencies.

p The growth of the GNP and the consequent increase in receipts for state and local budgets are major factors for achieving financial stabilisation. The GNP rose from $211,100 million in 1945 to $743,300 million in 1966.

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p At the same time, tendencies toward consistent price increases, preserved throughout the post-war period, contained socio-economic prerequisites for future budget difficulties. These were expressed specifically in the constant rise in the cost of state-local programmes.

p The composition of loans utilised by state and local authorities for capital investments is characterised by great diversity in the forms of placement, purpose, maturity and financial terms: these factors determine their expediency and economic effects.

p General principles determining placement and terms of borrowing are based on the desire of the respective authorities to ensure easiest redemption with a maximum economic effect. But the desire to achieve these aims runs counter to a number of objective and subjective factors which operate in the opposite direction. Among them are the enhanced interest of private corporations in buying government bonds to secure tax privileges.

The most widespread form for determining the terms of loans at present is the redemption of the total debt and interest in equal parts throughout the period of maturity from current revenue. This relieves respective local governments from the need to accumulate resources for a single redemption, as was the case with loans in the 1920s and the 1930s. But the constant increase in the debt leads to steadily growing current outlays for interest payment. This adversely affects the financing of non-capital needs.

Table VI-19 Interest on the General Debt  [192•1  (million dollars) 1902 1927 1934 1948 1960 1966 1968 1969 68 584 739 399 1,670 3,268 3,889 4,403 193

p Long-term bonds issued by state and local authorities are usually for 20-30 years, in the course of which, repayment of the debt, including interest, must be fully ensured.

p At the comparatively low interest paid on state and local debts private corporations, which buy their bonds, receive an income that was officially exempt by the federal government from the income tax by Congressional decision in 1913. This makes attractive the placing of capital in securities of this type.

p At the same time, interest rates on taxable bonds, all other conditions being equal, are always higher.

p This, in turn, makes such loans disadvantageous for local financial agencies.

p To prevent the accumulation of an excessive debt and possibility of default on loans, most states, as was the case after the crisis of 1873, set limitations on the rights of states to issue loans. Everywhere all restrictions in principle pursued one aim. However, in character and effectiveness they are not identical. As early as 1941, Professor Ratchford classified limitations on state and local borrowing into three main groups: I—borrowings must be authorised by Constitutional amendments; II-^the legislature enacts borrowing proposal but they must be approved by popular referendum and III—legislatures themselves make the borrowing decisions.

p The most effective barrier is the first category of restrictions which, according to an analysis of the debt made by Maxwell, showed that states which apply them have the smallest per capita debt.

p States which utilise restrictions on borrowing by subordinate local administrative bodies, chiefly municipalities, have, in turn, been suffering from an acute shortage of fund for capital outlays in recent decades.

p The economic basis for loan restrictions is usually taxable property with a definite percentage as the limit.

p The necessity to secure approval of bond issues through popular referendums is also regarded as a restrictive measure. But with appropriate advertising and promotion by local authorities and corporations this type of restriction has little effect.

p The purpose for restricting local borrowing basically 194 coincides with that for restricting state borrowing—to protect the financial position of corresponding governmental units as well as the bondholders from default.

p The gradual widening of the gap between property ownership and profitability makes these restrictions insufficiently justifiable economically and in some cases they are already incapable of preventing an excessive issue of bonds.

p A widespread means for avoiding restrictions on statelocal borrowing are bonds guaranteed by the incomes of the credited enterprises which largely compensate the principal and the interest from their own sources. Such operations are not limited by legislation, as is the case with bonds guaranteed by governmental units. But the money received from nonguaranteed borrowing cannot be used for capital investments not ensured in the established periods by incomes for redeeming the debt. They are used for financing public utilities and other public institutions yielding a regular income.

p Nonguaranteed bonds had already become widespread in the 1930s as a means of stimulating public works. By 1940, as many as 40 states had already utilised nonguaranteed bonds and the number of projects financed by them was steadily growing.

p Subsequently nonguaranteed bonds continued to increase at an accelerated pace. In five years, between 1957 and 1962, the total long-term debt ensured by the credit of cities rose 35 per cent, while the nonguaranteed long-term debt of municipalities rose 44 per cent.  [194•1 

p The system of issuing nonguaranteed bonds is now marked by diversity of forms in individual states which, basing themselves on different local methods of financial and economic organisation, set the legal regulations for placing, approving and using the funds.

p Self-financing projects, implemented through credits, in the final account include the cost of the debt and the interest on the volume of the collected duties which, in respect to guaranteed bonds, is somewhat lower than non-guaranteed ones.

