Overlapping Debt

What Is Overlapping Debt?

Overlapping debt refers to the financial obligations of one political jurisdiction that also falls partly on a nearby jurisdiction. Overlapping debt is common in the U.S. because most states are divided into numerous jurisdictions for different tax purposes, such as building a new public school or building a new road.

Understanding Overlapping Debt

Municipalities issue debt to raise money from the public to fund capital projects that will benefit residents of the region. For example, if a city or county decides to build a school, airport, highway, or hospital, it will typically issue debt to borrow the funds needed to construct such infrastructure. Two municipal government bodies may have overlapping jurisdictions, such as a state and a city or a city and a county. The different jurisdictions may each issue debt in the form of municipal bonds and notes when they need to raise money to pay for these major expenses, which are intended to serve all the residents of a political jurisdiction.

When the debt of a municipal authority is shared with another government, the debt is referred to as an overlapping debt. For example, a bond that funds a project in a county school district could be considered overlapping debt to a town located within that school district. The town is only responsible for its proportional share of the overlapping debt. This proportional share plus the municipality's direct debt together make up the municipality's overall net debt. The municipality's overall net debt is an important factor in its ability to obtain future debt financing. Also, taxpayers are responsible for paying their share of the debt from each jurisdiction.

Overlapping debt is often greater than the direct debt of a municipal government and is determined by the ratio of assessed valuation of taxable property lying within the corporate limits of the municipality to the assessed valuation of each overlapping district. Having overlapping debt may affect one or both governments' ability to repay.

Economic Implications of Overlapping Debt

Economic research has shown the practice of having multiple, overlapping local authorities that can issue overlapping debt to fund their activities can have significant fiscal effects on local governments. Empirical analyses have found that overlapping of local jurisdictions that can spend and issue overlapping debt tends to creates a bias toward more total public sector spending. Other researchers have found that overlapping local fiscal authorities tend to treat the available tax base and total ability to raise funds from the market via bond issuance as common-pool resources, with associated tragedy-of-the-commons problems. 

This means that the widespread practice of overlapping governmental authorities issuing overlapping debt tends to increase the size and fiscal burden of local government as overlapping authorities compete against one another on a political area to exploit the same tax base. Various authorities responding to different sets of voters and interest group demands for public spending thus end up overexploiting the tax base in a region while taking on more total debt and spending more on public programs and infrastructure than voters in the region as a whole actually want.