State Supreme Court enables local governments to avoid constitutional debt ceiling by using revenue bonds to fund public utility construction in opinion issued on August 22, 1895.

  • By John Caldbick
  • Posted 11/16/2013
  • HistoryLink.org Essay 10656

On August 22, 1895, the Washington State Supreme Court rules that the debt of a municipal corporation that is to be repaid exclusively with revenue derived from the project the debt finances does not violate constitutional restrictions on municipal borrowing. At issue is a Spokane ordinance authorizing a bond issue to pay for a municipal water system. The decision in Winston v. City of Spokane is the first in the nation to uphold "special fund" or revenue bond financing of this nature. It will make possible development by local governments of such things as water and sewer systems, public transportation, and, later, electrical utilities, and it comes just in time to allow Seattle to proceed with long-standing plans to tap the Cedar River for its water needs. As precedent, the Winston opinion will in later years be cited favorably by more than 100 courts in Washington and across the nation.

The Problem

For the first 50 years or so of United States history, there were few legal restrictions on the power of states to finance infrastructure projects by incurring debt, principally through the sale of interest-bearing bonds to be paid back from general tax revenues. The first use of this method -- a triumph for New York but a disastrous template for many other states -- was the sale of bonds to finance construction of the Erie Canal, completed in 1825. The canal was a huge financial success, and tolls charged for its use were more than sufficient to pay off the bond debt.

There were 24 states in the union in 1825, most of which were inspired by the New York experience to start financing their own public projects with bonds backed by general tax revenue. With the Panic of 1837 (one of a series of financial crises that afflicted the nineteenth century), states found themselves dangerously overextended, and many of the completed projects funded with bond debt produced little or no income. To service just the interest on the bonds, states had to drastically raise taxes. In many cases even this was insufficient, and several simply defaulted on their obligations. Taxpayers were understandably upset, and they turned to the ballot box. By 1850, voters in 19 of the 31 states then in the union had amended their constitutions to place stringent limits on how much debt state government could incur. As new states entered the union, similar provisions were often included in their original constitutions.

Almost all of these amendments imposed debt limits only on state governments, a failure of foresight that would lead to a whole new round of debt debacles. Local governments, largely unhindered by the limitations, stepped into the borrowing breach. In the years immediately following the Civil War, great wads of public money were showered on the privately owned railroad companies, which any city serious about its future needed to attract. The rail companies were given title to vast tracts of public land and a range of other incentives, including cash subsidies and the purchase of railroad stock with borrowed money, raised again through the sale of bonds backed by general revenue and again putting the taxpayers directly at risk. The baffling human tendency to quickly forget painful economic lessons of even the recent past was on full display.

As cities grew and their infrastructure needs increased, they increasingly relied on public debt to finance projects. Again, many of these would produce little or no income -- sidewalks and streets being perhaps the best examples. Predictably, it was not too long before many local governments were in the same condition of financial ruin as states had been earlier in the century. In a replay of 1837, but featuring different actors, the Panic of 1873 caused many municipalities to default on their bond obligations. Nonetheless, they were shortly borrowing again; in 1840, the total municipal debt in the country was approximately $20 million; by 1880 it had reached $280 million.

This was unsustainable, and no one knew it better than the beleaguered taxpayers. Once again, they responded by passing constitutional amendments, this time subjecting local governments to restraints similar to those imposed on state governments decades earlier. And again, new states entering the union often included similar provisions in their original constitutions. So it was in Washington.

The Washington State Constitution

Even before statehood, new towns cropping up in Washington Territory were subject to strict debt limitations that were written into the 1853 Territorial Act. Many believed these restrictions would be relaxed once statehood was achieved, but it was not to be. On August 24, 1889, the Washington State Constitutional Convention completed a draft constitution to submit to the voters in anticipation of achieving statehood. It was approved on October 1, 1889, and Washington entered the union as the 42nd state on November 11, 1889. The constitution's Article VIII, entitled "State, County, and Municipal Indebtedness," restricted the ability of both state and local governments to incur debt. Section 1 of that article limited the state's borrowing power to a fixed amount, $400,000 (worth about $10.25 million in 2013 dollars). Section 6 tied the debt limit of municipal corporations to the assessed value of taxable property within their respective jurisdictions:

"No county, city, town, school district or other municipal corporation, shall for any purpose become indebted in any manner to an amount exceeding one and one-half per centum of the taxable property in such county, city, town, school district or other municipal corporation, without the assent of three-fifths of the voters therein, voting at an election to be held for that purpose, nor in cases requiring such assent shall the total indebtedness at any time exceed five per centum on the value of the taxable property therein, to be ascertained by the last assessment ... " (Constitution, 1889, Art. VIII, Sec. 6).

