Part of the series “Viewpoints on Resilient and Equitable Responses to the Pandemic” from the Center for Urban and Regional Studies at The University of North Carolina at Chapel Hill.
The COVID-19 pandemic is causing people around the world to question how this virus will affect the many public and private systems that we all use. We hope this collection of viewpoints will elevate the visibility of creative state and local solutions to the underlying equity and resilience challenges that COVID-19 is highlighting and exacerbating. To do this we have asked experts at UNC to discuss effective and equitable responses to the pandemic on subjects ranging from low-wage hospitality work, retooling manufacturing processes, supply chain complications, housing, transportation, the environment, and food security, among others.
Whitney Afonso is an associate professor at the University of North Carolina’s School of Government. She works closely with public officials from around the state of North Carolina on subjects related to public finance and budgeting. She will discuss the impact of the COVID-19 pandemic on local government budgets, pulling from academic literature, discussions with budget officials, and a recent survey of local governments in North Carolina.
Transcript – Viewpoints on Resilient & Equitable Responses to the Pandemic. Whitney Afonso: Local Government Budgets
Municipalities and counties in North Carolina are scrambling to understand the fiscal ramifications of this pandemic. But before we get into the impact of COVID-19 and how local governments are budgeting in response to it, I would like to just briefly give you a 1,000 foot overview of local government finances and services in North Carolina. Counties are primarily financed through property taxes, sales taxes, intergovernmental transfers, and sales and services. Municipalities are primarily financed through utility revenues, property taxes, user fees and sales taxes. Counties in North Carolina must provide services such as: law enforcement, courts, capital for public schools, social services, public health and mental health services. They often provide additional services such as: libraries, community colleges and fire protection. The only service municipalities are required to provide is building code enforcement, but many also provide services such as: law enforcement, streets, water and sewer, solid waste collection and disposal, and parks and recreation services.
So, let’s go back to why we are here and start with what local governments do in times of recession. Well, state and local governments are legally required to balance their budgets, which means that unlike the federal government they cannot deficit spend during economic downturns, or during periods of growth for that matter. Historically we know that local governments typically reduce capital expenditures or cut back on their infrastructure maintenance and new construction efforts as one of their first tactics. Additionally, the other most common tactic is to reduce costs through staffing decisions—whether it is no new positions, hiring freezes, furloughing or other options. It is not surprising that these are the most common tactics because there is less impact on service delivery and these cuts are less visible to citizens. In addition to these two strategies, it is also common to use fund balance, or what is sometimes referred to as rainy day funds, and to increases fees.
That is what we have seen in the past. That, of course, does not mean that is what we will see now. While the majority of economists and others are anticipating a recession—some saying it will be the worst that the United States has felt in decades—we are not yet there. We have a sense of what local governments in North Carolina are actually doing now because the North Carolina League of Municipalities and the North Carolina Local Government Budget Association surveyed them in April of 2020, which is in the midst of budget season. Budgets, in North Carolina, have to be adopted by July 1st, which is the start of the new fiscal year. In order to accomplish this, the proposed budget, crafted by the budget or finance officer, has to be presented to the governing board by June 1st, and the budget requests from departments, have to be to the budget officer by April 30th. This is the timeline established by law. The reality is that most local governments start their process in December or January. So, a survey sent in April is usually close to when the proposed budget is being finalized for presentation to the governing board and/or public. This year is different though. Many jurisdictions are waiting until the last minute, hoping to have a better idea of what is going to happen to the stay at home orders, the economy, tourism, etc. Nonetheless, the results are very helpful in understanding what is likely to be in local budgets for fiscal year 2021, which begins on July 1st.
So, let’s briefly talk about this survey. There are 142 mostly complete, usable responses. Twenty-nine are from counties and 113 are from municipalities. The responses come from all over the state and from jurisdictions that range in size and capacity tremendously. For example, one responding town has a reported budget of less than $90,000 and no full-time staff to a county with a budget of almost $1.5 billion and over 8,000 full-time employees. And then there’s everything in between.
