Cities Optimistic About Economic Recovery, But Fiscal Headwinds Loom

Commentary

Cities Optimistic About Economic Recovery, But Fiscal Headwinds Loom

Optimism abounds and economic recovery continues, but major challenges linger

In early October, the National League of Cities issued the 2015 edition of its annual City Fiscal Conditions report, which found that cities continue to see slow, but sustained, growth in the wake of the Great Recession, though they still face significant future fiscal headwinds. The full report is available here.

The report finds that the city finance officers surveyed are feeling increasingly confident about their fiscal health. A total of 82% report that their cities are in a better fiscal position in 2015 than 2014, continuing a steady uptick since the low of 2009 (12%) and representing the highest level of confidence reported since 1990.

On the revenue side, after six straight years of declining general fund revenues between 2007 and 2012, cities are projected to see their third straight year of modest revenue growth. Revenues increased 1.3% in 2014 relative to the previous year and are anticipated to grow slightly by .31% in 2015, according to the report.

Notwithstanding this growth, city revenues still have yet to reach their pre-recession levels nine years after their 2006 peak. The report finds that cities are operating at 91.6% of their 2006 pre-recession revenues and are unlikely to exceed them for several more years. By contrast, city revenues fully recovered from previous recessions in 1990 and 2001 in five and six years, respectively.

Meanwhile, general expenditures rose 1.5% in 2014 and are projected to increase by 2.2% in 2015, a rate higher than projected for revenue growth.

The three major municipal revenue sources-property taxes, sales taxes and income taxes-are projected to see year-over-year increases in 2015, according to the NLC report:

  • Property tax revenues rose 2.4% in 2014 and are expected to rise 1.2% in 2015.
  • Sales tax revenues have seen growth every year since 2012, but have been slowing each successive year. Last year, sales tax revenues grew 3.1% and are expected to increase 2.3% in 2015.
  • Income tax revenues fell 1.7% in 2014, but are projected to increase 3.6% in 2015.

Another positive finding for cities is that general fund ending balances-essentially reserves or “rainy day” funds-have continued to rise from their recession lows. In 2014, ending balances were equivalent to 22.8% of expenditures and are budgeted at 25.2% for 2015. These levels are up significantly from their 2010 level of 16.5%. According to the report, “[t]he solid growth of ending balances signals cities’ desire to be more prepared for future fiscal downturns and recognition that key tax revenues, along with state and federal aid, have become less reliable.”

Despite the continuing economic improvement, fiscal challenges are looming on the horizon. NLC surveyed city finance directors regarding a list of factors influencing their city’s overall fiscal health to determine which factors increased or decreased since the previous year and which ones had the most positive or negative impacts:

  • Gas and oil prices, federal aid, and state aid were the most commonly cited factors that have declined over the past year, while employee wages and salaries, infrastructure needs, and service costs were the most commonly cited factors that have increased since 2014.
  • The value of the local tax base, health of the local economy, and gas and oil prices were cited as having the most positive budget impacts.
  • The factors seen as having the most negative budget impacts were infrastructure demands, the cost of employee and retiree pensions, and the cost of employee and retiree health benefits.

Regarding the budgetary drag from infrastructure, pensions, and health benefits, the report notes that, “[u]nfortunately, these are also factors that are likely to persist and worsen absent heavy investment.” This is consistent with the findings from earlier editions of the NLC report, suggesting this trio of factors will remain persistent challenges facing the municipal sector that threaten to squeeze future budgets. The report concludes that cities’ “longer-term fiscal sustainability will depend not only on [their] ability to balance their budgets annually, but also to manage infrastructure and employee-related costs and volatilities such as gas and oil prices, inflation and state aid.”

Overall, the report offers a mixed bag for cities. It is certainly positive news that they are collectively seeing a continuing economic recovery from the ravages of the Great Recession and that city finance officials are increasingly optimistic about their cities’ ability to meet their financial needs. Yet, the recovery has been slow and drawn out, and some major fiscal challenges remain looming on the horizon that should prompt policymakers to remain hawkish on fiscal matters, to pursue more cost-effective and sustainable retirement benefit structures, and to seek innovations in infrastructure delivery.

Leonard Gilroy is Senior Managing Director of the Pension Integrity Project at Reason Foundation, a nonprofit think tank advancing free minds and free markets. The Pension Integrity Project assists policymakers and other stakeholders in designing, analyzing and implementing public sector pension reforms.