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Thursday, July 25th, 2013

Cities Need More Fiscal Supervision By State Governments by Stephen Eide

[ When it comes to local affairs, I'm typically in favor of more devolution of powers to local governments, especially larger ones. On the other hand, Detroit's bankruptcy shows that local government can easily make a hash out of things. Stephen Eide makes the case for why states should exercise more not less fiscal supervision over cities - Aaron. ]

Four years after the end of the recession, cities’ fiscal outlook remains unpromising (discussions here and here, esp. 53-6). Spending on healthcare and pensions continues to rise faster than revenues, crowding out spending on basic services. Though Detroit-style insolvencies will continue to be rare, without reform, they will be more common than in the past. To strengthen budgets, states should exercise more fiscal oversight over local governments.

This is not a popular idea. For one thing, local government is Americans’ favorite form of government, consistently receiving higher favorability ratings than state and federal government (way higher in the latter case). If we take voter turnout as a rough measure of familiarity with government operations, then we must surmise that American’s widespread admiration for local government is based largely on ignorance. Perhaps if people voted in mayoral and school board elections as regularly as they did in presidential elections, city hall would be as unpopular as Washington. But, as things stand, David Brooks and the public as a whole now seem to regard local governments as those least in need of reform.

Another obstacle to increased oversight is that states don’t want the job. Too often, states are content to pass the buck to local decision-makers. They actively avoid aggressive oversight, which tends to be high-risk and low-reward. State interventions provoke resentment from local officials and produce few new friends. Interventions stabilize budgets; they don’t turn cities around or return them to glory. That may take decades, if it happens at all. Oversight is thankless work, which is why, from New York City in the mid-1970s to Detroit at present, state governments put off intervening until the last possible moment.

Finally, state governments are hardly the model of fiscal competence. They have run up massive pension and retiree healthcare deficits, they are dominated by special interests, and their tax systems are outdated and shortsighted.

But if increased state oversight were an easy sell, we would see more of it. The logic begins at the extreme: insolvent cities clearly need more oversight. Cities become insolvent because of incompetence and a lack of political will. States then must step in to provide expertise over fiscal and administrative functions and/or the will to make difficult choices through a control board or receiver. Since cities are the legal creations of state government, states have an indisputable right to intervene, and they also have a duty to do so. Whether state taxpayers realize it or not, they have potential exposure to local distress, through increased borrowing costs for other municipalities within the same state (“contagion”). Even municipal bankruptcy requires state action—no city can declare bankruptcy without being authorized to do so by its state government.

Most states don’t have general intervention systems in place, which define, in advance, how to manage distress from its earliest warning signs all the way through to bankruptcy, if necessary. Most interventions are executed by means of ad hoc legislation. More states should adopt general intervention laws similar to Michigan’s Public Act 436. Even when a small city falls into distress, it typically requires a major policy response from state government. Events can move rapidly, leaving little time for deliberation; an a priori articulation of the powers state authorities have to address distress will minimize controversy and enable the strongest response.

A general intervention system will require an early monitoring system. New York State comptroller Thomas DiNapoli recently established one; California’s Bill Lockyear would very much like to. Of course, treasurers and comptrollers have little real power. All they can do is raise awareness of the problem. If shame won’t suffice to restore solvency to cities, Governors must get involved.

States should require stronger local fiscal management practices. Of highest priority is multiyear planning. Most localities don’t project their costs and revenues out beyond the coming fiscal year. To give themselves, taxpayers, and the media a clearer account of their fiscal health, local governments should develop and publish plans of at least 4-5 years. States should also consider placing tighter restrictions on reserve balances, debt, and taxes. As the case of Detroit illustrates, high taxes in a poor city is a policy catastrophe. Massachusetts allows its local governments to tax businesses at a higher property tax rate than individuals. Since businesses don’t vote, this power has been grossly abused by poor cities and should never have been granted in the first place.

One useful oversight model is the North Carolina Local Government Commission (LGC), an obscure state agency with something of a cult following in public administration and public finance circles (here, here, and here). The LGC must sign off on all local debt issuances, making North Carolina the only state with this responsibility. It actively monitors property tax collection rates and other fiscal indicators and will not allow localities to issue any debt if their fund balance (reserves) drops below a certain point. Although it has the authority to intervene aggressively, it almost never has to, operating mostly through a milder, advisory role. Ratings agencies regularly cite the LGC’s effectiveness as a factor in granting strong credit ratings for both state and local governments in North Carolina. That’s the clearest evidence that cities benefit from stronger state oversight-their credit rating go up and borrowing costs go down.

