Ratios of indicators both internal and external to government are used to determine if a city is fiscally strained in this model, which conceives of fiscal stress as a lack of adaptation by a government to its private-sector environment.
Twenty years ago, no one spoke of fiscal strain, but now it is a central concern for American cities. The history of fiscal strain goes back to the depressions, especially the 1930s. There were a few studies of defaults then, but from the 1930s to the New York fiscal crisis in the mid-1970s, municipal bonds were so safe that no one wanted serious analysis. Yet with the New York fiscal crisis, it became clear that if New York City could default, so could any government. Risk was real.
The New York City fiscal crisis surprised and shocked many observers. Defining what happened and why, however, has been controversial. The most visible indicator was inadequate cash to pay bills in 1975. The city borrowed more and more for the short term to meet such expenses, and its short-term debt mounted considerably, as did its long-term debt. This led the banks to refuse to continue short-term loans and to press for more sound fiscal management. The mayor and union leaders held that substantial changes, especially staff cuts, were impossible. Months of conflict and negotiation continued until the state created the Municipal Assistance Corporation and the New York State Financial Control Board. These bodies pledged financial support to the city and imposed tighter fiscal management. This assistance was not sufficient to pay the bills, however, and the city then turned to Washington for aid, arguing that much of the crisis was not of its own making but was driven by the loss of jobs and population found in many other older cities. The federal government eventually loaned the city more than $2 billion, which was repaid over several years. The turbulence and controversy these measures generated led to questions that had not been asked since the Great Depression of the 1930s. How is support justified for one city and not for others? What sorts of similar aid should be provided more generally? What criteria should be used to assess fiscal strain?
In the summer of 1975, New York City officials were lobbying Congress for funds, and people were asking how many "New Yorks" might occur. How fiscally strained were large U.S. cities, and how many might follow a similar course? Answering these questions demanded 1) measuring fiscal strain and 2) specifying its causes for U.S. cities. No one in the country had the tools to do this: not the U.S. Treasury nor investment banks nor CPA firms. Municipal strain was almost unstudied. The disease seemed extinct--in sharp contrast to private firms, whose defaults and risk were common and more studied.
What Is Fiscal Strain?
The few people who had spent their careers on municipal risk, such as analysts at the top bond houses, often advocated using one single variable, like cash flows or housing starts. Others said to look at everything and use sound judgment; but when asked how, they could not answer except in vague generalities.
The lack of data on fiscal strain and the absence of systematic procedures for measuring it prompted the author and several students to research and analyze its causes. The first step was to create 28 indicators for a national sample of cities and to analyze causes of strain with systems of regression equations. The study showed that New York City ranked far above any other city on most strain indicators. The study had a widespread impact and became the foundation for additional research that culminated in an approach to fiscal strain that differed from several past approaches while incorporating some of their elements.(1)
One approach that had been used to measure fiscal strain was the internal-to-government approach of accountants and others who look, for example, at changes in debt--short-term, long-term, gross or net--or flow-of-funds indicators--debt coverage or quick ratios of cash on hand. Their primary model was the private corporation: look at the books carefully to see where things are going. The assumption was that private firms and governments are similar enough that both can use the same measures of success or impending failure. Yet the one clear lesson that emerged from the fiscal crises of New York and later Cleveland was that mayors are not profit maximizers, nor is debt payment their top priority. When New York's mayor had to choose in 1975 between paying the bondholders and city workers, he said the workers came first. Internal measures alone are misleading, but they are part of the story.
A very different second approach stressed factors external to government. This method, used more by economists, geographers and demographers, was derived from federal grant formulas like Community Development Block Grants, which used population change, poverty or per capita income data. The assumption was that these private-sector forces are so powerful in defining or generating urban distress that local government policy does not matter. The "Northeast Syndrome" was their main interpretation of the New York City fiscal crisis: New York went under because it was a large, old, distressed city suffering a loss of jobs and population to the Sunbelt. This had appeal, as it implied that city government was not culpable. More federal aid to distressed cities was their solution, but an unanticipated consequence was that many investors bought this argument and refused to invest in any city in the whole Northeast, thereby causing interest rates to rise. By the 1980s, with a drop in federal aid to cities, this approach to measuring fiscal strain was less heard.
Exhibit 1 FISCAL STRAIN INDICATOR SCORES FOR THREE CITIES, 1977 Common function expenditures City wealth per capita index Fiscal strain ratio (1) (2) (3)=(1)/(2) Palo Alto, CA $294 $18,212 0.016 Pittsburgh, PA 144 7,703 0.019 New York, NY 252 11,725 0.046
The approach developed through research of the author's group introduced a new idea, one which joined the internal and the external traditions; the idea was "adaptation." Fiscal stress was conceived of as a lack of adaption by a government to its private-sector environment. A government determines whether it is maladapted by creating measures that are both internal and external and that are explicitly interrelated. This approach uses ratios where the numerator is what a government does internally in its spending, revenue or debt and its denominator is the external, private-sector activities of the city--its per capita income, taxable property value, population size, etc.
An example of a fiscal strain ratio, comparing city spending to city wealth, is detailed for three cities in Exhibit 1. In this ratio, city wealth is measured by a city wealth index, which sums median family income and taxable property value, weighting each by the proportion it contributes to the municipality's revenues. As shown in the exhibit, Palo Alto spent slightly more money on common functions than did New York City near the time of New York's fiscal crisis. Palo Alto, however, was wealthier than New York, so its fiscal strain score was similar to that of Pittsburgh (.019). Pittsburgh was similar to New York in poverty and suffered more job losses, driving its wealth index down to $7,703, lower than in New York. Pittsburgh officials, however, cut spending to $144 per capita. Consequently, Pittsburgh's fiscal strain was almost as low as Palo Alto's. New York's spending was below Palo Alto's, but its lower wealth generated a fiscal strain ratio about three times higher than Palo Alto's.
