As Cities Recover, Financial Worries Loom

After the hit they took during the worst of the pandemic, cities around the country saw their financial situation improve as the economy reopened and the federal government sent billions of dollars in aid their way.

But just as things were looking up, rising inflation and the prospects of a recession began stirring fears of what the next couple of years will hold. And that’s leading cities to be more cautious about spending, according to an annual survey of city government financial health that the National League of Cities released on Wednesday.

The past year has seen “communities slowly but surely get back on their feet, largely thanks to the support from the federal government, including the American Rescue Plan. In 2022, our economy is well on its way back to normalcy,” said the group’s CEO and executive director, Clarence Anthony, at an event where the report was released.

“Make no mistake, though,” he said. “The challenge is continuing.”

The American Rescue Plan Act alone provided $45.6 billion in direct federal pandemic aid for cities, along with another $19.5 billion for smaller-sized local governments. The $1.2 trillion bipartisan infrastructure law President Biden signed last year is also sending a wave of money to localities. 

But Mary Ellen Leonard, finance director for College Station, Texas, said during a panel discussion that her town does not have enough money for the local match the U.S. Department of Transportation is requiring for grants in the infrastructure law.

According to the NLC report, which examined financial information from dozens of the nation's cities, sales tax revenue increased in fiscal 2021 by more than 4% when adjusted for inflation, after having declined by 5% the year before.

The sales tax growth was actually larger—about 11%—if inflation was not factored in, said Farhad Kaab Omeyr, program director for research and data at NLC’s Center for City Solutions. “It's a huge deal,” he said. “I went through the data and double-checked, triple-checked, and many governments reported more than 10%.”

Income tax revenue also increased in 2021, by nearly 1%, according to the report. Meanwhile, property tax revenue did not, slipping by just over 1%. 

Property, sales and income taxes are the revenue sources that tend to make up the bulk of city revenue in most places.

As a result of the higher revenue, the survey found that nearly nine out of 10 city finance officers the group surveyed said they felt better about the fiscal health of their city governments in fiscal 2022 than they did the year before.

However, with inflation driving up prices and curbing consumer spending, the report estimated that sales tax revenue in fiscal 2022, which ended on June 30 in many cities, is expected to fall by 2.5%. 

Income tax revenue is expected to be flat in fiscal 2022 compared to the prior year, according to the report. Because the Federal Reserve’s decision to raise interest rates will likely continue to cool home sales, property tax receipts are on track to decline by more than 4%, the study said.

As a result, only about 70% of finance officers said they were optimistic about their city’s finances in fiscal 2023.

With all these dynamics in mind, many cities are spending cautiously.

“We are getting out of the woods, but we are not completely out of the woods,” Omeyr said. “The narrative that I'm receiving from all these governments that we surveyed is that governments are getting ready for when and if, god forbid, another recession actually hits.”

“Governments are being super cautious and fiscally conservative when it comes to budgeting for the near future and for fiscal year 2022 and 2023,” Omeyr said at the event.

That’s the prudent thing to do, he said, noting that cities were “caught off guard” when the Great Recession began back around 2008. 

“That's why it took like many, many years for them to bounce back,” he added. 

College Station, the home of Texas A&M University, gets 38% of its revenue from the sales tax, and officials there are concerned about how a downturn would affect that income. 

“We get influxes for things like football games. And that income is all disposable income,” Leonard said. “Kids that come to school right now, they come with daddy's credit card. And daddy is going to put a little bit more restraint on them.”

The uncertainty has made it difficult to come up with the matching funds required for federal grants. “We looked at the infrastructure bill and we can't make the match,” she said. The city had been hoping to improve the local transportation system to make it easier for university students who generally live off campus to go to class.

“We thought, oh, great, we're finally going to be able to connect campus to where most of the students live,” she said.

Omeyr said he’s heard from other cities that they cannot afford to come up with the matching funds the federal government requires.

Virginia Beach, Virginia is also being cautious, said Kaitlyn James, the city’s deputy director of budget and management services. She characterized the city’s most recent spending plan as “pretty boring.” 

“I think the [city] manager’s message was to keep the lights on. We didn't add anything new or flashy”  she said.

The city is beginning work on next year's budget. “We set aside large amounts of money for fuel and energy just in case. We also provided large contractual increases for everything that we knew about for departments so that they wouldn't have to ask and we won't ask them to absorb it. Because we don't feel like with all the other inflationary pressures departments will be able to easily.”

Andrew Zoeller, finance director for Billings, Montana, said the city had been seeing a real estate boom in its downtown.

“We are starting to see a slowdown in residential real estate,” he said. “I think, largely due to rising interest rates.” 

And then, there is the approaching end of federal help. States and localities have until the end of 2024 to “obligate” their ARPA dollars and until 2026 to spend the money.