Credit: (AP Photo/Matt Rourke)Listed in state budget documents alongside some of the biggest year-over-year cost drivers is a $150 million expense for an “arbitrage rebate.”
Although it’s hard to tell from the budget documents, the $150 million is intended to be paid to the U.S. Treasury during the new fiscal year that begins this July, according to officials from the state Department of the Treasury.
The rebate largely stems from a controversial bond sale carried out by Gov. Phil Murphy and lawmakers during the throes of the COVID-19 pandemic in 2020 when interest rates were extremely low.
Totaling roughly $4 billion, the tax-exempt bond sale raised funds, without voter approval, to help sustain the annual budget at a time when the Murphy administration feared the state was in an unprecedented revenue shortfall set off by the health crisis.
However, revenue losses soon leveled off, and then tax collections eventually soared. The state would also go on to receive more than $6 billion from the landmark American Rescue Plan Act in 2021.
So instead of offsetting a major deficit, the bond proceeds helped pad a significant budget surplus. And the money the state got from the emergency borrowing generated interest earnings that outpaced the original, nearly 2% yield on the debt, state Treasury officials said.
Federal tax rules
Under federal tax rules, bond issuers, like state governments, are not allowed to profit from such investments and must return to the federal government what’s known as arbitrage.
“The Internal Revenue Code requires the State to monitor the interest earnings on bond proceeds and pay any arbitrage to the U.S. Treasury,” state Treasury spokesperson Danielle Currie told NJ Spotlight News in response to questions about the arbitrage rebate line item in the budget.
“The rebate is not a penalty of any kind,” Currie said. “It is just repaying any arbitrage amount over and above the yield of 1.90%,” Currie said.
‘The rebate is not a penalty of any kind. It is just repaying any arbitrage amount over and above the yield of 1.90%.’ — Danielle Currie, Treasury spokesperson
Such a rebate is generally due every five years, when warranted, and the first five-year date for the COVID-19 borrowing issue is now approaching, Currie added. That’s why it appears in Murphy’s proposed budget for fiscal year 2026.
The state Constitution generally puts tight controls on annual spending and borrowing, but the case for issuing debt to prop up the budget during the pandemic was based on a rarely used clause that loosens those restrictions during times of war or major emergency.
Disagreements over NJ borrowing
While Republicans objected at the time, saying the Murphy administration was overestimating the projected shortfalls, Democratic majorities in the Assembly and Senate went along with the Democratic administration and signed off on the borrowing issue.
The emergency borrowing also survived a legal challenge in a case that went all the way to the state Supreme Court.
But also questioned by GOP lawmakers at the time was the administration’s decision to issue noncallable bonds that must be repaid with interest over a 12-year term, with no option to pay down the debt early.
The next annual debt service payment attributed to the COVID-19 emergency bonds will total roughly $462 million during the 2026 fiscal year, according to a line item in the detailed budget book issued by the Murphy administration last month.
COVID-19 emergency bonds
The $150 million set aside to cover the arbitrage rebate appears in another section of the same, nearly 600-page budget book.
During the latest round of legislative budget hearings, Sen. Doug Steinhardt (R-Warren) quizzed Treasury officials on the planned arbitrage rebate and its ties to the COVID-19 emergency bonds as he also asked about potential “IRS investment violations.”
“We were the only state in the country that went out to borrow . . . even though our revenues ended up growing,” Steinhardt said during a budget hearing earlier this month.
‘We have not only reduced our outstanding bonded debt to more than offset the borrowing of the COVID bond, but, again, we’ve repaid an additional several billion dollars of debt.’ — Assistant state Treasurer Michael Kanef
In response, Tariq Shabazz, acting director of the state Treasury’s Office of Management and Budget, pointed to the low interest rates that prevailed when the emergency bonds were issued and then contrasted that with an upswing in rates that occurred not long after.
“If you recall, right after COVID, there [was] a high-interest rate environment, and so that’s yielding the arbitrage liability payment,” Shabazz said.
Retiring bonded debt ahead of schedule
During the same exchange, Treasury officials also highlighted the administration’s efforts to retire bonded debt ahead of schedule using revenue deposited into the off-budget Debt Defeasance and Prevention Fund. The dedicated reserve was created by Murphy and lawmakers in the wake of the pandemic amid a surge in revenues that followed the worst months of the health crisis.
According to new calculations included in the state’s latest annual comprehensive financial report, or ACFR, New Jersey reduced its bonded debt by nearly $2 billion during the last fiscal year.
That dropped the total amount owed to bondholders below $40 billion for the first time in more than a decade, according to the report released late last month. Other figures included in the report show the state’s total for bonded debt has been reduced by a net, more than $5 billion since Murphy took office in early 2018.
“From the time of that [emergency] borrowing to the current day, we have not only reduced our outstanding bonded debt to more than offset the borrowing of the COVID bond, but, again, we’ve repaid an additional several billion dollars of debt,” assistant state Treasurer Michael Kanef told Steinhardt during the hearing.
