Fiscal Challenges Facing Cities: Implications for Recovery

Christopher W. Hoene and
Christopher W. Hoene Executive Director - California Budget & Policy Center
Mark Muro

November 18, 2009

America’s current economic crisis is not only a national crisis. It is also a metropolitan crisis, and it will soon become a local government fiscal crisis.

Coping with the worst economic downturn in 50 years, U.S. cities face sizable budget shortfalls for 2009 that are expected to grow much more severe and widespread in 2010 and 2011.

With the pace of recovery still sluggish, local government budget tightening and spending cuts over the next two years could well impose a significant drag on the nation’s economic performance just as the extraordinary interventions of the $787 billion American Recovery and Reinvestment Act of 2009 (ARRA) trail off.

It could be that a deepening local government fiscal crisis—less remarked upon than the one challenging state governments—could hobble the nation’s incipient recovery with several years of layoffs, cancelled contracts with vendors, and reduced services.

This report surveys the current state of U.S. cities’ finances, reviews city leaders’ responses to those conditions, and places these developments in the context of efforts aimed at securing the nation’s recovery from the current severe slump. It finds that:

1. Local government fiscal conditions matter for national economic performance. Cities and their surrounding suburbs are important economic agents that not only provide services important to the functioning of regional economies, but also serve as major employers in many metros. Across the 100 largest U.S. metros, for example, local government accounts for some 10 percent of total non-farm metro employment. And what is more, local government has grown relatively more important in recent years as a source of jobs and wages.

2. Cities and towns face one of the most daunting and widespread fiscal crises in decades—and it’s only just beginning. Nearly nine in 10 city finance officers recently surveyed by the National League of Cities (NLC) report difficulties meeting fiscal needs in 2009. In aggregate, these cities face nearly 3 percent budget shortfalls on average this year. And the sense of trepidation is ubiquitous across a diverse range of metros, regardless of which aspect of the national crisis impacts them the most: declining consumption rates and increased property foreclosures; job losses in manufacturing or financial services; or record state budget shortfalls. Yet this is only the beginning of what will likely be a slow-moving crisis. That’s because while income and sales taxes are typically the earliest sources of city revenue to decline as job losses in a community increase and consumer purchases slow, property tax collections—which make up the bulk of city revenue nationwide—decline much more slowly as real property assessments are adjusted to reflect declining housing values. These have only just begun to slump, meaning that cities and other localities will be contending with increasing budget pressure for the next several years.

3. In most places, the local response to deteriorating conditions has consisted of a predictable round of unfortunate but unavoidable service cutbacks and layoffs. The vast majority of city officers report spending cuts for 2009 and expect further reductions in 2010 that will result in workforce reductions, delayed or canceled infrastructure projects, or general service cuts. As the full impact of the national economic crisis degrades city fiscal conditions over the next 18 to 24 months, these sorts of responses will continue—and likely spread.

4. However, some far-sighted city executives are making hard choices and trying to turn the crisis into an opportunity to innovate. Some innovative leaders are leveraging budget stress to proactively restructure government management, strategically modernize delivery systems, and find creative ways to raise new revenues to better serve residents and support greater growth and prosperity over the long haul. Through these efforts some of America’s best local leaders are pursuing tough-minded governance reforms that at once seek to reduce harm to the local economy while attempting to bring about longer-term effectiveness and efficiency.

5. The nation needs a partnership between all levels of government to ease the local government fiscal crisis. Local governments are innovating. And yet, city and suburban leaders are unlikely to avoid severe service pull-backs, major workforce reductions, and various capital project delays—retrenchments that will reduce economic demand, undercut metropolitan vitality, and place a drag on national recovery. For that reason both the national interest and the realities of American federalism call for national engagement. In keeping with this spirit, a number of options exist by which federal policymakers could lessen the extent to which cities must take actions that harm the economy. For example, federal policymakers could:

  • Target temporary fiscal assistance directly to cities to stabilize local budgets
  • Establish a public service employment program to fund local hiring for positions needed to respond to the consequences of the economic downturn
  • Strengthen and stabilize the housing market by opening up mortgage finance markets, investing in neighborhoods, and protecting homebuyers from predatory lending
  • Invest in transportation and transit in ways that provide flexibility for meeting city- and metro-specific goals
  • Enhance municipal credit to lower borrowing costs for municipal bond issuers and facilitate financing for local capital projects

By enacting responses like these the nation will act prudently to safeguard a still-shaky recovery.