Tag Archives: PA

Fixing decades of fiscal distress in Scranton, PA

In new Mercatus research, Adam Millsap and I and unpack the causes for almost a quarter of a century of fiscal distress in Scranton, Pennsylvania and offer some recommendations for how the city might go forward.

Since 1992, Scranton has been designated as a distressed municipality under Act 47, a law intended to help financially struggling towns and cities implement reforms. Scranton is now on its fifth Recovery plan, and while there are signs that the city is making improvements, it still has to contend with a legacy of structural, fiscal and economic problems.

We begin by putting Scranton in historical context. The city, located in northeastern Pennsylvania was once a thriving industrial hub, manufacturing coal, iron and providing T-rails for railroad tracks. By 1930, Scranton’s population peaked and the city’s economy began to change. Gas and oil replaced coal. The spread of the automobile and trucking diminished demand for railroad transport. By the 1960s Scranton was a smaller service-based economy with a declining population. Perhaps most relevant to its current fiscal situation is that the number of government workers increased as both the city’s population and tax base declined between 1969 and 1980.

An unrelenting increase in spending and weak revenues prompted the city to seek Act 47 designation kicking off two decades of attempts to reign in spending and change the city’s economic fortunes.

Our paper documents the various recovery plans and the reasons the measures they recommended either proved temporary, ineffective, or simply “didn’t stick.” A major obstacle to cost controls in the city are the hurdle of collective bargaining agreements with city police and firefighters, protected under Act 111, that proved to be more binding than Act 47 recovery plans.

The end result is that Scranton is facing rapidly rising employee costs for compensation, health care and pension benefits in addition to a $20 million back-pay award. These bills have led the city to pursue short-term fiscal relief in the form of debt issuance, sale-leaseback agreements and reduced pension contributions. The city’s tax structure has been described as antiquated relying mainly on Act 511 local taxes (business privilege and mercantile business tax, Local Services Tax (i.e. commuter tax)), property taxes and miscellaneous revenues and fees.

Tackling these problems requires structural reforms including 1) tax reform that does not penalize workers or businesses for locating in the city, 2) pension reform that includes allowing workers to move to a defined contribution plan and 3) removing any barrier to entrepreneurship that might prevent new businesses from locating in Scranton. In addition we recommend several state-level reforms to laws that have made it harder to Scranton to control its finances namely collective bargaining reform that removes benefits from negotiation; and eliminating “budget-helping” band-aids that mask the true cost of pensions. Such band-aids include state aid for municipal pension and allowing localities to temporarily reduce payments during tough economic times. Each of these has only helped to sustain fiscal illusion – giving the city an incomplete picture of the true cost of pensions.

To date Scranton has made some progress including planned asset monetizations to bring in revenues to cover the city’s bills. Paying down debts and closing deficits is crucial but not enough. For Pennsylvania’s distressed municipalities to thrive again reforms must replace poor fiscal institutions with ones that promote transparency, stability and prudence. This is the main way in which Scranton (and other Pennsylvania cities) can compete for businesses and residents: by offering government services at lower cost and eliminating penalties and barriers to locating, working and living in Scranton.

Scranton, PA and the failures of top-down planning

City officials in Scranton, PA are concerned that a recently released U.S. census map used as a basis for distributing federal grant money doesn’t reflect reality. The map was created using 2010 census data and identifies which neighborhoods meet the U.S. government’s criteria for low-to-moderate-income classification. Such neighborhoods are eligible to receive Community Development Block grant (CDBG) funding.

Scranton Councilman Wayne Evans stated that:

“A lot of us feel that the map is inaccurate, knowing the neighborhoods like we do,”

The city is hoping to conduct their own survey of the area and then use the results to petition the federal government to change the designations of the areas city officials believe are misclassified so they can receive funding.

This situation is a great example of the importance of local knowledge. Economist F.A. Hayek wrote the seminal paper on the importance of local knowledge in 1945. In his book Doing Bad by Doing Good, economist Chris Coyne builds on Hayek’s idea and defines the “planner’s problem” as “the inability of nonmarket participants to access relevant knowledge regarding how to allocate resources in a welfare-maximizing way in the face of a variety of competing, feasible alternatives.” The primary goal of the CDBG program is to create viable urban communities. In order to accomplish this a top-down planner needs to take certain steps: 1) the place to be developed needs to be identified and the goals of the development need to be established; 2) the availability of the resources needed for the development project needs to be confirmed and the resources need to be allocated; and 3) a feedback mechanism needs to be identified that can confirm that the goals are met. If any of these steps are not taken effective economic development will not occur.

