Crunch Time for Cities, Counties and States
It gives me no joy to address problems without easy solutions, but the sooner we face what’s already visible ahead, the higher the probability that whatever plans we make will be realistic enough to benefit us going forward.
The era of living off debt and asset bubbles is ending, because such eras are inherently artificial and unstable and so they always end badly for those who mistakenly reckoned they were The New Normal and somehow permanent.
The ending of this era will be crunch time for local governments: state, county and city, as their tax revenues all depend in one way or another on soaring debt and asset bubbles funding more consumption and generating more taxes.
Property taxes have risen sharply as the housing bubble inflated and tax rates notched higher in many locales. State and local property taxes were $797 billion in 2024, an increase of 8.2%. Total Property Tax Collections Hit Record High in 2024.
This chart reflects the revenue sources for state and local governments:
“According to the Census Bureau’s Quarterly Summary of State and Local Taxes, state and local property tax revenue totaled $797 billion, up 8.2% from the prior year and making up 38% of all state/local revenue. General sales tax revenue was up 1.2% to $587 billion (28% of the total) while individual income tax totaled $537.4 billion (25.6%), up 4.7% over the year. Corporate income tax totaled $174.5 billion (8.3%), up 0.2%.”
Once the housing bubble deflates, property taxes will no longer rise based on valuations bubbling higher.
Sales and real estate transfer taxes are driven not just by inflation but by the wealth effect, as the top 10% who have reaped the majority of the gains in the stock and housing bubbles account for about 50% of all consumer spending. Once the asset bubbles pop, the wealth effect reverses and people no longer feel richer, they feel poorer, and reduce borrowing and spending.
As layoffs reduce the number of wage earners, consumption drops accordingly.
As spending and asset valuations decline, so do fees, business license revenues, etc.
Meanwhile, the costs of operating local government are soaring–especially for salaries, pensions and retiree healthcare benefits.
Unfortunately, that’s not all the negatives in sight: as federal spending finally reaches some version of limits, the free flow of federal money to state and local governments will either stop rising or potentially decline sharply.
Another negative is the way many public pension plans are funded by stock market gains. When California’s CALPERS pension fund, for example, reaps big gains in its investment income, the annual contributions paid by municipalities is reduced accordingly. Should investment income dry up or even reverse, municipalities will be hit with larger than anticipated increases in pension contributions.
Once asset bubbles pop and spending declines, where are local governments going to get the money to fill the shortfall between revenues and spending?
Many municipalities have set aside “rainy day funds” for such downturns, but they are generally modest in scope, designed to cover a few negative quarters, not years of declining tax revenues. Many local governments have used accounting gimmicks and drained special funds to balance their budgets.
Others have played the game of offloading expenses such as filling potholes that were once paid out of general funds (i.e. tax revenues) to “infrastructure bonds,” i.e. taking on debt that will cost the city double over the lifetime of the bond to fill potholes.
Let’s take one mid-sized city in a metro/urban area as a real-world example of the widening gap between revenues and expenses, which the largest salaries and pension benefits that are generally mandated by law or union contracts. To avoid politics–because these issues will affect red and blue locales alike–I’m not naming the city.
Salaries are increasing by 12%, or $23.7 million annually.
Pension contributions are increasing by 9%, or $4.7 million annually.
Healthcare benefits cost increases aren’t broken out, but $386 million of the $776 million budget for fiscal year 2025 will go to salaries and benefits for city employees — a 12.7% increase from the previous year. This suggests healthcare expenses rose in line with salaries and pensions– in the 9%+ range.
As a generality, public employees receive more generous healthcare benefits than most private-sector employees.
As for revenue increases, these are far more modest than the increases in expenditures: an increase of $7.6 million. So salaries and pension costs rose by $28.3 million, and revenues rose by $7.6 million. (The cost increases don’t include rising healthcare costs.)
So what happens when the asset bubbles pop and the economy slips into an extended stagflationary cycle of rising costs and stagnating incomes / tax revenues?
There is very little wiggle room in the 50% of the budget that is devoted to employee salaries, benefits and pensions, as these are mandated by law / union contracts, and the few court cases of municipal bankruptcies indicate that these employee benefits and pension are not on the chopping block, meaning that cities, counties and states will have few options to cut expenses other than laying employees off and slashing discretionary spending.
In other words, public services will be cut today to pay for yesterday’s pension promises.
At the same time the public is being dealt reductions in services, they will also be hit with higher taxes, as trimming staffing and cutting programs will be unlikely to cover the widening gap between revenues and spending.
In locales where the public must approve tax increases, a wealth-generational gap opens: retirees drawing ample pensions who bought their homes for $50,000 decades ago tend to vote for tax increases because their share of the higher taxes is modest compared to their income and net worth. And since they may rely on city/county services more than younger people, raising taxes to maintain services serves their interests.
At the other end, young people facing layoffs and reduced income, strapped by student loan debt and soaring costs of living, are less inclined to increase their already high tax burden.
If the local governments can’t raise taxes enough to maintain services, then the city’s quality of life declines, possibly precipitously. Those who can move will be increasingly motivated to do so, and these tend to be high earning households who have job mobility.
Entrepreneurs are also highly motivated to abandon ship as their businesses decline and fees rise.
As the incentives to leave increase, those who remain will tend to be retirees who are less likely to start new enterprises, create jobs or spend a lot of money, and lower-income households with less job mobility and a mortgage to pay on a house that’s rapidly losing value as the jobs that attracted new residents dry up.
Doom Loop is an apt description of this dynamic, as local governments will be forced to slash public services and squeeze more tax revenues out of whomever is left and can afford to pay higher taxes–moves that increase the incentives of those most able to pay higher taxes to move to lower tax-rate locales.
The past 80 years of growth and prosperity interrupted by a handful of recessions has normalized the view that every recession is brief and we’ll all be off to the races again in no time. The possibility that the stagflationary era we’re entering is the end of the 80-year cycle of permanent expansion of everything–jobs, income, wealth, asset valuations–doesn’t compute.
If the asset bubbles pop–and all asset bubbles pop–and debt-fueled spending finally encounters limits on expanding debt to boost consumption–then it’s crunch time for local governments and the public they serve–which is all of us.
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