As I have argued elsewhere, cities do deserve more autonomy over some functions, such as labor relations. Cities’ most significant fiscal problems are rooted in personnel spending—chiefly pensions and health benefits for active and retired employees—and any way that states can increase local management’s leverage over labor will help provide budget relief. This is obviously most urgent among blue state cities.

But more autonomy won’t be enough, for the simple reason that we can’t trust that all local officials would use their enhanced bargaining leverage. States’ attitude should be “trust but verify”—empower local officials inclined to do the right thing, and pressure those who aren’t.

To sum up, local budgets now have little margin for error. While it would be appropriate to increase local autonomy in some areas, there is little evidence for the view that broad-based mandate relief alone would produce broad-based budget relief. Flawed as they are, states are the only entity in a position to strengthen fiscal management and transparency norms. For the age of austerity, we need more state supervision.

Stephen Eide is a senior fellow at the Manhattan Institute’s Center for State and Local Leadership and editor of PublicSectorInc.

18 Comments
Topics: Public Policy

18 Responses to “Cities Need More Fiscal Supervision By State Governments by Stephen Eide”

  1. As the former Mayor of Milwaukee (1988-2004) I disagree with your conclusion that states should have more oversight over cities. State governments have often driven cost increase at the local level. Mandates driven by special interest groups well positioned in state capitals have boosted infrastructure, labor and service delivery costs. As an example, in 1994 we reached the only non arbitrated voluntary settlement between the City and the Milwaukee police union. The leverage we had to escape binding arbitration was that taxpayer support for the salary and benefits for the 3 highest union officers was not a mandatory subject of the state binding arbitration law. My predecessor Henry Maier had included it on his own volition in arbitration submissions throughout his mayorality. I excluded this benefit from our offer and the union, in a non arbitrated contract, agreed to remove 2 out of 3 positions from the tax payer financed payroll. They also agreed to changes in police employee health benefits that significantly reduced cost.
    One year later the police union got their friend GOP Governor Tommy Thompson to insert a provision in the 1995 state budget mandating that Milwaukee taxpayers pay the salary and benefits of the top 3 Police union officials by state law. We tried to get the legislature to remove the provision unsuccessfully.
    The following link shows how Milwaukee has been more responsible fiscally than the state of Wisconsin. http://urbanmilwaukee.com/2013/07/23/murphys-law-is-milwaukee-the-next-detroit/
    I think your proposal of more state oversight of cities is unjustified by reality. Even in Michigan state mandates have played a significant role in undermining fiscal stability in Flint, Saginaw, Benton Harbor and many other cities.City Journal has often commented on the parasitic burden that New York’s state government is to New York City with the special interest encrusted state legislature feeding power groups on the City’s wealth. Do you really believe Sheldon Silver should have more oversight over NYC?
    IMO, cities would fare far better with much smaller and less powerful state governments.

  2. John Morris says:

    The flip side of this is that many bond investors assume an implied guarantee that state, county or the federal governments will bailout badly managed local governments.

    We can’t have heads you win and tails the state loses.

    I agree that state oversight is no replacement for the rule of law or market discipline and that states usually lack local knowledge and actively compound the problem.

    Badly run cities need to face the consequences of their actions sooner and in many cases, union leaders and local politicians should be charged with gross negligence or corruption.

  3. John Morris says:

    Or state leaders. Who the cap fits must wear it.

    Sovereign immunity at all levels of government has run amuck.
    Accounting fraud is accounting fraud no matter who is doing it. Until the system places liability on decision makers for often criminal actions, little will change.

  4. John Morris; I do not advocate state or Federal government paying local governments’ bad debts anymore than the Federal government should pay for beach house repair on Cape Hatteras.
    I object to the assumption that state governments occupy some high moral perch from which to pass judgement on cities. Look at the long history of interest groups lobbying states to impose their products and services on local governments. Building trades, cement producers, chiropractors, sprinkler fitters, street signage producers, school facility planners, ambulance and fire truck producers are just a few of the many interests that seek to force cost onto municipalities.

  5. John Morris says:

    I agree with you, special interests and often anti urban interests often infest state governments.

    But, the implied bailout backstop is there. If cities want states to mind their own business, they have to face the full impact of their actions.

  6. James says:

    It’s ironic that one would use Detroit as an example of state oversight since it is the state of Michigan’s constitution that is potentially prohibiting Detroit from discharging its debt burden.

  7. John Morris says:

    I think that’s a pretty common situation.

    What happened to private sector controls? Why have ratings agencies so often downplayed real risks?

