Attack of the Bond Zombies (*corrected)

by E.J. McMahon |  | NY Torch

At least one leading bond counsel firm is issuing supplemental opinions to the effect that New York State’s cap on local property taxes may violate the state Constitution’s debt impairment provision.  The lawyers’ reasoning is unpersuasive, serving mainly to generate needless concern about added credit risk for holders of New York municipal debt.  Nonetheless, this development does spotlight the tax cap’s potential vulnerability to legal challenge.

Must … have .. more taxes!

Effective with the next round of local budgets, increases in property tax levies will be limited to 2 percent or the rate of inflation, whichever is less, excluding taxes generated by new construction or increases to cover a portion of rising employee pension costs.

The ink was barely dry on the bill including the tax cap, which passed both houses June 24, when the California-based law firm of Orrick, Herrington & Sutcliffe began amending its legal opinions for New York issuers of local government debt.  (See, for example, the first three pages of this recent prospectus for a bond issuance by the town of Somers.)

Orrick says the cap could violate Article 8, Section 2 of the State Constitution, which requires issuers of public debt to pledge their “faith and credit” to repayment of bonds.  It also cites Article 8, Section 12, which gives the state the power to restrict local taxes while providing that the Legislature “shall not, however, restrict the power to levy taxes on real estate for the payment of interest on or principal of indebtedness theretofore contracted.”

Taking off from that clause, here’s the heart of bond counsel’s argument:

..[W]hile the New Tax Levy Limitation Law may constrict an issuer’s power to levy real property taxes for the payment of debt service on debt contracted after the effective date of said New Tax Levy Limitation Law, it is clear that no statute is able (1) to limit an issuer’s pledge of its faith and credit to the payment of any of its general obligation indebtedness or (2) to limit an issuer’s levy of real property taxes to pay debt service on general obligation debt contracted prior to the effective date of the New Tax Levy Limitation Law. Whether the Constitution grants a municipality authority to treat debt service payments as a constitutional exception to such statutory tax levy limitation outside of any statutorily determined tax levy amount is not clear.

This reasoning implies the cap is impervious.  But it clearly is not: as noted in Orrick’s own analysis, the cap can be overridden by 60 percent of voters in school districts (whose debt is excluded from the cap), or by 60 percent of the members of the governing body of a county, city, town or village (which have no debt exclusion from the cap). The county and municipal override must take the form of a “local law,” which requires a separate public hearing and, under many local charters, some added time for public review. Moreover, the tax cap doesn’t aim to restrict the ability of local governments to raise taxes to repay debt; rather, it seeks to limit the rate of annual rate of growth in the total tax levy, of which debt service typically represents a small portion.

Orrick’s analysis relies in part on the state Court of Appeals’ 1976 ruling in Flushing Bank vs. Municipal Assistance Corp., which overturned the state’s attempt to impose a moratorium on repayment of New York City bonds. While the facts of that case are otherwise irrelevant to the current tax cap situation, the Court noted that debt service payments were not subject to an existing 2.5 percent cap on New York City property taxes, and went on to say this:

“So, too, although the Legislature is given the duty to restrict municipalities in order to prevent abuses in taxation, assessment, and in contracting of indebtedness, it may not constrict the city’s power to levy taxes on real estate for the payment of interest on or principal of indebtedness previously contracted … While phrased in permissive language, these provisions, when read together with the requirement of the pledge of faith and credit, express a constitutional imperative: debt obligations must be paid, even if tax limits be exceeded.”

But, really, just how much of a restriction or constriction are we talking about here?  For all New York towns and many (if not most) cities and villages, which have governing bodies with five to seven members, a 60 percent vote is the same as a simple (50 percent-plus-one) majority. In such localities, the net difference between the tax cap and the status quo ante is the requirement for enactment of a local law to raise  taxes above the cap.  For a governing body determined to bust the cap, this will be a political nuisance — but hardly an impediment to repaying debt.

In counties, cities or villages with larger legislative bodies, an override will require one or two (or, in rare cases, three) more votes than a simple majority — which will still be fewer votes than the two-thirds vote typically required to override a budget veto by a county executive or mayor.  General obligation debt issued by any locality before the enactment of the tax cap is effectively built into the local tax base, and will continue to have first call on local property tax revenues.

The Orrick analysis already is being exploited by some local officials who seem determined to stoke alarmism about the impact of the cap.  Today’s (subscription required) report in Newsday, for example, includes this:

Previously, municipalities could guarantee they could always raise property taxes as much as needed to repay bonds. Now, Suffolk County Chief Deputy Comptroller Christina Capobianco said the county would change its wording on new bonds because “that’s no longer the case.”

Huh?  In Suffolk, raising taxes above the cap will require exactly one more “yes” vote from the 18-member County Legislature than was required for any tax hike under previous law — and one fewer vote than the Legislature always needed to override the (not infrequent) budget vetoes of County Executive Steve Levy. Does Ms. Capobianco really want potential investors to believe that the cap means the county has become  less likely to repay bonds? Is the deputy comptroller trying to drive down her bond rating?

The likelihood of a court challenge

On this much, Orrick is probably correct: “It is likely that the New Tax Levy Limitation Law will be subject to judicial review to resolve the constitutional issues raised by its adoption.”  Somewhere out there, a deep-pocketed bondholder may even now be getting ready to file suit. In that case, as explained above, it’s difficult to see how the courts could conclude that the tax cap represents a real impairment of an obligation to repay debt. Stranger things have happened, though. The Court of Appeals is nothing if not unpredictable. Especially when the issue is debt.

Here’s where the tax cap’s vulnerability kicks in.  Neither the original version of the cap proposal, drafted by Gov. Andrew Cuomo’s office in consultation with the Republican state Senate majority staff, nor the final version, a compromise worked out with Assembly Speaker Sheldon Silver, contained what is known as a “severability clause.”

As a result, if any provision of the law is struck down in court, the entire law will be overturned. The only way to foreclose that risk would be to immediately enact a severability clause as a chapter amendment to the cap. But now that he’s secured his extension of New York City rent regulations, why would Speaker Silver agree to it?

The preceding two paragraphs were incorrect.  The tax cap law does, indeed, include a severability clause. See Section 45 on page 46 of the bill.



- E.J. McMahon is the Research Director at the Empire Center for Public Policy.