Debt Capacity and Capital Budgeting


Essentially, public administrators must use funds allocated to them in a proper way. These funds should only be used for the purposes, to which they are intended. This calls for proper accountability and responsibility to avoid misuse of funds. And, in doing this the state government is able to achieve excellence. Therefore, the state government agency uses Governmental Accounting Standards (GAS) to accurately and uniformly record how the allocated funds are used.

Debt Capacity of the Governmental Entity

The state government generates its funds through public debts, inter-governmental borrowings and transfers, taxes, and government-owned businesses. The state government ability to obtain funding from other agencies is very much affected by the debt ratio. The debt ratio affects the borrowing capacity of the state government. For instance, when the debt is higher than the assets, various agencies are reluctant to offer debt facilities to the state. This in turn affects the state rating process and various funding alternatives. Therefore, it is essential for the government to put in place and proper debt management strategies, which encourage accountability and responsibility principles. The debt management strategies are implemented through derivatives, borrowings and other debt-related businesses (Lee, Johnson & Joyce, 2008).

Moreover, the state’s debt obligations play a central role in determining the governmental entity’s debt capacity. For example, the amount of the accrued borrowings and the capacity to repay them in time without the governmental agency running in a deficit since the state has various development projects and other recurring expenditures to finance in every financial year budget. A certain amount of money is allocated for running the state budgets and the rest of the funds take care of debt financing. For example, a state can offload serial bonds for road construction that attracts some annual interest. This forms part of the government debt obligations. However, during the road construction there are some other risks to put into account. These risks include, but not limited to displacement of people and property. The displaced people would demand compensation from the state. Besides, the state incurs the destroyed property costs. In essence, the state would need more funding to finance these obligations. These government projects make the state accrue debts which might only benefit future generations since they have long-term benefits. And the state government uses taxes and bonds revenues to finance these development projects. The bond revenue forms part of the debt financing (Lee, Johnson & Joyce, 2008).

Some of the debt capacity indicators include value of assets, population and income. For example, state population is used to calculate a debt per capita. This is got by dividing the debt amount by the state’s populations. These indicators are important in meeting both the government’s short and long-term financial and capital plans.

Effect of Refunding or Reorganizing Existing Debt Obligations

Refunding obligations are used for refinancing or restructuring the earlier debt obligation costs. Often, the new obligations are associated with lower payment costs or interest rates to the financiers. Notably, under such obligations the short-term payments are reduced, but the government incurs higher costs of refunding these obligations which extend debts into a longer period. In order to reorganize or refund the existing debt would need to increase income taxes to meet this obligation. These funds are placed in a state general account and added to the expected fiscal year budget. This calls for the public support as well in meeting the financial obligation. The burden is distributed to the public under the motive that all of them benefit from the public goods, which the funds have been used. The new tax system to refund or reorganize the existing debt obligation is likely to draw political resistance, public criticism. Among the issues of great concern are those of equity since those with big retail market shares are likely to benefit in the process. However, upon funds redistribution adjustments, the wealthy groups of people would revolt against the new tax system since they may not benefit more than the less wealthy citizens (Robert, 2008).

In order to meet the refunding obligation costs, the government can invest on more development projects which generate a lot of revenue to finance the debts. The revenue surplus is injected in the economy to stimulate economic development.

Funding Alternatives that can be used to Support Debt Obligation

Selling government bonds to the public helps in raising funds to meet debt obligations. On the other hand, impact fees are imposed on developers who are constructing new housing units. The fees rising help in debt financing (Richard, 2005). However, there are some limitations associated with the impact fees since it is not easy to know the point at which the development units should be assessed for the fee. Besides, excise taxes are imposed on home buyers who purchase new homes, and this cost is passed to the new buyers, until the debt is exhausted. This usually takes ten years. In sum, capital budgeting requires proper management of debt equity financing.


  1. Lee, R.D., Johnson, R.W. & Joyce, P.G. (2008). Public Budgeting Systems (8th ed.). Sudbury, MA: Jones and Bartlett. ISBN: 9780763746681
  2. Richard, J.S. (2005). “Public Administration”. Concepts and Cases. Houghton Mifflin College Div. ISBN: 9780618310456
  3. Robert, A. C. (2008). American Public Administration: Public Service for the 21st Century. New York, NY: Pearson Longman Publishes.
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