Cities Need More Fiscal Supervision By State Governments

Four years after the end of the recession, cities’ fiscal outlook remains unpromising (discussions here and here, esp. 53-6). Spending on healthcare and pensions continues to rise faster than revenues, crowding out spending on basic services. Though Detroit-style insolvencies will continue to be rare, without reform, they will be more common than in the past. To strengthen budgets, states should exercise more fiscal oversight over local governments.

This is not a popular idea. For one thing, local government is Americans’ favorite form of government, consistently receiving higher favorability ratings than state and federal government (way higher in the latter case). If we take voter turnout as a rough measure of familiarity with government operations, then we must surmise that American’s widespread admiration for local government is based largely on ignorance. Perhaps if people voted in mayoral and school board elections as regularly as they did in presidential elections, city hall would be as unpopular as Washington. But, as things stand, David Brooks and the public as a whole now seem to regard local governments as those least in need of reform.

Another obstacle to increased oversight is that states don’t want the job. Too often, states are content to pass the buck to local decision-makers. They actively avoid aggressive oversight, which tends to be high-risk and low-reward. State interventions provoke resentment from local officials and produce few new friends. Interventions stabilize budgets; they don’t turn cities around or return them to glory. That may take decades, if it happens at all. Oversight is thankless work, which is why, from New York City in the mid-1970s to Detroit at present, state governments put off intervening until the last possible moment.

Finally, state governments are hardly the model of fiscal competence. They have run up massive pension and retiree healthcare deficits, they are dominated by special interests, and their tax systems are outdated and shortsighted.

But if increased state oversight were an easy sell, we would see more of it. The logic begins at the extreme: insolvent cities clearly need more oversight. Cities become insolvent because of incompetence and a lack of political will. States then must step in to provide expertise over fiscal and administrative functions and/or the will to make difficult choices through a control board or receiver. Since cities are the legal creations of state government, states have an indisputable right to intervene, and they also have a duty to do so. Whether state taxpayers realize it or not, they have potential exposure to local distress, through increased borrowing costs for other municipalities within the same state ("contagion"). Even municipal bankruptcy requires state action—no city can declare bankruptcy without being authorized to do so by its state government.

Most states don’t have general intervention systems in place, which define, in advance, how to manage distress from its earliest warning signs all the way through to bankruptcy, if necessary. Most interventions are executed by means of ad hoc legislation. More states should adopt general intervention laws similar to Michigan’s Public Act 436. Even when a small city falls into distress, it typically requires a major policy response from state government. Events can move rapidly, leaving little time for deliberation; an a priori articulation of the powers state authorities have to address distress will minimize controversy and enable the strongest response.

A general intervention system will require an early monitoring system. New York State comptroller Thomas DiNapoli recently established one; California’s Bill Lockyear would very much like to. Of course, treasurers and comptrollers have little real power. All they can do is raise awareness of the problem. If shame won’t suffice to restore solvency to cities, Governors must get involved.

States should require stronger local fiscal management practices. Of highest priority is multiyear planning. Most localities don’t project their costs and revenues out beyond the coming fiscal year. To give themselves, taxpayers, and the media a clearer account of their fiscal health, local governments should develop and publish plans of at least 4-5 years. States should also consider placing tighter restrictions on reserve balances, debt, and taxes. As the case of Detroit illustrates, high taxes in a poor city is a policy catastrophe. Massachusetts allows its local governments to tax businesses at a higher property tax rate than individuals. Since businesses don’t vote, this power has been grossly abused by poor cities and should never have been granted in the first place.

One useful oversight model is the North Carolina Local Government Commission (LGC), an obscure state agency with something of a cult following in public administration and public finance circles (here, here, and here). The LGC must sign off on all local debt issuances, making North Carolina the only state with this responsibility. It actively monitors property tax collection rates and other fiscal indicators and will not allow localities to issue any debt if their fund balance (reserves) drops below a certain point. Although it has the authority to intervene aggressively, it almost never has to, operating mostly through a milder, advisory role. Ratings agencies regularly cite the LGC’s effectiveness as a factor in granting strong credit ratings for both state and local governments in North Carolina. That’s the clearest evidence that cities benefit from stronger state oversight-their credit rating go up and borrowing costs go down.

As I have argued elsewhere, cities do deserve more autonomy over some functions, such as labor relations. Cities’ most significant fiscal problems are rooted in personnel spending—chiefly pensions and health benefits for active and retired employees—and any way that states can increase local management’s leverage over labor will help provide budget relief. This is obviously most urgent among blue state cities.

But more autonomy won’t be enough, for the simple reason that we can’t trust that all local officials would use their enhanced bargaining leverage. States’ attitude should be "trust but verify"—empower local officials inclined to do the right thing, and pressure those who aren’t.

To sum up, local budgets now have little margin for error. While it would be appropriate to increase local autonomy in some areas, there is little evidence for the view that broad-based mandate relief alone would produce broad-based budget relief. Flawed as they are, states are the only entity in a position to strengthen fiscal management and transparency norms. For the age of austerity, we need more state supervision.

This piece originally appeared in Urbanophile

This piece originally appeared in Urbanophile