Municipal Fiscal Health

Introduction

Last week, we noted how city sustainability has been made more difficult by prevailing financial and development practices. Before we can discuss solutions, we need ways of measuring fiscal health of a community. There is little consensus on these. The fiscal constraints cities face and their unique responses complicate accurate measures of fiscal health.

Constraints on City Fiscal Health

Before looking at a few specific definitions of fiscal health, we need to appreciate some fundamental constraints that limit local leader’s flexibility in making fiscal and economic choices.

Cities must balance their budgets. State laws require cities to approve balanced budgets. This forced discipline helps , but doesn’t always prevent, cities from making catastrophic financial problems. Cities, unlike the national government, can’t print their own currency. They may still fall into a trap of using debt to cover operating costs. Eventually this is unsustainable also because debt funding must be repaid from ongoing revenue.

City revenue authority is granted and limited by state law. States grant cities general and dedicated revenue options. In no case do cities have total flexibility on how they raise revenue. Most states permit their cities to levy a property tax and a sales tax. Some states permit other local taxes on income or business operations. States impose maximum tax rates and administrative procedures for raising revenue. It has been a trend for state legislatures to tighten these restrictions. For instance, Texas cities face the potential for a reduction in their property tax rollback rate from 8 percent to 4 percent in the upcoming 2017 legislative session.

It is hard for cities to escape debt through bankruptcy. Federal bankruptcy law requires a majority of each class of creditor to approve any debt resettlement. Further, the default judicial assumption is that cities can always increase taxes or raise fees – that they can always cover debt service. State policy also influences this option since states must explicitly give their municipalities permission to declare bankruptcy.

Cities differ in the expected scope of services they need to provide. Expectations on the type and level of services vary from state to state and across cities of different sizes. This often limits the options a city has in making financial decisions. Every public service has a constituency that is interested in its continuation. Cities do ultimately have a great degree of legal flexibility, but what they can accomplish in practice depends on how well they can engage their citizens and communicate both the costs and benefits of services. Then they may be able to secure public support for significant spending changes.

Many Concepts of Fiscal Health

Keeping the above fiscal constraints in mind, it has been difficult for practitioners and researchers to agree on a single definition of fiscal health. In reality, a single definition might not be useful in every circumstance. Some of these are more meaningful for internal operations and some are more useful for communicating with citizens. Others interest potential investors and bond rating agencies. Some of the common concepts include:

Fiscal health – the extent to which a city’s financial resources exceed its spending obligations

Fiscal strain – comes from a failure of the locality to adapt to changing economic and fiscal challenges

Fiscal stress – is a difficulty in balancing the budget (related to the potential for the city to raise taxes or fees)

Financial condition – depends on the relative level of city revenue to spending at a given time

Fiscal capacity – ability to generate funds from a city’s own revenue (measure of revenue autonomy)

For many of these, qualifications for health apply, including not regularly tapping into reserve funds or using debt to balance the operating budget.

Even these terms don’t share universal agreement. The common denominator seems to be the different emphasis each definition puts on the spending verses the revenue side. A financial problem can be solved by adjusting either. Some cities are in a better position to make various changes and that is the ultimate key to crafting a sustainable fiscal strategy. The policies of city management and other local leaders are they key variable to success. This includes the way cities respond to external economic conditions. If the local economy is strong, city leaders may be able to increase revenue somewhat and not damage the perception of the government or endanger economic development. When economic or political conditions make it hard for cities to increase revenue, the only solution is on the spending side.

Next Week

Most of the most important factors that influence city fiscal health are out of its control. These include national and state economic trends, (including federal monetary and fiscal policy) and long-term demographic trends. Local leaders must understand these trends and how they impact their fiscal and development choices. Making choices to adjust revenue or spending need to happen with an awareness of these external factors.

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