Financial Condition of Cities Improving Steadily
Reduction in Bonded Indebtedness Being Accomplished in Most Communities
TWO years of war have radically changed fiscal conditions in practically all cities and towns in the United States, in most municipalities income has risen, expenses have dropped or been held static, and debt has been reduced. A few years ago communities faced the problem of raising revenues to meet swollen relief rolls and of calculating to what extent debt might be increased to provide for essential capital improvements. Today, municipalities generally are flush with funds, but find difficulty in obtaining materials and manpower to extend water, fire protection and sewage services, or to erect needed public buildings. As a consequence, the financial condition of most municipalities has improved materially since Pearl Harbor.
Astute public officials are well aware that some of this improvement is more apparent than real. Some of the increased revenue represents non-recurring items. Lower current outlays do not fully reflect important deferred expenses. Communities that have maintained normal growth, to say nothing of those experiencing war-time hooms, have been unable to carry out the usual extensions of water, fire and sewer services or other needful facilities. Such potential expenses hover over the municipal budget of the future.
The income of most municipalities is increasing as a result of booming business activity. The real estate tax is usually the bulwark of municipal revenues. so the high level of consumer income is bringing great improvement in tax collections on current accounts. Available figures indicate that only about 6% of current tax collections are now delinquent, compared with over 25% in 1933 and around 9% in 1939. Collections on old delinquencies have also picked up. Furthermore, the upward trend of realty values is facilitating foreclosure sales of delinquent property.
We are especially pleased to present this article on the growing improvement of municipal finances, by Roger W. Babson; for there is none better qualified than he to discuss this topic.
As founder and present head of Babson’s Statistical Organization, Inc., Mr. Babson has an intimate knowledge of financing by cities. In addition, he has gained, through his many years of association with the securities field, a priceless experience which gives assurance that the predictions he makes are quite certain to materialize. It may be recalled that in 1929 he stood practically alone in warning against the depression which was to come in the early ’30’s.
Guessing has had no place in his predictions; they have been based on sound statistical data plus a wide experience in the fields of finance and economics. The now famous “Babson Curve” of security values is but one example of the type of information utilized by him in determining the future trends of business.
Thus the following article by Mr. Babson is worthy of careful study.
Where there has been a large influx of workers, the income experience of municipalities tends to vary widely. Some cities and towns are experiencing a sharp advance in realty values, assessments, and tax collections. In a few communities, however, lower tax collections have resulted from the transfer of large amounts of property to U. S. Government ownership for armament plants or for housing purposes.
Lower revenues are also the experience of some communties in states where all or part of the state-collected gas tax is apportioned to municipalities. Gasoline rationing is materially reducing the intake from this source. Furthermore, those states with high auto license fees have suffered a loss of revenue. On the other hand, those cities and towns deriving a substantial portion of their income from sales taxes, local income taxes or sharing in state collected income, license or liquor taxes have benefited.
There is a growing tendency among municipalities to attempt to seek new revenue sources in order that less dependence may be placed on the real estate tax. More and more states are helping out by apportioning a larger share of state collected sales, income, gas, liquor, and other taxes to municipal subdivisions. Charges are being instituted by a growing number of communities for such services as garbage collecting, sewage disposal, etc. The successful experience of some communities with parking meters has led to wide consideration of their general installation. Where other laws permit, auto license taxes and municipal gas taxes are being introduced. Detroit’s effort to place a 20% tax on the gross revenues of local public utilities may well uncover a new revenue source if the tax is upheld in the courts. It is argued that this type of tax merely reduces the utilities’ Federal tax bill and does not materially cut into their net income.
War Conditions Affecting Expenses of Cities
War conditions are having a widely varying effect upon the operating expenses of cities in various sections of the country. The high level of industrial activity, in the case of many individual cities, is bringing very few operating problems. The new residents are merely filling up existing facilities so that capital improvements or substantial increasess in operating expenses are not being required. In contrast are those communities whose populations may have increased several fold since the start of the Kuropean War, due to the establishment of shipbuilding projects, military camps, etc. For such boom communities, the solution of the problem of financing such capital improvements as sewers and schools, and of larger operating expenses such as those for expanded police and fire departmcnts, has depended to a large extent upon the amount of Federal Government aid being received.
