State-local relations get tested in new fiscal era: More reductions in state aid and calls for efficiency

In response to mounting budget pressures, state governments have cut aid to local governments. At the same time, policymakers are calling for more efficiency at the local level in order to make the most of limited financial resources.

Stateline Midwest Vol. 20, No.5: May 2011

Even as the U.S. economy shows signs of a turn-around, local governments across the Midwest and nation are preparing for what Jacqueline Byers calls the “double whammy” set to cut into their primary source of revenue.

Property taxes, which account for 72 percent of local tax collections, have been affected for a few years now by the mortgage crisis that began in 2007.

But Byers says the revenue outlook will only worsen as communities face a new wave of foreclosures (due in part to high unemployment rates) and as decreased property values begin to be reflected on local property tax rolls. (Some local entities are on a three- or even five-year assessment cycle.)

“The bottom line is that there is no rescue in sight for property taxes in most counties,” says Byers, the director of research and outreach for the National Association of Counties.

On top of these revenue cuts, local governments are also facing higher expenditures due to factors such as rising oil prices. The result has been a trend in recent years toward “functional consolidation”: the merging of specific services by entities that remain operationally separate but that combine certain services or staff functions.

“We have seen lots of functional consolidations in sheriff’s departments, libraries, planning and zoning, and animal control because it is much more efficient,” Byers says. “If the county is using a trash truck two days a week, why should all of the cities have one, too?”

Complete consolidation, however, becomes trickier because elected officials have to give up power and local voters may be wary of losing a voice in government.

Since 1920, Byers says, there have been more than 100 attempts to merge local entities; 38 have been successful. In some cases, the same units have tried as many as four times.

That being said, there are successful examples of local government consolidations. And sometimes merging is the most financially feasible way to continue providing services.

“In some states, there is no reason, except history and sometimes the state constitution, why some of these small counties haven’t merged,” she says.

Consolidation — either by mandate or in response to incentives — is one strategy being considered this year in the Midwest’s state capitols. Other efficiency measures are being given careful consideration as well, at a time when lawmakers are eyeing cuts to local governments as a budget-balancing fix — a move that will further squeeze the revenue base for cities, counties and other entities.

Cuts in aid a continuing trend

According to the U.S. Congressional Budget Office, 22 states reduced aid to local governments in 2010 and 20 proposed doing so in FY 2011.

More cuts are expected as states complete work on their next round of budgets.

This year in Nebraska, for example, lawmakers approved a bill that eliminates aid to counties, municipalities and natural resource districts. The measure is projected to save the state $44 million over two years as part of an effort to fill an overall $986 million state budget shortfall for the next biennium.

City managers testified to Nebraska legislators that LB 383 would result in a 2 percent cut in revenues.

With the state providing less, one idea is to expand revenue options for local governments beyond the property tax.

As of late April, a bill was advancing in Nebraska that would give municipalities more authority to raise local-option sales taxes. LB 357 would permit cities to levy a 2 percent sales tax with voter approval. Cities would be required to provide the public with a description of how the additional revenue would be used.

Under current Nebraska law, cities can raise taxes by 0.5 percent, 1 percent or 1.5 percent through a ballot initiative.

Proposals in Minnesota, too, would reduce general aid to local governments — and at least one would allow them to boost their own revenue sources.

Currently, local governments in Minnesota have a very limited revenue stream beyond property taxes, says Jay Kiedrowski, a senior fellow at the University of Minnesota’s Humphrey School of Public Affairs. While some communities have specific sales taxes related to hotels and convention centers, local entities do not have access to local-option general sales taxes.

“All the options they have [for increasing revenue] are to raise property taxes and to raise fees,” he says.

Minnesota policymakers are considering measures that would scale back state programs that have traditionally provided property tax subsidies to local governments. Property tax relief programs and local government aid make up about $3.4 billion of Minnesota’s general-fund budget (close to 10 percent of the total).

One attempt to scale back aid to local governments was included in a budget bill that was vetoed early in the year by Democratic Gov. Mark Dayton.

