Tag Archives: fiscal health

History of Fiscal Crises

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Introduction

As we pointed out recently, from a fiscal point, there has never been a golden age for American cities. The history of cities in this country is also a history of reoccurring fiscal crisis. Our cities seem to have been in hard financial times since they first grew from small towns and added modern services.

Early Urbanism in the U.S.

There were few real cities in the U.S. until the mid-1800s. City growth was tied to industrialization. Before that, professionalized city services and major capital projects were few and far between. This kept city spending low along with the risk of overextending financially.

The founders did not comprehended cities in the Constitution, which limited its attention to powers of the national and state government. The 10th Amendment reserved rights for states to set policy on the remaining, unnamed issues. States focused their attention on enabling counties to provide limited services to the mostly rural population.

Throughout the century, local communities lobbied state governments to continually increase the scope of city responsibilities. Population growth, new wealth and new technology made cities more complex and challenging to live in. As towns grew, states supported citizen-led charter initiatives to create new cities.

By the end of the 19th century, cities had added the authority to provide the range of services, that a modern urban dweller would recognize and expect: water, sewer, streets, police, fire, waste, parks, libraries, and so on. At the same time, state governments had imposed severe restrictions on local governments that prevented cities from directly administering those services. The most common arrangement was for state legislatures to appoint boards of local citizens who would administer the budgets and staff of city departments. Even the nation’s greatest metropolis, New York, in the 1890s only had direct control over a fraction of its budget.

State control was imposed to establish political party control at the local level. Cities were now important and city jobs and contracts were key prizes in political patronage systems. State control was also motivated by a series of municipal bankruptcies from poorly thought out and executed capital and economic development projects.

Cities were growing and their economies were becoming more complex economically and, as mentioned, their citizen and business leaders were seeking more modern services and infrastructure. Under our fiscal federalism system, localities were in keen competition with each other. They began taking on increasing amounts of debt. A series of financial crises and a major economic slow-down or depression in the 1870s revealed the precarious state of these cities finances. The response was state legislatures imposing those restrictions on city operations.

Modern City Financial Crises

Things didn’t improve much in the 20th century. The public administration revolution brought a more professional civil service to the national and some state governments. The initiative had less impact on localities. Local accounting practices were still poor. This made oversight very difficult. initiatives at There have been a series of financial crisis phases in American cities so that it is questionable whether there has ever been a time when cities were financially sustainable.

Localities also innovated ways to circumvent state debt restrictions. Again, much of the debt was for capital projects, but increasingly cities turned to debt to fund their newly professionalized police and fire departments and to support growing park and library systems. Poor management practices and lack of reporting or oversight requirements meant cities were operating recklessly. This behavior was exposed by the Great Depression.

Following WWII there was another, more surprising fiscal crisis era. Our metropolitan areas were generally booming. The problem, however was that within metropolitan areas, central cities were reaching their peak population. They became land-locked, unable to annex land because they were being surrounded by newly incorporating suburban cities. At the same time, older central cities were losing middle-class households to the suburbs. In addition, there was increasing out-migration from older cities to southern and western states. These changes brought about a period of sever central city financial crisis, especially in older regions of the country.

In the last half of the 20th century, the sunbelt boomed as formerly small cities grew into large multimodal metropolitan areas. New suburban expansion in the form of homebuilding and a retail explosion fueled city coffers in the South and West. Throughout the period, many older cities either continued to decline. As in the past, economic recessions revealed that U.S. cities were not so financially sustainable, even in the Sunbelt.

The 2001 and Great Recession finally saw a change in municipal philosophy. Cities were no longer able or willing cover financial crises with a mixture of tax increases and budget cuts. Cities North, South and West used mostly budget cuts to get through the dotcom recession. The situation was even worse in the Great Recession. Throughout the 21st Century, city spending levels bounced up and down, but in most cities they have not broken through to new highs. It appears that cities seem to have entered a period of sustained fiscal stress in the good and bad years.

What’s Next?

Given this timeline, we can see that there have been city financial crises as long as there have been modern cities. As cities have grown, they have continually run up against external economic pressures that challenge the traditional ways of doing business. Changes in the larger economy have continuously threatened cities as they first scrambled to modernize to serve an industrial population, and in recent decades, as population migration and economic change pulled the rug our from under these cities again. What can be done about it?

