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As U.S. Economy Improves, Cities May Be Headed for Another Downturn

Cities still haven't recovered from the recession, and a new report concludes that they might instead be sliding into another fiscal contraction.

An empty Sears store.
Sears, and several other big retailers, announced the closure of dozens of stores this year, contributing to cities' expected decline in sales tax revenue.
(AP/LM Otero)
Cities may be facing a new period of economic stress -- even as the national economy continues to improve.

According to a National League of Cities (NLC) report released on Tuesday, municipal finance officers are expecting minimal growth this year -- less than 1 percent -- after dealing with slower revenue growth last year. If that happens, NLC Research Director Christiana McFarland says it would “be the first time we are seeing two consecutive years of slowing growth since the start of the recession.”

The report also reveals a decline in public officials' confidence in their cities' finances. This year, 69 percent said they are better able to meet the financial needs of their communities -- down from at least 80 percent in each of the last three years.

This all may be “the start of fiscal contraction” for municipalities, the report concludes, and city revenues may never fully recover from the recession before the next economic downturn hits.

The wary outlook this year comes after a disappointing 2016. Last year, city revenues were expected to finally rebound from the Great Recession. But the reality fell short: City revenues (accounting for inflation) reached just under 98 percent of what they were in 2006 -- the year before the recession started. While property tax revenue increased by a healthy 4.3 percent, sales and income tax revenue growth were slower than normal.

Now, city officials are expecting much lower rates of growth in property tax revenue -- 1.6 percent for fiscal 2017 -- and budgeted for an outright decline in sales and income tax revenues.

The fiscal recovery for cities has been extraordinarily slow compared to previous recessions. It has been 11 fiscal years and counting, which is how long the recovery period was for the prior two recessions combined.

Meanwhile, the national economy has improved. This divergence, says the report, is a signal that city fiscal structures need to be modernized. The report notes that cities have had a “patchwork” approach to generating more revenue in this period of constraints.

Fees have become the dominant choice to find new revenue but, unlike property taxes, they can be a volatile and therefore unpredictable revenue stream. Additionally, many cities have state-imposed caps on how much they can raise property taxes. When that’s maxed out, they often turn to raising the sales tax. But as more major retailers close their doors and more people buy goods and services online (which is often sales tax-free shopping), the sales tax is capturing less and less economic activity.

“The drastic economic and technological changes occurring in the most recent recovery period, as well over the past 30 years, point to the imperative to re-examine the field’s conventional thinking about the ability of city finances to buffer against economic downturns and to capture revenue growth during periods of economic expansion," says the report.

There is the chance that -- given their failed expectations last year -- city finance officers are being overly conservative for 2017. The report, which surveyed 19,000 cities, towns and villages, notes that actual revenues are likely to be greater than what was budgeted.

Still, the noted drop in city finance officers’ confidence gives reason for pause. That metric has “historically tracked well with more quantitative fiscal measures,” says the report, and has tended to tick down during periods of economic contraction.

Liz Farmer is a former GOVERNING fiscal policy writer.
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