  8. bettybarcode says:

    Bruce Fisher’s column in today’s Artvoice (Buffalo, NY’s alternative paper) seems on topic. New York State government is flawed and corrupt, but as long as cities like Buffalo are essentially wards of the state, Albany could start adding sticks to carrots. Want your funding? Start consolidating or merging redundant municipalities.

    http://artvoice.com/issues/v12n30/news_analysis

  9. John Morris says:

    I think John Norquist’s point is that states already use carrots and sticks to push policies like sports stadiums, highways or mandatory parking requirements that hurt cities.

  10. John Morris says:

    In the case of New York city, State politicians have pulled out all the stops to stop the tolling of East River Bridges and congestion pricing in Manhattan. Even though Manhattan is the cash engine of the entire state.

    In Pittsburgh, a big thing state and county politicians want in exchange for aid is continuing parking subsidies.

    John Norquist’s point that states often push policies that are against urban interests and undermine city economies is valid.

    Careful what you wish for with consolidation. Remember Toronto’s anti urban mayor was made possible by a merger with its suburbs.

  11. Steve Eide says:

    Thanks for all the feedback. The outlook for local finances is dim. Would it be improved by more or less autonomy for cities? I think the evidence is very poor that cities’ finances would be strengthened by a broad grant of greater autonomy. State governments are imperfect agents for reform, but they are the only entity in a position to exercise oversight over the many, many local governments who make bad decisions all the time.
    The question of which government is more virtuous-state or local-seems to me entirely subjective. Where you stand depends on where you sit. The way I have tried to approach the problem is, how do we arrange our institutions to allow for dynamic managers and mayors to do the right thing, while still making provision for a way to limit the scope of the many bad local leaders. By all means, let’s get rid of binding arbitration laws and think of other ways to increase local managers’ leverage at the bargaining table. (Like here: http://washingtonexaminer.com/manhattan-moment-hail-massachusetts-health-care-reform/article/2531300)

    But not every local leader will use that leverage.

    The way I see it, states are too content to pass the buck, and localities too apt to demagogue the “democracy” or “self government” issue (as if Governors and state Legislators were not democratically-elected). So we never get very far in talking about ways of restructuring the state:local relationship, changing it from what it is now. The pendulum has swung too far in the direction of local autonomy and there needs to be some pushback.

  12. John Morris says:

    “Not every manager will use that leverage”.

    So what? The important thing is not to drag down everyone and to keep problems smaller and more manageable. As you say, states themselves usually work to extend and pretend.

    There are two important checks on local governments that you haven’t mentioned. The first is the credit ratings agencies and municipal bond market and the second is the threat of criminal liability for corrupt or negligent managers.

    I often wonder if officials would sign onto so many bad deals if they faced the threat of even small fines. Government officials have been placed above the law.

  13. Dave Thomas says:

    No, we do not need states overseeing cities. Concentrating power is the worst possible solution.

    Cities will fail because human beings fail. How else will we learn which policies are good and bad? It’s hard to overstate how counterproductive decreasing the freedom of municipalities is.

    Bad idea!

  14. James says:

    Typically urban areas are net tax contributors and rural areas are net tax dollar recipients. Rural areas also tend to be over represented in state legislatures. So I fail to see how giving the state more power and cities less will lead to “fiscal competence”.

  15. May says:

    A memo by a civic org in Michigan proposed more state oversight.
    http://www.crcmich.org/PUBLICAT/2000s/2000/rpt329.pdf
    AVOIDING LOCAL GOVERNMENT FINANCIAL CRISIS:
    THE ROLE OF STATE OVERSIGHT

    Several voices have pointed out the suburban development pattern within Detroit;but this is a common problem in cities and suburbs alike. This is not just true of citie like Charlotte and Houston.
    http://bettercities.net/news- opinion/blogs/charles-marohn/ 20319/second-life-cycle-blues
    Second life cycle blues

  16. May says:

    Former Harrisburg receiver was on a tv show about distressed municipalities. The discussion is worth watching
    http://pcntv.com/local- governments-in-distress/
    Local Governments in Distress
    His paper is also worth reading:
    It can be downloaded from this link:
    http://www.pennlive.com/midstate/index.ssf/2013/03/update_fharrisburg_receiver_ca.html
    Former Harrisburg receiver calls for swap ban, more state oversight, at national municipal finance summit

  17. May says:

    I support the notion of state oversight. In fact I think the changing economy (more low wage jobs) and demographic will require it if states want to keep municipal bond market for the local governments. Do consider also North Carolina has also many African-American led governments. Aside from Princeville, where the leaders ignored the LGC advice, it has escaped the problems seen in other states even though its economy suffered also.

  18. May says:

    See also:
    http://www.nakedcapitalism.com/2013/07/bad-derivatives-trades-added-to-detroits-woes.html
    MONDAY, JULY 29, 2013
    Bad Derivatives Trades Added to Detroit’s Woes

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