Cities and towns were given a little more leeway to fund certain projects:

"[A]ny city or town, with such assent may be allowed to become indebted to a larger amount but not exceeding five per centum additional for supplying such city or town with water, artificial light, and sewers, when the works for supplying such water, light, and sewers shall be owned and controlled by the municipality" (Constitution, 1889, Art. VIII, Sec. 6).

The convention delegates clearly anticipated the growing need for "water, artificial light, and sewers," but they underestimated the expense. Even with this additional debt allowance, many towns and cities soon found themselves unable to afford the infrastructure necessary to supply these most basic needs.

Feeling the Pinch

There were countervailing forces at play as well, perhaps more so in Washington than anywhere else in the country. Private corporations, many of them multistate conglomerates, were usually first or nearly first to offer such basic services as water, gas, and public transport. These were considered "natural monopolies" -- enterprises in which real competition was almost impossible once a primary provider was established. This made them very attractive investments for those with the capital to develop them. But pushing in the other direction was a growing belief, sprung from the Progressive Movement, that local governments, and not private corporations, should own and operate essential utilities and services.

One imperfect way to reconcile municipal debt limits with municipal ownership was to assess property owners for the cost of improvements or services from which they directly benefited. Local governments used these assessments to finance such projects, leaving tax revenues untouched. The courts upheld this method on the rationale that it imposed no tax burden on the general public.

But the need for some greater resolution was growing. Between 1880 and 1890, Washington's population ballooned from 75,116 to 349,390. Most people still lived in rural areas, but this was fast changing as well. Seattle's population -- 3,553 in 1880 -- was 42,837 by 1890, an increase of well more than 1,000 percent. All these people needed basic services, and by and large they preferred to get them from government rather than corporations.

The Seattle Dilemma

In few places did the municipal-ownership movement sprout earlier or grow stronger than in Seattle, and for good reason. In the 1880s, the city's water supply was provided by a number of different private companies, all of which pumped water from springs, wells, Lake Washington, or Lake Union. As early as 1888, Seattle Mayor Robert Moran (1857-1943) proposed that the city build its own water system, using gravity instead of expensive pumps to roll water down from the Cedar River in the foothills of the Cascade Mountains. A vote on Moran's measure was scheduled for November 1888, but a defect in the ordinance setting the election forced a delay until the following July. How it would have fared in 1888 can't be known, but the destruction of much of the city by fire just a month before the 1889 vote assured its passage by a margin not often seen.

Downtown Seattle burst into flames on June 6, 1889, and the entire business district and much of the waterfront was destroyed. The fire's unchecked spread was in large part due to the failure of the city's private systems to provide anywhere near enough water to battle the blaze. One month later, on July 8, 1889, Seattle voters passed the bond issue recommended by Moran, approving $1 million to set up a municipal water system. Voter anger and the strength of the municipal ownership movement were reflected in the lopsided 1,875 to 51 result. It seems at least mathematically possible that the only votes against Moran's plan were cast by owners or employees of the private water systems.

This was a start. Moran hired a hydraulic engineer from Chicago, Benezette Williams, to recommend how and from where to bring additional water to Seattle, and to determine the fair value of the Spring Hills Water Company, one of the city's leading private providers. Williams affirmed Moran's choice of a gravity system using the Cedar River as a source, and estimated the cost of doing so at $1.2 million.

Next, on June 4, 1890, Seattle voters, by another lopsided vote (705-16), approved a bond measure to buy the Spring Hills company and upgrade the city's water system. Based on Williams's valuation, the City bought all the assets of the company for $352,265.67. As things stood at the end of 1890, Seattle had a municipally owned water system inadequate for its future needs, an incomplete plan for replacing it with a gravity-fed system tapping the Cedar River, insufficient funds to carry out that plan, and no way to raise additional money without violating the constitutional restriction on municipal debt because the 1890 bond issue, together with earlier borrowing, put the city at the allowed limit.

Enter R. H. Thomson (1856-1949), who in 1892 was appointed city engineer. Thomson realized the importance of the Cedar River project to Seattle's future but he too was stymied by the debt restriction. Progress was knocked even further off course by yet another economic meltdown, the Financial Panic of 1893, the worst and most prolonged of the several "panics" that century. The full effects of it would not ebb until 1897, but in 1895 the Washington State Supreme Court threw Thomson and Seattle's public water utility a just-in-time lifeline.

