More municipalities are likely to become distressed, according to a new Fitch Ratings report on the outlook for U.S. local governments.
“In our view, the vast majority of local governments in the U.S. will manage the slow macroeconomic recovery through a combination of prudent budget management, including tax increases in some cases,” the Fitch report states. “However, we believe a few more local governments than the ones already making headlines could have negative outcomes.”
The key factors most likely to put local governments at risk are inflexible labor environments, high and rapidly growing fixed costs, and restrictive taxing limits, Fitch analysts wrote.
“Finding savings will become increasingly difficult for governments that have experienced years of service reductions and are now facing pressures to address deferred needs.” the report states.
Pension costs are a specific liability that Fitch sees as likely to trend up due to a convergence of factors.
“We expect most pension annual required contributions to continue to rise in the short run, as the losses in the financial markets in 2008 and 2009 continue to be phased in,” Fitch said. “Beyond that, we expect demographic pressures from the now retiring baby boomers to increase as they draw pension and unfunded retiree health care benefits.”
Many local governments are already taking steps to get those rising costs under control, including combinations of tax increases and pension plan restructuring.
Baltimore Mayor Stephanie Rawlings-Blake announced in February a series of such steps designed to prevent Baltimore from falling into the category described in the Fitch report. The plan includes reduced reliance on debt financing for infrastructure, and a pension reform requirement that employees make contributions for civilian pension benefits.
But there are obstacles in the way of such reforms for many localities, Fitch notes.
For many, modifying pension costs may hinge on increasingly important judicial decisions or state actions outside local control,” states the report. “Tax policies are generally decided at the state level, even if they only affect local government revenue such as property taxes.”
Municipal governments have a fine line to walk in an improving but still constrained fiscal environment, Fitch’s analysis concludes.
“In the end, a government’s ability to manage its resources and priorities and take the measures necessary to maintain fiscal balance are crucial in a slowly improving but continually challenging environment.”