CHICAGO - Like most cities in Ohio, Columbus is struggling with a decline in income tax revenue, its main revenue source. But unlike in other cities, officials there last month lobbied for and won an increase in the income tax rate - a move that was followed shortly by a reaffirmation of the city's coveted Aaa rating from Moody's Investors Service.

Now on a more stable fiscal footing, Columbus plans to head to market this fall with a $242 million general obligation bond issue it had delayed selling last year.

Columbus so far has proved to be the exception. Ohio's cities, which fund their operating expenses and debt service obligations mostly with income taxes, are expected to face fiscal and economic challenges through at least 2010, as the volatile revenue source continues to decline amid high unemployment and dwindling corporate profits, according to a new Moody's report on the state's cities.

However, despite the challenges, most cities are not likely to risk the political fallout from a tax hike- especially with municipal elections looming in November.

The decline in revenue is expected to contribute to a drop in debt issuance this year and next, market participants say. Debt issuance by Ohio's cities and towns has already declined by nearly half during the first half of 2009 compared to the same period 2008, according to Thomson Reuters.

"The current recession is placing unprecedented pressures on cities' income tax revenues," analyst Thomas Schuette wrote in the Moody's report. "Cities' ability to manage through the current recession without substantial budget reductions or revenue increases will be to a large degree reliant on timely recovery of income tax trends."

One survey of 61 cities noted that income tax collections so far this year had declined more than 5% from 2008, when they were down already from previous years.

In Columbus, income tax revenue is projected to fall 5.25% by Dec. 31. That does not include revenue generated from the new 0.5% income tax increase, which will go into effect Oct. 1 and push the city's income tax rate to 2.5%.

The city expects the increase to bring in an additional $10 million to $15 million by the end of this year, and between $90 million and $100 million annually, according to Megan Kilgore, Columbus' assistant city auditor. The city sets aside 25% of its income tax revenue to cover debt service.

The additional revenue prompted city officials to begin preparations to issue the $242 million of GOs that have been authorized by voters. Officials had postponed sale of the debt last year due to the city's financial challenges.

"With the exception of utilities [debt], which is paid back by user fees, the city was not going to go out and issue debt until we got on firmer footing financially," Kilgore said. "Now that the tax has passed, we can go ahead."

Columbus plans to enter the market the first week of November with the $242 million issue, which includes $226 million of voter-approved unlimited-tax GO debt that will finance a number of capital improvements. Stifel Nicolaus & Co. is the senior manager on the deal.

The new tax revenue is expected to eliminate a 2010 budget gap and help the city regain structural balance after two years of revenue declines. But it still may not be enough, according to Kilgore. "It's helped tremendously, but we're still not out of the water. There are still cuts to be made," she said.

After the tax increase and ahead of the GO deal, Moody's reaffirmed the city's Aaa rating. But in its recent report, the rating agency warned that so far, few other cities seem to have the political will to follow Columbus' lead.

"The political barriers to raising income tax rates can be high and cities have largely looked to augment revenues through more politically acceptable fee increases," Schuette said. "Should revenue challenges continue through the medium term, many cities will be faced with the difficult decision of placing income tax measures on the ballot to avoid large-scale budget reductions."

The success of Columbus could encourage other cities, said John Mahoney, deputy director of the Ohio Municipal League.

"With a lot of cities there was some, 'Let's wait and see how Columbus does and whether it's really possible to pass a tax increase,' " Mahoney said. He added, however, that most governments will wait until next year to attempt to raise taxes, after this November's elections.

"This year is a municipal election year, which makes it even more incredible that Columbus would go to the ballot [asking for an increase]," he said.

Like many states in the Midwest, Ohio's struggles are tied to losses in the manufacturing industry in general and the U.S. automobile industry in particular. In addition to falling income tax revenue, nearly all other operating revenue sources are down. The state has frozen the amount of aid it gives to local governments since 2003 and is expected to cut it this year and next, Moody's said.

Property tax revenue - 70% of which funds local school districts - is flat or down. Sales tax revenue, which largely funds counties, is also down, as are interest earnings.

"Everything's down," Mahoney said. "And it's a compound problem. Some cities, their income taxes are down by 3% this year, but that's off of a base that was down 3% last year and the year before. It's a little like the state budget, which this year is working off the same revenue dollars they had in 2006."

The revenue declines mean "it's a given" that debt issuance also will be down this year and next year, according to Mahoney. "It will also be down, because you always have a choice: You can do capital improvements or you can pay your police officers," he said. "Guess what the choice is most of the time?"

Debt issuance by cities and towns in Ohio in the first half of the year had declined by nearly 27%, to $472.5 million, compared to the same period in 2008, according to Thomson Reuters. New-money issuance by all issuers, including the state, was down 31% for the first half, while refundings were up 86%.

"The capital improvement budget doesn't stand aside from the operating budget," Mahoney said.

Despite the tough times ahead, many cities are expected to benefit from financial managers who are conservative and proactive in their budgeting practices, in part because they have confronted similar challenges in the past.

"They've become conservative," Mahoney said of municipal financial managers. "We go through recessions here that look a lot like depressions. Our folks have learned over the years that the income tax goes up and down. You don't restructure the entire steel industry without learning that."

Familiar with economic downturns, many city managers have maintained strong reserves and general fund balances that will help them manage the ongoing revenue declines, Moody's said. "City management teams are generally more prepared for revenue volatility and tend, on average, to maintain higher general fund balances," the report noted.

One bright spot for Ohio's local governments is that the state manages all pension and other post-employment benefit liabilities. "This has a significant beneficial impact to cities as it moderates the budgetary pressure of escalating funding requirements in a time period when budgets are already stretched thin," Schuette, the Moody's analyst, wrote.

Mahoney said given the revenue declines he's surprised by the moderate pace of layoffs in the public sector so far.

"We've had a lot of talking about layoffs, but people have found different ways to avoid it for the most part," he said. "It's not of the scale of, say, during the early 1980s. It's not as bad because of conservative management, which has meant we've been prepared a little better for this recession."

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