1. Governance
June 23, 2020updated 16 Sep 2020 12:47am

A looming fiscal crisis raises another fear for US cities: State oversight and financial control boards

Municipal finance experts worry the pandemic economy may revive some fraught methods for cutting city budgets.

By Jake Blumgart

It’s a tough time to be a mayor in America. Tax revenues have fallen off a cliff. Public sector layoffs have begun – a staggering 1.5 million jobs lost already – and there is no end in sight. The Upjohn Institute estimates that by the end of 2021, state and local governments will face a $1 trillion shortfall.

A pedestrian in downtown Detroit during the Great Recession (Photo by Spencer Platt/Getty Images)

To make matters worse, it is unclear if the federal government will do enough, or anything at all, to aid state or local governments.

“This is an unprecedented crisis and it could get quite ugly,” says Bruce Katz, co-founder and director of the Nowak Metro Finance Lab. “We stopped the economy. You don’t need to be a rocket scientist to figure out that even well managed cities and counties are being affected.” 

It’s hard to comprehend the magnitude of the austerity crisis facing local governments in the US. That’s why Katz and many other municipal finance experts believe there may be a resurgence of some fraught methods for aggressively cutting spending and ending or privatising local government services.

In the past half century, states have employed a variety of interventions to confront distressed local budgets. One model is the state oversight panel: New York City in the 1970s, for example, lost much of its agency to the unelected Emergency Financial Control Board. A more recent model features direct state control: Detroit and many other cities in Michigan were ruled for a time by state-appointed emergency managers in the aftermath of the Great Recession.

Cities that have operated under these systems – also including Detroit, Philadelphia, DC, and Camden, New Jersey – tend to remember them as dark times. With a primary focus on balancing budgets, oversight boards have made creditors whole while cutting back the social programs and public union contracts that comprise large chunks of municipal spending. The consequences can be frustrating or even devastating for residents, ranging from reduced garbage collection to tragedies like the Flint water crisis, which began with a disastrous decision by a state-appointed emergency manager.

Now, suddenly, American cities again face a looming fiscal reckoning of apocalyptic proportions. A recent report from Arizona State and Old Dominion universities shows states facing an average tax revenue decline of 20%, and 10 states facing declines of over 30%.

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Most states also have laws that require balanced budgets, meaning they’re in no position to dole out cash to keep their cities afloat. But even in the absence of massive federal intervention, which experts like Katz would greatly prefer, state leaders are still in a position to impose austerity on local governments.

That’s because American cities are creatures of their state governments, which can exercise an extraordinary amount of power over basic governance at the local level. They can and do block city legislation – a dynamic that’s inflamed when conservative state leaders interfere with governance in more progressive cities, as happened in recent years with preemption of plastic bag bans and soda taxes.

State governments can even strip local elected leaders of their governing powers. The Emergency Financial Control Board created by the New York legislature in 1975 could force spending reductions, audit municipal records, and reject public union contracts. In Michigan, when emergency managers are installed, local politicians cannot enact new laws without the approval of the state-appointed bureaucrat. Critics of these interventions say they are often used to advance particular interests and ideologies, like bondholders and small-government conservatives, over those of actual city residents and interest groups like public sector unions.

As national Republican leaders including Senate Majority Leader Mitch McConnell have expressed a desire to minimise aid to states and cities, the possibility of a super-charged austerity campaign looms over the coronavirus crisis. In some areas, where conservatives have control of the levers of power at the state level, they may even welcome the opportunity.

“We’re seeing serious municipal financial crunches that are going to lead to all these techniques being used – threats of bankruptcy, oversight boards, emergency managers,” said Samuel Bagenstos, professor of law at the University of Michigan Law School. “We saw a lot of that in the Great Recession. If anything, it looks like the hit on municipal finances will be much worse this time. It’s something we have to be very worried about.”

