The Covid-19 pandemic will affect municipal finance in many different ways, none of them good. The optimists hope that all we have here is a cash flow crisis that will ease once normal economic activity resumes. But how long will that take? Asian countries vaunted for their responses to the virus are still seeing new cases and imposing restrictions that states in the U.S. imposed weeks ago. Clearly, some U.S. regions are far behind others in their outbreak trajectory. Do we need to wait until months after Mississippi peaks to allow Chicago’s convention center business to rev back up? If the shutdown lasts for months, even municipalities with healthy cash flows face a rocky road ahead.
Fiscally distressed cities were a top public concern in the wake of the 2008-09 “Great Recession.” Five major cities went bankrupt, and many muddled through, but without ever addressing the structural deficiencies in their budgets. Across the nation, there are certainly dozens, likely even hundreds of cities who have experienced steadily weakening tax bases and ever-growing debt levels over the last several decades. Any recession thus threatens to “seed” fiscal crises all over urban America, and this one makes states especially vulnerable.
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Less revenue
On the revenue side, cities will experience immediate hits to their sales and income tax collections. They will also see diminished property tax revenue, the largest “own-source” revenue base for U.S. localities. Any problems that landlords are facing will eventually filter their way into reduced property tax revenues. All things being equal, a building full of tenants who pay the rent in full and on time and who can be evicted if they don’t, is more valuable than one inhabited by tenants who aren’t paying rent and can’t be evicted. Maintenance will be deferred and property tax payments delayed or not made at all. Cities that try to value buildings at artificially high levels will risk property tax abatement litigation. The pandemic’s effect on property valuations and tax collections won’t be as immediate as its effect on sales and income taxes. But municipal fiscal distress can sometimes take years to develop. Hartford, Conn. needed a state bailout to avoid bankruptcy in 2017, nine years after Lehman Brothers’ collapse.
Cities will be threatened by local aid cuts from their state governments as states deal with abrupt contractions in their own sales and income tax revenues. Mayors of poor cities view aid cuts to localities as outrageously unjust, but state governments have many obligations, including mental health, higher education, and infrastructure. State commitments to Medicaid and various other safety net programs will demand more resources just when there’s less tax revenue around to fund them. To minimize cuts to any of these priorities, states will funnel less aid to cities. Local aid reductions were one of the precipitating causes of the 2013-14 bankruptcy of Detroit.
Pressures on spending
On the spending side, the stock market decline will require increased payments to defined-benefit pension systems to maintain their funding ratios. These plans cover around 80 percent of the state and local workforce. Of course, increased pension payments have been the norm since the 9/11 recession. A generation of city budget officials has never known pension costs to do anything but rise faster than revenues every year. This has given them experience in manipulating payment schedules and liability valuations. Such gimmickry, which will probably increase in the near-term, minimizes costs to current taxpayers but pushes the obligations onto the next generation and will lead to more and worse pension crises in the future. Even the most inventive city CFO will not be able forestall at least some increase in pension costs in the near term.
Cities are generally obligated by law to balance their budgets. In a recession, that normally means staff reductions, since personnel is the largest expense borne by cities and layoffs are legally easier than salary reductions and cuts to bonded debt service. In the wake of the Great Recession, states and localities shed about 750,000 jobs. But are cities seriously contemplating laying off hundreds of thousands of cops, firefighters, sanitation employees, and other essential workers? How many of the ~2,000 confirmed Covid-19 cases in the NYPD should expect a pink slip during the next six months? It is unclear how much fat cities have to trim. Nationwide, state and local employment did not return to pre-recession levels until October 2019, over five years after private sector employment did. Fears of future public health emergencies, which may emerge as early as this fall, will prompt many cities to re-assess their definition of the right size of state and local workforces.
Many challenges are now more pressing than avoiding a wave of municipal bankruptcies. Municipal finance experts point out that many, (though not all), states have relatively strong reserve levels and some hope for hundreds of billions in aid via a “phase four” federal relief package. It’s early yet but fiscal emergencies can emerge in unexpected places and take years to develop—fiscal distress sometimes has its own timeline, too.
Stephen Eide is a senior fellow at the Manhattan Institute and a City Journal contributing editor.
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