Denver's New Welfare Hotel:

Why the Convention Center Hotel is a Mistake

By Dave Kopel

Issue Paper 4-2003, January 15, 2003

Introduction

Mayor Webb and the Denver City Council are planning to build a Convention Center Hotel. The 1,100 room hotel will occupy the block bounded by 14th and 15th Streets, and by California Street and Welton Street. If on time, the hotel will open in 2006. Denver plans to create a non-profit corporation which will issue $347 million bonds, build the hotel, and lease the hotel to Hyatt. The bonds would be repaid, in theory, by hotel revenues.

The plan violates the Colorado Constitution's mandate for strict separation of business and state, and it evades the Colorado Constitution's requirement that municipal bond issues be approved by taxpayers. It is emblematic of the misuse of tax-exempt municipal bonds for business purposes. It is a potentially risky business venture whose risks ought to be borne by private investors, not the taxpaying citizens of Denver.

Part I. Separation of Business and State

A. The U.S. Constitution Separates Church and State

In 1791, the United States adopted the First Amendment, a religious policy radically different from every major government in the western world. The federal government was prohibited from making an establishment of religion. Thus, tax dollars could not be used to support religious organizations, no religion could claim official endorsement, and laws neither required church attendance nor governed the conduct of church business. While the First Amendment barred only federal establishment of a church, those states which had their own established churches (or which subsidized churches in general) quickly followed the example of the First Amendment, while Massachusetts and Connecticut made disestablishment universal a few decades later.

The "separation of church and state" did not mean that government was required to be hostile to religion, to discriminate against religious organizations, or to abolish any mention of God in government speech. Separation did mean that the churches were completely deprived of government financial assistance.

In contrast, throughout Europe and Latin America, every nation (or, in a few countries, a subdivision of the national government) had chosen its preferred religion, and subsidized that religion with tax dollars. The established religions were frequently given special privileges or official powers which were denied to other religions.

In 1791, an English Anglican or a Swedish Lutheran might have suspected that the First Amendment was intended to de-religionize the United States. After all, many of the Founders -- such as Franklin, Adams, and Jefferson -- were Deists with no great affection for organized religion.

Yet the long-term effect of the Separation of Church and State was to greatly strengthen religion in the United States, making it far more powerful than in the nations with established churches. American churches focused on enticing individuals to attend voluntarily, and encouraging them to take personal financial responsibility for the support of their own church. Far more than any other nation, the United States of America has become the incubator of diverse religions, including Baptists, Quakers, Adventists, Methodists, Mormons, Moravians, Mennonites, Jehovah's Witnesses, Assemblies of God, the Theosophical Society, Christian Scientists, Shakers, and the Amish -- just to name a few. (Some of these originated elsewhere, but flourished in the free religious atmosphere of America.) Today in America, there are about 900 religious groups with roots in the Judeo-Christian tradition, and about 600 others of various origins. This diversity is a very legitimate source of national pride.

Today, polls show that a huge majority of Americans are religious, and that Americans attend religious services, pray, believe in an afterlife of rewards and punishments, and engage in other religious activity at a rate vastly higher than do Western Europeans. Western Europe is full of magnificent cathedrals and other churches built with government money -- but many of them are nearly empty on Sunday, and sociologists are describing Western Europe as a "post-Christian" society.

So the country that adopted strict separation of church and state ended up with much stronger religions than the countries which gave taxpayer subsidies to churches.

B. The Colorado Constitution Separates Business and State

The Founders of Colorado believed in the separation of church and state, and they also very strongly believed in the separation of business and state. The authors of the 1876 state Constitution were painfully aware of how many Colorado towns had wasted money on railroads demanding taxpayer subsidies.

In a report to the people of Colorado, the 35 delegates to the state Constitutional Convention noted that "no subject has come before the Convention causing more anxiety and concern" than the subject of corporate welfare. Accordingly, the Convention proposed -- and the people of Colorado adopted -- pervasive bans on government support or involvement with business.

Article V of the state Constitution specifies legislative powers. Section 25 mandates:

Special legislation prohibited. The general assembly shall not pass local or special laws in any of the following enumerated cases...granting to any corporation, association or individual any special or exclusive privilege, immunity or franchise whatever. In all other cases, where a general law can be made applicable no special law shall be enacted.

Another section of Article V outlaws grants of money to business:

Section 34. Appropriations to private institutions forbidden. No appropriation shall be made for charitable, industrial, educational or benevolent purposes to any person, corporation or community not under the absolute control of the state, nor to any denominational or sectarian institution or association. (emphasis added).