The results suggest that jurisdictions are anticipating pretty significant shortfalls. Ninety-two percent report expecting shortfalls for FY21 and almost a fifth of respondents are anticipating a shortfall of greater than 10 percent, and these numbers are probably conservative because the majority of responses not reporting a shortfall answered that they were unsure. While, the jurisdictions anticipating the largest shortfalls were mostly rural, the distribution is spread throughout the state and across different sized jurisdictions.
Some of the variation in responses is due to their economic base, but also their dependence on different revenue streams. Respondents, as anticipated, are expecting some revenue sources to be more impacted than others. Sales taxes are expected to be being hit hard. In fact, while we do not have the numbers yet, it is clear that they are already being hit hard. Most jurisdictions believe that the last FY20 Q4 and FY21 Q1 will see substantial shortfalls, however, many are optimistic that by FY21 Q2 the impact of the current COVID-19 pandemic will have only a minor impact on sales taxes and some are even anticipating growth by the close of the next fiscal year—so, by this time next year.
Occupancy taxes, and in some cases property taxes, are expected to be negatively impacted as well. The majority of jurisdictions are anticipating shortfalls in occupancy tax revenue for the remainder of FY20 and slightly less dramatic reductions in revenues for FY21.
What may surprise some is that most jurisdictions are anticipating stability or even growth in property taxes. This is actually to be expected since the property tax base was finalized in January before the effects of COVID-19 were felt in the United States. If property taxes are to be impacted, it will typically not occur until a reassessment has taken place in the community, otherwise the assessed values of the properties will remain the same. What can be impacted is collection rates, development and renovations.
Other revenues highlighted by comments were typically about reductions in revenues from: 1) utilities, 2) investment and interest earnings, and 3) recreation. There were also questions around intergovernmental transfers from the state and federal government. Most jurisdictions responding did not have a lot of certainty about how these intergovernmental transfers may be impacted, but those who were willing to speculate noted that they believed that they would be stable (though more reported expecting declines than increases).
Given that revenues are expected to decline AND that local governments have to have a balanced budget, how are they planning on navigating this next fiscal year? Mostly in the ways we would expect. The most common strategy reported was appropriating fund balance and the least common one was to increase taxes.
The strategies reported by counties and municipalities did vary though. Counties also reported relying heavily on reducing capital expenditures and increasing fees. Municipalities relied most heavily on closing facilities, then appropriating fund balance, and then increasing fees. Very few municipalities reported an intention to reduce capital expenditures.
Additionally, counties and municipalities both reported the reductions in revenues were going to impact staffing decisions. The majority of respondents report not budgeting for any new positions and almost half report instituting a hiring freeze.
Lastly, it is worth noting that some departments are reported to bear a larger portion of any decreases to the budget. Not surprisingly, law enforcement and fire and EMS are expected to be largely spared, whereas general government and parks and recreation are expected to both be moderately or highly impacted. Interestingly, for counties, education is also expected to be impacted greatly.
To wrap up, I want to take time to talk about best practices now that I have discussed what local governments have done in previous recessions and what they are expected to do for this coming fiscal year.
Well, the best practice is to smooth both expenditures and revenue policy, i.e. try and change as little as possible. Spend the money that had been planned to be spent and tax and apply fees at the rates that had been planned… So, how can local governments do that? Well, in two primary ways. First, by getting a lot of federal and/or state support and intergovernmental transfers. Of course, they have no control over that and it may not happen. Second, use reserves, what I referred to as fund balances. There is a lot of evidence that local governments are reluctant to spend down their reserves. This reluctance is likely due to two primary factors. First, that governments are often risk averse and it is hard to know how long a recession or emergency is going to last and how much worse it may get—so being conservative about spending down those reserves may be prudent. Second, smoothing of expenditures is not the only function of local government fund balance. It has many other purposes that are not related to emergencies at all.
So then, what is next best? Well, the literature suggests the next best option is to increase revenues temporarily and preferably not regressive ones (like sales taxes or many fees). The final recommendation from the literature is to avoid cutting back on capital expenditures! Everyone, okay almost everyone, decreases capital expenditures during recessions and there can be long term negative impacts associated with that strategy. Additionally, often during times of recession it is much less costly to invest in capital because interest rates are lower and often contracts are for less.
The School of Government has many excellent online resources around the the COVID-19 pandemic and how to govern, and also around budgeting and finance. I encourage you all to explore them at sog.unc.edu.