Some local governments in the Washington area, as well as many other local governments across the country, are facing the possibility of the worst financial pinch of the post World War II period. The causes of the problem are evident:
* Growth in revenues has been abruptly curtailed as a result of the national recession, deflation and cuts in federal aid.
* Spending commitments made during a time of economic growth and inflation cannot be trimmed fast enough to balance the reduced revenues.
When balanced city budgets were approved last year, governments based their estimates of sales, income and business-related tax revenue on assurances that by now, sales would be booming, people would be going back to work and business profits -- not bankruptcies -- would be growing. In addition, city officials assumed residential property values and new construction would begin to rise with a growing economy, and thereby provide a healthy growth in property tax revenues. None of these optimistic assumptions turned out to be correct. Just as their collapse has widened the federal deficit, so, too, it has helped throw local budgets out of balance.
City officials also did not expect the sharp decline in inflation rates. A year ago, optimists hoped that inflation might grow by only 8 percent this fiscal year. Now 5 percent appears more likely. This caused two adverse budget consequences. On the revenue side, estimates for inflation-sensitive revenues, such as the sales tax, were based on the assumption that inflation alone would cause total sales tax revenues to increase sharply. And on the expense side, key spending commitments were also based on high inflation rates. One obvious example is the labor contracts that appeared to give favorable below- inflation raises a year ago, but now are being criticized for being too generous. Similarly, cost-of-living increases to pensioners for the current year were based on last year's high inflation rate. Other spending commitments, such as for mass transit subsidies and capital improvements, cannot be easily reduced. Thus, although the lower inflation rate reduces revenues, expenditures remain high.
While it might appear that cities would at least find some relief as a result of the drop in interest rates, the opposite is true. Because cities invest large amounts of idle cash for short periods during the year, high interest rates provided a bonanza of interest earnings in past years. But this year, revenues from this source will fall sharply as short-term interest rates decline. On the other hand, the effect of lower interest rates on cities' long- term capital borrowing will be felt only in future years, and will have little or no effect this year.
The consequences of these unfavorable developments are summarized in a recent report I prepared for the Greater Washington Research Center's Task Force on Local Government. This report projects $605 million in budget gaps for Washington area governments by 1987. Unlike many academic projections, these are turning out to be all too accurate. Mayor Barry has announced that this year's District budget is currently out of balance by $110 million (we projected $109 million), and newly elected Prince George's County Executive Parris Glendening has projected the county's 1984 budget gap at $38 million (we projected $40 million). That these gaps are not just a Washington area problem is confirmed by the $341 million deficit facing New York City in its current budget.
The budget gaps facing local governments will not be easy to close. Many, including the District of Columbia and Prince George's County, have already been practicing austerity in recent years, as a result of slowing federal aid and voter resistance to increased taxes. The governments have reduced their work forces, cut school budgets and stopped expanding programs and services. In addition, prior to this year their pay increases to employees had averaged below the rate of inflation since the mid-1970s. As a result of these past budget-trimming actions, there will be few easy options to cut expenditures, and no additional federal aid is in sight to help solve current problems.
The best and virtually only hope for escaping the serious financial problems now facing local governments is an immediate and strong upturn in the national economy. If this does not happen soon, difficult choices between cutting staff and services and raising additional revenues will have to be made quickly and under crisis conditions.
The result for people in the Washington area will likely be: higher user fees and charges, including increases in Metro fares; increases in property tax rates to offset the decline in property values; increased efforts to control labor costs by reducing employment and overtime, and by holding down the cost of future pay increases and fringe benefits; and substantial reductions in some programs and services.
While the current problems developed too unexpectedly to allow well-planned solutions to them, our projections show that unless we commit ourselves to taking additional action now, these problems will recur in future years. It is essential, therefore, that government officials and community leaders face up to the need to develop long-range financial plans with well-developed and carefully analyzed alternatives for closing budget gaps.