Suppose you are the budget planner ( a part time job?) for some small California town. To run a balanced budget over time, your present discounted revenues (collected mainly from property taxes) must look roughly like your present discounted flow of expenditures (mainly schools and cops and infrastructure). Can these two streams get really out of whack such that you are running a big deficit?
Case #1: If you assume that home prices will continue to rise at 8% per year, you may have a rosy forecast of your revenue stream.
Case #2: If your schools are filling with kids so that you must build new schools and if these kids have special education needs and if your public workforce has nice union wage premiums, then your expenditure side could soar.
Case #3: Consider Proposition 13 capping property taxes on long term residents, if the turnover in your city slows down such that tenure increases then there are fewer new buyers paying high market prices and locking into a high property tax payment.
So, if you were a forward looking budget dude --- do you anticipate any of these trends? Does it pay to be stupid? Will the state government (also in deficit) give your city a transfer if ex-post you run a deficit? Such dynamic incentives would cause moral hazard effects.
Will actual local quality of life suffer due to these exurban budget deficits? Will the schools get worse? Will garbage not get picked up? Will crime rise?
John Quigley has some good quotes in the article below. He is a wise man!
New York Times
May 8, 2008
City Council in Bay Area Declares Bankruptcy
By JESSE McKINLEY
VALLEJO, Calif. — In a potentially ominous harbinger for some cities in California and elsewhere, the Vallejo City Council voted to declare bankruptcy Tuesday night in the face of dwindling tax revenues, the housing market meltdown and a faltering economy.
The unanimous vote was cast after late efforts to squeeze concessions out of city employees failed and with the city facing a $16 million shortfall for the fiscal year beginning in July.
“We finally realized there are no other options,” Councilwoman Joanne Schivley, a retired banker, said. “We were going to run out of cash come the end of June. It’s not a decision that any of us took pleasure in, but there are a lot of other cities that are probably be in the same boat shortly.”
What worries some experts is that some of the problems here are all too common, a steep decrease in property and sales taxes and transfer fees as a result of weakness in the housing market.
“At one point, bankruptcy seemed beyond the pale, but it’s something that one hears about a lot more now,” said John Quigley, a professor of economics at University of California, Berkeley. “And in California, you hear about a lot of cities being pushed to this sort of thinking by the housing crisis.”
A bayside community of 117,000 25 miles northeast of San Francisco, Vallejo is the largest city in California to declare bankruptcy, though Orange County did so in 1994 after a spate of bad investments.
“With Orange County,” Professor Quigley said, “there were identifiable bad guys. This is different. Near as one can tell, this is more of a low-level infection everywhere.”
Municipal bankruptcies are not unheard of, but are often accompanied by scandal or legal losses. County commissioners in Jefferson County, Ala., are considering bankruptcy amid a federal lawsuit over payments to the mayor of Birmingham, the county seat, and a missed bond payment.
Smaller cities like Half Moon Bay, Calif., and McCall, Idaho, have also flirted with bankruptcy. In Vallejo, Council members and residents fault decisions by past Councils, including agreeing to binding arbitration for contracts with city employees, whose salaries account for nearly 80 percent of the general fund.
Like many Bay Area cities, Vallejo has struggled to keep up with demand for services as its population has grown over 20 years. “We as a state are growing by 500,000 people a year, and that is continuing to put pressure on the cities,” said Dan Carigg, the legislative director for the League of California Cities, an association for the 478 cities in the state. “And when you run short, you tend to have two choices. Cut programs or try to raise revenues.
“And when it comes to cities trying to raise new revenues, their options are very limited.”
Because of propositions approved by voters, California strictly limits increases in property taxes. And in Vallejo, public workers say the cutting has already gone too far.
“We’ve been doing more with less forever,” said Detective Mat Mustard, vice president of the Vallejo Police Officers Association, which opposed the bankruptcy declaration. “We’re going to start losing people. Who wants to work for a company or a city that’s bankrupt?”
Council members disputed that public safety or the attractiveness to businesses would be reduced.
“This morning, going around town, it’s weird, because everyone’s saying congratulations,” Councilwoman Stephanie Gomes said. “Its kind of odd to say, but the mood among people is that we’re finally going to solve the problems.”
Along the main drag, Georgia Avenue, the sentiment seemed to be more bittersweet.
“I’m sad to see it go this way,” Debbie Rojas, owner of the Georgia Street Grill, said. “But I’m kind of excited for bankruptcy.”