During the recent economic crisis, local government finances have taken an epic battering. The financial condition in our 50 states, 3,000 counties and 36,000 municipalities is severe. State and local governments employ almost 10 percent of the U.S. workforce and have been laying off folks at a brisk clip. Contraction in government hiring, spending and service provision threatens to lower economic growth, reduce quality of life and increase inequality of income and opportunity. We are early into a decentralized, local austerity program similar to events in the Euro Zone.
From 2003 to 2007 states were the beneficiaries of growing revenues from booming construction, housing markets and retail spending. They spent at a fairly high clip and taxed at relatively low rates. As the recession began in late 2007, demand for state services — direct and through aid to localities — increased sharply. State governments continue to face record demands for services, and have unfunded health and pension liabilities that run into many hundreds of billions of dollars.
Shrinking personal and corporate income tax receipts and sales tax revenues since 2007 have created one of the largest declines in income for state governments in modern history. Many states have been getting by through federal assistance and issuing federally subsidized Build America Bonds. With these two measures trailing off in 2011, there will be widespread and long-term deficits in most states. This year, states face more than $110 billion in budget shortfalls.
Localities rely on state assistance for nearly one in every three dollars that they spend. They depend heavily on property taxes for income — and in some cases sales taxes. Housing is in the worst crisis in living memory, and the average house price has plunged more than 25 percent since 2006. The massive decline in property values will begin to pressure already stretched local and municipal budgets. Because property is reassessed every few years, it takes several years for falling property prices to show up in declining revenue. State aid to localities will decline as federal stimulus funds trickle off this year, compounding the states’ dire finances.
Local areas spend more than half their budgets on education and social services, which are increasingly squeezed. Like states, most municipalities have a fiscal year that begins in July. We can expect battles over wages, benefits and employment levels to heat up this spring. Massive pressure to lower costs and employment at the state and local level are here and are likely to intensify.
According to the Congressional Budget Office, local governments have cut spending by 2 percent and reduced their workforces by 241,000 since the start of the recession. As payrolls are cut, service provision will likely decrease despite continued high demand. This will stress public education, fire and police departments, infra¬structure and many other services.
Reductions in state and local spending and employment will hobble economic growth. Reduced growth is likely to acutely affect lower-income populations. Cuts in progressive and graduated federal income taxes, estate taxes and capital gains taxes reduce the burden on the most affluent. Rising property and sales taxes, and declining services at the state and local level are regressive. Taxes that land hard on lower and middle-income households will rise and services to these households will fall. The bipartisan federal tax bill reduces income taxes on more affluent Americans. This is likely to hurt localities. How? Localities and local authorities — schools, utilities, transit systems, water works — raise money for projects by selling bonds to investors in the municipal bond markets. The income from these bonds is usually tax exempt. The higher the investor’s tax rate, the more appealing municipal bonds usually are. Cutting the tax rate on higher income earners lowers the appeal of municipal bonds. Also, a federal stimulus program has been subsidizing the interest cost of local bond issuers, but is set to expire after 2011. All of this is increasing fears of rising municipal defaults or attempts to renegotiate their debts over the next year.
As states and localities reduce spending and employment, education and basic social services are likely to suffer the lion’s share of pain. At-risk communities are already suffering from weak labor markets, low wages and the end of unemployment benefits. To this we will add a shrinking pool of opportunity for secure jobs with good benefits in state and local employment. Public sector unions will likely be weakened. There is a big fight brewing over public sector pension benefits. And there will be contentious and dramatic suggestions for social spending cuts as Congress is required to debate and vote on raising the national debt ceiling.
We now run the risk that as 2010 closed with tax cuts heavily benefiting the most affluent, 2011 will begin with service, education and employment cuts falling hardest on the least affluent.