Article XI controls Public Indebtedness. It states:

Section 2.No aid to corporations no joint ownership by state, county, city, town, or school district. Neither the state, nor any county, city, town, township, or school district shall make any donation or grant to, or in aid of, or become a subscriber to, or shareholder in any corporation or company or a joint owner with any person, company, or corporation, public or private, in or out of the state....(emphasis in original).

Notably, section 2 of Article XI provides a single exception where government may enter into a business venture with a corporation:

Nothing in this section shall be construed to prohibit any city or town from becoming a subscriber or shareholder in any corporation or company, public or private, or a joint owner with any person, company, or corporation, public or private, in order to effect the development of energy resources after discovery, or production, transportation, or transmission of energy in whole or in part for the benefit of the inhabitants of such city or town.

This provision allows governments to enter into joint ventures to provide electrical service, or to explore for energy. By specifically creating an exception for government involvement in the energy business, the Constitution makes it all the clearer that the government may not get involved in other types of business. The legal maxim for this is Expressio unius est exclusio alterius-- or "the expression of one thing is the exclusion of another." [The maxim first appears, in a more verbose form, in Sir Edward Coke, The First Part of the Institutes of the Laws of England; Or, A Commentary Upon Littleton, vol. II, section 339, star page 210a (Union, N.J.: The Lawbook Exchange, 1999; reprint of 18th edition, 1823).]

Article XI further requires that local governments receive taxpayer approval before contracting debt:

Section 6.Local government debt. (1)....Except as may be otherwise provided by the charter of a home rule city and county, city, or town for debt incurred by such city and county, city, or town, no such debt shall be created unless the question of incurring the same be submitted to and approved by a majority of the qualified taxpaying electors voting thereon, as the term "qualified taxpaying elector" shall be defined by statute....

(3)Debts contracted by a home rule city and county, city, or town, statutory city or town or service authority for the purposes of supplying water shall be excepted from the operation of this section.

Denver is a Home Rule city, and its charter states "No general obligation bonds shall be issued until the question of issuing the bonds shall have been submitted to a vote of the qualified electors of the City and County of Denver and a majority of those voting upon the question by ballot shall have voted in favor of issuing such bonds." (Denver City Charter, section 7.5.1.)

Again, there is a clear -- and solitary -- exception to the rule requiring voter approval for bonds: a vote is not required for water bonds.

C. How the Colorado Supreme Court Nullified the Colorado Constitution

Given these constitutional and charter restrictions, it would seem impossible that the City of Denver could spend money for a joint business venture with Hyatt Hotels, or that the City could issue $347 million in bonds in pay for the business plan.

Unfortunately, the Colorado Supreme Court has judicially nullified several parts of the Colorado Constitution. Beginning in the 1930s, the Court began creating a "public purpose" exception to the prohibitions on corporate welfare. Now, according to the court, corporate welfare and government entanglement in business is fine, as long as there is some "public purpose." Of course everything the government does has some putative "public purpose."

As law professor Dale Rubin details in the 1996 Issue Paper Public Subsidies To Private Corporations, the court's creation of the "public purpose" loophole was utterly devoid of support in precedent, constitutional text, or any other source of law. It was purely a lawless invention by a court, usurping power in order to destroy a constitutional protection. There is a legal maxim for this: Gloss viperina est quae corrodit viscera textus."It is a poisonous gloss which corrodes the vitals of the text." (Coke's Reports, vol. 10, at 70.)

Professor Rubin quotes an earlier case, in which a constitutionally faithful Colorado Supreme Court rejected a proposed corporate subsidy, even though the subsidy would have a public benefit: "If the existence of a public benefit is to...take it out of the constitutional prohibition, then the prohibition is utterly nugatory and valueless, as such consideration would exist in every probable case." [5 Colo. 192 (1879].

Beginning in the 1970s, the Supreme Court began undermining the rules requiring a public vote before the imposition of public debt. In a case involving the Colorado Housing Finance Authority, the court ruled that governments could incur public debt without voter approval. The governments simply had to avoid incurring debt in their own name, and instead set up shell organizations which would incur the debt. Thus, Colorado has seen a proliferation of "public/private" shell organizations and corporate loopholes invented to avoid public votes on public debt. "Certificates of participation" are among the most common. The Denver welfare hotel would evade a public vote by having the hotel owned and built by a special non-profit corporation created by the City of Denver.

