Avoiding the Pitfalls of the Next Economic Downturn

As many county and city officials are aware, evidence indicates that our nation, our state, and our local governments have, for the most part, recovered from the Great Recession. In Washington State, sales and property taxes have grown from their lows while inflation has remained low.  For the first time, the state’s population has exceed 7 million. Many local officials have incorporated into their 2017 budgets the filling of new positions, expansion or growth of services, and the incurring of new debt to be serviced by General Fund/Current Expense revenues.

As I review the past 8 years, I’m troubled with the question of whether those local governments are destined to experience the problems that they encountered from 2009 to 2012. In this article I would like to explore the issue of how elected county or city officials should respond in a fiscally prudent manner to what is, at best, an uncertain future. The following are some guidelines that I’d suggest to avoid the potential of “falling over the cliff,” as we all recognize the reality of an economic cycle characterized by peaks and troughs, and its impact on local government revenues:

Step back, determine where you are and where you are going! Every county and city should adopt a 5-10 year strategic plan, review that plan periodically, modify the plan, and reestablish priorities. Local governments should budget resources based on the community’s priorities, changing needs, costs, and fiscal resources.

The citizenry expects continuity of services and disdains tax/fee increases. By and large, citizens want a responsive government and one that maintains services at current taxation levels. They also want service expansions and enhancements that reflect evolving needs.

Understand the elements of your revenue structure and the factors that impact changes in revenues. Local governments don’t live in an environment in which a 2-3% annual growth in revenues is expected and can cover all existing costs. Some revenue sources are less responsive to changes in economic conditions than are others, such as the property tax versus the sales tax. Local officials must recognize the vulnerability of certain revenues to declines in economic activity and set resources aside to compensate. Is your jurisdiction overly dependent on intergovernmental revenues that may be uncertain in the future?

Familiarize yourselves with the elements that impact expenditures. Certain elements of government spending are characterized by cost changes that differ from general rates of inflation. Recent examples include health care costs, motor vehicle fuel, and construction materials. Local officials should almost anticipate worst-case scenarios in those cost-drivers when developing multi-year budget forecasts.

Demographics, demographics, demographics! Know what is happening to the size and composition of your population. Is your population growing; is the nature of the population changing, perhaps to a younger population; is the changing population increasing the demand for services, such as a rising level of homelessness? Changes in the size and character of the population will impact county and city budgets.

Monitor your labor force. For the average local government, labor costs average approximately 70% of total costs. Local officials should be extremely vigilant in adding new positions during periods of economic growth lest they be unsustainable during periods of economic stability or during a downturn.

Use nonrecurring revenues for nonrecurring expenditures! During periods of strong economic growth, local governments generally experience extraordinary revenue growth. Those “additional” revenues should not be used to expand ongoing services, but rather for such nonrecurring costs as one-time capital expenditures, enhancement of medical insurance reserves, or, most importantly, to build up ending cash balances. In my opinion, every county or city should have unrestricted general fund reserves equal to at least 6-8 weeks of operating expenditures.

In closing, these guidelines are intended to provide suggestions to local officials on how to avoid the dislocations that may arise during the next economic downturn. It must be recognized that our economy is characterized by economic cycles that impact the flow of local revenues and the demand for services. Prudent fiscal management suggests that counties and cities recognize those cycles and budget accordingly.