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494 ECONOMIC ANALYSISIN THE PUBLIC SECTOR
No Time-Value-of-Money Concept
Ingovernment, monies are obtained through taxation and spent about as quickly as they
are obtained. Often, there is little time delay between collecting money from taxpayers and
spending it. (Remember that the federal government and many states collect taxes every
paycheck in the form of withholding tax.) The collection of taxes, like their disbursement,
although based on an annual budget, is actually a continuous process. Using this line
of reasoning, some would argue that there is little or no time lag between collecting and
spending tax dollars. As such, they would advocate the use of a 0% interest rate for economic
analysis of public projects.Cost of Capital Concept
Another consideration in the determination of interest rates in public investments is that
most levels of government(federal, state, and local) borrow money for capital expenditures
in addition to collecting taxes. Where money is borrowed for a specific project, one ~ne of
reasoning is to use an interest rate equal to thecost of borrowedmoney.This argumentis less
valid for state and local governmentsthan for private firms because the federal government,
through the income tax laws, subsidizes state and local bonded debt. If a state or one of
its political subdivisions (like a county, city, or special assessment district) raises money
through the sale of bonds, the interest paid on these bonds is exempt from federal taxes. In
this way the federal government issubsidizingthe debt, thereby encouraging investors to
purchase such bonds.
These bonds, called municipal bonds, can be either general obligation or revenue
bonds.General obligation municipal bondspay interest and are retired (paid oft) through
taxes raised by the issuing government unit. A school district may use property taxes it
receives to finance bond debt for construction of new language labs.-Revenue bonds,
on the other hand, are not supported by the taxing authority of the government-unit;
rather, they are supported by revenues earned by the project being funded. As an ex-
ample, the city of Athens, Ohio, would use toll revenues from a new bridge over the
Hocking River to retire debt on revenue bonds sold for the bridge's construction. For
those who purchase municipal bonds, the instruments' tax-free status means that the ex-
pected return on this investment is somewhat less than that required of fully taXedbond
investments (of similar risk). As a rough estimate, when fully taxed bonds yield an 8%
interest rate, municipal bonds might make interest payments at a rate of 6%. The dif-
ference of 2% represents the effect of the preferred treatment for federal taxation, and
hence a form of hidden federal subsidy on tax-free bonds. This means that thecost of
capitalapproach is sometimes skewed for debt incurred through the use of long-term
bonds.Opportunity Cost Concept
Opportunitycost, which relates to the interest rate on the best opportunityforgone, may take
two forms in governmental economic analysis: government opportunity cost and taxpayer
opportunity cost.Inpublic decision making, if the interest rate is based on the opportunity