State takeovers of local governments have usually been spurred by fiscal crises years in the making, with an impetus beyond local control. In 1975, New York City faced a financial reckoning as a result of white flight and deindustrialisation, which hollowed out its tax base while social service costs grew along with the low-income population. New York papered over this political challenge by borrowing to pay for its operating expenses – which worked until the city’s financial institutions decided to stop lending.

As part of the solution, the state created the Emergency Financial Control Board, an unelected body that took ultimate power over the city’s finances away from locally elected leaders. When policymakers made a decision, like signing a new union contract with the teachers, the board could reject it and force them back into bargaining. In effect, the mayor and city council no longer had ultimate power over the resources allocated to municipal programs ranging from law enforcement to public education.  

The state-appointed body – which comprised four public officials and three corporate representatives, but no one from labour or community groups – forced substantial budget cuts on New York. They pushed for the elimination of more than 15,000 city jobs, the closure of public hospitals, and the imposition of tuition costs on the City University of New York for the first time in its history. 

The Financial Control Board stopped having final say over New York City’s budget in 1986. But it still exists and exerts nominal oversight over municipal finances to this day. There are even triggers in its 45-year-old enabling legislation that would allow it to again have approval powers over the city budget: The state legislature can legally re-empower the board if the city does not service its debt obligations or runs a deficit of $100 million in a fiscal year. (For context, Mayor Bill DeBlasio’s pandemic-era budget is over $89 billion, and he’s considering borrowing to pay for operating expenses for the first time since the lead up to the 1975 fiscal crisis.)

“The mechanisms, the institutions, and the approach is there and I’m sure that could be activated,” says Kim Phillips-Fein, professor of American history at New York University and author of Fear City, a book about the 1975 fiscal crisis. “We could see a similar type of distribution of power upwards in the hands of people who are less immediately and democratically accountable, which is how institutions like the control board work.”

New York’s Financial Control Board was only the beginning. A less aggressive version was implemented in Pennsylvania after Philadelphia’s fiscal crisis in the early 1990s, in the form of the Pennsylvania Intergovernmental Cooperation Authority. Smaller cities in Pennsylvania, with far worse financial situations, faced far more ferocious state oversight. In 2011 Harrisburg was taken over by the state. In New Jersey, similar dynamics led to an eight-year state takeover of Camden, when local politicians were stripped of all power and a state-appointed chief operating officer was installed in exchange for $175 million in state investment.

Deeper into the Rust Belt, Michigan saw unelected, state-appointed power brokers placed in charge of many of its cities following the Great Recession. When Republicans took total control in the state capitol after the 2010 elections, they passed a law giving state-appointed “emergency managers” sweeping powers over the finances, contracts, and policymaking of cash-strapped cities and school districts. Although they could not raise taxes, these state appointees held unilateral power over labour contracts, local budgets, and public assets.

Even in the state’s largest city, Detroit, an emergency manager was appointed and steered the city into bankruptcy to settle its debts. The optics of the policy were terrible when overlaid with racialised political polarisation: Republicans who appointed the emergency managers from the state capitol were mostly white, while the cities being placed under their control were often ruled by Democrats and had majority Black populations. At one point in 2013, roughly half of Michigan’s Black population was under emergency management. Only 1.3 percent of white residents were similarly affected.

“Michigan has been sort of a bellwether for the rest of the country with this,” Bagenstos says. “We have tended to have a response to municipal fiscal crises that relies on state governments and the financial sector essentially displacing local democracy.”

The results of these state interventions have, at times, been tragic. In Flint, Michigan, the emergency manager made the decision to use the Flint River as part of a cost savings proposal, then did not treat the water properly to prevent corrosion of the aged pipes. That sent lead levels soaring throughout the city. The human toll was devastating, as hundreds of children were poisoned.

People protest in Flint, Michigan.

(Chip Somodevilla/Getty Images)

“All too prevalent in this Flint Water Investigation was a priority on balance sheets and finances rather than health and safety of the citizens of Flint,” state Attorney General Bill Schuette said after the emergency manager was criminally charged for the crisis.

