States Increase Tabs They Keep on Municipalities’ Fiscal Health

Chapter 9 bankruptcies and debt defaults have driven a surge in monitoring -- and the localities seem to appreciate it.
by | November 2016
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When New York state released the latest scores for its fiscal stress monitoring system this fall, a few local governments received a bit of unwanted news. Two cities (including Albany), four counties and two small towns were deemed to be under “significant fiscal stress” -- the system’s most severe designation.

Those localities are hardly the only places to find a spotlight being trained on their fiscal woes. A growing number of states are either establishing new systems or strengthening existing initiatives aimed at monitoring the fiscal health of their localities. In all, a recent Pew Charitable Trusts study found that 22 states regularly review local government finances to detect fiscal distress or assess fiscal conditions.

States have had plenty of reasons in recent years to want to keep tabs on local governments’ fiscal health. Municipal bankruptcies, while extremely rare, sounded the alarm in some states. In others, jurisdictions sparked concern when they missed debt payments. “There was this wake-up call moment in multiple states,” says Mary Murphy, who co-authored the Pew report. “The last few years have been especially important for thinking about these concerns.”

In 2013, New York State Comptroller Thomas DiNapoli initiated a system assessing a series of financial indicators, such as operating deficits and year-end fund balances, along with a different set of environmental indicators that consider a municipality’s demographics, property values and a range of other measures. In all, 59 local governments merited one of three designations indicating varying levels of stress in fiscal 2015. That’s a relatively small share of municipalities in the state, so being on the list acts as an added impetus for local officials to get their financial house in order.

Nevada added teeth to its existing system last year, formalizing a process that requires local officials in designated “fiscal watch” jurisdictions to appear before a state oversight committee; just one county in the state is currently under watch. Recent legislation also expanded the state’s role in overseeing municipalities with “severe financial emergency” status -- a designation that hasn’t been applied since 2009 -- such as approving a locality’s employment contracts.

Keeping an eye on local governments’ finances helps a state better distribute revenues and detect potential problems down the road. It also tends to make ratings agencies happy: Moody’s Investors Services noted in a report that it tends to go easier on troubled local governments if they’re in states with strong oversight and established intervention policies.

Fiscal monitoring systems take vastly different forms. Some are part of annual budget approval processes, as in Nevada, where all local governments submit tentative budgets to the Department of Taxation to check for technical errors and compliance with state statutes. Nevada is one of eight states with laws formalizing monitoring systems and processes for determining fiscal stress, according to the Pew report. That helps ensure continuity as administrations come and go and provides for consistent tracking. Other states, such as New York, simply collect annual financial data for analysis. These monitoring programs aren’t necessarily new -- efforts in many states date back several decades. North Carolina maintains the country’s oldest system, adopted in the 1930s.

One of the more robust systems is Tennessee’s. There, every city and county must submit its budget to the state, which reviews them for red-flag issues such as improper fund transactions or failing to appropriate enough money for debt service. It’s not uncommon for localities to need to tweak their budgets: The state Comptroller of the Treasury reports it most recently requested 20 to 30 percent of counties to make adjustments to their budgets before approval. A state analyst is assigned to each individual government, serving as a fiscal coach.

Tennessee’s arrangement is more hands-on than most other states’, but officials there say it helped them weather the recession better than some other places. “We don’t want to stigmatize [localities],” says Ron Queen, a manager in the Office of State and Local Finance, “but to have a very proactive system.”

Tennessee maintains an internal watch list and tracks measures informally. In recent years, though, more states have begun publicizing the results of fiscal analyses, to raise awareness of municipalities’ fiscal challenges. The Ohio Auditor’s Office, for example, plans to launch a formal financial health indicators system later this year, and North Carolina created an online interactive benchmarking tool. Many produce annual reports on municipalities’ fiscal health.

Being slapped with an unflattering label by the state can be unwelcome publicity for a city or county. But local officials generally express support for these monitoring systems, Pew’s Murphy says. In Iowa, localities pushed for a state law that toughened reporting requirements for smaller jurisdictions. Monitoring systems are particularly valuable for small jurisdictions that lack the resources or technical expertise to conduct their own fiscal analyses.

In Connecticut, local officials sit on the board of the state’s oversight commission. “It goes a long way toward alleviating concerns that this is just some bureaucratic organization that doesn’t understand a municipality’s fiscal situation,” says George Rafael of the Connecticut Conference of Municipalities.

Pew further recommends that states provide local governments a formal role in the monitoring process, emphasize training for local personnel and interact with municipal officials throughout the year -- not just when it’s time for an audit.