HF 130 would have cut general aid to cities and counties by roughly $270 million over the next two years and reduced property-tax credit programs by about $210 million for the biennium. In addition, the bill would have made $100 million in cuts to a property-tax refund program for renters.

Another measure being considered by the Legislature, SF 27, would make similar cuts, and it would allow localities to impose a 0.5 percent sales tax, if approved by voters, in order to raise revenue.

Kiedrowski believes that if proponents of cutting general local aid are successful, “the safest bet” is that property taxes will go up as much as 30 to 40 percent.

Dayton cited the rise in property taxes as one reason for his veto of HF 130.

But Republican Rep. Mary Liz Holberg wrote soon after the Legislature passed this initial cost-cutting plan that the actions were based on a “concept that most Minnesotans can understand: when you’re out of money, stop spending.”

In a 2009 paper arguing for a change in Minnesota’s state-local fiscal relationship, John James — a former state revenue commissioner — says that the $3.4 billion spent on property tax relief goes into a “black hole, without regard to what results the spending at either the state or the local levels produces.”

And now more than ever, state legislatures are wanting results.

Consolidation: Easier said than done

Many states in the Midwest have considered various measures that would force local units of government to merge. In Kansas, for example, there are currently 105 counties. A bill introduced this session, SB 204, called for reducing that number by as much as three-quarters.

Under the bill, which failed to advance this year, the governor would have appointed a 12-member study commission to develop a strategy for consolidating counties, including consideration of a plan to reduce the total number to 23.

A 2009 Wichita State University study found that reducing the number of counties to 25 could cut statewide county expenditures by $826 million by reducing salaries, hospital expenditures, utility costs and other costs.

Illinois Democratic Sen. Terry Link says the time has come for similar review of local consolidation in his state.

“The financial burden we face is mounting, and Illinois currently has more units of local government than any state in the nation,” says Link, who wants a bipartisan commission formed to review the effectiveness of local governments and recommend ideas for eliminating or consolidating them.

“By consolidating these units, we will not only save the state money, but we’ll provide more efficient services to our residents.”

Link points out that the state has many outdated and extraneous government entities, such as four tuberculosis sanitarium boards.

Policymakers in Ohio, meanwhile, are trying to make it easier for local governments to team up in order to operate more efficiently. They will need to find all the efficiencies they can under Republican Gov. John Kasich’s proposed budget, which cuts funding to local government by 25 percent next fiscal year and by 50 percent in FY 2013. As a result, The Cleveland Plain Dealer reports, about one-third of the state’s 5,600 local government units would be at risk of coming under fiscal watch or fiscal emergency.

Some state policymakers, including Auditor Dave Yost, would like to allow townships to voluntarily merge, which is not currently permitted under state law.

These consolidated townships would be encouraged to write up their own new governing structures, but if they were unable to come to an agreement, they would have access to pre-written charters offered by the state. (As of early May, this proposal was included in the state’s budget bill, HB 153.)

Prior to this year, Indiana had been the most active state in the region on issues related to local government reform, with much of the legislative discussions and actions stemming from a 2007 report done by a commission appointed by Republican Gov. Mitch Daniels.

That study provided a host of ideas on how to restructure and streamline local government.

One recommendation was to eliminate the state’s more than 1,000 township boards. SB 405, introduced this year, would have done just that by transferring the boards’ duties to county governments. The bill, however, was defeated in February.

Talk of incentives, unfunded mandates

Reforming local government has been a key goal of Indiana Republican Sen. Randy Head, and he believes one way to make it happen is by rewarding local officials that successfully find cost savings — whether it is through sharing 911 dispatch centers, getting volume discounts with new purchasing agreements, or other means.

“We are forcing local governments to do as much — or more — with a smaller budget,” Head says. “Yet there is no reward to local government for being more efficient in whatever ways they can.”

Under SB 26, which was awaiting the governor’s signature as of early May, local governments could retain parts of their levies and budgets that would otherwise be reduced because of government reorganizations or consolidations.

In the first year, local governments would receive 50 percent of the amount they cut from their budgets through efficiency. That percentage would scale back over four years until it remained permanently at 10 percent.

