Cities Prepared for Rainy Days, but Not a Fiscal Tsunami

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As the pandemic-induced economic downturn continues, cities are facing immediate, significant and irreplaceable losses to major revenue streams. NLC estimates that cities will experience a $360 billion budget shortfall over the next three years.

The question, of course, quickly turns to are cities prepared to weather a fiscal storm this severe?

One critical way to assess fiscal preparedness is levels of General Fund ending balances (also called reserves or rainy-day funds). To better understand the fiscal position of cities, we analyze city ending balances as a percentage of General Fund expenditures.

Our findings reveal that cities have built up reserves to levels greater than at any point over the past 34 years. However, the depths and speed of the current economic downturn and ensuing fiscal impact are beyond what cities could have anticipated, rendering historic levels of reserves insufficient.

Ending Balances as an Indicator of Fiscal Preparedness

City ending balances, which are revenues transferred forward to the next fiscal year, provide a financial cushion for cities in the event of a fiscal downturn or the need for unforeseen outlays.

Bond underwriters also look at reserves as an indicator of fiscal responsibility, which can increase credit ratings and decrease the costs of city debt, thereby saving city money in annual debt service costs. As noted by Tom Kozlik of Hilltop Securities, those cities that have made tough fiscal choices in recent years to build ending balances will be more favorably viewed by investors when buying municipal bonds.

Additionally, as federal and state aid to cities has become a smaller share of city revenues over time, cities have become more self-reliant and more likely to set aside funds for emergencies or other purposes.

While a city’s strategy to grow ending balances must also be weighed against less spending on services and other expenditures, the growth of ending balances signals the desire of cities to be more prepared for future fiscal downturns and the recognition that key tax revenues, along with state and federal aid, have become less reliable.

Ending Balances Reach Historic Highs

Ending balances are typically measured as a percentage of General Fund expenditures. Using data from NLC’s annual City Fiscal Conditions survey and city financial documents, we analyze ending balances as a percentage of total annual expenditures from 1985 to 2019. We find that coming into 2020, at greater than 30% of annual expenditures, city ending balances are greater than any point over the past 34 years.

Rainy Day Funds Blog@2x

Prior to the Great Recession, as city finances experienced sustained growth, city ending balances reached a high of 25% of expenditures. As economic conditions made balancing city budgets more difficult, ending balances were increasingly utilized to fill the gap. Ending balances returned to pre-recession levels in 2015 and have continued to grow.

The Government Finance Officers’ Association recommends that cities maintain a minimum ending balance of at least two months of regular General Fund operating expenditures. Our analysis demonstrates that city ending balances prior to COVID-19 were steadily increasing in the wake of the Great Recession and on average are much better positioned overall than the recommended guidelines.

But is It Enough?

In recent months, cities have been relying extensively on these funds to help cover immediate responses to the crisis, as well as revenue gaps. The city of Baltimore, MD, which reports losing $20 million per month in revenue due to the coronavirus pandemic shutdown and is spending an extra $5 million per month in emergency costs, is using its rainy day fund to close a $42 million budget deficit.

In Evansville, IN, the city council approved borrowing $16 million to cover revenue shortfalls resulting from late property tax payments. Council Finance Chair Ron Beane said the decision to borrow was made in anticipation of depleting the city’s $3 million rainy day fund, as well as casino gaming and local option income tax revenues, to help cover additional shortfalls in coming months. “I don’t see any way we are going to avoid that,” Beane said.

In the city of Lansing, MI, the Council cut more than $150,000 from a budget proposal already slashed by Mayor Andy Schor, with reserves poised to drop to only about $2 million (a longstanding city policy aims to keep that figure closer to 12% of the city’s annual operational expenses, which is almost $16 million).

“We don’t have a cushion anymore,” Mayor Schor said. “If we have another pandemic, there will be much less of a cushion to cover these shortfalls. We still have plans to build that backup, but nobody was expecting the economy to completely shut down. This was unprecedented.”

Coming into 2020, most cities have positioned their finances and budgets to be sustainable in the face of an economic downturn. In discussing state revenue challenges, Dan White of Moody’s Analytics noted that like cities, “States have never been in better shape to withstand a relatively normal recession. The only problem is that this is not a relatively normal recession.” Cities have been drawing down reserves to cover unexpected expenditures while weighing what type of cushion they will need if the virus reemerges later in the year while weighing how revenues will respond, and while weighing what level of services will be adequate.

Cities are also deferring property taxes, waiving late fees on utilities and providing small business loans – all of the things needed to help get our economy back on track. These supports for residents and businesses come at a cost to their own budgets, but are critical for reopening and recovery. These circumstances make it clear that for cities to remain fiscally viable during these unprecedented times, and for them to continue to make decisions that support the economy, rainy day funds are only part of the answer. They also need strong state and federal partnerships to weather the current health, economic and fiscal tsunami together.

The authors would like to thank Farhad Kaab Omeyr in the Department of Public Administration at University of Illinois at Chicago for his data collection and analysis support.

 

About the authors

Christy McFarland small

Christiana McFarland is NLC’s Research Director. She leads NLC’s efforts to transform city-level data into information that strengthens the capacity of city leaders and that raises awareness of challenges, trends and successes in cities. Follow her on Twitter @ckmcfarland.

 

michael_pagano_125x150Dr. Michael Pagano is the dean at the University of Illinois at Chicago’s College of Urban Planning and Public Administration. Follow him on Twitter @MichaelAPagano