The answers are likely to be different for each community. Our brief fiscal history here only hinted at some of the many causes of fiscal stress for U.S. cities. The solutions will involve addressing the ways cities operate, their financial practices and the way they deliver services. A better way forward also means shifting away from the high-cost, subsidized economic development practices that more than once have undermined the fiscal health of communities they were attempting to help. In the following weeks, we will take a closer look at specific fiscal threats to our cities and what can be done about them.

Causes of Fiscal Stress

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Introduction

We spent the last several weeks outlining a framework to improve municipal financial sustainability including goals, indicators, community engagement and long-range planning. Today we introduce potential sources of fiscal stress for America’s cities and towns. Every community is unique, but many of these factors are impacting most places.

Two Centuries of Change

There was no golden age of sustainable urbanism in the U.S. Urban America has grown and changed continuously for two hundred years. (Before that there was no significant urbanism, only a handful of small towns.) Towns grew into cities and conditions and concepts of fiscal health changed with them. These changes altered what was economically viable for businesses, households and city governments. Population growth, new techniques and modes of organizing were reinforced by new energy sources like coal and oil. Growing wealth, knowledge about public health and sanitation and political and cultural changes increased demand for more services and influenced the way cities were built and the way municipalities operated. As cities aged and economic competition increased among them winners and losers emerged and economic health varied across the country. Always, these shifts influenced new rounds of public and private cost-benefit calculations.

The simplest definition of municipal financial health is that municipal operations are not so large or complex to be sustained through its existing revenue system. The local private economy that is the source of wealth for government operations may or may not be capable of supporting higher revenues. That circumstance will vary from place to place. When a city’s circumstances change from fiscal health to fiscal stress it may be because of internal or external changes or both. Solutions will also vary depending on local circumstances. Changing service levels, trying to enhance the local economy or both may make sense. Making the right choice as a community depends on what specific factors contributed to the fiscal stress. There are several candidates to consider. Some of these changes have been happening throughout U.S. urban history, others have been more important at certain times. Some are a bigger factor in some parts of the country that others. We present these in no particular order, though evidence exists for all these in at least some cities today.

  1. Landuse that no longer takes advantage of traditional urban form (positive spillovers from proximity and agglomeration.) Spatial segregation of uses, too much private land in unproductive uses like parking and setbacks are examples. This requires more infrastructure per acre and more municipal fleet and staff requirements to serve the private sector.
  2. Economic changes in the location, size and mix of industries and businesses. Technology change and continuing competition shift the fortune of local industries. In some communities, the tax base declines. There are also fewer self-employment opportunities nationally as industries become dominated by larger firms.
  3. Shrinking tax base from a shift in tax types. Over the 20th Century, taxation generally became more regressive. Property taxes and sales taxes tend don’t generally increase proportionately to higher household incomes.
  4. Changes in fiscal federalism. Federal government aid to cities grew over the last century, but began declining in the last 40 years. Many states have not increased local aid, resulting in a net decrease in this revenue source to cities.
  5. Post WWII pension and retirement benefits have become a growing burden for local governments as their workforces matured. The dependency ratio increased as even the Sunbelt boom towns built out. Health costs have recently grown much faster than than any revenue source or other spending categories.
  6. Higher debt service. This may be a symptom of stress when it results from using debt for operations. It can be a contributor to stress when the underlying economic base weakens and what looked like prudent investments in years past become stranded sunk costs.
  7. National and regional population migration that weakens the markets of origin and increases service demand in the destination markets. Origin cities see a decreasing private sector trying to support the operating and infrastructure of a formerly larger city.
  8. City growth. As cities grow in population, their spending per capita increases faster than population growth. This has been the case since industrialization in the mid 19th century. Americans continue a long-term trend of crowding into larger cities and suburbs where demand and provision of services is at a much higher level than in small cities and towns.
  9. New awareness of public health and environmental risks promoted greater demand for infrastructure upgrades especially in water and sewer systems. Citizens have also generally demanded high levels of public safety protection.
  10. Technology innovation has also added to the service burden of cities. For example, development of steam-powered fire engines allowed a smaller crew, and lower brigade costs. However, formerly volunteer or privately funded services moved onto municipal books.