In between these extremes is the average city, which seems to have been successful in keeping down expenses in relation to income. Shortages of materials and labor are generally resulting in the elimination of capital improvements and construction not considered essential to the war effort. From 10% to 15% of the total normal expenses of the average American city of around 100,000 population is normally for construction or improvements. Some increase in this item of expenditure is probable as the war continues because the material situation will doubtless ease.
It is to be hoped, of course, that the end of the war will not find cities competing too intensely for materials and manpower in order to expedite capital construction. This would tend to accentuate inflationary trends. It would be preferable for such less urgent capital improvement program to be delayed until there is another period of acute business depression, such as may well come around 1950 to 1953.
Relief expenses during the 1930’s took an average of about 10% of the expenditures of most cities. A high level of employment has reduced this expense materially. The prospect seems to be, however, that there will be more interruptions in factory schedules and activity during the coming year, so that relief outlays may increase somewhat.
From 50% to 60% of the cost of operating most cities is paid out in salaries and wages to such municipal employees as teachers, policemen, and firemen. The rising cost of living, competition for manpower from defense plants, and other factors have necessitated the payment of higher compensation to municipal employees. It is also being necessary to increase the outlay for necessary commodities, materials, and services.
In some cases, the increase in wage and salary payments offsets to a considerable extent the savings resulting from curtailed construction and relief payments. With the anticipated continuation of inflationary trends, wage and salary demands on the part of municipal employees are likely to become more pressing.
Treasury in Besf Condition
The net result of the variations in income and outgo is that the average municipal treasury is now in the best condition in a number of years. Many smaller cities and municipalities are therefore reducing tax rates in the face of unchanged assessed valuations. The largest cities, on the other hand, are continuing to increase tax rates in order to offset the continued decline in assessed values. It is an open question whether the indicated upward trend in realty values will prevent a further reduction in the assessed value of numerous areas of land and property in some of the country’s large cities.
As the war continues, and particularly if inflationary trends are more pronounced, most municipalities will doubtless find it more difficult to continue their recent good budget showing. Rising costs of labor and materials may well be underestimated. Such sources of income as payments of delinquent taxes will dry up. Rationing and manpower shortages may well force the closing of more and more business establishments.
City managements operating under laws which attempt to prohibit the accumulation of surpluses may be in a particularly difficult position in trying to make up budgets. It is gratifying to see that many states are removing restrictions on the accumulation of surpluses, while other states are passing or considering legislation which would encourage municipalities to accumulate reserve funds for post-war capital needs. The financial position of cities and towns in such states will be strengthened further if maximum advantage is taken of the new laws.
Summary of State and Municipal Financing (In Thousands of Dollars)
Note: Above figures do not include funds obtained by states and municipalities from any agency of the Federal Government.
Source: The Commercial and Financial Chronicle.
As indicated in the accompanying table, borrowing of new capital by municipalities is at a low ebb. New state and municipal offerings for new capital in 1943 are about 20% of the 1939 figure. This reflects in part inability to obtain materials and manpower which arc necessary for capital improvements. Where small improvements are necessary and materials and manpower are obtainable, they have been financed in many cases out of income.
New bond issues for refunding in 1943 and 1942 were well below the average level of the two previous years. The improved treasury position of many municipalities is permitting them to pay off debt maturities which normally might have required refunding with new bond issues. Sinking funds are being refigured and replenished in many instances to take care of large maturities in future years. Some of the larger cities have been endeavoring to smooth out their debt maturity schedules by offering serial bonds in exchange for term bonds maturing some years hence.
Philadelphia is a good example of a city which has rearranged bond maturities and lightened its debt burden by a bond refunding program. Annual debt service charges increased from about 23% of the city’s 1922 budget to nearly 40% in 1935. High interest bonds have been replaced by low interest bonds, maturities smoothed out and some debt retired. Debt service charge is now about 30% of the annual budget.
Cities Reducing Debts
These influences, together with the Federal Government’s policy of financing improvements and extending financial aid under certain circumstances, have permitted most municipalities to reduce debt. Excluding New York City from consideration, the country’s largest cities are estimated to have reduced their debt about three per cent in the past year. Medium sized cities cut debt about five per cent, but in the past five years the reduction has been about 16%. Smaller municipalities have made the best showing in debt retirement since 1930, but their debt retirement rate in the past three years has not accelerated as much as for the larger cities.
