[The following is from Funkhouser & Associates‘ December newsletter, reprinted here with permission.]
This September, I had the privilege of attending the second annual Richard Ravitch Public Finance Initiative Symposium, hosted by the Pew Charitable Trusts and sponsored by the Volcker Alliance. This gathering of leading public-finance experts underscored the urgent need for state and local governments to strengthen their fiscal positions as they brace themselves for challenging times ahead.
The symposium’s report, “Resilient State and Local Finance,” highlights the critical importance of intergovernmental cooperation and sound financial management.
While states and localities currently rely on substantial federal funding for essential services (including infrastructure, education, public safety, and Medicaid), the impending withdrawal of pandemic fiscal aid and the potential for decreased federal support in the coming years necessitate a shift toward greater self-reliance.
Public finance expert Girard Miller warns, “For the next four years, I see no hope whatsoever that there will be ‘helicopter money’ coming from the federal government to bail out state and local governments in a recession the way we did during COVID.”
What’s more, according to the U.S. Treasury Department gross federal debt had ballooned to 123% of GDP as of fiscal 2024, and President-elect Donald Trump’s proposed tariffs and tax cuts are unlikely to reverse that growth.
These factors combined are pushing local governments toward the mother of all fiscal cliffs. To avoid plummeting over it, state and local governments must prioritize self-sufficiency and strategic financial planning. By pooling resources, building robust reserves, and developing contingency plans, they can better withstand economic downturns and other unforeseen shocks. Here’s how:
Develop a federal grant policy
While federal grants have been a lifeline for many local governments, the complex application and reporting processes often deter smaller localities from pursuing them. To make the most out of limited resources, these smaller governments can implement a strategic policy that helps them identify and pursue federal grant opportunities worth their investment. Miller agreed that there is reason to be cautious: “There’s no question that some of this will entail sticky social-conservative strings … requirements attached to that money that some people will find unpalatable or unmanageable.”
To optimize grant application and management, localities should consider designating a dedicated grants team or individual. This could leverage existing staff who coordinated federal funds from the American Rescue Plan Act (ARPA) or the Infrastructure Investment and Jobs Act (IIJA). For short-staffed governments, collaborating with neighboring jurisdictions to pool resources and submit joint regional proposals can significantly enhance their chances of securing grants. Regional bodies like councils of government or metropolitan planning organizations can coordinate planning and grant efforts and provide technical assistance to local governments in grant writing, project management, and compliance. The Appalachian Regional Commission, for example, is a federal-state partnership that provides grant funding, expertise and peer learning support to 13 Appalachian states, facilitating community-based, regionally driven economic development.
Justin Marlowe, director of the Center for Municipal Finance at the University of Chicago, noted that municipal finance directors could also benefit from developing relationships with regional representatives of federal agencies who can help guide them on specific programs under their purview and on which key performance indicators would be significant to track. In addition, consulting firms like Guidehouse can provide staffing around collecting and reporting information to meet grant requirements.
Move to risk-based reserves
The Government Finance Officers Association has traditionally framed fiscal reserves as akin to a piggy bank, advocating for a target reserve level of 15 percent of the jurisdiction’s general revenue. GFOA Senior Research Manager Shayne Kavanagh now recommends a shift to reserves built on an insurance model, one that calculates for the likelihood of certain risks and costs should those risks come to pass. As Marlowe noted, “It’s not enough to say we have a policy based on [GFOA], but we also need to have a model that is tailored to our circumstances. That’s a much more appropriate way.”
As we have written before, measuring and managing a jurisdiction’s risk profile also requires a broader, more holistic assessment of TCOR — the total cost of risk.
In one example, Douglas County, Colorado’s Risk-Based Analysis of General Fund Reserve Requirements began by identifying risks that posed the most danger to the county — floods, wildfires, hazardous materials spills, and the potential for decreased revenues due to an economic downturn. That exercise calculated the probability that the county would experience each of those risks over a 10-year period, and if so, what the magnitude of loss would be. The results were combined into a 10-year model of the county’s reserves.
To help the county identify the appropriate risk management strategy, GFOA’s analysis showed points where using reserves would be most economical and where other risk-financing tools, such as debt or insurance, would be more prudent. Risk-based reserves not only provide a financial cushion for potential crises but also prevent the accumulation of excess reserve funds that could be better utilized for infrastructure improvements than issuing bonds.
This brings us to the final point.
Address unbooked liabilities
With the Governmental Accounting Standards Board’s adoption in 1999 of the GASB 34 standard, governments were finally required to account for the long-term costs of capital assets, either by depreciation or by using what’s known as the “preservation” method. Under that alternative to depreciation, governments can expense maintenance and preservation costs as incurred, avoiding the recognition of deferred maintenance liabilities in financial statements. This simplifies the financial statement, but by not accounting for future maintenance needs it can obscure a government’s long-term financial obligations.
This issue is exacerbated by other potential liabilities that may not be explicitly recorded. For instance, the financial impacts of natural disasters, lawsuits, and climate change can be substantial but often go unrecognized in traditional financial statements. Failing to recognize these unbooked liabilities paints an incomplete picture of a government’s long-term fiscal health.
The federal government is not likely to cover debts related to these contingent liabilities, according to Marlowe. “The Senate has made it very clear that there’s very little interest in ramping up federal spending to allow local infrastructure to adapt to climate change,” he said. So localities should do the math to know what they’re up against. “Having more information about where the unmet needs are and having that be the financial reporting imperative is completely appropriate.”
“The magnitude of risk would be extremely useful information for both investors and, frankly, for the elected officials that are presumably responsible for watching over their jurisdiction’s finances.”
Miller agreed that GASB could require supplemental information of the biggest contingent liabilities facing a specific jurisdiction, equivalent to mandatory disclosures that a private company must make during a securities offering. “The magnitude of risk would be extremely useful information for both investors and, frankly, for the elected officials that are presumably responsible for watching over their jurisdiction’s finances,” he said.
As noted in our Issue Brief on the Financial Data Transparency Act, GASB’s previous disclosure mandates on the costs of depreciating assets and unfunded pension liabilities brought greater visibility, clarity and uniformity to previously obscure financial data that coalesced into meaningful conversations among stakeholders and decision-makers. Similarly, more accounting transparency and ease of access to financial data as a result of the FDTA might address contingent liabilities and the infrastructure icebergs that many local governments are bound to hit.
A return to “fend-for-yourself federalism:”
The term was coined by researcher John Shannon in 1987 to capture the impact on state and local government finances of President Ronald Reagan’s federal budget cuts and devolutionary initiatives. In fact, it made the headline for the cover story of Governing magazine’s first-ever issue that year, ushering in an increased focus on local governments to drive innovation and effectively fend for themselves in the national laboratory of governance. While pandemic-era relief may have provided emergency funds, it also kept a spotlight on cities and counties to develop innovative, creative, and locally driven solutions. It’s a muscle they must now flex more than ever as they fend for themselves financially during the coming storms.