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p Non-self-financing projects, which use nonguaranteed issues, create additional financial burdens for state or local governments which annually must allot money from their own funds for redeeming the bonds.

p The employment problem which is growing sharper and the search for ways to expand the tax base have promoted states and local government units to issue interest-bearing bonds for the purchase of land, buildings and installations. These are leased to private industrial corporations as a means for stimulating the expansion or retaining industrial enterprises within the territories under their jurisdiction.

p The fact that private corporations can obtain taxexempt incomes throughout the country leads to competition between local authorities, which ultimately benefits private and not public interests.

p Yet the additional incomes obtained by private companies in the form of exemption from taxes, under other conditions, could return to the state and local authorities in the form of grants via the federal budget.

p Thus, local and state governments who provide loans to aid industry and do not bear either financial or administrative responsibility for their redemption, practically become simple intermediaries, with the help of which private individuals derive an additional profit.

p Maxwell, who analysed the economic content of credit aid to industry, correctly noted: “This cost advantage means that tax exemption serves to raise the rate of return earned by firms so that the direct benefits of the exemption accrue to individuals."  [195•1 

p Expansion of borrowing operations to aid industry attests to the increasing “official” evasion of income taxes by private corporations which are oriented not on solving state and local problems but on deriving additional profits practically financed by the federal government.

p At present almost all states have given their subordinate local governments the right to issue aid-to-industry bonds. In 1960, the debt on these bonds amounted to $56.4 million, 196 while in 1967 the issue of such new loans reached $1,400 million.

p The debt on nonguaranteed bonds rose from $2,500 million in 1949 to $41,200 million in 1966.  [196•1  Cantor regards the exemption of state and local bonds from federal taxes as a form of grants to the former, the size of which can be calculated through the difference between the interest rates on the market value of credit and on state-local bonds containing tax privileges.

p He points out that the difference represents a federal subsidy, which costs the US Treasury about $1,800 million in income lost on taxes, and gives the states and local governments $1,200 million annually. The sum of about $600 million accrues chiefly to rich investors who gain the benefit from tax exemptions.  [196•2 

p If we consider that in conditions of an unfavourable situation in the capital market, state and local authorities are willing to pay higher interest rates on bonds, since they have no alternative, the advantages accruing to private buyers of their bonds are, most likely, even greater.

p Thus, in an effort to extend the tax base, raise employment and this way solve their problems, state and local governments facilitate the transferring to the private sector of part of the government funds they need.

p Together with these shortcomings in the issuance of aidto-industry bonds, they, to a certain extent, limit the financial means of states for satisfying their own primary needs and make them even more dependent on the situation in the money market.

p On the other hand, the expanding process of issuing nonguaranteed bonds affects projects which do not ensure complete financing. This leads to the formation of a type of debt which superficially does not appear to be dangerous but which in reality proves to be a heavy burden on state and local governments.

p The general rise in the level of state-local needs, resulting from expanding urbanisation, has also been reflected, to a certain extent, in the distribution of the debt. The tendency 197 for the sum of the debt to vary in accordance with the population size of an area, is obvious. But differences in economic development, geographical location and population density have made this tendency less noticeable in recent decades. Capital investments, which mainly create debts, have a higher share in the per capita expenditure in big cities and industrial areas. As their level of incomes is higher, this, in itself, presupposes a higher level of financial operations.

p The choice of rational solutions in the spheres of borrowing and utilising available resources has become an exceptionally complex problem for state and local governments. Frequent changes of the situation in the money market, in the growth rate of the economy, in the level of employment and other factors make successful long-term planning impossible. In this sense, budget planning, as a rule, is confined to the solution of problems as they arise and to ensuring (if this is possible) the financing of operating programmes.

Analysing the existing system of drawing up municipal budgets, John Crecine, a budget modelling specialist, stated: “It is quite clear (from interviews) that the decision-makers do not see the problem as one of optimally balancing community resources, allocating funds among functions to achieve overall community goals, and the like."  [197•1