Potential municipal market ripples in November’s election
With two months until Election Day, Coloradans are faced with important decisions that could ripple throughout the municipal market. Most pertinent are three initiatives asking voters to increase funding – through various means – for transportation and PK- 12 education.
While Colorado’s finances and consumers’ wallets have both benefited from a strong economy, initiatives without a dedicated funding stream create cause for concern for discretionary spending sectors, mainly higher education.
Proposition 110 asks voters to increase the state sales tax from 2.9% to 3.52% to pay for state and local transportation projects. These projects will be paid for initially by the Colorado Department of Transportation (CDOT) issuing up to $6.0 billion in bonds.
According to the State Demography Office, Colorado’s population has swelled +11% since 2010 to over 5.6 million, with most of the growth along the I-25 corridor. Compounding these demographic changes, gas taxes account for a majority of Colorado’s transportation funding and are losing their purchasing power in the face of advancing technology and inflation. As a result, Colorado dedicates 80% of a $1.4 billion transportation budget solely to maintenance and operations, leaving little left over for growing infrastructure needs. The increased sales tax is expected to raise $767 million annually to pay debt service and fund to-be-determined transportation projects at both the state and local levels.
Currently, Colorado has the 6th lowest state sales tax rate and would remain there should Proposition 110 pass. The next lowest rate is 4.0% shared by five states. Given the need for improved and expanded roadways, Equus is less sensitive to the argument that an incremental increase in rates would slow overall consumer activity. According to a Colorado Legislative Council report, a family with household income of $75,000 would only spend an additional $131 per year.
Proposition 109 would direct CDOT to issue up to $3.5 billion in bonds for sixty-six pre-determined transportation projects throughout the state. The amount is lower than Proposition 110 because supporters are not asking to raise taxes or fees and instead will rely on lawmakers for an annual appropriation. CDOT undertook a similar project in 1999 when voters approved $1.5 billion in Certificates of Participation (COPs) funding for highways and were fully paid off in 2016.
Debt payments would cost on average $260 million annually and are significantly lower than the $470 million under Proposition 110. However, a lack of a dedicated revenue stream is a credit negative for the state’s discretionary spending departments (i.e. higher education system). While Colorado’s general fund revenues are up nearly 60 percent from their 2010 lows, a hodgepodge of state constitutional amendments limit legislators’ flexibility in downturns. Proposition 109 would further restrict legislators’ hands, putting an even greater strain on state universities and colleges during the next downturn.
Amendment 73 would raise income taxes on taxpayers with income over $150,000 solely to support and enhance PK-12 education in Colorado. The measure would create a graduated income tax system highlighted in the chart below and projects to bring in $1.4
billion in new money annually beginning in 2019-20. More than half of these funds would go to raise per pupil funding (PPF) to $7,300 (+11.5% from $6,546 in 2017-18) and increase full-day kindergarten funding. Charter schools stand to benefit as they rely more heavily on PPF revenues than traditional public schools for operations. All else equal, a larger PPF provides a greater cushion to pay back bondholders.
For high-net-worth Coloradans, a higher income tax rate would enhance the tax benefit of owning Colorado municipal bonds. A high-grade 10-year municipal bond currently yields 2.47%. To a Coloradan earning over $500,000 in taxable income, their tax-equivalent yield is 4.53%. The same investor would only demand 2.31% in the municipal market to achieve the same tax-equivalent yield at a 8.25% state income tax rate. Should Initiative 73 pass, Equus would expect a slight tightening between Colorado municipal bonds and the national market, much like we have seen in California following tax reforms passed at the end of 2017.
An Uphill Battle
With Colorado’s and consumers’ finances on solid footing, supporters believe it will be easier to get a ‘yes’ vote during times of surpluses rather than deficits. Equus will be watching spreads on higher education and charter schools leading into and after the election. Charter schools stand to gain while higher education could face hardships should monies be prioritized for PK-12, healthcare, and now transportation in the next downturn. However, given Colorado’s history as a low- tax state, Equus is well aware of the uphill battle these measures face come November. While their impact to the Colorado municipal market would be profound, acting as if their passage is set in stone would be premature.
This report is for information purposes only and should not be considered a solicitation to buy or sell any security. Neither Equus Private Wealth nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without the express written consent of the Equus Private Wealth Management, LLC. Data for this report was obtained from State of Colorado Comprehensive Annual Financial Reports, Colorado Secretary of State, Colorado State Demography Office, Colorado Legislative Council. For questions regarding this report, please call Scott Hanley at (970) 963-2674.