Part II. The Welfare Hotel Bonds

A. How the Corporate Welfare Bond Program will Work

If the Denver City Council proceeds with the plan promoted by Mayor Webb, the Council will create a non-profit corporation. The corporation will own the city block which Denver's government bought several months ago from a real estate developer. The non-profit corporation will build the $250 million hotel itself, and then lease the hotel to Hyatt. The non-profit corporation's share of the hotel operating profits will be used to pay off the $347 million bond issued to build the hotel. (The extra $97 million is for non-construction costs, such as legal fees.)

B. The Bond Interest Rate Switcheroo

As of early 2003, corporate bond interest rates are around 9.5%. Interest rates on municipal bonds are around 5.5%. The theory for involving the city government in hotel construction is that the hotel is only financially viable if financed at a 5.5% rate, rather than a 9.5% rate.

To begin with, it is not true that a hotel near the convention center could not be built with ordinary, private financing. Downtown Denver has many hotels, as do the downtowns of other major cities. With a few exceptions, these hotels were all built with ordinary private financing. Perhaps the main difference between hotel financing of today compared to half a century ago is that modern hotel operators have been extremely adroit at extracting taxpayer subsidies for new construction projects. Yet the fact that some city governments choose to spend taxpayer money on welfare programs for large corporations does not prove that the corporations could not finance their own construction projects, if the welfare were withdrawn.

Rather significantly, Hyatt was willing to "finance, develop, and operate the hotel" itself--rather than relying on the city. (Hyatt would have received a $55 million subsidy from the Denver Urban Renewal Authority. [RMN 10/31/02].) But Mayor Webb rejected the Hyatt proposal to build the hotel itself. Because the proposal did not have a firm start date, Mayor Webb contemptuously dismissed the Hyatt proposal as akin to a visit "from the tooth fairy." (RMN 4/26/02).

Yet several months later, Mayor Webb announced that Hyatt would be the lessee of the new city-built hotel. He said he chose Hyatt because of his high confidence in the corporation. In a few months, Hyatt went from being the "tooth fairy" to being the business partner in whom Denver taxpayers were supposed to feel high confidence.

David C. Peterson, author of the book Developing Sports Convention and Performing Arms Centers (Urban Land Institute), told the Rocky Mountain News: "It doesn't make sense for the city to seek another developer or create a nonprofit corporation, if Hyatt is willing to do the job." (4/26/02).

Of the $347 million dollars in bonds to be issued to build the hotel, Hyatt will take on only $12 million of liability. (RMN 8/20/02).

C. Taxpayers at Risk with the Welfare Bonds

In a debate at the City Club on Jan. 14, 2003, Councilwoman Cathy Reynolds repeated a claim often made by advocates of the welfare hotel: "The general fund is not at risk." In a purely technical sense, this claim is correct. If the hotel does not generate sufficient operating revenue to pay the bonds, then the only recourse of the bond holders would be to seize the hotel. The bonds are not formally secured by general Denver tax revenues. (If the bonds were secured by general revenues, voter approval of the bonds would necessary.)

But as a practical matter, the city government and the taxpayers are liable for the hotel bonds. If Denver's government allowed the non-profit corporation to default on its bonds, the effects on Denver's bond rating would be catastrophic. Rating agencies such as Moody's would sharply downgrade the rating of Denver bonds. As a result, future Denver bond issues -- including issues for legitimate public purposes such as public schools, parks, and streets -- would be forced to pay significantly greater interest costs.

Further, the bond rating agencies are perfectly capable of seeing through the legal fiction of the "non-profit" corporation which ostensibly will own the hotel. Rating agencies can recognize that Denver dare not let the hotel bonds default; accordingly, as rating agencies assess Denver's creditworthiness for future bond issues, the agencies will take into account the fact that Denver has a real-world financial obligation of a third of a billion dollars on the convention hotel. This huge obligation may cause Denver to receive a lower debt rating than Denver might have received if the city owed less debt.

Politicians promoting the corporate welfare hotel like to point out that the welfare model, with bonds issued under the authority of the city of Denver, costs less in interest, because the Denver bonds are free of federal and state taxes; accordingly, they can pay a lower rate of interest. But the tax-free nature of municipal bonds is only part of the reason why municipal bonds pay lower rates of return. The other reason is that if there is a problem paying off the bonds, a city government enjoys the power which no private corporation does: the power to take money by coercive force.

A private corporation which is having trouble making payments on a corporate bond can try to cut business costs, or try raising prices or selling more of its product; ultimately, the corporation only has as much money as people voluntarily choose to give the corporation through free business exchange. In contrast, a city government which is having trouble making bond payments can simply take more money from the public, by raising tax rates. (Colorado's Constitution restricts tax increases without a vote of the people, but state and local officials have been extremely clever about inventing loopholes in the Taxpayers' Bill of Rights, and the Colorado Supreme Court has generally been deferential to loophole creation by government.) While a person has a choice about doing business with a corporation, he has no choice about paying taxes; if he refuses to pay, men with guns will eventually come to arrest him, and he will be locked in a cage and his property confiscated.

