VideoPittsburgh doesn't look like a city that almost didn't pay its bills last year. Its streets are clean. Crime rates are low. A gleaming new convention center and two stadiums rise along the banks of the Allegheny and the Ohio, two of the city's three rivers. Pittsburgh's nonprofit sector, which includes world-class medical centers and three universities, is flourishing.
But just as a handsome house with a luxury car in the driveway may belie the owner's empty bank account, Pittsburgh's financial condition is bleaker than it looks. The city has run a structural deficit annually since the early 1990s. Debt service devours nearly a quarter of the annual budget. Pittsburgh's credit rating dropped to junk status in 2003 and remained there for most of 2004. Finally, to avert possible bankruptcy, city leaders filed for "distressed municipality" status with the state of Pennsylvania. The state now oversees Pittsburgh's finances.
For the city government, the struggle for solvency has brought a steady procession of committee reports, public arguments, and budget reductions. "It has been grueling," says Ellen McLean, the city's finance director.
Pittsburgh is not alone. Communities ranging from Atlanta and Buffalo to Chicago and San Diego are in dire shape. Compared with the fiscal troubles of the federal government, those of municipalities have received little attention from corporate executives. But sooner rather than later, businesses will feel the effects of local budget shortfalls, through higher taxes and fees, crumbling roads and bridges, and smaller police departments. Simply relocating may not be the answer — many suburbs now face the same fiscal pressures as inner cities.
Indeed, if conditions worsen — for example, if the property market were to tumble — what is now a collection of local problems could become a national crisis affecting all taxpayers. "If the housing market were to collapse tomorrow, the sting for cities would be enormous," says Michael Pagano, a professor of public administration at the University of Illinois at Chicago and author of a recent National League of Cities (NLC) study on city fiscal conditions. "With a record federal budget deficit and a war with no end in sight, I'm not sure where resources could be shifted to cover the local governments' budget woes," he adds.
The NLC study, which included a survey of 288 municipal CFOs, found that 61 percent of municipalities will be less able to meet their financial obligations in 2005 than they were in 2004. And last year was not a good one for cities: it was the third year in a row that general fund revenues, adjusted for inflation, declined. At the same time, costs — especially for public safety and health care — have soared. The result is predictable: with reserves dwindling, many cities are resorting to severe budget cuts and hikes in taxes and fees.
The trouble isn't limited to the old industrial cities of the Northeast. In fact, the study showed that communities in the West and Midwest — including some suburbs — are even worse off. Seventy-five percent of CFOs in Western cities reported deteriorating conditions, as did 74 percent of those in Midwestern cities, compared with 59 percent in the Northeast and 43 percent in the South.
Unfortunately, few are doing enough to solve their problems, according to experts. "For the most part, cities haven't confronted their problems head-on," says James Hughes, dean of the Edward J. Bloustein School of Planning and Public Policy at Rutgers University in New Brunswick, New Jersey. "Some are hoping that they'll grow their way out of it, but that notion is fading away."
Cash Crunch
How did American cities arrive at this point? The answer lies with a convergence of factors, some of them within the control of city governments, but many imposed from outside. Most obviously, the sluggish economy hit cities hard, raising expenses and holding down revenues. For example, city hospitals face much higher costs when residents lose their jobs and, with them, their health insurance. The same job losses can mean unpaid taxes. "Cities feel the effects of a recession before other communities, and the effects linger longer," says Henry Coleman, an economist at Rutgers.
And these days, cities can't rely on support from the states or the federal government. Because of the states' own budget woes, aid to cities fell 9.2 percent on average last year across the nation; federal aid to cities all but ended in 1987. This comes on top of a rise in unfunded mandates, such as the Clean Water Act, which impose new costs without new revenues.
There are also problems with local taxes. Many cities rely too heavily on either sales or property tax, exposing them to swings in the economy. And these taxes haven't kept pace with demographic and economic changes. For example, a growing proportion of those with jobs in the city now live in the suburbs, meaning that while they spend their days in town, their property taxes go to another local government. Similarly, the sales-tax base is shrinking. In 1960, goods (which are taxed) represented about 60 percent of all sales in the United States versus 40 percent for services (which usually aren't taxed). Today, that ratio has flipped. Surging online sales also cut into city revenues. "Sales tax is our single largest source of revenue, but it's eroding," says Jim Dailey, mayor of Little Rock, Arkansas.
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