City budgets are getting wrecked by a pandemic. Heed this caution into the fight

During economic shocks, one popular philosophy of response for government is Keynesian-style stimulus. When demand is collapsing, government should step in as the spender of last resort.

This is not a dissection of that approach — don’t @ me. Instead, this is an explanation of why fiscal stimulus is primarily reserved for sovereign governments, not state and local ones.

The allure is understandable. A pandemic has effectively shutdown our national economy, causing still-un-calculated ripple effects.

For one, local governments across this country of diffuse federalism are already confronting ballooning budget shortfalls, as revenues shrink and expenditures mount — and the idea of state budget bailouts is predictably political. In the City of Philadelphia, Mayor James Kenney says his finance team is now projecting a deficit of $650 million. In its original form, the Kenney administration was projecting nearly $5.2 billion in revenue for this next fiscal year. Last week they revised that down to less than $4.7 billion, as the novel coronavirus took hold.

Even that revision could be optimistic — it projects sales tax declining just 6.27%, for example, which is an uncertainty depending on lockdown.

As part of his new proposed budget, Kenney recommended drastic cuts, including the closure of several city offices — including the Office of Workforce Development and the Office of Arts, Culture and the Creative Economy. The latter in particular sparked outrage among the city’s varied arts community.

We’re in our second once-in-a-lifetime economic shock in just over a decade. Surely we should go on the offensive and invest, goes the thinking. Austerity kills, and this sounded something like the beginning of that to many. But it’s critical to understand why that doesn’t work in a local sense.

In some ways, things were looking rosy for Philadelphia in 2020.

The Pennsylvania Intergovernmental Cooperation Authority (PICA), which since 1992 has been something like the City of Philadelphia’s state-ordered parental budget cop, recently issued its latest monthly tax revenue overview. March 2020 actually ended with a 0.4% increase over March 2019, a $1.4 million sum. But the report ended with this ominous warning: “Due to the COVID19 pandemic crisis, these projections will change with the issuance of the next” report.

Unlike the federal government, which includes control of the money supply by our central bank, local governments have no such monetary power. Cities have only three budgetary tools: increasing revenue, decreasing expenses and issuing debt, primarily through municipal bonds.

Commonly, states governments cannot legally operate in a deficit like the federal government. That's true in Pennsylvania.

It is considerably different for the U.S. federal government to inject stimulus that amounts to 6.9% of annual GDP, presently among the most generous in the world, and what local governments can do. Big city government bankruptcy is rare but has precedent. Five years after the largest municipal government bankruptcy in American history, Detroit leaders have bandied about a rebirth narrative.

Commonly, states governments cannot legally operate in a deficit like the federal government. That’s true in Pennsylvania.

From the Pennsylvania Constitution Article VIII, Section 13: “Operating budget appropriations made by the General Assembly shall not exceed the actual and estimated revenues and surplus available in the same fiscal year.” (Find here a helpful primer on state debt by Arthur Heilman, last updated in 2018).

In its own way, Philadelphia City leaders must have their five-year budget plans approved by PICA, which has overseen a generation of relative financial stability and growing budget surpluses in recent years.

(For those who skipped accounting class, it’s important to remember the difference between deficit and debt: A deficit is the difference between revenue and expenses in a given year, and debt is made of bonds and other obligations to cover those annual deficits)

With plunging revenue and emergency expenses, Philadelphia’s only immediate options are debt, by going to the bond market.

But it is seen as a municipal budget no-no to cover a deficit with debt, as two city budget veterans told me this week and a city rep echoed. As city Deputy Communications Director Mike Dunn said in a followup email: “It winds up creating a new fixed cost (debt service on the borrowing) that makes it even harder to handle the next budget shortfall.”

You might say, “then make the cuts but invest elsewhere with the bond market,” as the Nutter administration did during the Great Recession. But, friend, the typically sleepy municipal bond market has been racked by the pandemic, too.

In March, investors withdrew from the muni market (what insiders call the municipal bond market) more in one week than ever before, $12 billion, as they feared a wave of pandemic-prompted defaults. Costs for local governments and associated entities to borrow shot up. Certain variable-rate bonds supporting hospitals surged from an interest rate of 1% to more than 7% in one week in March, prompting some states to buy back the debt on behalf of their coronavirus-smacked health providers — including Pennsylvania.

This was all alarming enough that the U.S. Federal Reserve took the unprecedented step of pledging to backstop much of the market. But it’s an unusual role for a central bank. There is a $500 billion stimulus bill for states and local governments in Congress but it’s hampered by a perception among some that it will reward profligate spending.

All told, just as state and local governments are tackling unexpected costs and confronting plunging revenue in the face of a pandemic, their ability to borrow has gotten costlier.

It’s worse for Philadelphia, which is more indebted than its peer cities (see the below chart). Its investment grade among the country’s 25 biggest cities is only better than Chicago and once-bankrupted Detroit.

Philadelphia has been heading in the right direction since the early 1990s.

Just last year, the City of Philadelphia’s Treasury Office boasted “historically low” bond yields (overview here), reflective both of  macroeconomic trends and a rosy outlook for the city’s finances — in past bond issuances the Kenney administration has noted its work on pension reform, though it was predicated on aggressive market returns. (Find Philadelphia’s open bond issuances on the secondary market here.) The Kenney administration in November reported that the City was more prepared for a recession than it had been in a decade.

Improved or not, Philadelphia could well be an example of the kind of place federal budget hawks don’t want to help.

As the federal government has decreased its redistributive spending, more have looked to state and local governments to combat ever more intractable problems, like income inequality. The Kenney administration, which came in backed by a progressive collaboration of backers, represents the trend.

In Kenney’s first term, the city’s budget ballooned by nearly a quarter, and it’s grown by nearly a third since 2011, thanks in part to an investment community schools and universal pre-K, initiatives Kenney has championed. Kenney budget critics cite missed opportunities during the boon times of the last decade, including property tax accuracy and use of overtime. Just in February, PICA Executive Director Harvey Rice told The Philadelphia Tribune the city could not weather a severe economic downturn, citing familiar shortcomings for the City of Philadelphia: not contributing enough to the City’s fund balance and under-funded, yet still budget-dominating pension obligations, amounting to at least 16% of each year’s budget.

With plunging revenue, surging expenses and even-more constrained debt options, what do you do?

During the Great Recession, the Nutter administration avoided layoffs by dramatically increasing taxes — and issuing a bond for capital projections which contributed to the first improved investment grade since the 1970s. His administration also tried to bargain with threats to cut core services, including neighborhood libraries, something an otherwise-popular mayor hasn’t entirely lived down. The Kenney administration says its new budget proposal doesn’t close such critical services — something some in the arts community will loudly challenge.

Locals can call their congressional leaders and plead for federal support. But locally, the choices are stark. Rather than purely complain about losing an office you care for, ideas are needed. Credit should be given to a coalition of progressive groups for putting together their Revenue for a Just Recovery (PDF). Perfect or not, they’re at least putting forward a plan. We can’t ignore this away.

Budgets have two inputs: revenue and expenses. By demanding services beyond our available means, we’ve never confronted our structural problems. Now the check is being withdrawn. Acknowledging that reality is the first step to moving forward, productively.