This is an essential reason why municipal bonds can pay lower interest rates than corporate bonds: municipalities can take money, whereas corporations can only earn it through voluntary exchange. Accordingly, investors recognize that the municipal bond has better security against default.

D. Corporate Welfare Bonds Should Not be Treated Like Legitimate Municipal Bonds

The bond marketplace is competitive, and the supply of money to be invested in bonds at any given time is not infinite. The market for Colorado municipal bonds -- consisting mainly of Coloradoans who want bonds exempt from their state's income taxes -- is not especially large. Denver's addition of $347 million in new debt will not have a trivial impact on the Colorado market; it will necessarily compete with new bonds issued in 2003 by other municipalities. At the margin, the Denver hotel bond issue will raise cost of borrowing for other municipalities in Colorado, making projects for legitimate government purposes (such as public school improvement, or road and parks) more expensive.

If we accept the claim of the welfare hotel advocates that the new hotel is financially wonderful when financed at a 5.5% rate, but economically impossible if financed at 9.5%, then the question arises: why doesn't the government finance every business venture which would be profitable with 5.5% financing, but unprofitable with 9.5% financing? Surely there are more grocery stores, more high-tech manufacturers, more bookstores, more athletic clubs, more businesses of every type imaginable who could open up in Denver if given tax-free 5.5% financing. Many of these businesses could, like Hyatt, present business models to the city showing that the city would make a profit in the long run by going into debt to build the buildings needed by the prospective business.

The main justification for building the convention center hotel is that the hotel is needed to attract more business to the convention center. But this argument simply highlights the error in city governments getting into private business in the first place. Private businesses are perfectly capable of building convention centers, and if they choose not to build a convention center in a city, the decision suggests that the convention center is not economically viable. But then politicians with an edifice complex decide that Denver must a great city, and a great city means big government construction projects (as opposed to well-maintained parks or excellent public schools). And before the new expanded imagine-a-great-city convention center is even opened, the taxpayers are told that the city needs to build a hotel to support the convention center.

By exempting municipal bonds from taxation, the taxpaying citizens of America must shoulder an extra tax burden. If municipal bonds were subject to the same taxation as corporate bonds, then federal and state tax revenues would increase; accordingly, federal and state taxes imposed on ordinary citizens could be reduced. Yet municipal bonds have historically been exempt from taxation because they serve entirely different purposes from corporate bonds. Municipal bonds were traditionally used to pay for the construction of facilities which would serve the public for free: public schools, parks, streets and highways, public libraries, police stations, and fire stations. Because all of these public services are provided for free, they are not supposed to make a "profit." Their purpose to create a common public good, not to generate revenue. Accordingly, it made sense for municipalities to be able to sell bonds for these projects at an especially low rate -- a low rate facilitated by exemption from federal and state taxes.

The convention center hotel bonds reverse all of the presumptions accorded to traditional municipal bonds. Although, ironically, the bonds will be issued by a "non-profit" shell corporation created by the Denver City Council, the purpose of the bonds is to construct a for-profit private business. It is true that the for-profit business will provide jobs and boost the Denver economy, but the same could be said about every for-profit business. The Hyatt Hotel will not be open to the public for free, but will be available only to people who can afford to pay to use its services -- just like every other private business.

There is another reason why, in the past, it made sense for the taxpayers to allow municipal bonds to be exempt from taxation: because municipal bonds required an affirmative vote of the people, the issuance of a municipal bond reflected the collective decision and common purpose of the community. It made sense that taxpayers, having collectively decided to endorse the bonds, would facilitate the bonds' success by exempting them from taxation. In contrast, a corporate bond was issued only by the corporation's owners, not by the public as a whole; the corporate bond could not be said to be part of some public purpose chosen in a democratic vote.

Again, the convention center hotel welfare bond is very different from a traditional municipal bond. The bond issue is structured precisely to avoid a vote of the people of Denver. There is little doubt that if the people of Denver were asked to vote on $347 million in debt to build another hotel downtown, they would overwhelmingly vote "no." Because the hotel bond will not enjoy the blessing of a popular vote of the people, the hotel bond cannot be said to reflect a common purpose for the public good, as traditional municipal bonds do.

