DR. ERIC SCORSONEGOVERNMENT PUBLIC POLICY AND FINANCE
GROUPMICHIGAN STATE UNIVERSITY
WASHINGTON ASSOCIATION OF COUNTIESNOVEMBER 20 , 2013
Fiscal Sustainability: The Challenge and Promise
Goals and Objectives
My goal is to give you a set of tools and mental models for thinking about, measuring and communicating fiscal sustainability to your constituents
To make you a good consumer of financial indicators and ratios measuring and implementing fiscal sustainability
Roadmap for Today
Defining Fiscal Sustainability
Measuring Fiscal Sustainability
Managing for Fiscal Sustainability
Communicating Fiscal Sustainability
DEFINING FISCAL SUSTAINABILITY
Many Definitions of “Fiscal Sustainability”
Revenues grow at rate of inflation + population (Ulbrich, 1997)
Revenues must grow to meet continued provision of service and capital needs (Chapman, 2008)
Ability of government to sustain its current spending and tax policy without threatening solvency or default
What is Fiscal Sustainability?
Brundtland report (1987) defined as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”
Decision making & Governance that is future oriented and ensures that local government (county) can protect public health, safety and welfare of present and future generations
Fiscal Distress vs. Fiscal Health
Fiscal Distress Generally based on cash flow and immediate short
term problems Cash ratios and fund balance ratios
Fiscal Health Based on long term sustainability of a governments
finances and operations Measured by assets, revenue and spending per capita
and ability to provide services Structural deficit or surplus
A Brief History of Budgeting
Prior to early 1900’s, government did not budget at all, just paid invoices as they came due
NYC developed the line item budget; look ahead one year and plan on revenues and spending Fed. Govt. adopted budgeting in 1920’s
Annual budgeting represents a look ahead and potential impact of decision one year ahead
U.S. Government Fiscal Sustainability
Fiscal Indicator: Debt as a percent of U.S. GDP
Predicted that privately held debt will exceed 100% of GDP in 2030 This matters if bond market decides that U.S. becomes
a credit risk
Health care (Medicare) and Social Security will consume entire U.S. budget Primarily baby boom generation
“Laboratories of democracy”
200 years ago, de Tocqueville noted that America’s strength lay in its local towns and villages
Still true today, local governments can carve out different sustainable pathways in partnership with state government
MEASURING FISCAL SUSTAINABILITY
The Fiscal Equation
Revenues = Spending
Over what time period?What sources of revenue?Changes in spending pressures?
Fiscal Gap
Fiscal gap is the amount of spending reductions or revenue increases required to balance the government’s budget and avoid insolvency or default
Insolvency is not just promises to bondholders Vendors and suppliers Pensioners and retirees Citizens and constituents
Local Fiscal Sustainability Indicators
Govt. Revenue and fees
Govt. Spending
Asset Condition
Debt & Liability Condition
Economic Condition
Tax base Condition
Revenue Questions
Types of revenues (diversity, elasticity and flexibility)
Level
Growth or Change and Stability
Govt. Revenue per capita (Level)
Govt. revenue has two roles: Critical to maintaining public services Has a potential direct impact on local economy
Revenue component Local taxes User fees Intergovernmental aid
Formula Net operating revenue (inflation adjusted) / population
Revenues per capita interpretation
Falling revenue per capita my be inability to maintain services
May reflect: Local policy choice State imposed changes Weakening tax base
Population is a tricky measure What about in-commuters, tourists?
Detroit Tax Collection Trends (1938-2011)
Falling Property Tax Base
Revenue Growth and Stability
Will revenue grow at an adequate rate to support population and economic conditions?
Measures of revenue growth:
Change in revenue per capita
(Revenue in yr. 2 – revenue in yr. 1) / (revenue in yr. 1)
Use as many years as possible
Revenue Trend and Cycle Issues
Requires separating: Underlying Trends from Business Cycles
Trend is long term idea of revenues and spending and service needs
Cycle is short term movement in revenues in particular
Govt. Spending per capita
Govt. spending has two roles: Critical to maintaining public services Higher than necessary spending (and tied to local
taxes) can act as drag on economy
Spending per capita measures both of these roles simultaneously
Formula = net operating expenditures (inflation adj.) / population
Govt. Spending per capita interpretation
Increased spending may be caused by new services added, changes to state mandates or demographic shifts
What about productivity and internal efficiency?
What is the relationship between revenue and spending per capita
Spending and Service Questions
How will spending pressures impact the growth in spending over time? Population, inflation, land use……..
What will the impact of technology be on spending and new or altered services?
Potential impact of state and federal mandates on spending?
Detroit Deficits and Spending
Rules of the game: Spending Mandates
Election administration
Property tax collection
Civil and criminal justice system
Process and maintain records
Expected changes in state mandates may put pressure on county government spending per capita over time
Expected changes may be based on history and looking forward
Rules of the Game: Budget rules
State imposed balanced budget rules
Does the state require a “balanced budget’
What is the definition of balanced budget
Annual budgeting may actually encourage short term thinking
Adding it up….key elements on spending
1. Inflation or cost of providing current goods and services
2. Technological change in “what” and “how” services are provided
3. Changes in social and demographic characteristics of “demand” side
A. Residents, nonresidents, commuters
4. Current Services + Capital (investment and maintenance)
Debt & Liability Condition
Debt burden as a future fixed cost; usually a key issue in fiscal sustainability analysis
Types of debt Leases Bonds and notes Unfunded liabilities
Formula: long term debt / assessed value or population
Debt and Liability interpretation
Debt levels as a relationship to population growth or decline
Is debt burden as a fixed cost rising as a percent of spending and why if so?
