Opportunities for Restructuring in State and Municipal Finance


Robert Litan, right, vice president for research and policy at the Ewing Marion Kauffman Foundation, takes part in a discussion of oversight mechanisms for cities in distress at the Financial Innovations Lab. With him are Glenn Yago and Betsy Zeidman of the Milken Institute.
The Great Recession has had a devastating effect on state and municipal budgets throughout the United States. While an economic recovery will alleviate the cyclical components of today's crisis, tackling the structural aspects of budget shortfalls will be paramount for long-term stability within the nation's 91,000 local governmental units. Revenue/expenditure mismatches, trillions in unfunded or underfunded pension obligations, increasing longevity and the escalating cost of other post-employment benefits all need to be addressed.

The Milken Institute, along with the Kauffman Foundation, convened a Financial Innovations Lab to identify solutions. Participants included state and local government officials, union representatives, capital markets experts, money managers, academics, public-sector attorneys and representatives from bond rating agencies.

Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois, Chicago, said 2010 will mark the first time since the Great Depression that income, sales and property taxes will decline across the board. To strengthen tax receipts going forward, Pagano proposed broadening the sales tax to include services and extending the property tax to sites that are now exempt.

Changes are likely in store for public pensions as well, said Robin Prunty, managing director in the Public Finance Ratings Group at Standard & Poor's, which uses public pension funding ratios to formulate state bond ratings. Noting that more than a decade has passed since the Governmental Accounting Standards Board last revised public pension rules, Prunty predicted major modifications for public pension accounting, reporting and pension obligation funding methods.

Participants agreed that Chapter 9 bankruptcy and other pre-packaged proposals are an unappealing last resort for municipalities in distress. Henry Kevane, managing partner at Pachulski Stang Ziehl & Jones LLP, spoke from his past experience with Orange County's 1994 bankruptcy filing, calling the Chapter 9 process a costly, arduous gauntlet for municipalities. To better deal with municipalities on the verge of bankruptcy, participants suggested revisiting the concept of oversight control boards such as New York's Municipal Assistance Corporation of the 1970s, and models such as the Pennsylvania Intergovernmental Cooperation Authority.

Among the more noteworthy remedies suggested were:

  • Adopting standardized actuarial assumptions for public pension retirement plans
  • Implementing multi-year budgeting plans for municipalities
  • Considering economies of scale through consolidation of service providers and even municipalities themselves
  • Revisiting the concept of rainy-day funds
  • Using short-term federal stimulus funding to nudge states and municipalities toward long-term restructuring

    Participants agreed that long-term solvency for states and municipalities will require structural, even painful paradigm shifts. But kicking the can down the road is no longer a viable option.

    To read the results of the Lab, including recommended next steps for implementation, view the full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.