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COMMITTEE REPORT 33 The changing economic structure of central cities thus has a number of fiscal implications, and not all of them are gloomy. There are some opportunities for revenue growth, although state and local governments have not been especially innovative in adjusting their fiscal structure in the past. Urban Fiscal Conditions Long-term structural economic and demographic changes con- tinue to transform regional and local economies, but not in the same ways or at the same rates. These changes have differing fiscal and managerial implications for an urban government, depending on its location, the demographic makeup of its population, and the local economic base. Many central cities, except those in the fastest grow- ing areas of the South and West, face the revenue and expenditure consequences of slowly growing or shrinking economic bases and pop- ulations. Some older suburbs, and even entire metropolitan areas in the Midwest and Northeast regions, face the same problems. In con- trast, some metropolitan areas in the South arid West have to adjust to the fiscal and political consequences of fast growth, which calls for expanding services and infrastructure. Urban areas suffered with the rest of the country through sev- eral recessions in the early 1980s. It is common wisdom that older metropolitan areas, and especially their central cities, suffer dis- proportionately from business recessions, which in turn cause fiscal distress. The same period (the early 1980s) has also witnessed sig- nificant reductions in federal aid for cities. Have fiscal conditions in central cities worsened as a result? RECENT FISCAL TRENDS A city's fiscal health depends on the balance between the costs of the services it provides and its ability to raise revenues.7 The ability of a city to raise revenues through taxes and user charges in turn depends on the level of economic activity taking place within 7 The complexities of defining and measuring local government fiscal ca- pacity are discussed in Ladd et al. (1985:Ch. 4) and U.S. Department of the Treasury (1985:Ch. 83.

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34 URBAN CHANGE AND POVERTY its boundaries. A city government also relies on state and federal aid for some of its budget. Older urban areas, especially in older regions, have in the past been affected adversely by recessions. The 1974 fiscal crisis in New York City and subsequent fiscal problems in some other older cities coincided with a recession and seemed to confirm this pattern. Also, metropolitan areas in general, and central cities in older regions in particular, performed relatively poorly during the 1970s (Garnick, in this volume:Tables 2 and 5~. As George Peterson (1986) has pointed out, these trends led to attempts to explain why older cities might be more vulnerable to economic cycles. The leading explanation has been that sIow-growth or shrinking urban areas, and especially their central cities, have higher proportions of obsolete and worn- out capital facilities and high-cost union labor, which are first to be abandoned when a recession reduces demand. Also, central cities tend to be more closely linked to national rather than to local or regional markets, a factor that could make the cities more sensitive to national business cycles. This analysis has led some researchers to predict that metropolitan areas generally would be more sensi- tive to recessions than nonmetropolitan areas, that sIow-growth or no-growth metropolitan areas would be more vulnerable than fast- growth areas, and that central cities would super more than suburbs. Finally, The cyclical instability of city economies was expected to spill over to city finances, making them especially precarious during recessions (G. Peterson, 1986:13~. These beliefs in urban fiscal vulnerability were consistent with intergovernmental fiscal policy during the 1960s and 1970s. T~ocal governments became increasingly dependent on aid from the federal and state governments until federal aid peaked in 1978. Between 1960 and 1980, federal aid grew nearly 12.6 percent per year (after adjustment for inflation). The biggest increases (31 percent per year) occurred during 1970-1974, when federal grants to local governments grew from $2.93 billion to $8.64 billion (in 1972 dollars). More than half the increase came from general revenue sharing (U.S. Depart- ment of the Treasury, 1985:64, Table ITI.10~. In response to the 1974-1975 recession (the worst since the Depression up to that time) and the belief that urban economies were cyclically unstable, several anticyclical aid programs were adopted; the Antirecession Fiscal As- sistance Program, the I,ocal Public Works Program, and the Public Service Employment Program of the Comprehensive Employment and Training Act (CETA) provided more than $13 billion to state