The special privileges granted to municipal bonds are abused when they are issued without a vote of the people, or when they are used to subsidize private business ventures. Accordingly, the time has come for the Colorado legislature reform the improper use of municipal bonds. In particular, the legislature should:

III. Predictions of Easy Money

Government forecasters are telling the public that the hotel is a sure money-maker, but the facts and history suggest otherwise. This is a hotel whose advocates insist cannot be operated profitably if the hotel construction must pay the ordinary cost of capital, rather than receiving a special government subsidy. This fact alone should make one skeptical that hotel is sure to make a profit.

Welfare hotel advocates also point out that private investors in convention center hotels tend to demand a high rate of return, and that the hotel could not generate enough revenue to pay such a rate of return. Again, this is an indirect admission about the precarious financial nature of a convention center hotel. Investors demand a high rate of return as compensation for extra risks. The higher a rate of return which the investor demands, the greater a risk which the investor is being paid to assume. This is why junk bonds (significant risk of default) pay a much higher rate of return than 90-day Treasury Bills (virtually no risk of default).

In other words, the reason that private investors these days are demanding a high rate of return for investing in convention center hotels is because such hotels are considered a risky investment. Average downtown hotel occupancy rates are below 60% (RMN 4/26/02), which makes one wonder whether a gigantic new hotel in an already over-saturated market might be especially risky.

"There's always risk involved in something like this," acknowledges Cathy Reynolds, chair of the City Council's special hotel committee. (RMN 11/19/02). But there is no need for the city to assume any risk, rather than to leave all the risks to any developer who thinks he can build and operate a hotel profitably. It is especially unfair to force financial risks onto the taxpayers of Denver without asking for their consent.

The proposed Hyatt Regency Convention Center Hotel will be the most expensive hotel in the history of Colorado, exceeding even the $160 million cost of the Beaver Creek Ritz-Carlton (Rocky Mountain News 11/20/02). If everything stays on schedule, ground for the hotel will be broken in the summer of 2003, and the hotel will open in 2006. Of course anyone who is familiar with Denver's last major construction project -- Denver International Airport -- knows that promises about construction costs and opening dates aren't always fulfilled. More recently, Denver spent $18 million to build police substations which had been promised to cost $8 million. It seems questionable whether a city which does not have a consistent record of on-time, on-budget construction should attempt to build a quarter-billion dollar hotel.

Now city planners are offering projections that the city government will reap $9 million in additional taxes in 2010, and $14.2 million in 2030. In 2030, hotel is projected to generate $32 million profit. (RMN 10/29/02). Presuming that bond insurance companies support the bond (as they likely will), these projections may be considered reasonable forecasts.

On the other hand, Denver's forecasts about the benefits of business subsidies don't always come true. Denver's taxpayers are now on the hook for loan guarantees that the city gave to the now-bankrupt Ocean Journey aquarium. (Again, Denver voters were not asked for approval.) In 1991, United Airlines came to the city council and state legislature, demanding enormous corporate welfare in exchange for building a maintenance facility in Denver. The city council and state legislature hastily approved the welfare demands. Government economists provided detailed projections showing how the welfare payments to United would pay for themselves many times over in increased tax revenues from new employees.

Fortunately, United found an even more desperate suitor in the city of Indianapolis, and built its facility there. Now, United is bankrupt.

Conclusion

Although the Constitution of the State of Colorado prohibits schemes such as the Denver welfare hotel, the Colorado Supreme Court has lawlessly nullified the Constitution's prohibitions on corporate welfare. Nevertheless, constitutionally-faithful public servants and voters can and should still adhere to the Constitution's text and spirit -- just as earlier generations of Americans adhered to the Fourteenth Amendment, even during a period when it was judicially nullified.

The financing for the convention hotel amounts to a series of legal fictions, through which the private purpose of constructing a hotel is allowed to use the special financial privileges which should be used only for public, civic projects for the benefit of the entire community. The interest rate manipulations highlight the need to require voter approval of all forms of municipal debt (even those involving shell corporations), and the desirability of eliminating the state tax exemption for municipal debt which is used for business subsidies rather than for the public as a whole.

The Denver government has a record of construction cost overruns and delays, and the Denver government has a record of over-credulous acceptance of promises about making money by handing out corporate welfare.

"The business of America is business," said President Calvin Coolidge. That pro-business President, who presided over an era of unprecedented prosperity, enforced the separation of business and state more rigorously than any other twentieth century President. A government which wants to encourage prosperity and to reap taxes revenues from that prosperity needs to understand, as President Coolidge did, that the government has no role in trying to operate businesses itself, or in using public dollars for private business purposes.

The business of local government is parks, libraries, schools, and police -- not the construction and leasing of expensive hotels.

 

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