The Spokane Experience

Seattle wasn't the only city in Washington having trouble supplying basic amenities to its residents. By 1890, Spokane was the state's third largest city, and its rate of growth put even Seattle to shame. In 1880, only 356 people lived there; 10 years later, the total was 19,222, a mindboggling 5,300 percent increase.

Spokane started its first municipal water service in 1884 with the purchase of a small private waterworks located on Havermale Island in the Spokane River. It had just a few hundred feet of wooden water mains fed by pumps. The city water department built a new pumping station, but soon realized that what was really needed was a new source of plentiful, fresh, clean water. This need was driven home when, on August 4, 1889, less than two months after the Great Seattle Fire, flames destroyed much of downtown Spokane. As in Seattle, insufficient water hampered efforts to control the blaze.

In 1894, Spokane began building the Upriver Dam and Pumping Station. All this was expensive, and the city soon found itself facing the same dilemma as Seattle: barred by the constitution from issuing any more bonds repayable from general revenues. That same year, Spokane voters approved an ordinance to fund a new water system. This ordinance would become the legal lever that pried the cap off the constitutional limit on municipal debt. Its title, in relevant part, explained exactly how this would be done:

"An ordinance providing for the borrowing of money for the completion of the water works system of the City of Spokane and the issuance of obligations therefor, and providing that sixty (60) per centum of the gross revenues derived from the water works belonging to the city shall be applied in the liquidating of said debt ... " (Ordinance No. A583).

Presumably due to uncertainty over whether this arrangement was in fact consistent with the constitutional debt limitation, the ordinance provided that its validity was to be "determined by a suit properly brought and taken to the Supreme court of this State" (Ordinance No. A583).

Winston v. Spokane

The plaintiff in the test case contemplated by the ordinance was Patrick H. Winston (1847-1904), a Spokane attorney, newspaper owner, and veteran of a brief stint in the Confederate Army during the Civil War, who would, a year after the decision bearing his name was issued, be elected Washington State Attorney General on the Populist Fusion ticket. Winston's complaint alleged that the ordinance was invalid because "the existing indebtedness of Spokane was in excess of the limit authorized by the constitution" (Winston v. Spokane). The city's lawyers didn't deny that this was the case, but argued that only a "special fund" fed by the profits of the water system would be used to retire the debt, without resort to taxes or to the city's general credit. This, they said, removed the borrowing from that category of "debt" that Article VIII, Section 6 addressed. Spokane wasn't arguing that it somehow should be relieved of the burdens imposed by the constitution, but rather that what it had done was simply beyond the amendment's reach. Although the parties were actually in accord, the Spokane County Superior Court was not persuaded and ruled that the ordinance violated the constitutional debt limitation provisions, declaring it null and void. The City appealed.

The state supreme court had five members in 1895, four of whom had served since statehood. Two of the justices had been delegates to the 1889 constitutional convention. One of those, Justice Ralph O. Dunbar (1845-?), joined by Justice Elmon Scott (ca. 1854-?), dissented from the majority decision in Winston, leaving no written opinion reflecting the reasons for the dissent.

The other, Justice John Philo Hoyt (1841-1926), had a very interesting background. After service in the Union cause during the Civil War, he passed the bar, served in the Michigan House of Representatives, and was governor of Arizona Territory from 1877 to 1878. He moved to Washington Territory and in 1879 and was made a justice of the territorial supreme court. In 1887 he became manager of the Dexter Horton Bank in Seattle and helped develop the city's Fremont district. He was a delegate to the constitutional convention in 1889 and was chosen to serve as its president. As such, he presided over the making of the document he was now asked to interpret.

Justice Hoyt was joined in his majority opinion by Justice Thomas J. Anders (1838-1909) and by Justice Merritt J. Gordon (1859-1925), who was serving his first term on the court. Hoyt used well less than 1,000 words to dispense with Winston's arguments and overrule the superior court. His decision centered narrowly on the definition to be given the word "debt." Analogizing from earlier cases that upheld "special fund" financing based on assessments against property owners, Hoyt noted that "the obligations to be issued ... shall be payable only out of the special fund, to be created out of the receipts of the waterworks ..., and ... the city shall not be in any manner liable to pay the same" (Winston v. Spokane, 526). From these facts, which were not in dispute, he concluded:

"[W]e are of the opinion that neither the ordinance, the contract, nor the obligations to be issued by the city in pursuance thereof, do or will constitute a debt of the city, within the constitutional definition" (Winston v. Spokane, 526).

A Boon to Progress

Few constitutional issues have been decided with fewer words. Hoyt did not bog himself down in an elaborate analysis of constitutional theory -- he simply decided that Article VIII, Section 6 was not applicable to "special fund" financing by local governments.

