More cities are seeing budget gaps: Here’s what not to do

Faced with a $400 million gap between projected revenues and spending, the Los Angeles City Council passed its Fiscal Year 2025 budget on May 23 with plans to cut 1,700 vacant positions, institute program cuts and utilize cash from general reserves.

Earlier that month, two hours south, San Diego Mayor Todd Gloria released a budget with a $178 million shortfall, describing actions he would take to get through “this difficult financial time.” The story was the same up the coast. The San Francisco Chronicle reported on May 24 the potential for “deep budget cuts” as the city faced an estimated $800 million shortfall over two years. A day later, the Bay City News published a story that neighboring Oakland would have to close a $360 million gap.

Similarly, in Texas, Houston City Council members last month were warned of escalating trouble. “The city of Houston's expenses continue to rise while revenue decreases, and the situation is becoming critical," said Chris Hollins, city comptroller. "With a structural deficit of $200 million and growing, we are in an unsustainable position and in need of real solutions.”

Across the country, a growing number of medium to large cities have begun reporting budget shortfalls.

The problem isn’t just isolated to big cities. Smaller cities, too, are having to deal with revenues that are falling short of rising costs. Some signs of structural imbalance began to appear last year, but this budget season the problems are accelerating. “A third of our cities are projecting financial challenges,” says Carolyn Coleman, executive director of the League of California Cities.

So, what’s leading to these shortfalls?  

Spending Pressures

Problems like these often emanate from “pressure on the expenditure side,” according to Jane Ridley, sector lead for local governments at S&P Global Ratings. Expenses are escalating for a wide variety of reasons, including the need for downtown revitalization, persistent housing and homelessness issues, deferred maintenance, public safety needs and widespread compensation increases.

In fact, long-term difficulties in hiring have pushed wages up by 5% over a 12-month period that includes the first calendar quarter of 2024. That’s the highest growth rate in at least two decades, based on data from the U.S. Bureau of Labor Statistics. Although inflation has been moderating, higher interest rates and escalating construction costs are other factors propelling expenditures upward.

In addition to the escalation of wages and benefits that occurred across the country due to hiring and turnover problems, there are also special circumstances, such as Los Angeles’s large negotiated pay raises for police and civilian employees and   Houston’s $650 million settlement with current and retired firefighters. The Houston deal will pay wages owed back to 2017, along with an additional 10% wage hike on July 1 and other raises guaranteed through 2029.

The Revenue Side of the Equation

Though rising expenditures are at the core of budget pressures on cities, S&P is observing signs of softening revenues as well, according to Ridley.

The League of California Cities’ Coleman notes that transitions stemming from the pandemic in the way people work, live and shop have led to a redistribution of tax revenues and some rethinking of revenue mixes in the future.

Cities that became dependent on federal pandemic dollars to support ongoing expenditures are more likely than others to confront upcoming shortfalls. When the use of temporary revenues becomes habit forming, the budgetary pain can be intense when those one-time resources dry up. “Anytime you inject a bunch of money and then it goes away, you’re going to be creating a disruption,” says Shayne Kavanagh, senior manager for research at the Government Finance Officers Association, or GFOA.

Buffalo, New York, provides a good example. It spent about half of its federal pandemic dollars to support operating expenses and will likely use a bit more of what’s remaining for its FY 2025 budget. But its dependence on one-time revenues over recent years has necessitated large property tax increases for the next four years. As one council member said in late May, “this tax increase is nothing compared to what’s going to happen in the future. We should have been making cuts sooner. We kicked the can down the road.”

Beyond the loss of federal dollars, the strength of city revenues varies from place to place depending largely on the local tax structure. For example, New York City and San Francisco both have very high office vacancy rates, but the decline in commercial real estate values in San Francisco has far more impact due to its dependence on property taxes, whereas the property tax in New York is a minor part of its total tax structure, and at least currently, its general revenues have been strong. 

Balancing the Budget

When a budget is being constructed, there are lots of ways to bring it into balance, many of which make people unhappy—particularly the upfront but unpopular approach of raising taxes or making across the board spending cuts. The latter isn’t generally considered a judicious budgeting practice, as it means that agencies that are operating on a lean budget will suffer more than those with more fat. Selected cuts, based on evaluation and solid evidence of effectiveness make more fiscal sense. But they can pit interest groups against one another as they try to convince elected officials to retain the spending they depend on.

There are other routes cities can take, many of which have serious problems of their own. For example:

• Raising fees can be regressive, particularly when applied to generally used services.
• Eliminating vacant positions may be strategically unwise given current understaffing. Once a position has been eliminated it may be difficult to get it back into a future budget.
• Hiring freezes can leave thin staffs that remain overworked and can also lead to expensive overtime.
• Efficiency savings sound great, but they’re very often exaggerated, and when they don’t work, the shortfalls are pushed forward into future years.
• Using general fund balances or budget stabilization funds are legitimate but must be used with care as they are a one-time resource that will be gone over time.

“The basic concept of fiscal first aid is that some techniques are better than others. They're not all equal,” says Kavanagh. “You want to think about the risk that you're creating for yourself, down the line by [using] any particular balanced budget balancing strategy.”

On occasion, estimates themselves are manipulated in order to produce the appearance—if not the reality of—a balanced budget. For example, the state control board that acts as an advisory board for Buffalo’s finances has expressed concerns that $131 million of future four-year revenue projections for that city are shaky as they depend on new taxes that haven’t been approved, highly uncertain casino gambling revenues, optimistic guesses at traffic violation and parking meter fees and potentially overstated estimates of future state aid.

Over many years, GFOA has assembled a great deal of advice on promising budgeting practices and those to avoid. Its reports on “primary treatments” and “riskier treatments” for budget balancing in difficult times are here.

“There’s a whole list of things that can be useful,” says Kavanagh, “but you have to weigh the downside against the upside and see where you come out.”