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.

Sustainable Municipal Finances

Introduction

Cities and towns across the nation are struggling to maintain infrastructure and levels of service. These municipal programs were created and expanded to support wave after wave of new households after WWII. Most subdivisions and shopping centers were built to accommodate these new families. They were built to accommodate the peak of these families’ commercial activity. Those young founding families aged and their spending and economic activity changed. The municipal services needed and demanded by those young families are still in place. Many of those communities have changed so much that they no longer generate the tax base needed to keep municipal services running. Fiscal sustainability for cities comes from strengthening the tax base, but also from improving the efficiency and effectiveness of city services.

Municipal Financial Pressure

This last month, we engaged local leaders from across Texas through several state conferences. We participated in Texas Municipal League, Texas Economic Development Council and the Government Finance Officers Association of Texas. As expected, the topics were wide ranging, but a common thread ran through them all. Municipal financial sustainability is on the lips of panelists, speakers and attendees alike.

Communities across the state face growing inventories of aging and failing infrastructure. The scope of the challenge includes every component of municipal capital: streets, storm sewers, water mains, street lights, facilities, equipment and computer systems. Even the more prosperous communities have a growing maintenance challenge.

Likewise, municipal operations and staffing is a challenge. Municipal services need upgrades, and new technologies mean city staff need more advanced skills. Local governments have an older than average workforce and are competing with the private sector for many of the newly needed skills. Pensions and retiree health costs are a growing expense for many governments.

In recent decades, Texas cities, suburbs and towns grew and government finances grew with them. Cities built their infrastructure to accommodate this growth and design standards increased the scope and scale of many infrastructure projects. It is becoming clear that this pattern of growth has had consequences for the sustainability of local governments. Today, the economic foundation in many communities cannot support that level of municipal services.

Waves of Growth

The growth that benefited so many communities in the past, especially in the 1960s, 1970s and 1980s, took the form of adding new fully-built subdivisions. These communities were built quickly, at about the same time with essentially identical residential and commercial real estate. Their founding families were mostly at the same point in their economic life cycle. They bought the new homes and began filling them with children, furniture, appliances and clothing. This supported the large retail centers being built on the edge of growing cities.

Those founding families eventually entered a less spendthrift phase of life. The children left for college and jobs. The spending has decreased as retirement becomes a more pressing concern. The shopping centers that were built for peak use struggle to stay open. Many now present fading marquees, pot-holed parking lots and too many dollar stores.

This is not a new process. City neighborhoods have gone through these cycles for generations. The challenge today is that so much of our urban environment is experiencing this trend at once. Even more serious is that entire cities were built at the same time and now face across-the-board challenges as every neighborhood experiences this relative decline. This has consequences for the sustainability of our municipal governments.

For many years, the conversation among local leaders has been about how to grow their way out of this situation. Traditional economic development strategies are unlikely to make much of a difference for most communities. Most places are off the site-selection radar. Their challenge is to make better use of their existing assets, grow from within and focus on core municipal responsibilities. Aligning services to support a more sustainable economic model and better infrastructure management are the immediate concerns.

Next Week

We will continue exploring the evolution of local government services created to support post WWII growth and what cities and towns can do to improve their financial sustainability. In the meantime, sign up for email updates and let us know how we can help.

Economics and Politics of Property Taxes

Introduction

Property taxes are the largest source of general fund revenue for local government in Texas and across the U.S. This tax is more stable than sales taxes when it comes to economic cycles. It is also more important in Texas than in most other states. It often escapes public perception, but cities account for a very small share of the total property tax burden.

Property Tax Nationally

The Rockefeller Institute refers to property taxes as the financial backbone of local government in the U.S. It accounts for nearly three-quarters of total local tax collections and is the main way localities fund K-12 education, police, fire, parks, and other high-profile services. Property taxes are also the foundation of a local government’s capacity to issue debt for capital projects. Local governments collect over $400 billion annually in property taxes.

Texas Property Tax

The current property tax system in Texas dates from 1979. In that year, reforms were implemented to the local property tax process and the final vestiges of the statewide property tax were eliminated. In Texas, counties, cities, school districts, municipal utilities, community college districts and other special districts may levy a property tax.

Property tax is levied on land, improvements (structures) and revenue-generating personal property (also known as business personal property.) When homeowners and businesses receive their estimated tax bills in the fall, they are seeing the combined tax owed to all local governments. According to data from the Texas Comptroller, in 2014, $49.1 billion in property tax revenues were collected by local governments. The largest share was for school districts. Schools consumed 55 percent of all Texas property taxes. Counties took the second largest amount at 17 percent. Cities accounted for only 16 percent of the total. Special districts claimed the remaining 13 percent.

