- December 1, 2020
- Posted by: Erik
- Category: Newsletter
Local Government Finance and the Coming Economic Recovery: How Will We Pay to Restart our Economic Engines?
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Erik R. Pages
Local Government Finance and the Coming Economic Recovery: How Will We Pay to Restart our Economic Engines?
I’ll admit that it doesn’t feel like we’re on the verge of economic recovery, but I believe that we are moving in the right direction. The good news on vaccine development and the arrival of a new Administration suggest that we may soon see positive economic news on Main Street—not just on Wall Street. But, for many communities, the path to prosperity is going to be slow, painful and challenging. COVID 19 was a hard hit for everybody, but it was especially challenging for distressed communities that we just digging out from the Great Recession. These regions must now start a new recovery process with “one hand tied behind their backs,” as they need to invest in new economic development efforts while also dealing with a host of legacy challenges, many of which relate to local government budgets and revenue streams.
This issue of EntreWorks Insights will dig a little deeper into these challenges. It builds on our last two newsletters, which also offered suggestions for community recovery programs. We’ll offer some additional tips, but also assess some core finance fundamentals that must be addressed if we want a recovery that “lifts all boats.”
The Looming Local Finance Challenge
Local government finances have been crushed by the COVID-19 pandemic, and Congress’ inability to pass a second round of CARES Act funding has made things worse. The data on local government finances are grim. For example, the National Association of Counties has estimated that county governments have lost more than $114 billion in revenue in 2020, and city government revenues shortfalls are expected to exceed more than $360 billion between 2020 and 2022. All local governments have been hard-hit, but the pain is especially pronounced in places that rely on unique revenue sources like tourism-related taxes (e.g. Las Vegas and Orlando) or natural resource related severance taxes (e.g. West Virginia, Wyoming).
These budget shortfalls occur at a time when demand for public services is skyrocketing. Greater demand for services combined with fewer resources to pay for them is a recipe for trouble. Meanwhile, many local governments lack the tools or authority to raise taxes or develop new revenue sources. For example, only 29 states allow local governments to impose a sales tax, and 26 of these states place strict limits on this authority.
A pressing set of challenges looms. Local governments will need to fund immediate recovery efforts, such as small business support, worker retraining, and the restart of key institutions like local schools. They will also need to begin investing in longer term recovery efforts, and in rebuilding local economies. They will be forced to do this with hamstrung budgets, continued long-term structural problems (due to issues like pension liabilities), and limited capacities to finance this tsunami of unmet needs.
What Does Recent History Tell Us?
I would like to say that this experience is unprecedented, but sadly, that’s not the case. Many of America’s legacy cities have been living through this challenge for decades, as they have suffered from deindustrialization, disinvestment, discrimination, and outright neglect. Their experiences can tell us a bit about what to do, and even more about what not to do.
Pennsylvania is a good place to start on this journey. Back in the 1980s, Pennsylvania was ground zero for deindustrialization, and the impact on local cities and townships was akin to the current economic impacts of COVID-19. As steel mills and other factories shuttered, tax revenues cratered, local people moved elsewhere, and local infrastructure started to crumble. A vicious downward spiral resulted, as local needs and costs rose while funding to fix these problems disappeared. Dozens of once prosperous places were on the brink of bankruptcy.
The Commonwealth of Pennsylvania responded in 1987 with Act 47, the Municipal Financial Recovery Act. Under Act 47, at-risk communities work with state agencies to hire a recovery coordinator who oversees recovery planning, and who has special authorities to reorganize municipal operations. (Pennsylvania is not unique on this front; 19 states have similar programs focused on distressed municipalities).
Act 47 is a drastic step, but it’s sadly not that rare. Thirty-one PA communities, including Pittsburgh, Harrisburg, Scranton, and Reading, have been in Act 47 status. These communities account for six percent of state population. Another 15% of the population lives in communities that are at risk of entering into Act 47 status.
Each city’s circumstances are unique, but they share similar problems. They face major legacy costs, such as pension obligations or ailing infrastructure, lack needed internal capacity, and are unwilling or unable to develop new revenue sources to close budget gaps. Under Act 47, the community receives outside technical assistance and develops a “recovery plan” that likely includes efforts to increase service delivery efficiencies, to attract grants and other sources of revenue, and to restructure government operations.
These aggressive restructuring efforts have had mixed success. Of the 31 communities in the program, fourteen (45%) have “graduated” (i.e., they have succeeded in creating more robust and resilient financial structures and systems). This list includes places like Pittsburgh and Altoona, but many Act 47 municipalities have been in the program for decades.
This essay is not intended as a sustained critique of Act 47. It instead seeks to show that the job of rebuilding local governments is so challenging that we cannot simply rely on a growing economy to fix things. Most importantly, the Act 47 experience can also offer useful guidance on the types of policy and program interventions that might work.