What is debt being used for? Long term capital expenditures (maintenance
accounted for?) Operating costs
Socio-Economic Condition
To assess the tax base and the demand for government services
Formulas: Population trends Median age Personal income per capita, source of income Percent of households in poverty Housing starts and age of housing Property values, vacancy rates and home prices Business activity and retail sales
Socio-Economic Condition interpretation
Population growth may boost revenues but also capital and operating spending needs
Older population may require a different mix of services
Job and retail sales activity main drivers of potential tax base
Tax Base Condition
Tax Based condition = economic condition + legal condition
Economic conditions drive the potential revenue that can be collected (income, employment….)
Legal conditions shape how much of this potential revenue can be realized and collected
Asset Conditions
Measures the stock of resources (cash and noncash) available to a government entity
Measures: Net asset ratio = total net assets / total assets
Net financial asset ratio = (total net assets – capital assets) /(total assets – capital assets)
Return on assets = 100% * change in net assets / (total assets – capital assets)
Asset condition interpretation
An example: city of Detroit
Year Net Asset ratio
Net Financial Asset Ratio
Return on Assets
2006 .17 -1.07 .7%
2007 .16 -1.0 .4%
2008 .12 -1.12 -3.0%
2009 .09 -1.42 -3.5%
2010 .03 -1.66 -2.6%
Taken from Woods Bowman, 2011
Budget and Revenue Trends
City Budget (% Change)
State Aid (% Change)
Total City Revenues
Govt. Inflation (% Change)
2000's -0.05% -2.60% -0.32% 3.87%
1990's 2.6% 2.5% 2.6% 2.9%
1980's 4.1% 7.6% 6.1% 5.6%
1970's 7.1% 11.8% 7.2% 7.7%
1960's 4.3% 6.4% 3.6% 4.2%
1950's 5.1% 4.3% 5.5% 4.1%
1940's 4.5% 3.1% 2.4% 6.5%
Overall Average 3.7% 4.6% 3.7% 4.9%
Asset condition interpretation
Net assets is interesting but problematic because in general we aren’t going to sell government assets like roads
Net financial assets is a better measure because it removes capital assets and…..
Best measure may be return on assets Should be at least 2.5% (inflation and we can also
adjust for population growth
GOVERNANCE: MANAGING AND ADDRESSING FISCAL
SUSTAINABILITY
The Governance Equation
An intangible but crucial factor
Ability to go beyond measuring and discussing fiscal sustainability…..to implement fiscal sustainability principles
Requires long term thinking and an ability to recognize that different versions of the future exist and there is a need for debate, discussion and compromise
Strategies and Options
Revenue growth limits = population + inflation (personal income)
Conduct 3-5 year financial projections (minimum)
Ensure a robust rainy day fund (worst case scenario) Recognize revenue volatility
Use performance or priority based budgeting
Improve budget and long term finance transparency
Revenue and Spending limits
Limits make sense to ensure that government growth is “reasonable”
Washing and Michigan are tied for second most restrictive revenue limits Not reasonable, creates a fiscal crisis
Population + inflation + 1% or (income)
3-5 yr. Forecasting Challenges
How do we know what the future looks like? (forecasting problem)
How do we know if we are “kicking the can down the road”? (information problem)
What if we disagree about priorities or even defining fiscal sustainability? (compromise problem)
Forecasting problem
How do we look so far in the future? 3, 5 10 years or more
Identify domains that are more easily assessed than others Pensions and retiree health care are more easily assessed Economic conditions may be volatile, what does the past tell us Spending may be easier if we can use population and inflation as
drivers
Recognize that every good forecast has a “range” around which the true values are likely to occur Scenario planning: May need to explore several scenarios rather
than one “forecast”
Compromise problem
We will not all agree on what the future looks like
Attempt to establish boundaries over view of what the future should like How far apart are we really? Use skilled facilitation if necessary Find common ground
Generally we agree on a lot more than at first glance
Rainy Day Fund
How big should it be? How to protect it from use in non-emergencies?
Minimum of 5-10% of total governmental spending but may require depending on experience with revenue volatility
Some will argue it should be much higher to sustain spending in a downturn
Revenue Volatility
Revenue volatility will be a reality, we just don’t know when
Many forecasts act as if revenues will grow in a straight line
Revenue volatility can only be removed if revenue options move in different directions during business cycle
Performance Based Budgeting
Ensure that government is as efficiently as possible meeting service demands of citizenry
Lays out short and long term priorities and how budget is targeted to meet those priorities
Can be used to educate state about spending mandate pressures
Improve Budget Transparency
MI Citizen Guide to Local Unit Finances
Required by law of every local government in Michigan
Communicating about Fiscal Sustainability
Challenge is shifting publics attention from the “here and now” to the impact on future generations
Balancing the need to provide services now and in the future
Using enhanced tools such as community scorecards and citizens guide Go beyond the budget and audit
Fiscal Sustainability
State Policy
Local Policy
Socio-Economic Conditions
Thank You!
Questions and Discussion……
Dr. Eric ScorsoneMichigan State [email protected]
Fiscal Sustainability: The Challenge and the Promise