How States and Localities Can Plan for the Growing Economic Uncertainty

It is difficult to avoid the headlines. Inflation is soaring. The Federal Reserve has raised the fed funds rate this year. Supply chains are broken, causing shortages of goods and increased prices. GDP growth has stalled. Gasoline prices are soaring and the list goes on. 

For the average American family, these headlines make planning and remaining optimistic difficult tasks. But for government leaders, these conditions are even more complicated to understand as they relate to the economic environment in which we operate.      

What’s Happening

Let's start with the basics. As of February 2022, inflation, a measure of the growth in prices for a standard set of goods, was measured at its highest rate since 1982, according to the Bureau of Labor Statistics. 

On the revenue side, despite soaring home prices, property tax growth lags behind economic growth. This is due to the delay in the assessment process and limits in many states in appreciation of taxable value. When you consider that roughly 71% of local government revenue comes from property taxes, you can see a darkening cloud forming over the economic forecast.     

To make matters worse, according to The Pew Charitable Trusts, the state and local government workforce employment growth is struggling to return to pre-pandemic levels. While the reasons for this stall are numerous, one remains the dominant factor: The traditional lag in salaries in the public sector compared with the private sector. Add heightened inflation in the midst of the “Great Resignation”, and you can see how difficult it will be to recruit and retain talent.           

Inflation plus a limited ability to grow the top line (revenue) while competing for talent with private sector employers that have more control over their prices, is a perfect storm for state and local governments. This does not even consider the growth in other expenses that these governments are experiencing, just like all organizations. But few have the limitations to pass along price increases like state and local governments.

Additionally, a review of generally accepted market indicators such as the S&P 500 or the Dow Jones Industrial Average, takes you on a roller coaster ride. Coupling this with the fact that GDP fell in the most recent quarter leads anyone to believe a recession is coming, which would only hamper the ability of state and local governments to grow recurring revenue even more.

The Irony

When the pandemic first hit the United States, state and local governments faced much uncertainty. In order to survive, many, including my home county of Wayne County, Michigan introduced cost-cutting measures. But the onset of aid from the CARES Act’s Coronavirus Relief Fund, which expired last December, and the American Recovery Plan Act’s Coronavirus State and Local Fiscal Recovery Funds, initially helped to stabilize our budgets. But now we are facing a more complex and bittersweet outcome. 

On one hand, this money will help our communities, especially those that have been historically marginalized, deal with and recover from the Covid-19 pandemic. And it offers us an opportunity to promote data collection and reporting on equitable impacts for services and programs in communities and states. 

On the other hand, the continued rise of inflation and minimized government employees means these dollars will not go as far as we initially anticipated, reducing the overall impact we are able to have.          

Under The Radar

While the public looks at headlines related to the federal funds rate, inflation, gasoline prices and the stock market, there is an under-the-radar set of statistics in the municipal bond market that has been troubling government finance officers for months. 

The municipal bond market has been experiencing significant volatility. The tax-free municipal bond market has been under stress. Indeed, the first two months saw a net outflow of $12.4 billion from the market by investors. While there has been stabilization in the market, it has been due to lower yields (higher pricing). 

Additionally, according to investment management firm PIMCO, limited supply is expected for the remainder of the year, which would help maintain stability. But stability due to lower issuance levels does not equate to health in this market.

With so many governments keeping recurring costs low and the availability of funding from the federal government still in play, one has to wonder what municipal bond investors are seeing in terms of collective fiscal health in this sector. While all investment markets have struggled in 2022, this market tends to be a safe haven. Investors typically use municipal bonds to offset or avoid the volatility sometimes exhibited with equities in the stock market. They, along with treasuries, provide a level of “safety” but with a better yield than treasuries. However, in the first few months of the year, investors are not exhibiting the usual utilization of municipal bonds, leading to the worst January performance since 1981.   

What To Do

In these times of uncertainty, the fundamentals are critical to ensure fiscal health. Maintaining budgetary discipline, utilizing technology to get accurate data and precise reporting, and ensuring the ability to collect tax revenues effectively are all critical. However, the need for and attention to making sure services are equitable and comprehensive are front and center for municipalities. 

Often when cuts happen, they disproportionately impact communities that need such services the most. After the 2009 recession, we in Wayne County, Michigan, reduced our headcount, which resulted in less available services to residents in need. While we have attempted to hire and increase the number of employees, the effects of the “Great Resignation” have made those efforts difficult. This is not because of a sustained decision to stop hiring, but instead from our inability to hire. 

As the economy recovered, Wayne County has been working to hire and ramp-up services for mostly disadvantaged communities, such as wrongful conviction investigations and post-pandemic mental health services. 

Now, as the economic signals become mixed, we remain committed to these services and will need to monitor the changing macroeconomic conditions to ensure we deliver on that commitment. And if the next recession is coming, we will need to rethink how we modify our services so as not to do more harm to those who most need our help.