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The wide improvement in municipal governments’ finances has been a under-covered story during the US’s Big Fiscal era.
This oversight is understandable for global readers; non-US investors don’t get a tax benefit for coupons clipped in the muni bond market, after all. And looking at aggregates are challenging because state- and local-government data sets are incredibly . . . diffuse. And diverse.
But the economics of state and local governments matter a great deal. Their spending makes up about one-tenth of US GDP. And municipalities employ nearly 20 million Americans, compared to the federal government’s roughly 3 million (that’s including the Postal Service), BLS data shows.
And over the past two years, municipal hiring — the category includes teachers and other public employees — has sped up to its highest pace in decades. This of course follows the steepest round of job cuts since at least 1990, as shown in the chart below from Goldman Sachs:
State and local government “job growth has averaged 471k (+2.5%) year-on-year over the last three months, the fastest pace since 2002 outside of the 2021 pandemic recovery period,” writes Goldman Sachs in a recent note.
So, hey, that’s good! But as the bank hints in the headline of the chart above, this hiring hot streak — and the strength in municipalities’ real (inflation-adjusted) spending — probably won’t continue.
The bank predicts that real municipal spending will rise around 0.2 per cent this fiscal year, down from the 3.3-per-cent real growth in spending budgeted by states over the prior year. One reason is that lower spending and income will cut into tax collections, the economists say:
Tax revenues are already down 8.5 per cent in real terms over the past year, says GS, in part because of lower capital-gains receipts. Beyond that, “state budgets suggest general fund real revenues will decrease 3 to 4 [per cent] in fiscal year 2024,” the bank wrote.
Property taxes, often the largest revenue provider for local governments, could also drop as property values fall in a recession or slowdown. But that may take some time to trickle through into municipalities’ bottom lines, says the bank. That’s because property-tax income doesn’t shift as quickly as income or even sales taxes — even if the market value of a home changes, it will take time for its value to be reassessed and show up in the owner’s tax bill.
On the other side of the scale is federal transfers to states and municipalities, which has already boosted spending significantly and will help a bit more this year, GS says. The bank’s economists predict municipal spending will get a 0.6-percentage-point real boost from the US’s Infrastructure Investment and Jobs Act over the year starting July 1.
Even so, the act’s “funding is fixed in nominal terms over a 5-year period and rapid inflation in the cost of non-residential construction is likely to absorb most of the additional funds, as was the case in 2022”.
The bank continues:
. . . weaker growth in construction project infrastructure orders this year and flat real state transportation budgets for FY 2024 both suggest limited upside to spending growth. As such, our infrastructure analysts forecast growth in nominal public construction spending will slow by 7pp to 5 [per cent] in 2024.
Another reason the apparent downshift in investment is notable is that state and local governments are sitting on plenty of excess cash from the past few years. States’ rainy-day funds had climbed to $136.5bn at the end of fiscal 2022, according to S&P Ratings, a 71-per-cent increase from $80bn in 2019.
Instead of embarking on a flurry of spending, municipal governments appear to be holding on to their funds. And states’ budget officers say there’s been additional growth in rainy-day funds and other general reserves so far this year, S&P Ratings notes.
This is interesting for a couple of reasons.
The first and rather abstract one is this: municipalities’ hesitation to spend is at least partly structural. If a referendum is required to sell bonds backed by your taxing power — as it is many places in the US — hoarding cash in rainy day funds makes sense.
Another is that the rainy-day funds will ideally offset (or at least make temporary) other state or municipal pressure when or if recession hits. The latter point is GS’s main takeaway too.
Sagging revenues are reflected in weaker spending plans: recommended budgets for FY 2024 point to a +2.5% nominal spending increase (vs. +12.6% in FY 2023) in state general funds, which likely means a small decline in real terms.
Balance sheets are much healthier however, with S&L total balances currently totalling $274 billion (1% of GDP).
A significant portion — particularly the 60% allocated to rainy day funds — is unlikely to be spent before states encounter more severe revenue shortfalls, which we do not view as likely in the near-term. This reduces the risk that S&L spending declines even if revenues weaken more than we expect but is unlikely to boost spending absent a downturn.
Read the full article here