Bureau of Census figures indicate that the outstanding indeotedness of states and local governments had declined $540,000,000 or 2.7% in the year ended June 30, 1942, to leave the total at $19,643,000,000. The decline in the previous fiscal year was $47,000,000. As combined state and municipal debt increased $663,000,000 between 1932 and 1940, the reduction since 1940 has undoubtedly been much larger than the 1937-1940 increase.
Municipal Bond Prices High
Prices of municipal bonds, as measured by most of the commonly used “averages,” have recently been at record highs. This follows an upward price trend which has been in evidence tor many years. While the improving financial status of many municipalities has played a certain part in the price advance of their obligations, other factors have undoubtedly made a greater contribution.
Chief among these has been the growing demand for tax exempt issues from individuals and corporations in the upper and middle income tax brackets. The continued advance in income tax rates have steadily enhanced the value of the tax immunity carried by municipal issues. The differential in yield between taxable corporate and non-taxable municipal bonds has widened with each increase in the personal income tax rate, particularly in the upper tax brackets.
The importance of tax immunity to the price structure of municipal bonds has been vividly illustrated by the fact that the principal intermediate declines in bond prices in recent years have followed proposals that outstanding municipal issues be subjected to Federal taxation. From time to time, representatives of the United States Treasury and of other Government departments have made strenuous efforts to eliminate the tax exemption of municipal issues. In one direction, Congress has been asked to impose taxes on interest from not only new municipal bonds, but also from outstanding issues. The opposition of state and municipal authorities to such tax proposals has been successful at Congressional hearings. To date, there has been very little popular support for proposals that one of the few remaining vehicles of tax immunity for the wealthy should be eliminated even if larger taxes are to be levied on those in the lower income brackets.
Another effort is the Treasury’s attempt to levy taxes on interest received from the Port of New York Authority and Tri-Borough Bridge Authority bonds. This case is now in the Courts and is considered in some legal quarters as an attempt to bring the larger question of taxing all municipal issues before the Supreme Court. The final Court ruling cannot be predicted. If the decision seems to open the way directly or indirectly for Federal taxation of municipal bond interest, the principal recent support of municipal bond prices would probably be eliminated.
Furthermore, the decline in new municipal offerings and the steady progress in reducing debt have created a basic supply-demand situation which has favored the persistent rise in municipal bond prices. The U. S. Treasury’s easy money policy has also been an important factor in maintaining relatively high prices for all types of bonds—U. S. Government, corporate, and municipal.
A concomitant of the high price level of municipal bonds has been a substantial change in ownership of such issues. Institutions like life insurance companies have been steadily selling off their holdings of municipal to both individual investors and corporations. Such guardians of public funds as sinking funds, pension funds, etc., have also sold their municipal holdings. The sellers have for the most part reinvested the funds received from the sale of their municipal holdings in U. S. Government issues.
Looking ahead to the post-war years, it is difficult to see how states and municipalities will be able to borrow on the favorable terms recently available.
A slump in bond prices, and a higher interest cost to borrowing municipalities would occur if municipal bond interest should be made subject to Federal Income taxation. Even assuming that municipal bond interest will remain tax exempt (this is not necessarily a safe assumption) there are likely to be sufficient changes in the recent situation so that municipalities will have to pay more for borrowed money.
The basic level of interest rates is likely to be somewhat higher during post-war years. There may be a smaller supply of .funds seeking investment. Savings from personal and corporate current income, as well as accumulated savings, are likely to be used for the purchase of consumers and capital goods which have not been available during the war years. The controls which have been exercised to maintain stable prices of U. S. Government bonds, and thus finance the war at low interest rates, are likely to be relinquished.
Demand for Funds To Grow
Demand for funds promises to grow, particularly if international financial arrangements give the United States the role of financing world rehabilitation and world trade through extensive foreign loans. Furthermore, it is not beyond the realm of possibility that a deliberate policy of tightening interest rates (with an accompanying lowering of bond prices) might be attempted by the monetary authorities in an effort to check inflationary trends.
The recent supply-demand status in the municipal bond field seems likely to be completely reversed. Lower Federal tax rates on the income of wealthy individuals and corporations are probable in the post-war era. This would tend to reduce the recent abnormal spread in prices and yields between tax exempt muincipals and taxable U. S. Government and corporate issue. The resumption of municipal borrowing to finance deferred capital improvements will bring a greater supply of municipal issues into the market. Basically, a large supply of municipal bonds and a smaller demand for them would bring lower than recent prices for municipal issues. In a declining market, the most speculative issues would have the largest slumps.