Residents and businesses often fail to notice the distinction when faced with the total tax bill. This can be a challenge to city leaders. Not every household has children in the local schools, but core city services are familiar to all and used by many. In the public eye, their total property taxes may appear to go entirely to support police, streets, parks and libraries. It is easy for citizens to note deficiencies with these city services and then compare them to their total tax bill.

The risks for city leaders is compounded because total collections by other local governments is increasing faster than for cities. Since 2009, total property tax collections have increased by 23 percent. City property tax revenue increased by 19 percent. At the same time, school districts took in 23 percent more revenue. Counties saw a 25 percent increase in property taxes. City leaders may need to assume a greater role in educating constituents on this issue.

Economics of Property Taxes

Property taxes are a sort of stabilizer on municipal budgets. In economic downturns, appraised property values respond slowly. The full effect of a downturn may take several years to be registered in property values. Nationally, property tax revenue fell for three years after the bottom of the Great Recession. If that decrease had been as quick and automatic as the decrease in sales taxes, the necessary budget cuts would have been devastating to local governments. The slower decrease gave local leaders time to streamline and reorganize services. Further, since cities set their rate annually, they have some flexibility in adjusting to changing economic conditions.

In Texas, state “Truth in Taxation” automatically gives cities an effective tax rate that yields the same revenue as last year. Falling property appraisals drive up these effective tax rates automatically. By simply adopting the effective rate, a City Council can avoid the risk of a roll-back proposition and election. In very difficult economic times, however, City Councils may choose to adopt a lower than effective rate, but they need not do so under state law.

This process works in reverse as well. In a booming real estate market, the slow adjustment of appraisals, and in Texas, the threat of a roll-back election, puts a damper on municipal budget growth. This also helps city leaders by encouraging them to plan carefully. There is a perpetual need for basic services regardless of where we are in the economic cycle.

Next Week

Come back next week where we will look at the second largest general fund service for most cities – fire / rescue operations. In the meantime, sign up for email updates and let us know how we can help.

Sales Tax and Retail Sales

Introduction

This week we look at sales tax revenue. We also report the latest retail trade statistics. In Texas, many industries pay sales tax. Retail sales is a major part of that total, especially in some smaller communities.

Sales Tax System in Texas

For most Texas cities, sales tax is the second largest source of general revenue, after the property tax. According to information we received from the Texas Municipal League, statewide, 28 percent of general fund revenues come from sales taxes. Property taxes contribute 35 percent. Most cities levy a sales tax. Other local jurisdictions also have the opportunity to levy a sales tax under some circumstances.

The Texas Comptroller administers the sales tax. The Comptroller collects the entire sales tax levy statewide. It keeps the State’s portion, then allocates each localities’ share. The State of Texas levies a 6.25 percent tax on certain items. There are many exemptions. In fact, according to the latest Comptroller data, only 25% of gross sales are subject to the sales tax. Total gross sales in Texas were $432 billion in the first quarter of 2016. Of that total, $109 billion was subject to sales tax.

Local governments may levy up to an additional 2.0 percent sales tax. Many cities levy a one cent tax for general revenues. Also, by referendum, communities can levy additional sales tax designated for special purposes such as offsetting the property tax rate, streets and economic development. Transit authorities also absorb some of this local tax capacity. If a city is not using its maximum 2.0 percent, the local county can claim the unused amount and levy a sales tax. This is not common in Texas.

Latest Sales Tax Performance

We assessed the latest Texas Comptroller data. The recent slump in the energy industry continues to take a toll on the Texas economy. For September, total sales tax revenues are down 3.9% compared to September 2015. Because of slower reporting for the local allocation, we will look at data ending in August for local governments. For the twelve months, ending in August, localities pulled in 6.2% less sales tax revenue than in the twelve prior months. The situation will differ from place to place.

Retail Trade and National Retail Sales

In Texas, 24% of gross sales come from the retail sector. Other industries like utilities and media account for the majority of sales tax revenue so local leaders need to consider their overall industry health when assessing their sales tax revenue prospects. The retail share will tend to be higher for small cities, especially if they have a lot of highway frontage or large tourist sectors. Within the retail category, less than half of gross sales are subject to tax. Groceries are a notable and large example of exempt sales.

We can get detailed retail performance information from the Census Bureau’s monthly retail trade survey. Nationally, retail sales are doing better than they are in Texas. From September 2015 to September 2016, national sales are up 2.7%. These number, however, are not as robust as they seem because they are not adjusted for inflation. This means sales are probably positive, but not booming. Over the last year, several retail sectors have seen growing sales including: furniture and home furnishings (+2.7%), building and garden materials (+5.6%), clothing and accessories (0.7%) and food and drinking establishments (+0.8). Sectors that saw falling sales over the year include: electronics and appliances (-3.8%), gas stations (-3.4%) and department stores (-6.4%).

