After a tough year of declining property tax collections and budget cuts among local governments there appears to be some relief in sight, but new challenges have emerged in an environment of moderate growth.
It has Been One Tough Year for Local Governments
Over the past year, local budgets have been under pressure as the home price declines of the housing bust have put a damper on property tax collections, and slower consumer spending has held back growth in local sales tax revenues. The result has been budget cuts at the local level that have affected funding for such areas as school districts, city services and local infrastructure projects. These budget cuts have not gone without their effects on economic and job growth. Employment within the local government sector has declined 11 percent since July 2009 when the first local layoffs began (top graph). Besides the effects on the labor market, local government consumption, which makes up the bulk of total government spending, continues to detract from top line economic growth. The reality of slower revenue growth and increasing future liabilities will likely keep the pressure on local budgets in the year ahead.
The Sources of the Problem and New Challenges
When looking at the composition of local government revenue, the two main sources of funding include property taxes (40 percent) and local sales taxes (22 percent). The pullback in property tax collections following the housing bubble lagged the decline in home prices (middle graph) and, along with stimulus funding from the Recovery Act, delayed the inevitable onset of cuts at the local level. At the same time, demands on local governments have continued to increase. The new long-term challenges facing local governments, besides slower revenue growth, is the rising costs of healthcare and pensions for local government employees along with increased risk of reduced federal and state funding support as all levels of governments attempt to restructure operations.
Implications for Economic and Job Growth
Our outlook continues to call for slow revenue growth for local governments as a result of moderate consumer spending and only gradual appreciation in home prices, keeping sales and property tax collections growing below historical trends. In order to better balance the needs of growing localities with future liabilities, tough choices will need to be made at the local level about public pensions and healthcare benefits. In addition, many localities will need to address these issues in light of reduced federal and state level support. As a result we believe that local governments will continue to struggle on a regional basis and only provide a slight boost to economic growth by the second half of next year (bottom graph). The outlook for local government job growth is less rosy. The new rebalancing effort at the local level implies that fewer workers will be needed in the current environment. Thus local government layoffs should subside, but overall employment levels will likely remain relatively unchanged over the next year.