This conclusion does not mean that municipal issues will fall into disrepute compared with other type of fixed interest obligations. Efficiently managed municipalities should be able to borrow on terms which will not be as onerous as those prevailing in the years following World War I. It does mean, however, that individual municipalities must plan to pay more for borrowed money, particularly short-term money, than they have paid in recent years.
The lesson for those interested in furthering municipal fire protection is to take the maximum advantage of the currently favorable market situation in municipal obligations. Every effort should be made to refund callable bonds at lower interest rates and to arrange maturity dates properly. The best way for any individual municipality to improve the credit standing of its bonds is to reduce debt and to increase sinking funds. New and unexpected Court decisions are permitting municipal subdecisions in some states to redeem bonds which had previously been considered non-callable. Moreover, those municipalities which are first after World War II to spend money on fire protection will get the needed money easiest and will get the fire protection at the least cost.
“Authority” or “Revenue” Bonds
A type of issue which has been growing in popularity among both certain investors and municipalities is the socalled ’’Authority” or “Revenue” bond. While its terms may vary widely, this type of issue is generally secured only by the earning power of a municipal project like a toll highway, electric light plant or water works. “Authority” or “Revenue” bonds are generally not full faith and credit obligations of a city, are not usually payable out of ad valorem taxes and therefore offer a convenient vehicle for financing capital improvements without increasing the city’s direct debt. Many “Authority” or “Revenue” issues are finding a ready market among wealthy investors and corporations, and may well continue popular with such investors as long as current high personal and corporate income taxes are in effect. Many city managements are studying the possibility of segregating city owned utilities in an “Authority” or “Revenue District,” and bonding them separately in the hope that the city’s direct credit status would thereby be improved over a period of time.
A word about the post-war problem of war-boom communities. Such communities have experienced a tremendous gain in population. Even the most carefully managed communities in this category, however, have been forced to expend large amounts of money for such capital improvements as schools, sewers, and water systems. It has often been necessary to expand materially ordinary public services such as police, school and health departments.
As was the case during World War I, realty values, assessments, and tax collections have spurted in most boom communities. This has permitted many cities to take care of the larger operating expenses. Federal aid has also been forthcoming in many cases.
The 1921-22 post-war period of readjustment brought a collapse in realty values and assessments along with the drop in armament activity in many boom towns. Tax collections slumped. Relief expenses increased. The decline in population left many communities in an overbuilt condition. Refunding instead of payment of debt became necessary. The advance in realty values and assessments thus far during the present war is not generally as pronounced in boom cities as it was during the previous war. The post-war readjustments may, therefore, be somewhat milder.
Of course, some communities will hold much of their war growth. Others will lose all of their war growth and probably more. Unless post-war trends are exceptionally clear, however, it behooves officials of boom towns to avoid borrowing as far as possible for capital improvements; to arrange debt maturities so that there will be no large amounts of maturing bonds in individual years; to maintain high tax rates during the boom period so that the temporary population will pay its just share of higher expenses and will help build a reserve fund; and to be ready to cut operating expenses drastically at the first sign of any slump in business activity and of declining payrolls.
The post-war financial status of the average municipality will depend to a large extent upon its management during the remainder of the war period. Good fiscal management can generally avoid financial troubles in the face of basic economic difficulties. On the other hand, poor financial management can bring trouble even for those communities which now seem favorably situated economically.
The high level of municipal bond prices has probably obscured the poor basic financial condition of some municipalities, particularly the larger cities. It has perhaps been too easy to sell bonds at favorable prices to fund deficits or to refund maturing issues. Some of these large cities are increasing assessments and tax rates to such high levels that new construction is discouraged, industries are being lost to other communities with lower tax rates, and old property is torn down to save taxes. The tax levy is nevertheless held up in order to maintain essential services. In such cases, courageous and efficient city managements will have to take the bull by the horns and break the vicious cycle. The alternative may be acute financial trouble when the bond market declines or there is another business depression.
Funds Should Be Earmarked for Fire Protection
By and large, however, the combination of larger revenues, controlled expenses and reduced debt is placing most municipalities in the best fiscal condition in some time. They should have the financial strength to play a large part in helping to solve the social and economic problems which will arise in the readjustment period after the war. Believing that increased fire protection is now one of the greatest needs facing most municipalities, I strongly urge that fire chiefs use the present time to ear-mark funds to be spent for such uses as soon as labor and materials are later available.