This is a long list and we will spend much of the new year taking a closer look at some of these. Finding answers for financially strapped communities means not making reactionary decisions. Solutions based on fads or what another community tried can squander scarce resources. Cities did not become fiscally stressed overnight. Some of these trends have been in place for well over a century. Change for the better will probably need to be gradual and thoughtful as well. There is no golden age of American urbanism to return to, but most every community has the capacity to make positive changes. We will need to work out the answers that make sense in each place.

Next Week

Next week, we will present a few predictions for economic development and municipal finances for 2017. If you would like to know more about how Axianomics can help you put your community on a more sustainable path let us know.

Indicators for Fiscal Sustainability

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Introduction

We are continuing our series on building a more fiscally sustainable community. This week we will look at standard fiscal indicators and how they can help local leaders make more sustainable fiscal and economic choices.

Broad Categories of Indicators

There are two broad categories of fiscal and economic indicators. The first category covers economic or social activity outside the organization. These include measures of community population, jobs and other economic and demographic indicators. These are important because they determine municipal resources through the tax base. They also influence need for municipal services and infrastructure spending.

The second class of indicators measure features of municipal operations and finance. These are internal or organizational indicators. These reflect a combination of policy choices by the city and the influence of external indicators.

There are many metrics in each category. Our review will focus on high-level, summary indicators. After starting with these high-level indicators, each community may want to identify more detailed metrics that are important for its circumstances.

Revenue Indicators

Most cities begin budgeting and planning by reviewing revenue performance and projecting future revenue. This is practical, but communities could just as easily start budgeting by looking at service needs. It would be an interesting experiment if a community were to begin budgeting with an ongoing engagement process similar to the one we discussed in recent posts. The goal would be to developed a budget that citizens were willing to pay for. This might support sustainability by starting with citizen willingness to pay rather than automatically budgeting to the maximum available revenue. Whatever process a city uses, key revenue indicators for sustainable finance include:

  • General operating revenue by source in total and per capita terms
  • Grant and other inter-local agreement revenue

Operational / Service Indicators

City revenue sources differ some from state to state, but spending priorities are similar. Public safety, parks, libraries, streets and other infrastructure dominate general fund spending in every city. Detailed studies of major programs can find potential improvement and efficiency opportunities, but tracking overall spending is a good place to start. Important service indicators include:

  • Growth in total and per resident expenses by function or department
  • Total employment by function and department

Operating Position Indicators

A city’s operating position means its ability to balance its budget on a current basis with current revenues. A sound operating position will support day-to-day liquidity and prevent a city from having to dip into operating reserves for ordinary expenses. Every city will experience periodic emergencies, but repeated drawdown of reserve funds is a sign of long-term structural financial problems. In these cases, a city needs to have a serious conversation with taxpayers. The community needs to decide if it is willing and capable of supporting current service levels or whether city operations need to be simplified. The most important operating position indicators include:

  • Total annual revenue minus total spending
  • Liquidity measured by ratio of cash and short term investments to current liabilities
  • Fund balances

Debt and Infrastructure

It can be helpful to citizens and decision makers to report debt indicators with key infrastructure indicators. This will improve understanding of the conditions of city capital assets in the context of debt capacity. Key debt and infrastructure indicators include:

  • Net debt per-capita
  • Total debt-service as a percent of tax base
  • Road, bridge and other asset conditions

External Indicators

There are many economic indicators that help local leaders understand what is influencing city spending and revenue. The most important to track are total population, total households, household income and jobs in the city. Central cities may also be interested in measuring commuting and other indicators of how their services are supporting nonresidents.

Fiscal analysts and economists have identified hundreds of potentially useful indicators. It is a good idea to start with a small set and learn what you can from them. Any community will gain important insights from the few listed above. For more detailed information you can consult the Government Finance Officers Association and the International City/County Management Association.

Next Week

Next week, we will look at the long-term financial planning process for fiscal sustainability. For more information on how Axianomics can help your community build and use a fiscal trend monitoring system, fill out our contact form.

Municipal Fiscal Health

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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.