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COMMITTEE REPORT 35 and local governments between 1976 and 1978 (U.S. Department of the Treasury, 1985:371-372~. By 1980 intergovernmental aid accounted for 44 percent of local government general revenues, compared with 31 percent in 1960. Within 3 years, however, federal and state aici dropped to 40 percent of local general revenues (U.S. Department of the Treasury, 1985:61- 64~. The decline in federal aid to localities that began after 1978 accelerated after 1981 as the new administration succeeded in making major cuts in outlays for urban programs. In an examination of nine urban programs, G. Peterson (1986:31) found that 1982 federal outlays were $5.8 billion less (23 percent) than they would have been on the bash of 1980 policies. (Most of the reduction $3.7 billion was accounted for by the ending of the CETA Public Service Employment Program.) The recessions and federal aid cuts led many observers to pre- dict that cities in general, and especially large central cities in the older regions with their declining economies and higher dependence on federal aid, would experience fiscal crises. In fact, cities currently are not only in a fairly favorable economic position (although some central cities and entire metropolitan areas in the Mideast and Great Lakes regions are still declining), but they are in better fiscal con- dition than at any time during the 1970s, at least as measured by balance-sheet indicators. Of course, these favorable fiscal measures may result from tax increases or service cutbacks or both, which may have adverse economic and political effects, as well as from tax-base growth or more efficient operations. Measuring the fiscal condition of cities is difficult because cities differ in their scope of services and in their ability to reexports taxes- -- for example, to make commuters and out-of-area buyers assume part of the tax burden. One approach to measuring the fiscal conditions of cities, a method that does not adjust for differences among localities, is to use national income accounts figures giving the balance between general revenues and expenditures. Analyzing the state-Ioca] sector of the national income accounts as a whole, the U.S. Department of the Treasury, for example, recently concluded that "the fiscal out- look for the States and localities is more favorable today than it has been at virtually any other time in recent history" (U.S. Depart- ment of the Treasury, 1985:42~421~. George Peterson (1986:25-26) found that the annual and quarterly movements of the state-Iocal fiscal surplus have matched the expansions and contractions of the economic cycle since at least 1969, with some interesting exceptions.

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36 URBAN CHANGE AND POVERTY In the aftermath of the 1974 recession, the state-Iocal sector posted its largest and longest deficits since World War IT, despite the $13 billion in federal countercyclical aid that was made available. In contrast, the deficits resulting from the 1981-1982 recession were smaller than expected and lasted only three quarters, despite cuts in federal aid. Peterson suggests that the prospect of federal aid in the 1974 recession, most of which was not approved until 1976, led states and localities to wait for federal help instead of moving quickly to raise taxes and cut expenditures. In 1981 they did not ex- pect countercyclical aid and anticipated additional federal aid cuts; therefore, they moved quickly to balance their budgets through local actions. The general surplus figure in the national income accounts may indicate the state-Iocal sector's overall financial condition, but it cannot measure the fiscal conditions of individual cities or a group of cities. Philip Dearborn has been analyzing the financial statements of 30 large cities since 1971 and has assessed their fiscal conditions in a series of reports (Advisory Commission on Intergovernmental Relations, 1973, 1985; Dearborn, 1978, 1979), the latest of which is contained in this volume.8 Over the period 1971-1984, the 30 large cities (excluding New York) had current-year general budget revenues that were larger than their current-year expenditures in 9 years of the period; they had revenues that were smaller than expenditures 5 years of the period (Table 9~. All but one of the deficiencies took place in years following nationalrecessions (1971, 1975-1976, 1983), indicating a lagged effect on tax revenues (the deficiency took place in the year of the recession in 1980~. The current-year surpluses a~nounted to 1.5 and 1.2 percent of expenditures in 1981 and 1982 and 2.4 percent in 1984, the highest percentage since 1977 band the highest ever in nominal terms). Although revenue growth (in constant dollars) went down in previous recessions, it actually increased during the 1981 ~1982 recession (Table 10~. Most of the cities (18 to 20 of the 21 cities Dearborn examined in detail) purposefully budgeted a general fund deficiency in 1982,1983, and 1984, but actual expenditures were, as usual, below budget. The . The 30 cities were the largest U.S. cities in 1970, except for Washing- ton, D.C., Honolulu, and San Jose, which were excluded. Dearborn analyzed only general fund budgets through 1980, but added restricted operating funds and capital improvement funds to the analysis of conditions in 1981-1984.

