Northwest Indiana Discussion

DECEMBER 18, 2008 Wall Street Journal

States Squeeze Cities, Spreading the Economic Pain
Recession Hits Both Levels of Government, but Some Local Bodies Push Back and Take Fight Over Funds to the Courts

By CONOR DOUGHERTY and AMY MERRICK

The worst budget crisis in decades is forcing states to cut funding to cash-strapped cities, which already are slashing police, firefighters and other services.

Cities have limited options when presented with state cuts, but some are fighting back. Last month, the League of Arizona Cities and Towns sued the state over its demand for city funds. A group of California redevelopment agencies sued their state to block it from conducting a "raid" of $350 million in local redevelopment funds.

The Local Burden

States typically reduce city aid during budget shortfalls. Localities will be hurt more during this recession than when government finances turned down earlier in the decade, said Scott Pattison, executive director of the National Association of State Budget Officers. After the 2001 recession, sales and income taxes were squeezed, but property taxes -- the primary source of local-government funds -- held up relatively well.

In today's recession, both state and local revenues are suffering across the board. In the past 30 years, state spending has grown by an average of 6.3%. States cut a total of 0.1% from their budgets for fiscal 2009, which ends in June; the faltering economy is increasing projected deficits in the coming months.

States are facing $30 billion in budget deficits for the current fiscal year, according to the Fiscal Survey of States released this week by the National Governors Association and National Association of State Budget Officers. That figure is likely to grow in the coming months.

Twenty-two states, including Georgia, California and Nevada, already have cut spending from their 2009 budget.

This week Minnesota's governor and legislators said cities and counties can expect aid to decrease soon. The state is coping with estimated shortfalls of $426 million for this year and $5 billion for the two-year budget period that begins in July. New York Gov. David Paterson's budget proposal, released this week, would cut about $240 million in aid to New York City. The Nevada legislature voted earlier this month to take out a line of credit from its local-government investment pool to help fill a $342 million shortfall in its $6.8 billion, two-year budget.

Governors and state lawmakers say extraordinary measures are necessary because the downturn has sliced revenue including sales, corporate and personal income taxes. Commitments to local aid must be on the table, they say, along with across-the-board cuts to state agencies, tuition increases at state universities and pleas for federal assistance.

Cities say any decrease in funds could trigger higher local taxes and would cut into municipal services. While states usually handle big-ticket programs such as health-care funding, prisons and social-services programs, municipalities are responsible for services such as fire and police protection.

In Mesa, Ariz., the police academy won't have a graduating class next year, says Mayor Scott Smith, because the force is cutting positions. Libraries have cut their hours and swim programs will be limited to six of the city's 11 public pools next summer. Mesa gets most of its revenue from local sales taxes, and about one-third of the city budget comes from money distributed by the state, according to Mr. Smith. "For the first time our cuts are across the board and affect all departments, including public safety," he said.

Nevada, already reeling from foreclosures, has seen sales and gambling taxes from Las Vegas and Reno tumble. The Nevada legislature voted in a special session last week to establish a line of credit of as much as $160 million from a $725 million local-government investment pool. Cities, counties and school districts allow the state to invest that fund to earn a higher rate of return than they could on their own.

Borrowing from the investment pool would increase Nevada's debt at a time when state finances are expected to worsen. That troubled officials in rural Humboldt County, a mining community in the northern part of the state. On Dec. 1, the county decided to pull out the $11.5 million the county had invested in the Nevada fund. "The state has not clearly set a plan out for how the line of credit will be repaid," Humboldt County treasurer Gina Rackley said. County officials planned to meet Wednesday to decide what to do with the investment, which currently is in a savings account, she said.

Most municipalities assume some state aid in their budgets. Already, many cities have pared spending through layoffs and lower public-safety funding, amid declining revenue from sales and property taxes. Because cities have less taxing power than states, reductions in state aid likely will force further cuts.

Adding to the local burden: During the real-estate boom, several states placed caps on local property taxes, to quell protests over taxes that soared with home values. In Indiana, statewide caps that voters welcomed earlier this year now are expected to hurt local governments that depend heavily on property taxes.

Last week, Gary, Ind., filed a petition about its economic plight with Indiana's Distressed Unit Appeals Board, which was set up recently to hear complaints about the tax caps. Gary officials said the new law could force the city to cut its general-fund budget by about half, or more than $30 million.

In some states, legislation limits cities' exposure to the state budget knife. Four years ago California voters passed a law that requires state loans taken from local revenue to be paid back within three years. "It really changes the relationship between locals and the state," says Megan Taylor, a spokeswoman for the League of California Cities.

Some local bodies are taking their fight to the courts. The California Redevelopment Association, which represents local redevelopment agencies, filed a lawsuit this month seeking to block a bill that would use $350 million in redevelopment funds to plug a state budget hole. In Arizona, cities sued the state after the state demanded that cities give the state about $30 million. "We can't allow this precedent to stand," said Ken Strobeck, executive director of the League of Arizona Cities.

Write to Conor Dougherty at conor.dougherty@wsj.com and Amy Merrick at amy.merrick@wsj.com