Local budgets: The crisis that didn't happen (yet)

State revenues have rebounded, and there was no municipal bond default crisis. But given the furor over public pensions and labor compensation more generally in 2011, the coming year could be one of conflict in state capitols and city halls.

The year’s top story in state and local government was “hundreds of billions of dollars” in municipal bond defaults.  Oh wait, that didn’t happen. 

It was “states coming to Congress as mendicants, seeking relief from the consequences of their choices.”  No, although the Dickensian imagery may fit with the holiday decorations, that didn’t happen either.  To the contrary, governors spent much of the year fretting about federal inaction on the budget and debt limit.

What did happen is that state revenues rebounded.  After falling further and faster than in any recession since the Great Depression, taxes started coming back in early 2010.  They continued growing through the third quarter of 2011. 

However, tax revenues still haven’t regained peak 2008 levels.  The latest data also suggest growth may be moderating, and some states are reporting monthly collections below projections. 

2011 was also the year that local property taxes finally dropped.  The resilience of property tax revenues until now may seem puzzling given 30 plus percent housing price declines.  The explanation is that it typically takes 2 to 3 years for lower prices to show up as lower assessed values and property tax bills. 

In the meantime, some local governments have been able to raise property tax rates to compensate for depressed home values.  Others benefited from lags in adjustment from home prices to tax revenues, just as homeowners benefitted from these delays in boom years.

The other big story of 2011 is state and local government job cuts.  Although the private sector added jobs in 2011, state and local governments have been shedding them since 2008.  Overall, state and local governments have cut 640,000 jobs (3.2 percent of payroll) since August 2008 and they show no signs of hiring again anytime soon. 

What’s next for 2012?  Making New Year’s predictions is a mug’s game, but there are a few trends worth watching. 

First, chickens will come home to roost.  It’s hard to imagine voters will fail to notice cumulative effects of real cuts to state and local government spending per capita in 2009 and 2010.  Tracking government outputs and service quality is always tricky.  However, news reports suggest longer waitlists, uninvestigated crime reports, shorter school years, etc.  If the economy does not pick up steam and voters continue to resist tax increases, we can expect more of the same in 2012.

Of course, there may have been room for efficiency improvements before the recession.  But state and local governments specialize in exactly the kinds of labor-intensive services (education, health care, public safety) that are notoriously resistant to productivity gains.  What’s more, voters tend to reward politicians for more – not fewer – teachers in the classroom, cops on the street, and so forth.

Next, there will be more cracks in the edifice of federal-state-local government cooperation.  Governors may not have come begging to Washington in 2011, but they did implore Congress’ super committee to leave states alone as it sought to stabilize the federal debt.  Now, although the committee’s failure triggered automatic spending cuts starting in 2013, these cuts will exempt Medicaid and other big ticket items.  Still, communities that depend on federal wages, contracts, or grants will be affected.

Finally, state and local governments will continue attempting to tackle their long run fiscal challenges – pensions and retiree health costs – which happen to look a lot like the federal government’s own challenges.  New government accounting standards to be released in June 2012 may accelerate this trend.  Given the furor over public pensions and labor compensation more generally in 2011, this could be another year of conflict in state capitols and city halls.

In other words, fasten your seatbelts, it’s going to be a bumpy 2012.

Originally posted at the Brookings Institution Up Front Blog.