Communities that have exited the Act 47 process share a few characteristics. Most importantly, they embrace the process and use Act 47’s “breathing room” to get serious about local government finances. The most successful places made major cuts to services and took on tough decisions related to spending, pension liabilities, collective bargaining agreements and the like. At the same time, they aggressively sought out new revenue sources. These sources included state grants and other supports, but also included steps like commuter taxes or new fees for service. For example, Altoona’s main new revenue source comes from its decision to resume management and revenue of regional water and sewer systems. Many of the successful municipalities also undertook the often-delayed and politically perilous decision to update property tax assessments.
Much like bankruptcy status, Act 47 and similar programs provide communities with breathing room that, in theory, allows them to make tough decisions and restore fiscal balance. But they also require that local officials be willing to make tough decisions in terms of personnel, agency budgets, and local taxes.
Building the Road as We Travel
The data on Pennsylvania’s experience with municipal financial distress tell us that it’s very tough to fix these structural finance problems. Most places cannot do it without outside help. That was true in the 1980s when Act 47 was created, and it’s going to be true over the next decade as communities plot their recovery from COVID-19. If distressed places are not given a chance to address historic structural and economic challenges, their prospects for recovery are limited.
We can and should do better. We don’t need to “rescue” these places, but we need to help them take control of their own destinies. And, they can only do this if their fiscal house is in order. Several strategies can help get them there:
- Create Warning Systems for Local Economic Distress
Programs like Act 47 have shortcomings, but they have succeeded in creating early warning systems for municipal distress. These early warnings help ensure that state governments can offer assistance before it’s too late, and that critical outside investments in local capacity are available. All states should embrace programs of this sort, and guidance on what works for effective early warning programs can be found here. These systems will be especially important in states like North Dakota, Wyoming, and West Virginia where tax systems remain too dependent on revenue from energy-related development.
- Update Local Tax and Revenue Structures
In economic development planning, we often encourage communities to embrace economic diversification as strategy for economic resilience. Diversity in revenue sources is similarly important. Too many local governments are too dependent on a single source of revenue—typically property taxes. A more diverse set of funding streams is needed. Potential examples might include fees for service or for specific programs, such as recreation services or trash removal.
Updating these revenue streams will require courage from local leaders who will likely be accused of raising taxes. It also requires that state governments become more flexible in terms of both mandates on local governments and restrictions on local authority to raise needed revenues. My home state of Virginia is one of 31 Dillon Rule states, which means that local government can only exercise powers granted by state government. In practice, this means that local governments have little or no prospects for creating new revenue streams.
Local fiscal reform will be especially important in smaller rural communities, and in many Western states where tax structures are especially antiquated. Researchers at Montana’s Headwaters Economics have done excellent work detailing these challenges, and their research is well worth checking out.
- Embrace Regionalism
In many places, local governments are too small to generate needed revenues or to provide the full range of needed services. This does not mean that we need wholesale consolidation, but it does mean that local leaders must to be more strategic about what work needs to remain in-house or managed locally. This may require outsourcing some work and embracing shared services on a more sustained basis.
Regionalism makes sense for economic development planning purposes; it also makes sense for local government service delivery. Challenged local governments will need to get more serious about embracing shared services with other communities, especially for high-cost services like police, fire, ambulance, and parks and recreation. This is one means to reduce costs while still providing essential services that every resident needs and deserves.
- Invest in Capacity Building
Many at-risk municipalities failed to respond to changing economic circumstances due to corruption or unqualified and poorly trained government leaders and staff. Improving the quality of local government personnel via training and other capacity building efforts is also essential. One benefit of programs like Act 47 is that they also provide training to local officials and bring outside technical expertise to at-risk communities. We need continued and sustained investment in programs that train local government staff members. These programs can be based in state governments, trade associations, or in higher education institutions.
- New Tools for Community Development
Local governments need to get their finances in good order, but they also need new tools to support community development. This is a huge topic that we’ll be covering in future blog and newsletter postings. But, at this point, let me say that we need to think big. We’ll need to restructure and revitalize existing programs by increasing budgets for key agencies like the Economic Development Administration, the Community Development Block Grant program, and efforts like the Community Development Financial Institutions initiative. We’ll need to restructure existing tools like Opportunity Zones and the Community Reinvestment Act. And, we’ll need to develop new tools, like a Local Equity Tax Credit, to generate new revenue sources for community development.
Fortunately, there are many good ideas for moving forward here. I’m especially intrigued with current ideas coming from the Urban Institute, the Legacy Cities Initiative (Lincoln Institute for Land Policy), and the Council of Development Finance Agencies. These groups have developed excellent policy platforms for how to do community development finance better!
Even if the COVID 19 vaccine rollout works at maximum efficiency and effectiveness, we still have a long road ahead for economic recovery. As this process continues, we should also ensure that all local communities can participate in the recovery process. They can only do so if they have the capacity and resources to invest in this work. Local government fiscal reform may not be a sexy topic, but it’s one that we desperately need to address.
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We wish happy holidays to you and your loved ones, and look forward to meeting in person at some point in 2021!