Thursday, May 27, 2010

Consequences of the Budget, Part Four

This year’s budget was tough. But dealing with the county’s long-run fiscal future will be even tougher.

The chart below, adapted from the County Executive’s proposed operating budget, summarizes the county’s fiscal difficulties in a nutshell. The bottom line represents resources available to the county from FY 2012 through FY 2016, consisting of taxes, state and federal aid, fees and fines, investment income and reserves. The top line represents uses – in other words, spending on operations and capital. Note the fact that these two lines are never projected to meet. This is the very essence of a structural deficit.

The county is projecting deficits of $212 million in FY 2012, $303 million in FY 2013, $415 million in FY 2014, $464 million in FY 2015 and $514 million in FY 2016. But these estimates likely understate the problem for six reasons. First, Annapolis may very well hand off tens, perhaps even hundreds of millions of dollars in teacher pension liabilities to the counties next year. No county will pay more than Montgomery. Second, the state has received $4.5 billion in federal stimulus funds over the last three fiscal years (2009-2011). That money will dry up, and as it goes, so will state aid to the counties. Third, if the county cannot match its prior year per-pupil local education funding, it may be fined by the state in accordance with the Maintenance of Effort law. (It narrowly escaped that fate this year.) Fourth, the county has been delaying payments it owes for retiree health benefit costs. It must resume them in the future and they will add up to tens of millions every year. Fifth, the bond rating agencies are pressuring the county to increase its reserve from 6% of the general fund to 10%. That will siphon off money that would otherwise be available to county agencies. And sixth, if the county cannot show the bond agencies that it has a long-run plan to make the resource and use lines shown above meet next year and every year, it will lose its AAA bond rating. That means borrowing costs will go up. All of the above together represents a VERY SERIOUS challenge.

Consider these comments from informants inside the county government.

Spy #1:

Fiscal policy is forever changed so that any future expansion of services has to be in the context of setting higher reserve levels. If you consider the bond house demands that we move toward 10% reserves over time, that we have to start paying into the other retirement fund, that we’re likely to get teacher pensions in part - those are going to be fixed demands against every new dollar of revenue. So while the budget may grow, much of that growth will be captured in funds that just sit there and provide security against another economic meltdown like this one. In that context, service restoration will be slow and contracts aren’t going to see any significant increases for awhile. We don’t have many revenue sources that fill these large gaps. A year ago people thought we’d solve next year’s problem with a tax increase. Now we’ll need the increase just to stay level and it’s unlikely to close the gap.
Spy #2:

The Montgomery County Executive, County Council, and the Maryland General Assembly must come to terms with the fact that the Maintenance of Effort law and the 2006 pension agreement for teachers were predicated upon a faulty assumption that revenues would rise every year. Our county and state simply cannot afford to comply with either of these laws now. Both must be revised. MCEA [county teachers] and MSTA [state teachers] will fight any changes tooth and nail but elected officials must resist pressure from the teachers’ union or our county and state will be insolvent in the next few years. Good managers can increase productivity with shrinking resources and the Montgomery County Public Schools must learn to do the same thing…

The county must now persuade the rating houses that it has a long-term plan for fiscal solvency and that too is likely to provoke stiff opposition from the teachers and other public employee unions. Employee compensation and benefits can no longer rise at a rate two to three times the increase in the Consumer Price Index as they have during the past decade.
Spy #3:

Bottom line is that unless we get a big boost in the tax base in the coming year, we will have to make even worse cuts next year, because we have to keep up our reserves and start contributing to retirement health benefits (OPEB) that we’ve put off. Query whether we get downgraded by Moody’s. If we do, it will be a black mark to the county’s reputation that can never be erased and we are all probably toast, union endorsements to the contrary.
Council President Nancy Floreen has called for a study of the county’s structural deficit and Council Member Roger Berliner proposed a commission to examine it. Both are following a long tradition in MoCo of using process steps to demonstrate progress on items that need urgent action. Here is what every county politician knows but few are saying.

The current county government was built up at a time when the tax base was significantly larger. That tax base can no longer support the government at its current size. The tax base is unlikely to grow back to its former strength if the county implements anti-competitive measures like the job-killing energy tax hike while using band-aids like a new economic development authority to try to cover up its problems. As bad as this budget year was, the county eliminated just 450 positions out of its nearly 30,000-person workforce and only 90 of those positions were occupied. With labor costs accounting for roughly 80% of the budget, is this enough to achieve long-term balance?

There is a lot of blood yet to be spilled on the cutting floor. Otherwise, the county’s head itself will be on the block and the rating agencies will bring down the axe.

Tomorrow, we will look at politics.