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The authors, who wrote the National League of Cities' City Fiscal Conditions in 2008, adapted the report for Government Finance Review. The annual survey report was released in September 2008.
The recent financial turmoil on Wall Street had well-publicized effects on Main Street. But the current and pending fiscal challenges facing cities, other local governments, and states will also affect Wall Street and the health of the U.S. economy Combined, the state and local government sector comprises 13 percent of the U.S. gross domestic product, according to the U.S. Bureau of Economic Analysis. When local and state governments are hurting, the nation is hurting. Three sets of concerns are worth highlighting: the effects on cities of problems in credit and capital markets, stemming from the global financial crisis; the fiscal conditions in cities, in relation to the broader economic downturn; and the fiscal conditions of state governments, and the implications for resulting state aid to cities.
THE FINANCIAL CRISIS AND CREDIT
One set of challenges facing many local and state governments is the lack of credit that is a result of the global financial crisis. The inability or unwillingness of financial institutions to lend money is constraining public- and private-sector borrowing in the shorter and longer term.
In the very near term, some local and state governments have an immediate need for short-term access to credit. Local and state governments need access to credit to pay the men and women who police our streets, teach our children, and collect our trash. Very often, state and local governments depend on short-term credit to float between revenue streams. Most local revenues are collected at different intervals throughout the year, and cities often access short-term credit, through banks, that is secured by the promise of these future revenue collections. If that credit is suddenly limited, or the costs associated with the borrowing increase dramatically as a result of interest rate increases (the interest rate on variable-rate bonds, for instance, climbed from 1.79 percent on September 10, 2008, to 7.96 percent on Sept. 24), it is then more difficult for local and state governments to pay their bills. Early warning signs on this front emerged at the state level when the governors of California and Massachusetts requested federal assistance in the event that their state treasuries would be unable to find credit to cover their short-term obligations. Nevertheless, there are signs that the short-term borrowing challenges may subside in the coming months.
Yet, in the longer term, there is larger concern that financial market turmoil is curtailing the ability of cities and states to borrow money for ready-to-go capital projects like roads and bridges. The struggles in the credit market mean that there are fewer buyers for municipal bonds or that the costs of borrowing are increasing because of interest rate hikes. A quick scan of stories from around the country in September 2008 revealed that many jurisdictions canceled or delayed bond issuances for capital projects, or had difficulty finding financing, including:
* Kansas Missouri, which canceled $200 million in water financing bonds.
* Billings, Montana, which had trouble obtaining $70 million in bond financing for a hospital emergency room.
* Arlington, Texas, which delayed seeking financing for $180 million in bonds.
* Fresno, California, which could not obtain funding for a $15 million bond for library construction, resulting in the city having to cover the financing from its annual budget.
Similar stories have been written about local governments in North Carolina, Virginia, and Tennessee, noting that they are either having trouble obtaining financing bond issues or are delaying bond issuances in hopes of more favorable conditions.
The cancellation or delay of capital projects at the local and state level is more bad news for the national economy Capital projects create jobs, generate economic activity through the purchase of materials and supplies, and establish a foundation for private investment.
CITY FISCAL CONDITIONS IN 2008
However, concern about capital projects and municipal bonds is not solely a function of turmoil in financial markets. The fiscal health of cities, overall, is also a major concern in light of the larger economic downturn.
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In September, the National League of Cities released its annual survey report, City Fiscal Conditions in 2008, pointing to a number of concerns about the fiscal and economic health of cities--currently and over the next several years. The survey of city finance officers, conducted each spring-summer since 1985, raised a number of warning signs for cities.
In 2008, 64 percent of city finance officers reported that their cities are less able to meet fiscal needs than they were in 2007. This is dramatic shift from the 2007 survey, when 70 percent of city finance officers said just the opposite--that their cities were better off financially than they had been in 2006. Looking to 2009, 79 percent of city finance officers predict that their cities will be worse off than in 2008.
Many city finance officers predicted that by the close of fiscal 2008, both general fund revenues and spending would decline (in inflation-adjusted terms). Revenues are predicted to decrease by 4.3 percent, and spending by 1.5 percent--leaving a budget gap of 2.8 percent. Since state law requires cities to balance their budgets, that gap will have to be closed by the end of the fiscal year through spending cuts, tax and fee rate increases, or drawing down available reserves.
Of course, the situation is not the same across the country. Local tax and revenue authority can vary greatly, depending on state law. A recent report from the National League of Cities (NLC), Cities and State Fiscal Structure, examined state-local fiscal arrangements and found that, in terms of local tax authority;, there are essentially three regimes in place around the country. Some states authorize cities to levy only local property taxes, which is common in many of the Northeastern states. Some states authorize the use of local property and sales taxes, which is fairly common in Western and Southern states. Other states such as Ohio, Kentucky, and Michigan (for some cities) allow a local income tax in combination with property or sales tax authority. In some cases, local income taxes are also authorized for individual cities, usually larger cities such as New York and St. Louis and Kansas Missouri.
The variation in revenue authority around the country usually means variations in the impact of economic downturns--some taxes, and therefore some cities, tend to be more or less affected than others. However, for 2008, for the first time in the 20-year history of the NLC survey, city finance officers predicted that all three major sources of general fund tax revenue--property, sales, and income taxes--will decline at the same time.
Beyond the shorter-term credit crisis, this troubling trend in city revenues points to the need for economic bases of revenue to start growing again. Revenue from property sales, and income taxes makes up a large portion of the money local and state governments use to pay for day-to-day needs. These revenue streams are driven by what happens in the broader economy These revenue sources diminish as the value of homes declines, the sale of new homes slows, the unemployment rate rises, wages fall, and consumer spending decreases.
Most experts predict that the low point of the economic downturn will occur in the first or second quarter of 2009. What this likely means for cities is several years of declining fiscal conditions as the sources of revenue catch up with changes in the economy There is always a lag between economic shifts and city revenue collections. Following previous recessions in 1991 and 2001, the low point for city revenues occurred in 1993 and 2003--18 to 24 months after the low point of the recession.
STATE AND FEDERAL CHALLENGES
State and federal governments are facing fiscal and economic declines as well, which will likely increase the challenges facing local governments.
In October, the Center on Budget and Policy Priorities reported that 27 states and the District of Columbia faced mid-year budget shortfalls totaling nearly more than $12 billion. (1) Most experts think the number of states facing shortfalls will reach 30 to 40 states, and the size of the shortfall will be in the $40 billion to $50 billion range.
Ray Scheppach, executive director of the National Governors Association, summed up the situation this way: "The bottom line is that states are facing a very difficult fiscal outlook over the next two to three years. This economic downturn will likely be longer and more severe than any states have experienced since the downturn of 1982 to 1983, when unemployment hit double-digit levels. In short, the fiscal situation for states could get really ugly.
As most local government officials know, state fiscal difficulties often result in cuts in state aid and transfers to local governments and transfers of responsibilities for services and programs. Those actions are likely to come at the worst time for many cities.
The federal government is also facing a budget deficit that is likely much larger than is currently being reported and may be unprecedented in the nation's history. A recent analysis published in State Tax Notes estimates that when accounting for slower-than-projected revenues and the costs of federal legislation such as economic stimulus, tax cut extensions, and the federal economic rescue plan, the actual size of the 2009 federal deficit might reach $914 billion, or 6.2 percent of the U.S. gross domestic product. (2)
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