As the example from Scranton shows, sometimes the planner – in this case the Department of Housing and Urban Development – fails to carry out step 1 effectively: Scranton officials and HUD can’t even agree on the place to be developed. Instead of letting the local officials who are knowledgeable about the area allocate the CDBGs, HUD officials in Washington bypass them by identifying the areas that need help via census data. Sometimes this approach might work, but when it doesn’t resources will be given to relatively prosperous areas while poorer areas are ignored.

The misallocation of resources will be an issue as long as the ability to allocate the funds is severed from the people with local knowledge of the communities. Cities and municipalities are receiving more and more of their revenues from the state and federal government, as seen in the graph below for Pennsylvania, and this contributes to situations like the one in Scranton.

PA intergov grants

As shown in the graph, total intergovernmental revenue and state intergovernmental to local governments in Pennsylvania increased in real terms from 1992 to 2012 (measured on the left vertical axis). In 1992, total intergovernmental revenue to local governments was equal to 59% of the revenue that local governments raised on their own (the orange line measured on the right vertical axis). In 2012 it was equal to 69%, an increase of 10 percentage points. This means that local governments became more dependent on higher-level governments for funding.

Funding from higher-level governments usually comes with restrictions and conditions that must be met, which prevents local citizens from using their local knowledge to alleviate the problems in their community. The further away decisions makers are from the region, the more likely they are to misidentify the problem areas. In Scranton’s case, city officials now have to expend scarce resources conducting their own survey and petitioning the federal government to change the neighborhood classifications.

Local knowledge is important and it should be utilized by decision makers. State and federal governments should limit intergovernmental transfers and allow local communities to keep more of their own tax dollars, which they can then use to address their own local issues.

Municipalities in fiscal distress: state-based laws and remedies

The Great Recession of 2008 “stress tested” many policies and institutions including the effectiveness of laws meant to handle municipal fiscal crises. In new Mercatus research professor Eric Scorsone of Michigan State University assess the range and type of legal remedies offered by states to help local governments in financial trouble.

“Municipal Fiscal Emergency Laws: Background and Guide to State-Based Approaches,” begins with some brief context. Most municipal fiscal laws trace their lineage through the 1975 New York City fiscal crisis, the Great Depression and the 19th century railroad bankruptcies. Writing in 1935, attorney Edward Dimock articulated three pieces to addressing municipal insolvency:  1) oversight of the municipality’s financial management 2) stop individual creditors from undermining the distressed entity and 3) put together a plan of adjustment for meeting the creditor’s needs.

These general parameters are at work in state laws today. The details vary. Some states are passive and others much more “hands-on” in dealing with local financial troubles. Scorsone documents these approach with a focus on the “triggers” states use to identify a crisis, the remedies permitted (e.g. can a municipality amend a collective bargaining agreement?), and the exit strategies offered. Maine has the most “Spartan” of fiscal triggers. A Maine municipality that fails to redistribute state taxes, or misses a bond payment triggers the state government’s attention. Michigan also has very strong municipal distress laws which create, “almost a form of quasi-bankruptcy” allowing the state emergency manager to break existing contracts. Texas and Tennessee, by contrast, are relatively hands-off.

How well these laws work is a live issue in many places, including Pennsylvania. In 1987 the state passed Act 47 to identify distressed municipalities. While Act 47 appears to have diagnosed dozens of faltering local governments, the law has proven ineffective in helping municipalities right course. Many cities have remained on the distressed list for 20 years. Recent legislation proposes to allow a municipality that can’t “exit Act 47” the option of disincorporating. Is there a middle ground? As the PA State Association of Town Supervisors put it, “If we can’t address the labor issues, if we can’t address the mandates, if we can’t address the tax exempt properties, we go nowhere.”

