The Overshadowed Plight of City Budgets

While the coronavirus-driven economic downturn hasn’t been as disruptive to most state budgets as initially feared, for many local governments it’s dealt a brutal financial hit.

Congress has now responded with historic levels of direct aid to thousands of cities and counties. But some experts are cautioning that the windfall shouldn’t be spent just on today’s problems. That’s because local governments are likely to still be feeling the effects of the downturn for years to come, even after the Covid-19 outbreak has subsided. And in some cases these future pressures will compound budget problems that predated the pandemic.

Houston is perhaps an extreme example. It has a more than $200 million budget deficit for the next fiscal year that starts on July 1 and officials have said they would have to cut services and lay off employees to make up the gap. While the pandemic has made matters worse, the city had already been dealing with deficits for several years, said controller Chris Brown.

The financial outlook for the city brightened after President Biden on Thursday signed a $1.9 trillion coronavirus relief bill—the American Rescue Plan. Houston is slated to get more than $600 million in direct federal aid from the act, which would take care of any shortfalls in the next two years. Brown, however, worries about what will happen after that and how long the fallout from the pandemic will leave a mark on the city’s budget.

“I’m honestly not a fan of big bailouts and massive spending, but I think this is what the city needed so I do feel a little bit of relief,” said Brown. But he also pointed out that many of the city’s budget problems stem from structural issues. “If we use it as a one-time financing source to plug the hole,” he said of the aid, “we’re just going to have deeper holes down the road.”

The covid relief package is a lifeline to many local governments in similar predicaments thanks to the $350 billion allocated for direct aid to states, localities, tribal governments, and territories. The aid will be delivered to governments with populations of 50,000 or higher and can be used to cover unexpected costs and to offset the dent the pandemic made in revenues.

For most localities, it will be the first time they’ve received any money from the federal government since the pandemic began. Aid legislation known as the CARES Act, passed nearly a year ago, only allocated direct aid to states and to local governments with populations of at least 500,000 and also restricted how that money could be used.

Houston received $405 million under that earlier law, but the city burned through that money on expenses tied to the pandemic, such as testing and contact tracing, renter and small business assistance and personnel costs.

Now, for Houston and many other cities, the latest round of federal aid is coming just in time. Brown said the city’s finances would have been an “absolute disaster” without it.

The tight fiscal spot many localities have been in runs counter to headlines in recent months that show tax revenues haven't plummeted as far as initially expected since the virus struck. That has been the case mainly at the state level, however, and is driven by income tax revenues, as higher-wage earners have been able to keep their jobs.

It’s a different story for localities. According to the National League of Cities, cities are facing a collective revenue shortfall of $90 billion this fiscal year alone, “which represents a steeper revenue decline than any recession in recent history, including the Great Recession.”

Most cities don’t tax income. They instead typically rely on a mix of sales and property taxes, as well as fees, including hotel and restaurant charges, parking fees, and business license fees.

Compared to income taxes, those revenues are far more sensitive to how the virus has harmed the economy—forcing restaurants and entertainment venues to shutter, emptying out downtown office space and curtailing vacations and business travel.

When and how these types of revenues will recover is unclear.

Recently, the jobs recovery has lost momentum, and the Congressional Budget Office predicts the economy won’t return to its full potential until 2025.

What’s more, it’s still unknown how many more people will opt to permanently work from home or do so on a part-time basis after the pandemic ends. Less demand for downtown office space has implications for commercial property values and, in turn, tax collections. But because of the lag in property valuations, any revenue impact will take years to emerge.

“Property tax revenue can promote stability in a downturn, but it can also create a lag in the recovery period,” said Michael Rinaldi, a senior director at Fitch Ratings. “So I wouldn’t be shocked to see that drag on other revenues down the road.”

With uncertainties like this, some are urging that part of the federal aid be spent or invested in areas that promote long-term economic stability.

Marc Joffe, a senior policy analyst for the Reason Foundation, suggested that governments set aside some of the funding to help cover growing retiree healthcare costs, otherwise known as other post-employment benefits, or OPEB. "For the governments that have extra fiscal capacity, paying down OPEB liabilities as part of a reform strategy could be affordable as well as shrewd," he said.

The National League of Cities notes that cities can also use the funding to pay for long overdue investments in infrastructure, such as broadband upgrades or drinking water and sewer projects. A survey last year found that infrastructure and capital spending are areas that were in line to take significant budget hits.

Back in Houston, William Fulton, with the Kinder Institute for Urban Research, said the city could set aside some of the federal funding to help with phasing in cuts necessary to eliminate the structural budget deficit. Over a period of four to five years, he said, the city could reduce staff through attrition and use some federal money to help fill budget gaps over that period.

“It’s a little pain now and a little pain later instead of no pain now and a lot later,” Fulton said.

Brown can rattle off a host of costs in Houston that he sees as viable targets for covering with some of the aid—including deferred maintenance, retiree healthcare and expenses tied to a dispute over firefighter backpay. “We need to use these funds to address some of these long-term liabilities and that will help our burden in the future,” he said.