Arnold, for once, is right

From fiscal failure to green destructiveness to an utter lack of courage when it would have mattered most, Gov. Arnold Schwarzenegger’s tenure in office has not been an exercise in analytic rigor. But on one proposal – the sale and leaseback of 11 state office buildings – Arnold is correct, and the state Legislative Analyst and many others questioning the plan are wrong.

However boring, such issues of public-sector management are not trivial. A 2009 law authorizes the state to sell and lease back (rent) 11 office buildings in Los Angeles, Sacramento and San Francisco, the state’s use of which now is rent-free because the state is the owner. But even apart from such current costs as maintenance and utilities, “rent-free” is not “cost-free”: The state could, in principle, rent the office space to others and receive payments in return.

Even though the hidden “opportunity cost” of those forgone rent payments does not appear in the budget, it is a real economic cost, equivalent in “present value” to the price that the state forgoes by not selling the buildings.

Bids on the properties have been received and a deal could by announced this month.

Under a sale/leaseback arrangement, the state would continue to use the office space, so that the purchase price that potential buyers would be willing to pay the state for the buildings would be determined directly by the future rent that the state is offering to pay.

By owning the buildings, the state now avoids paying rent, but also forgoes the interest it could earn on the basket of cash that would be obtained through a sale. And that “interest” should be defined broadly: it can be actual interest earned or saved if the cash is invested or used to retire debt. It can be hard-to-measure implicit “interest” in the form of a social return to state spending on education, health care, and all the rest. (Whether those returns to government spending are high or low – or even positive – is a separate question.) Or it can be the explicit or implicit interest that taxpayers could earn if the cash was returned to them.

And that is one source of error in the Legislative Analyst’s examination of the sale/leaseback proposal: The current, budgeted cost of remaining debt service on the buildings, which would be saved if the buildings were sold, is less than the forgone opportunity of earning actual or implicit interest on the large lump sum that would be obtained from selling them. The present value of that forgone stream is the parameter that should be compared with the present value of the future rent payments that would be made were the space to be leased back.

That such forgone interest does not show up explicitly in the budget is beside the point; it is a real economic cost that ought not be ignored in the analysis of alternative options for the management of public assets.

From a more political standpoint, the sale/leaseback route offers a different advantage: Because the office space now is used rent-free, its true cost does not show up in the budget, and so political decision-makers have weak incentives to economize on the use of such space. Were the buildings to be sold, with the subsequent rent payments made explicit in the budget, the office space would have to compete with alternative uses of state budget resources, providing an incentive to scrutinize the use of such space more carefully, and, thus, perhaps to reduce state employment (or expand it less) so as to lessen the need for such space.

It is unlikely that Gov. Schwarzenegger has gone through this analytic thought process; he just wants the sale/leaseback arrangement so that he can get a large basket of cash that can be spent now. The costs of the future rent payments will be a problem for future public officials.

But motives in this context matter not; the sale/leaseback proposal is the one that serves taxpayer interests and so should be allowed to proceed.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

Scroll to Top