Municipalities end up in distress for a complex set of reasons: self-inflicted policy and governance failures, uncontrollable social and economic shifts, and external shocks. Unwinding the effects of decades of interlocking problems isn’t a neat and easy undertaking. The purpose of the paper isn’t to evaluate the effectiveness various approaches to helping municipalities out of distress, it is instead a much-needed guide to help navigate and compare the states’ legal frameworks in which municipal leaders make decisions.

 

 

 

Two cities down to their bottom dollars

This week, two large cities dealt with the consequences of fiscal irresponsibility. On Monday, Scranton, PA joined the state capital of Harrisburg in the list of municipalities that have run out of money to meet their commitments. The city has a budget deficit of $17 million, leaving the Mayor Chris Doherty without enough money to pay his employees.

He made an executive decision to slash all city employees’ compensation to reflect minimum wage in the paychecks they received this week because the city now has just $5,000 in the bank. Full payroll costs the city about $1 million, he said.

On Tuesday, the City Council in San Bernardino, CA gave approval for the city to file for bankruptcy. Investigation is underway in San Bernardino to determine whether fraud was involved in the budgets of the previous 13 years that reported surpluses when in fact there were deficits each year.

In both cases, cities have gone the extreme route of nearly spending their last dollars before making abrupt and drastic decisions. While no public investigation for criminal activity is underway in Scranton, Gary Lewis, an accounting consultant closely tracking the city’s financial crisis questions whether recent federal grants to Scranton have been managed appropriately.

It appears inevitable that Scranton will follow San Bernardino into bankruptcy filings, as it’s likely impossible to raise taxes sufficiently to cover the city’s current deficits and past debts. While these two cities have few options remaining, other cities should learn from these practices to avoid the costly and painful bankruptcy process.

This difficult situation could be avoided with increased transparency in budgets and with accrual budgeting. This budgeting process requires that cities set aside money for expenses as they agree to pay for them rather than when the bills are due. Following this process would prevent policymakers from spending money in the present that will have negative consequences down the road.

Bankruptcy in Birmingham

Jefferson County, AL has filed for bankruptcy protection, joining the ranks of Vallejo, CA; Central Falls, RI; Boise, ID; and Harrisburg, PA. In this case, the debt that the county used to finance a new sewer system is the main driver of insolvency. The county currently owes about $4.15 billion on the sewer system.

The Associated Press reports:

The problems were years in the making.

Its debt ballooned after a federally mandated sewer project was beset with corruption, court rulings that didn’t go its way and rising interest rates when global markets struggled.

Since 2008, Jefferson County tried to save itself the cost and embarrassment of filing for bankruptcy. But after three years, commissioners voted 4-1 to bring the issue to an end.

“Jefferson County has, in effect, been in bankruptcy for three years,” said Commissioner Jimmie Stephens, who made the motion to file for protection in federal bankruptcy court in northern Alabama.

While the last few years have seen a few cases of municipalities filing for Chapter 9, Jefferson County’s case represents by far the largest. Unlike other recent bankruptcies that were a result of both poor financial management and the economic downturn, Jefferson County’s problems were in part a result of corrupt public officials. Twenty-two people have been convicted for illegally refinancing the sewer bonds to benefit local and Wall Street financiers. Residents in Alabama’s largest county will likely face higher sewer rates as a result.

But the biggest problem for residents when municipalities file for bankruptcy protection is the resulting policy uncertainty. Businesses are typically reluctant, with good reason, to move to a bankrupt municipality. The shadow of Chapter 9 means that for years, residents and businesses will be paying higher taxes in exchange for fewer services because of the remaining debt burden. This will put the county and even the state in a poor competitive standing for new jobs.

In 1994, Orange County, CA, filed for Chapter 9 protection on $1.7 billion in debt, and residents there are still paying taxes toward that debt today. In the short term, Jefferson County will face painful and immediate cuts. The Birmingham Business Journal spoke with Commissioner Jimmie Stephens on what the future holds for the county:

“We’re looking at all of these services that are not mandated by the constitution and, from there, we will begin the reductions and take it as far as we need to, keeping in mind the services that the citizens need,” he said.

 

Harrisburg, PA Bankruptcy Proceedings Continue

On October 11, Harrisburg, PA filed for Chapter 9 bankruptcy, the first state capital to do so in several decades. Now, the city council must develop a plan for the city’s finances going forward. If the state does not approve the council’s plan by November 25th, Harrisburg’s finances could be turned over to a receiver and the city would not have a say in the budget process.

