The Declining Fiscal Health of America’s Cities

Municipal revenues are expected to grow much more slowly in 2017 while expenditures remain steady and state and federal aid continues to decline

A wall in Detroit. (Photo: AP) A wall in Detroit. (Photo: AP)

The fiscal conditions of America’s cities are beginning to deteriorate following several years of growth, according to a new survey of municipal financial officers conducted by the National League of Cities. This could potentially impact the market for municipal bonds, which are popular investments for high-net-worth advisor clients, and it is already affecting local tax policies. Moreover, the declining health of municipal economies couldl eventually impact the national economy, according to the report.

“This year’s results point to the potential start of a contraction in the municipal sector after optimism about growth hit a peak in 2015,” the report said.

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Municipal revenue growth is expected to slow sharply in 2017, to 0.9% from 2.6% last year, while expenditures are anticipated to be steady — up 2.1% vs. 2.18% last year, according to the NLC report, which bases its analysts on the latest figures in municipal budgets.

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Sales and income tax revenues are expected to decline by 0.2% and 2.7%, respectively, this year compared with increases of 3.7% and 2.4%, respectively, last year. Property tax revenues are anticipated to rise, but at a much slower rate, up 1.6% vs. 4.3% in 2016. Sales tax collections are hampered by the limited ability of local governments to tax online purchases, according to the report.

“General Fund revenues still have not fully recovered from the recession,” the report states, adding that municipal revenues now equal less than 98% of what they were in 2006. “It is possible that revenues may not return to prerecession levels during this economic cycle.”

The decline in municipal revenues has led many cites to raise local taxes and fees, which has, however, been a common development over the past two decades, according to the report. For 2017, two in five financial officers report raising municipal fees and 27% report increasing local property tax rates.

Despite these increases, cities have limited options to raise revenues, so they often turn to reducing services in order to balance their budgets, says Christiana McFarland, director of research at the National League of Cities.

Sixty-nine percent of finance officers say their cities are better able to meet the financial needs of their communities in 2017 than they were in 2016, but that’s down from 81% sharing that sentiment in 2016 compared with 2015.

While municipal budgets are supported by the local tax base and mostly healthy local economies, they are under pressure from increasing spending needs for infrastructure, public safety, employee wages, salaries and health benefits and employee and retiree pensions — “costs that can no longer be delayed,” according to the report.

Adding to those pressures are declines in state and federal aid and, in selected cities, the increasing frequency and intensity of natural disasters like hurricanes Harvey and Irma.

But the relationship between cities and the federal government is a two-way street, according to the NLC report. It cites recent analysis from the Bureau of Economic Analysis noting that “positive contributions to GDP made by personal consumption, nonresidential fixed investments, exports and federal government spending have begun to be offset by negative contributions from state and local government spending.” (Italics added)

“At the end of the day, local governments will balance their budgets and make the hard choices needed to serve their communities,” the NLC report states. “These forced choices, however, have consequences and threaten the competitiveness and quality of life of our nation’s drivers of economic and social vitality: its cities.” According to the 2010 census, almost 81% of Americans live in cities.

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