Joseph Krist

Publisher

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CITY REVENUE OUTLOOK

The National League of Cities has released the results of its annual survey of City Fiscal Conditions. This year’s City Fiscal Conditions research looked at the fiscal conditions and factors across 500+ U.S. cities. It found that almost two in three finance officers in large cities are predicting a recession as soon as 2020. Cities’ revenue growth stalled in the 2018 fiscal year, but this year’s continued drop indicates mounting pressures on city budgets. The Midwest is bearing the brunt of declining conditions, the report found. Overall general fund revenues in Midwestern cities dipped by 4.4% in fiscal year 2018.

In fiscal year 2018, total constant-dollar general fund revenue growth slowed to 0.6 percent. Income tax and property tax revenues slowed, while sales tax revenue growth was unchanged from the prior year. Property tax revenues grew by 1.8 percent, compared to 2.6 % in FY 2017. Sales tax revenues grew by 1.9 %, compared to 1.8 % in FY 2017. Income tax revenues grew by 0.6 percent, compared to 1.3 percent in FY 2017. expenditures are climbing, increasing by 1.8 percent in fiscal year 2018. While that’s a growth rate is slightly lower than the prior three years, officials also expect it to climb again to 2.3 percent for fiscal year 2019. Infrastructure needs, public safety spending and pension costs are among the most significant expenditures.

The data shows the impact of the continuing decline in manufacturing and the impacts of tax and trade policies and their very detrimental effect on the Midwest. Overall, revenues in Midwestern cities declined 4.4%. Much of that appears to be driven by  large revenue drops   in big cities. Chicago, Illinois, recorded an 11.7 percent revenue decline in fiscal year 2018 while Minneapolis, Minnesota, dropped by 9.6 percent. According to the NLC survey, finance officers from large (63%) and larger mid-sized cities (49%) are more likely than finance officers from smaller mid-sized cities (38%) and small cities (35%) to predict that the next recession will occur in the next one to two years.

The NLC attributes the difference in outlook to a couple of factors. large cities are experiencing a bigger gap between revenue growth and spending growth than their smaller counterparts. Housing market growth is also reaching its peak in large cities and is already slumping in some large West Coast cities such as Seattle, Washington, and San Francisco, California. June home prices for  major West Coast cities fell for the first time since 2012, declining by 1.7 percent. Business investment in 2019 is also on the decline, a metric which tends to hit larger cities first.

The report reiterates the leading pressures on local budgets. Infrastructure needs, public safety needs and pensions were reported as the top three burdens on city budgets in 2019. At the same time, the survey revealed several trends on the revenue side of the credit equation that should give one pause. Sales and income tax growth rates peaked in 2015 and growth rates for property taxes peaked a year later. Another source of concern is the growth of state level preemptions which limit local powers to tax and regulate. For example, this year the Texas state legislature signed into law a bill to cap local property tax revenue growth at 3.5%. In addition to preemptions that have been in place for years in states like Michigan and Colorado, new legislation was passed this year to cap local spending in Iowa, to require elections for tax increases in Texas, and to prevent cities from imposing their own commercial activity taxes in Oregon.

Put all of this together and one begins to ask, at current market conditions do I get paid for the risk I’m taking? It’s not so much a question of whether the market is most effectively pricing municipal debt relative to different asset classes but rather a question of whether current absolute rates generate a sufficient reward for the risk potentially being assumed. It’s clear that the best days for revenue growth have passed while the same pressures  plaguing local budgets have not subsided and in many cases have increased. We don’t propose the end of the world as we know it but we do wonder when the market will wise up and asked to be paid for the risk they take.

NEW YORK MAKES ITS CHOICES

The war on mass transit continues in New York City. The MTA continues to scramble to find funding for projects expanding access in poor neighborhoods (the Second Avenue subway extension to 125th Street), improving accessibility for the disabled and the aging, and maintaining its capital plant in general. The affordable housing crisis continues with the revelation that there are some 110,000 homeless students enrolled in the City’s public schools ( that’s a lot more than the City’s regularly peddled number that there are 60,000 homeless overall in the City). Not to say that the NYCHA is in a bit of a funding pickle for capital themselves.

So what has the City government agreed on for $1.5 billion in spending over a ten year period? 250 miles of protected bike lanes. Lanes by the way which are paid for by some sort of user fee, right? Some form of safety regulation (helmets) or insurance requirement? Some form of revenue generated from the user base (even the farebox covers a much higher % of operating costs than most other US transit systems)? No. None of that. Instead, the City will spend this money which intentionally or not really covers a very specific cohort (white males under say 45) at the expense of other more diverse population cohorts.

In the end, it’s up to the City to do what it wants but it is fair to question the capital priorities especially when there is no connection between use and funding of an asset. It’s one side of the dilemma posed by the advances of various modes of micromobility. Until the issues of funding relative to utilization are more clearly established, issues not directly related to transportation will continue to intrude on the debate over the future of transportation.

CHICAGO BLUES

This is shaping up to be a tough budget season for the City of Chicago. The Mayor’s budget proposal is receiving lukewarm support from a variety of constituencies. Many are expressing concern about the need for the state to take actions in order to allow the City to address its revenue and pension problems. And the teachers strike against the Chicago Public Schools continues. The longer it goes the more vicious the cycle gets as more people will look for permanent alternatives to CPS schools. With each passing day, the district doesn’t get aid based on average daily attendance.

It can be hard to see through the rhetoric of this strike. The union is taking on a variety of issues outside of traditional workplace issues. They are attempting to direct funds from tax increment districts. According to the Chicago Tribune, TIFs now cover about one fourth of the city’s real estate, including some areas downtown. The city can redirect money from TIF districts that isn’t committed to specific projects through a process called declaring a surplus. Mayor Lightfoot has proposed declaring a record $300.2 million TIF surplus in 2020. That’s up from the $175.7 million this year that Emanuel included in his final budget. As the biggest taxing body, CPS stands to collect $163.1 million of the proposed $300.2 million surplus.

We do not take the view that the City is in danger of default. What we do however believe is that investors need to be compensated for the risks they are taking in connection with the direct debt of the City or the schools district. These entities are fortunate that absolute market levels provide reasonable borrowing costs for both new money and refunding purposes. In a market where rates rise and are expected to continue to do so, credits like the City of Chicago and the CPS are in a position to get hammered in terms of spread.

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