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COMMITTEE REPORT TABLE 9 Current-Year General Fund Revenues and Current-Year Expenditures in Selected Major Cities, 1971-1984 Excess or Deficiency Number of of Revenues, All Citiesa Expenditures Amount Exceeded (in millions Revenues of dollars) Percentage 1971 16 -23.1 -0.5 1972 12 16.1 0.3 1973 8 175.1 3.5 1974 9 156.1 2.9 1975 16 -28.4 -0.4 1976 13 -154.2 -2.2 1977 6 230.6 3.1 1978 12 73.6 1.0 1979 9 98.8 1.2 1980 19 -188.7 -2.2 1981 10 212.6 1.5 1982 12 168.9 1.2 1983 16 -164.4 -1.3 1984 6 309.9 2.4 NOTE: The selected major cities were the 30 largest cities in 1970 (except Honolulu, the District of Columbia, and San Jose). New York is excluded from this table because its size tends to dominate the totals; other cities are excluded for some years in which information was not available. aCities did not necessarily have a deficit on their general fund balance sheet because they could use carryover surpluses to make up for the gap between current-year revenues and expenditures. SOURCE: Dearborn (in this volume:Table 23. 37 1983 deficiency resulted when actual revenues also fell well below budget estimates in 11, mostly larger cities. Fortunately, there were relatively large surpluses in 1982 ($336 million), which most cities used to help fund their 1983 budgets (Table 11~. Although the revenue shortfall in 1983 reduced the accumulated surplus somewhat, to $247 million, most cities budgeted surpluses again in 1984. General fund revenue was greater in 1984 than expected, and the overall surplus was larger at the end of 1984 than in 1982$364.7 million. Not all cities, however, were blessed with general fund surpluses. Some cities had end-of-the-year surpluses of greater than 5 per- cent of their spending budgets; others had trouble balancing their

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38 URBAN CHANGE AND POVERTY TABLE 10 Annual Revenue Increases in Selected Major Cities, 1972- 1984 __ Percentage Increase Type of In Annual Revenues Year Period (in constant dollars) 1972 Expansion 8.0 1973 Recession 3.6 1974 Recession -2.7 1975 Expansion 1.3 1976 Expansion 2.2 1977 Expansion 5.0 1978 Expansion 1.1 1979 Expansion -2.9 1980 Recession -4.4 1981 Recession 0.0 1982 Recession 0.3 1983 Expansion 1.3 1984 Expansion 3.4 NOTE: The selected major cities were the 30 largest cities in 1970 (except Honolulu, the District of Columbia, and San Jose). SOURCE: Estimated from Dearborn (in this ~rolume:Figure 2~. TABLE 11 General Fund Unreserved Surpluses in Selected Major Cities: 1982, 1983, and 1984 Surplus (in millions Percentage of Year of dollars) Revenues 1982 336.1 1.1 1983 247.1 0.9 1984 364.7 1.2 NOTE: The selected major cities were the 30 largest cities in 1970 (except Honolulu, the District of Columbia, and San Jose). Data for this table include New York and exclude Los Angeles. SOURCE: Dearborn (in this ~rolume:Table 6~.

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COMMITTEE REPORT 39 revenues and expenditures. At the end of 1984, 25 cities accounted for the $365 million in surpluses, and 4 (San Francisco, Atlanta, Minneapolis, and Seattle) had surpluses of more than 10 percent of their previous year's expenditures. Meanwhile, 5 cities had persis- tent deficits on their general fund balance sheets: Chicago, Detroit, Cleveland, Boston, and Buffalo. Chicago necessarily has a deficit because, under state law, it collects property taxes the year after expenditures are incurred; Cleveland and Buffalo had deficits of less than 1 percent; only Boston's (6 percent) and Detroit's (3.1 percent) deficits were worrisome (Dearborn, in this volume:Table 7~. Dearborn also reviewed the financial condition of the same 30 cities for 1981-1984 using information on all governmental operating and capital funds and not just the general fund as in his previous reports.9 He found that aggregate operating revenues were larger than expenditures in all 4 years, although the difference was very small in 1983 when the general funds showed deficiencies. Liquidity, the ratio of cash or cash equivalents on hand to total operating fund expenditures, was about 35 percent from 1981 to 1983 and increased to 47 percent in 1984. The liquidity of only one city was less than 15 percent in 1984, compared with six cities in 1982. One analyst (G. Peterson, 1986) has suggested that one reason federal aid cuts in 1982 and 1983 did not have a greater impact on city finances was because federally assisted programs were segregated from general fund budgets (G. Peterson, 1986:31-32~: Since the termination of Carter's antirecession federal aid, federal categorical assistance in most cities has not been used to support basic services like police or fire protection, sanitation, financial management, or even schools to a great extent. Federal grants typically were handled through separate funds and were used to finance auxiliary activities whose spending could be adjusted upward or downward to reflect federal assistance levels. By 1981, for example, almost all cities had moved their Public Service Employment workers out of general government services, in anticipation that federal funding for the program would be terminated at some point. When federal aid was reduced or eliminated, the cuts were passed through to specific programs, most of which city officials considered 90perating funds include general, debt service, and special-revenue funds. Special-revenue funds contain proceeds of specific revenue sources that are legally restricted to expenditure on specified purposes. Capital-improvement funds use receipts from bond sales and federal grants. Enterprise funds for local utilities, airports, and the like are not included in the analysis because such activities are supposed to be self-supporting.