This is not a great report. National data continue to paint the picture of an economy that is moving sideways. There are some benefits to consumers from lower gas prices, but as can be seen in this data, there are even bigger hits to major retail sectors. Since the Great Recession, wage growth has been slow and many jobs added during the last few years do not pay as much as the jobs that were lost.

Local governments in Texas are accustomed to booms and busts. The current slowdown should not be a surprise. There are ways to prepare for lean times. Prudent budget and operational planning, maintaining adequate fund balances and making surgical economic development investments are critical to prevent unnecessary budget pain down the road. It is also essential for local leaders to pay attention to their local economies and the wider state and national situation. We encourage you to reach out to us if you want to discuss how Axianomics can help you make more confident fiscal choices in these uncertain economic times.

What’s Next

Next week, we will look at local property taxes in Texas. Tax bills are going out and a common challenge for local leaders is helping their communities understand the composition of the total tax burden, which supports more than just cities.

Economics of Policing

Introduction

Effective policing is critical to society. The police are the most visible demonstration of government’s monopoly on the use of force. Government’s very legitimacy depends on effective and fair policing. Policing is also critical for economic stability in a community. Public safety and the protection of property are the foundations to any successful economy. Finally, policing is a huge focus of government spending. It usually represents the largest piece of cities’ and towns’ operating budgets. Local leaders and their stakeholders should pay closer attention to the economics of policing. Except where mentioned, the statistics in this post come from the Bureau of Justice Statistics.

Scope of Policing in the U.S.

There are about 700,000 police officers in the U.S. Two thirds are at the local level. Two thirds of local officers are with city departments. The rest are in sheriff’s departments and special districts like transit, university and school district departments. Three fourths of the nation’s police departments have 25 or fewer officers. Fully one-third of all officers work in large forces with 1,000 or more sworn officers.

Context Before the Great Recession

A 2013 report by the Justice Policy Institute reviews trends in policing in the decades before the Great Recession. To summarize, the public response to rising crime rates in the 1970s and 1980s took the form of more resources devoted to policing and new policing policies. Beginning in 1994, the federal government provided funds for local departments to recruit and train 100,000 additional officers in community policing tactics. This strategy coincided with zero-tolerance policies and included among other initiatives, the war on drugs. The result was a dramatic increase in police encounters, arrests and incarcerations. Over the same period, there was a dramatic decrease in violent crime. Reported incidents fell almost 50 percent from early 1990s to the Great Recession.

Conflicting Evidence of the Recession’s Impact

Nationally, total spending on police by local governments continued to grow through the Great Recession. Total spending was $72.6 billion in 2007 and had increased to $84.0 billion by 2012. These national totals contradict survey research and other anecdotal reports from departments at the time. The Police Executive Research Forum began surveying departments in 2008 to assess police department responses to the recession. For various reasons, local government budgets felt the effect of the recession three years after the national economy hit bottom. In 2010 half of the departments being surveyed were still facing reduced budgets and 40% planned to have additional cuts in 2011. This was two full years after the official end of the national recession.

It may be that some of the media stories and survey studies at the time were capturing what were actually reductions in the rate of growth in police spending in some communities. Another possibility is that the uneven impact of the recession caused dramatic cuts in some communities but only slowed spending increases in others. There were dramatic examples of departments in poorer communities reducing their forces.

Nevertheless, across the U.S., police departments reported several other strategies they were implementing to manage budgets after the recession. These included: prioritizing calls and not responding to low-level crimes, hiring private security officers for some services, civilianizing portions of the police process, mergers of local departments and sheriff’s offices. It may be that departments faced with several years of lower than historic budget growth were increasingly scrutinizing their spending.

Future Efficiency and Effectiveness Concerns

Regardless of whether a given local department had to actually cut its budget or just slow the rate of growth, several challenges remain for local leaders who will be making the decisions on police policy and spending. Three in particular include:

Continued competition for talent among some departments and with the private sector. Talent is the number one issue when it comes to more effective policing. The key to effective use of that talent is better, ongoing training and better human resource management, particularly supporting officer health.

Improving community relations. Communications, engagement and transparency are perhaps some of the best ways to build a baseline and track police effectiveness and efficiency. Citizen involvement and departmental transparency help improve public perception of policing.

Better use of technology is a third key efficiency and effectiveness focus. Recent work by the RAND corporation highlights that the human factor in technology is an essential gap. Needs include better information on best practices, training on the use of technology including social media, and procurement and deployment of new tools.

All three issues are key drivers of police spending. They will need to be addressed by local leaders who want their governments and police forces remain effective and be even more responsive to unique community needs. There is a role for analysis in each area. This includes a focus on efficiency that goes beyond typical pay and pension debates that surround police finance. Long-term sustainability of effective policing requires better police practices that address community needs, fairness and efficiency.

What’s Next

Next week, we will highlight some of the most interesting local government finance trends and studies we discovered over the last month. In the meantime, let us know how we can help you nurture your community through better decisions.