“If you find a way to be more efficient and save taxpayer money, you should get a reward for doing so,” he says.

Michigan, too, is looking for new ways to promote local efficiencies and reforms while it seeks budget savings for the state through cuts in local aid.

In his February budget address, Republican Gov. Rick Snyder proposed reducing the state’s revenue-sharing fund for municipalities by one-third, to $200 million. (The state has a second, constitutionally mandated revenue-sharing program.)

Snyder would also like to encourage local governments to merge by setting up a $5 million incentive fund. If governments want to take these ideas a step further, an additional option could be to set up metropolitan governments made up of several counties and cities. This form of consolidated government would also be voluntary, the governor says.

Other ideas in Snyder’s eight-point plan focus on pension and benefit reform, such as moving to defined-contribution retirement plans for new hires and requiring municipal employees to pay 20 percent of their health premiums.

One of Snyder’s more controversial ideas would make it easier for local units of government to share services. The proposal would remove collective-bargaining laws that say public employees cannot lose rank or pay when their jobs are shifted due to a government merger. He says that these laws make it more expensive for governments to cooperate because workers must essentially be offered the most generous contract of any participant in the merger.

Republican Rep. Eileen Kowall has sponsored legislation that would change this employment policy by amending the state’s existing Urban Cooperation Act, which governs labor contracts in intergovernmental mergers.

“It has been a huge disincentive to communities to share services,” Kowall says.

The package of legislation (HB 4309-4312) would eliminate various provisions that currently require entities that take over services to retain existing labor contracts. Instead, when governments agree to merge services, labor contracts would be renegotiated for an entire group of workers under a new authority. In addition, the “new employer” would no longer be obligated to provide workers with the same benefits, paid leave, seniority and pay that they received in their previous positions.

Another legislative goal of Kowall’s is to ease the burden of unfunded state mandates on local governments. Kowall, a former county commissioner, has helped develop a package of bills (HB 4038-4041) that would:

  • require the state to finance the costs incurred by schools and local units of government in carrying out state mandates;
  • create a state mandate panel to monitor whether the state is meeting its constitutional obligation to fund required programs and services;
  • direct the state to study and report on whether proposed administrative rule changes would result in unfunded mandates; and
  • speed up the process through which localities appeal unfunded mandates in court.


States mull new ways for handling financial emergencies at local level

Ssome local governments have already found themselves in serious financial trouble. 

One option is for local governments to file Chapter 9 bankruptcy, but it is only available in the 26 states that have laws allowing it, according to the Congressional Budget Office. Georgia is the only state that prohibits local governments from filing. 

So in the 23 other states, an individual local government unit cannot file for Chapter 9 bankruptcy unless a state law is passed that specifically allows it to do so.
At least two Midwestern states – Indiana and Michigan – have considered laws this year that would provide a different path for local governments in fiscal trouble: being taken over by the state.
In March, Michigan Republican Gov. Rick Snyder signed HB 4214, a controversial bill that allows the state to step in when local governments and school districts are financially distressed. If a state review finds that a “financial emergency” exists, the governor can appoint an emergency financial manager to step in. During this time, the local government’s chief executive and governing body lose their responsibilities and salary.
Among other powers, the financial manager is permitted to renegotiate or terminate existing contracts and collective-bargaining agreements, sell certain assets and redesign school districts’ academic plans. If a pension plan is less than 80 percent funded, the emergency manager can make certain changes to it. With the governor’s approval, the financial manager can also order the dissolution of the local government unit.
The bill has spurred widespread outcry and concerns that local governments in trouble will be completely controlled by a single, appointed manager with far-reaching powers. Critics say that citizens and elected officials will lose the ability to shape their own communities.
This session, legislators in Indiana considered SB 105, which would allow local governments to use emergency financial managers in a different way. The “bankruptcy avoidance” bill would allow governments to be deemed “financially distressed” by a three-member state panel. With this designation, an emergency manager could then take over legislative and fiscal responsibilities. One option for the emergency manager would be to file for Chapter 9 bankruptcy on behalf of the distressed local unit of government in order to deal with its debt problem.