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40 URBAN CHANGE AND POVERTY low priority, according to a survey done for the Urban Institute (G. Peterson, 1986:31-33~. Meanwhile, Congress prevented high-priority federal programs such as wastewater treatment, general revenue shar- ing, and mass transit from receiving major cuts. States, however, increased local aid. For example, many states acted to restore at least some of the fevers funding cuts in most of the block grants created in 1981 (G. Peterson et al., 1986:13-15~. State aid to local governments increased from $82.8 billion in 1980 to $99.5 billion in 1983, a 20 percent increase; but state aid as a percentage of local revenues decreased from 35 percent in 1980 and 1981 to 34 percent in 1982 and 33 percent in 1983 (U.S. Department of the Treasury, 1985:Tables V.13 and V.14~. Yet municipalities receive only 16 per- cent of state aid to local governments. Most such add goes to school districts (52 percent); the rest goes to counties, townships, special districts, and other recipients (Gold, in this volume:Table 9~. Federal aid cuts apparently did not require general budget ad- justments, except in a few cities.~ Moreover, in the cities examined by Dearborn, special-revenue funds, for which intergovernmental aid is usually received, did not shrink in the early 1980s. In fact, special-revenue funds as a percentage of total operating revenues were slightly higher in 1984 than in 1981 (27.1 percent compared with 26.4 percent). The elimination of general revenue sharing (GRS), how- ever, may show more of an effect. The 30 large cities (excluding Los Angeles because of a lack of data) received $730 million in GRS in 1984, which amounted to 2.2 percent of their overall operating rev- enues. (The percentage of GRS received by individual cities ranged from 1.2 percent in Buffalo to 5 percent in New Orieans.) Most of the cities include some GRS in their financing of current operations and will have to adjust for its loss. For example, the cities' surpluses of nearly $365 million at the end of 1984 represented only half of the $730 million in GRS aid that year. But some cities had less of a surplus than others. Unless cities without enough surplus funds had cut services, 15 cities instead of 5 would have had general fund balance sheet deficits in 1984 without GRS. Dearborn estimates that, with the loss of GRS, most cities will have to make a 2 percent or 3 percent adjustment in revenues or expenditures or both, which will Detroit, for example, still had more than 1,800 public service employment workers in general city positions when CETA was terminated in 1981. This figure constitutes more than 10 percent of that city's workers (G. Peterson, 1986:32~.

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COMMITTEE REPORT 41 cause problems for those cities already experiencing fiscal problems (Dearborn, in this volume:274-276~. Finally, whereas the 30 cities as a group have had their ups and downs, reflecting fluctuations in the business cycle, at least until the 1981-1982 recession, some cities have had consistently good fiscal conditions during 1971-1984. Others have had problems for most of the period. The cities that have consistently enjoyed good fiscal con- ditions are San Francisco, Minneapolis, Indianapolis, Jacksonville, Milwaukee, Atlanta, and San Diego (and probably Los Angeles, al- though its financial reports cannot be analyzed well enough to find out). Cities that had problems for extended periods were New York, Chicago, Philadelphia, Detroit, Boston, Cleveland, St. Louis, and Buffalo. Over time, however, it appears that fewer cities have shown indicators of fiscal problems, such as expenditures greater than rev- enues for 2 or more consecutive years, accumulated deficits, and Tow liquidity (see, e.g., Advisory Commission on Intergovernmental Relations, 19853. Only Detroit and Boston had major deficits in 1984. SUMMARY City finances survived recent recessions and federal aid cuts remarkably well for reasons that are not entirely understood. They now have relatively large general fund surpluses to cushion future revenue shortfalls. But there are individual exceptions to this rosy picture in the Midwest and Northeast. One likely factor has been the resilience of urban economies during recent recessions. Another has been the cities' ability to pass program cuts directly on to recipients without affecting their budget balances. George Peterson (1986) reviews the evidence on both these factors for the recessions of the 1970s and discusses possible reasons. New theories and more research are needed to understand this unexpected situation in which urban economies appear to be mildly countercycTical in recessions. It is important to note that the fiscal situations of most older central cities in the Northeast and Midwest may not have been greatly affected by recent recessions, but their underlying economies continue to decline in response to long-term trends, as discussed in the previous section of this report. It is also important. to realize that good fiscal conditions do not necessarily mean that a city's social conditions are healthy. In fact, a balanced budget may result