Across the country, cities as varied as Cloverdale, Calif., Newport, Ky., and Philadelphia have begun pulling from their budget reserves to address shortfalls resulting from the coronavirus pandemic's extraordinary financial impact. But many other local governments are holding back, looking instead to hold down overall spending and preserve their reserve funds. For many jurisdictions, the most difficult and perplexing financial question is when — or if — they should tap their reserves.
Why is this such an important question when managing an immediate crisis? What difference does it make? The money has to be spent; the crisis must be addressed. The answer, however, may be critical to the long-term financial health of the jurisdiction.
Almost all public organizations face two kinds of financial challenges throughout their existence. One kind is cyclical and short-term in nature, caused by a one-time or temporary event — a natural disaster, for example. Short-term cash, such as from the jurisdiction's budget reserves, may solve this kind of problem.
The other kind of challenge is structural and longer-term in duration. It will not disappear in the short term and reoccurs across multiple years. It reflects a fundamental flaw in the organization's operating structure, one that likely has been building under the surface and cannot be corrected by a one-time infusion of cash.
In the public sector, financial reserves have always been a topic of frustration, temptation and potential misuse. Rarely are they maintained at levels recommended by public-finance experts. Too often reserves provide a convenient, but inappropriate, way to temporarily mitigate the negative impact of long-term financial problems. The consistent or long-term use of financial reserves usually masks a serious underlying structural issue.
So when is using the budget reserves the right decision? There are at least four tests that should be applied — questions for public leaders to ask themselves — in the decision-making process:
1. How is the organization's general financial health? Is there a structural deficit hidden within? Does the organization normally maintain adequate or better reserves? Does it have and adhere to a well constructed, up-to-date, long-term financial plan — one based on tested assumptions, intelligently projected into the future and spanning at least five years?
2. Can reserves be maintained? Is the use appropriate and can the reserves be quickly replenished without financially crippling the organization? Can the immediate crisis-related need be met with only a one-time use of reserves, or is there likely to be ongoing annual need?
3. Are there opportunities for operational improvement? For example, should changes in processes or practices that have been forced by the crisis, such as teleworking and virtual meetings, or other improvements to operations be continued after the pandemic? And if so, do they require additional investment now to be successful into the future?
4. Are there good alternatives to using reserves? Or is leadership simply taking the easier political path? What about reorganization, changes in services or service levels, partnerships with other jurisdictions, downsizing, or looking for innovative ways to reduce operational costs?
The conundrum of COVID-19 is not knowing the length or severity of the virus threat. This makes it impossible to determine when the costs associated with the pandemic will diminish and when the revenue stream will return to pre-pandemic levels, if at all.
All of this confusion provides both demanding challenges and opportunities. Organizations that can see a light at the end of the tunnel may be well within good financial-management boundaries to use reserves. These would be communities whose tax base is not severely eroded by the pandemic, that can realistically project a swift return to pre-pandemic revenue levels, that can securely identify an end to the need for spending from reserves, and that have rigorously asked and answered questions 1-4 honestly.
Communities that are experiencing a deep erosion of their revenue streams due to COVID-19 may need to strenuously avoid the use of reserves except in the most demanding and critical of circumstances. Among those communities might be those heavily dependent on revenue from the hospitality, convention or restaurant industries. It is impossible to determine when the revenue stream from those industries may begin to flow again, let alone reach pre-pandemic levels. These communities should also rigorously ask and answer questions 1-4.
The reality is that those communities will most likely need to focus on questions 3 and 4 and plan for a vastly different future, one in which financial reserves should be used only as a small part of a much more dramatic survival plan. Such a plan might mean drastic cuts in staff or services, dramatic changes in service delivery, or implementation of high-risk innovation processes. In the most extreme cases, it might even mean municipal bankruptcy.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing editors or management.