Ratios can measure levels at one particular time or changes over time. Both types of measures and comparisons are important. A rich city can have large expenditures but still not be fiscally strained, like Palo Alto. If a city loses its tax base but cuts its spending proportionately, it can maintain the same ratio, as in the case of Pittsburgh. If a city loses jobs and population and continues to increase spending, however, strain escalates. This was New York City in the early 1970s prior to its crisis.
Causes of Fiscal Strain
Indicators of fiscal strain are not causes or solutions. Explaining why fiscal stress emerged in one city or state and not another, and determining what would alleviate it, takes more than excellent indicators. It also requires some kind of model of the processes, a specification of causes and effects.
Using data from surveys of 62 U.S. cities and many other sources, the author's group examined causes of fiscal strain to develop a systems model. The causes included population and economic base, political leadership, unions, ethnic groups and the disadvantaged, grants and legal structures. By showing the causes that lead to fiscal strain, the model specifies what kinds of fiscal policies flow from political leadership, socioeconomic makeup and various other factors. This approach was refined and developed into a practical manual on how to construct an indicator system to monitor fiscal strain published in 1990.(2)
Dealing with Fiscal Strain
Solutions to fiscal strain can be found in specific innovations in government that creatively adapt to austerity, often by improving productivity. Many can improve productivity. Major innovations often come from new leaders. To find solutions to fiscal strain for their own locality, government officials can look for a visible problem, devise an innovative solution and closely examine the feasibility of that solution, since governments differ in political and administrative feasibility. For example, in a strong union city like Chicago, policies that do not confront the unions are more feasible than those that must overcome strong union resistance.
A program of Urban Innovation in Illinois has organized competitions and made awards to Illinois governments that reduce strain by improving productivity. Some examples of such solutions are presented below.
The Village of Downers Grove has a 10-year budget using many information sources to critique its programs and to make them more efficient and responsive. One specific tool is a citizen survey. Officials have conducted a mailed citizen survey every year for more than a decade, asking detailed questions as to the courtesy of librarians and school crossing guards, the frequency of water drain backups on streets, etc. At budget time and in salary decisions, the results of the citizen survey are part of the decision process. Other Illinois localities have demand-response performance indicators, like the City of Lake Forest and Elk Grove Village, which send a postcard to every citizen who calls to complain. The postcard asks the citizen to evaluate the government's response. It is a simple idea that works well.
Other awards were given to three municipalities that contracted out services. The City of Elgin developed a major park with baseball and other facilities at no cost to the taxpayer by contracting with a firm that mined gravel under the park and built the facilities without charge. The Village of Park Forest created a Volunteer Recruitment Fair to enlist citizens to volunteer services. The Village of Lombard contracted with the local electric utility company to inspect the city water meters simultaneously with the inspection of electric meters, realizing a major cost savings. The company agreed to perform such inspections elsewhere, and dozens of localities signed on, eliminating duplicate inspections and saving money.
In all these cases, the heroes are the local officials, the ones in the trenches who came up with good ideas. These are tangible innovations that reduce fiscal stress and improve productivity. The awards program features and rewards them via their local media and professional meetings.
Productivity-enhancing innovations alleviate fiscal strain by cutting costs while maintaining services; they suggest to citizens that local officials are addressing management problems creatively. This enhances government legitimacy, which can encourage citizens and government staff to accept solutions that may be painful to them. Awards such as those made by Urban Innovation in Illinois bring attention to examples that actually work and provide specific information on successful innovations for government staff elsewhere.(3) Municipalities in Illinois have demonstrated that innovative solutions can be very successful while being very simple.
Fiscal Strain as Adaption
Every urban problem has a solution that is neat, simple and wrong. Cities are complex multidimensional systems, and describing or explaining fiscal strain with one key factor can be misleading. Fiscal strain can be considered as adaptation, measuring how internal fiscal policies are adjusted for external private-sector strength. Examining indicators both internal and external to a government can yield a more complete view of its fiscal status.
A system that monitors multiple indicators also may be low on spending change, which will affect the fiscal strain interpretation.
Finally, a government benefits from going beyond analysis of fiscal strain to identify and act on its causes and consequences. An analytical framework that includes major variables, such as fiscal management, political leadership and unions, as well as the standard economic and population items, can facilitate the identification process.
1 See Clark, Terry Nichols and Ferguson, Lorna C., City Money, New York, NY: Columbia University Press, 1983.
2 See Clark, Terry Nichols, ed., Monitoring Local Governments, Dubuque, IA: Kendall-Hunt, 1990.
3 More information on the awards is available from William Stafford, Executive Director, Illinois Government Finance Officers Association, 2321 Ridge Ave., Evanston, IL 60201. A brochure summarizing award-winning innovations in Illinois, Urban Innovation: Who's Doing It, What Really Works?, is available free from Urban Innovation Analysis, 1126 East 59th St., Suite 322, Chicago, IL 60637.
TERRY NICHOLS CLARK, a GFOA member, is professor of sociology at the University of Chicago where he teaches urban public finance. He is author of City Money, Urban Policy Analysis, and Financial Management Handbook for Mayors and City Managers and is editor of Research in Urban Policy, Urban Innovation and Monitoring Local Governments. He holds M.A. and Ph.D. degrees from Columbia University.…