The decision authorizing what soon became known as revenue bonds -- because the bonds sold to fund a project were to be repaid only from the revenue generated by the project that they financed and not from general funds -- had an immediate and profound effect on the development of the state, and perhaps nowhere more dramatically than in Seattle. Before the ruling George Cotterill (1865-1958), assistant to R. H. Thompson, had proposed the then-novel idea of using income from water sales to repay bonds sold to finance the Cedar River project. His plan had been put on hold pending the resolution of the Winston case. He would later write:

"The first ray of hope had come into the situation after the Supreme Court decision of 1895. ... When the decision came from Olympia, we knew we had won -- if Spokane could borrow one hundred thousand dollars payable on revenue only, we could build the Cedar River Water System by special warrants or bonds ... ." (McWilliams, 61).

On December 10, 1895, the voters of Seattle approved a $1.25 million bond sale to finance the Cedar River Project. It was not quite as lopsided as earlier votes -- the bond measure was fiercely opposed by supporters of a plan for a private syndicate to build a Cedar River water system and sell the water to city residents -- but still won by a sizeable margin: 2,656 to 1,665. Seattle would go on to use similar revenue bond measures to develop and improve other services, including Seattle City Light, the first municipally owned electrical utility in the nation. Even before the Seattle vote, the Winston decision allowed Spokane to become the first city in the country to fund public utility construction by issuing revenue bonds.

And the value of the Winston precedent to municipal progress was not limited to the Northwest. Over the years, the opinion has been cited favorably in more than 100 cases across the nation, in both federal and state courts and as recently as 2012. Revenue bonds became and remained an important funding mechanism for all sorts of public utility improvements. No doubt cities and towns would have found a way to provide basic services had Winston been decided differently, but the decision's importance to the development of many U.S. cities and towns in the twentieth century is beyond dispute.


Sources:

Winston v. Spokane, 12 Wash. 524 (1895); Constitution of the State of Washington, Washington State Legislature website accessed October 31, 2013 (http://www.leg.wa.gov/LawsAndAgencyRules/Documents/12-2010-WAStateConstitution.pdf); John Lamb, The Seattle Municipal Water Plant: Historical, Descriptive, Statistical (Seattle: Moulton Printing Company, 1914); Dennis J. Heil, "Another Day Older and Deeper in Debt: Debt Limitation, the Broad Special Fund Doctrine, and WPPSS 4/5," 7 Seattle U. L. Rev. 81 (1983); "Ordinance No. A583," in The Municipal Code of the City of Spokane, Washington, Comprising the Ordinances of the City Revised to October 22, 1896 (Spokane: W. D. Knight Company, 1896), 138-45; Robert F. Utter and Hugh D. Spitzer, The Washington State Constitution (New York: Oxford University Press, 2013), 53, 159; Mary McWilliams, Seattle Water Department History: 1854-1954 (Seattle: Seattle Water Department, 1955), 58-63; "John P. Hoyt," Union Civil War Veterans: Washington State, Part 1, RootsWeb website accessed November 2, 2013 (http://wc.rootsweb.ancestry.com/cgi-bin/igm.cgi?op=GET&db=miscsea&id=I315); HistoryLink.org Online Encyclopedia of Washington State History, "Washington State Constitutional Convention delegates frame constitution stipulating that voters must be male, but append separate woman suffrage and Prohibition amendments on August 17, 1889" (by Paula Becker), "Municipal Ownership Movement" (by Walt Crowley), "1890 Census -- Eleventh Decennial Census counts Washington as state for first time ... " (by John Caldbick), "Seattle voters authorize Cedar River water supply system and re-elect Mayor Robert Moran on July 8, 1889" (by Alan J. Stein and Cassandra Tate), "Cotterill, George Fletcher (1865-1958) (by David Wilma), and "Spokane's Great Fire" (by Laura Arksey), http://www.historylink.org/ (accessed November 2, 2013); Benezette Williams, et al., Report on Water Works for City of Seattle to the Mayor and City Council (Seattle: Lowman and Hanford Stationery and Print Company, 1890); "Col. Patrick Henry Winston and the Statue of Limitations," Washington State Library Blog website accessed November 3, 2013 (http://blogs.sos.wa.gov/library/index.php/2013/09/col-patrick-henry-winston-and-the-statue-of-limitations/); "States by Order of Entry into Union," Infoplease website accessed October 31, 2013 (http://www.infoplease.com/ipa/A0763770.html).


Related Topics:   Cities & Towns | Infrastructure | Law

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