The state is engouraging Harrisburg to pay off its remaining debts primarily by raising property taxes, but the council has been reluctant to raise taxes on its residents, 29% of whom live in poverty. To limit the pain for city residents, Councilman Brad Koplinski supports bankruptcy:

“If the bankruptcy is allowed to proceed, I feel that unfortunately it’s the most beneficial option, because it will allow us to get the city out from under its debt,” Koplinski said at the meeting [held yesterday].

Today, the city’s debt totals about five times its yearly general-fund revenue, and lawmakers have few options to turn to for increased revenues. Vallejo, CA and Central Falls, RI also recently filed for Chapter 9 protection. In both cities, budget problems were driven in large part by increasing unfunded pension liabilities. In Harrisburg, however, the problem developed because the city borrowed $242 million to finance an incinerator that turned out not to be as profitable as expected.

Unfortunately for Harrisburg, even municipal bankruptcy is not a silver bullet for ailing city finances. The Vallejo case illustrates that while bankruptcy gives municipalities some bargaining power for negotiating pensions and can reduce the debt burden, filing for Chapter 9 will not eliminate past obligations. Harrisburg will likely emerge from bankruptcy with a heavy debt burden and nowhere to turn for increased revenue. In this case, bankruptcy may be the city’s best option, but other municipal lawmakers should look to the Vallejo example when promising lavish projects on borrowed money. There is no easy way out of municipal debt.

Will Harrisburg, PA make its next bond payment?

Harrisburg, PA’s next bond payment of $3.3 million is due on September 15. A bill they may miss according to The Wall Street Journal absent a $7.5 million payment from the city authority that runs parking facilities. With $1 million cash on hand, Harrisburg’s other big ticket item is $3 million in monthly payroll expenses. The city owes its fiscal problems to a $221 million incinerator project (five times the size of the general fund budget)  that has saddled Harrisburg with an enormous amount of debt.

Bloomberg reports that the city council is now deciding on a rescue plan. Harrisburg avoided defaulting on its GO debt last year with state aid. The plan to stabilize the long-term finances of the city includes selling the incinerator and other assets, job cuts, renegotiation of labor agreements and the imposition a commuter tax. To date, the city council has rejected Mayor Linda Thompson’s plan. She will again ask the council’s approval on August 31.

In the meantime, hearings will be held. Creditors want to be paid back and the incinerator turned over to a receiver. The incinerator has received two bids to date.

Harrisburg’s new attitude towards GO debt

Nicole Gelinas writes at Public Sector Inc that Harrisburg, PA may simply choose to writedown some of the city’s incinerator debt to bondholders. The reasoning to paraphrase one city councilwoman, “they took an investment risk”. If this is the way the city intends to go, there are implications. Creditors now no longer should only consider whether the issuing authority is likely to have the money to pay back the bond, but whether or not they are willing to pay it back.

The “Pac-Man” of New Haven’s budget

Steven Malanga of The Manhattan Institute has an article tracking the impact of compensation in municipal budgets.  New Haven’s Mayor John DeStefano, long a public sector union ally, now finds himself in the position of trying to reduce the fast-rising costs associated with employee compensation. In the city’s $475 million budget, pension and health care benefits are projected to rise by $12 million this year. Other cities facing out of control employee costs include Costa Mesa, California, Pittsburg, PA, New York City, Chicago and Newark, N.J.

But so far attempts at money-saving by city officials has mainly been met with union protests.  A self-defeating stance.

As Malanga notes, the local level is where these costs are most strongly felt. Municipal managers are increasingly being forced to choose between offering basic services and keeping up with fast-rising benefits costs – in some cases the result of state-level statutes that enhanced benefits and failed to consider the costs.

In a forthcoming paper we find that one culprit is decades of budgeting in the dark. These costs appear to be a surprise because budgets don’t indicate in a meaningful way to the public how  much a municipal government is carrying in pension and health care costs. Budgets reflect what the municipality chose to pay in a given year and not how much is needed to keep the system funded. In fact, in the case of New Jersey, these numbers aren’t always made clear to the local governments due to state reporting conventions.

For more on the pressures in local budgets, read the original article here.