In Camden, meanwhile, the state takeover accomplished few (if any) measurable improvements for city residents. Unelected appointees could make cuts, but they couldn’t affect any of the structural economic and societal forces crushing the small New Jersey city.

Bagenstos argues that even in situations like New York in 1975 or Detroit in 2013, the core issue usually isn’t that local politicians in these cities are more irresponsible or craven than their suburban counterparts. Instead they face structural issues, chief among them white flight and capital flight that aggravate municipal finance structures that allow people who live in suburbs to get the benefits of cities without actually contributing their fair share to city revenues.

But proponents of such interventions, like Clayton Gillette, say these measures are only enacted in the most extreme circumstances. They are a consequence, he argues, of local leaders failing their constituents and not bearing up to the reality of their situation. Gillette says that too often, powerful local interest groups – chiefly public sector labour unions – are able to pressure local politicians into fiscal irresponsibility. 

“That’s the premise, you’ve got some rogue elected officials so the state’s going to come in and the state’s going to do a better job of serving your local constituents,” says Gillette, who is a professor at NYU’s School of Law and author of a defense of state takeovers entitled “Dictatorships for Democracy.”

But Gillette argues that the fiscal crises faced by New York in 1975 or Detroit after the Great Recession are fundamentally different from the economic impact of the Covid-19 pandemic. 

“This is not a consequence of municipal incompetence or municipal leaders giving in to local interests,” says Gillette, who advocates massive federal aid for states and cities. “This is a function of an exogenous shock. What we’re seeing is not amenable to a more professional state body coming in and taking over the city finances.”

Bagenstos and other experts, including the University of Pennsylvania’s Robert Inman, say that institutions like emergency managers and financial control boards could be installed in the wake of the pandemic, rather than amidst its throes. The recovery from this depression is likely to be unequal, like the aftershocks of the Great Recession, which hit areas like Detroit harder and longer than America’s superstar cities like San Francisco and Boston.

For cities that weren’t seeing the benefits of the 21st century’s narrow urban revival, especially smaller municipalities that were teetering on the edge before the pandemic took hold, states could well move in to make decisions for beleaguered local leaders in the medium term. That’s what happened in Michigan, after all. The emergency managers weren’t appointed until four to five years after the Great Recession itself.

“It wouldn’t surprise me for the cities that are on the fence right now to fall off in two or three years,” says Inman, Mellon professor emeritus of finance, economics, and public policy at the Wharton School of the University of Pennsylvania. “Then PICA arrangements are very likely to be put in place.” 

Inman says that if this kind of oversight does come back, he hopes it looks more like Philadelphia’s PICA model than what occurred in New York or Detroit. In those latter cases, the state-appointed authorities could wade into the city budget and insist that, say, sanitation workers had to be cut, a particular asset sold, or a specific union contract rejected. In PICA’s case, the authority only looks at the final budget and ensures that the city isn’t running a deficit. They don’t make choices or pronouncements about individual budgetary line items or taxes. 

Instead, PICA sets out basic requirements: Philadelphia must map out a five-year plan for itself and it can’t run a budget deficit. In addition to these basic competency requirements, the state-empowered board also has power to reject the final budget, at which point hundreds of millions in state funding could be pulled. But that threat is so huge that it’s never realistically been considered. 

Still, Inman says PICA’s existence gives Philadelphia politicians the understanding that they cannot govern outside their means. The current mayor, Jim Kenney, even argued for the authority’s continued existence before the pandemic because its backstop gives creditors more confidence and, relatedly, the city gets lower interest rates.

For Bruce Katz, all of these policy interventions are possible in the post-pandemic future. He says the current crisis will place enormous pressure on local governments to change their ways, probably at the prompting of a higher authority. He foresees municipal consolidations, service sharing across borders, and various forms of state oversight.

“We’re in the early stages here,” Katz says. “But the fact of the matter is, I think oversight, like the one we saw in New York and elsewhere, is just one of many possible outcomes here.”

Jake Blumgart is a staff writer for City Monitor.

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