The Municipal Fiscal Crisis: Are Local Government Consolidation or Dissolutions Likely to Increase?

By Lisa K. Parshall

The long-term impact of the COVID-19 crises for state and local governments is anticipated to be worse than the Great Recession of 2008-09. Experts predict that it will be years before municipal governments return to their precrisis fiscal baseline. Without additional federal assistance, the fiscal outlook for many municipalities is bleak. As local governments look for solutions to this looming fiscal crisis, should we then expect to see an increase in the structural reorganization of general-purpose governments (counties, cities, towns, townships, and villages) as a coping strategy?

Theoretically, prolonged fiscal stress may pressure previously reluctant localities to consider structural reorganization through the consolidation or dissolution of government entities. First, there are the immediate pressures to find efficiencies and savings to be had from the reevaluation of service delivery structures. Once such cooperation or significant service sharing develops, it is an arguably shorter step toward the consolidation of governing entities or the merger through the dissolution of smaller, nested units of government. More importantly, whereas budgetary responses may be short-term and limited, reorganization arguably provides longer-term savings through a reevaluation of core services and subsequent elimination of unnecessary duplication.

Without additional federal assistance, the fiscal outlook for many municipalities is bleak. As local governments look for solutions to this looming fiscal crisis, should we then expect to see an increase in the structural reorganization of general-purpose governments as a coping strategy?

Managing through budgetary responses is particularly difficult given current uncertainties over the scope and duration of both the crisis and the anticipated economic recovery. We can also anticipate more of what local government scholars refer to as “scalar dumping”—the downward shift of state fiscal pressures to their local governments, which potentially will crowd out local efficiencies and growth. Similarly, short-term austerity approaches may contribute to future financial unsustainability as local infrastructure investments or economic development opportunities are deferred. In short, the fiscal stress experienced by municipalities is likely to cumulatively worsen, making restructuring options more attractive or perhaps even—in some cases—inevitable.

Limited Options for Local Governments

The ability of any municipality to weather the crisis depends upon their unique circumstances, including their preexisting fiscal health, their primary revenue sources, and available reserve (rainy day) funds. To maintain a balanced budget during a crisis or economic recession, localities generally must either find new or additional revenues or else limit their expenditures. Table 1 provides an overview of the various budgetary and restructuring options that are generally available to local governments.

High property tax burdens in some jurisdictions, taxing and expenditure limitations (TELs), property tax caps or freezes, and high rates of property tax exemptions, along with declining populations and tax bases, are persistent challenges to local revenue raising capacity in the best of times. In a recession, revenue raising options are even more restricted. Even the property tax, on which many localities heavily rely, although generally less volatile than personal income or sales receipts, becomes increasingly vulnerable to lagged effects as unemployment and tax delinquencies rise. Short- or long-term borrowing options are often constitutionally or statutorily limited and may adversely impact municipal credit ratings or contribute to an unstainable debt burden. While the first rounds of federal stimulus have provided some relief, federal funding has proven insufficient and cannot be used to make up for lost revenue, decreased state aid, or budgetary shortfalls.

Table 1. Local Government Options

 

With limited revenue raising options, it is anticipated that most local governments will weather the current storm by cutting services, drawing down reserves, increasing their borrowing, pursuing informal or voluntary shared services arrangements, or delaying or deferring expenditures and payments. Reductions in personnel (furloughs or layoffs) are generally a later-step solution, but one which many municipalities are contemplating.

Local governments may also seek efficiencies through shared service agreements, or by transferring or consolidating functions—eliminating separate village and town courts or assessment services, for example. Where fiscal stress is acute, localities may seek to restructure themselves financially through municipal bankruptcy, or structurally, by consolidating or dissolving units of government. The viability of structural reorganization depends upon the ease of state procedures, the scope of the fiscal pressures and potential financial benefit, and the political will of local elected officials and residents.

New York: An Eased Pathway, New Incentives, and Pressure for Municipal Reorganization

In New York, passage of the New N.Y. Government Reorganization and Citizen Empowerment Act (Empowerment Act), effective March 21, 2010, eased the pathway for municipal reorganization by lowering the petitioning thresholds to call a public referendum that would compel local officials to formulate a consolidation or dissolution plan. Behind the law were state-level narratives citing high property taxes on local government proliferation and inefficiency.

Table 2 summarizes the basic process for consolidation and dissolution under the Empowerment Act. Consolidating or dissolving local governments may be initiated in one of two ways: by act of the local governing body or by citizen petition. In the board-initiated proceedings, a dissolution plan precedes the public vote—whereas in citizen-initiated proceedings, the referendum precedes the formulation of a plan. The process, in tandem with the reduced threshold for petitioning to put reorganization on the ballot, was designed to enable citizens to pursue municipal reorganization when local elected officials are reluctant to do so.

Table 2. The Empowerment Act (General Municipal Law 17-A)

 

The passage of the Empowerment Act was followed by other measures designed to increase efficiencies and incentivize restructuring:

  • The Local Government Citizens Reorganization Empowerment Grants (CREG) program, enacted in 2009 as a new category of local efficiency grant, funds both the study and implementation of reorganization up to $100,000 and requiring a 10 percent local match.
  • The Citizen Empowerment Tax Credit (CETC), enacted in 2011, provides tax relief to communities that have approved a dissolution. Local governments involved in a merger (dissolution/consolidation) receive additional annual aid (equal to 15 percent of the combined amount of real property taxes levied by all of the municipalities involved in the consolidation or dissolution, not to exceed $1,000,000), with the directive that at least 70 percent of such aid is to be used for property tax relief.
  • A property tax cap, enacted in 2012 and made permanent in 2019, restricts year-to-year increases in the tax levy by local governments to 2 percent or the rate of inflation, whichever is less. Local governing boards may override the cap through a local law or resolution.
  • The Office of the State Comptroller introduced a Fiscal Stress Monitoring System in 2012 that is designed to provide early warnings for local governments. The system assigns designations of no stress, susceptible to stress, moderately stressed, and severely stressed based on key metric scoring.
  • The creation of a Financial Restructuring Board for Local Governments in 2013 allows fiscally eligible municipalities to receive state-level review and recommendations, along with available grants and loans to improve their fiscal situation.
  • The County-Wide Shared Services Initiative and Municipal Consolidation and Efficiency Programs, introduced in 2018, incentivizes collaboration between local government jurisdictions and efficiencies through consolidation of services and units of government.

Alongside the Empowerment Act, these various measures give guidance, provide incentives, and create pressure for local government to explore efficiency options, including the consolidation or dissolution of municipal units.

Barriers to Municipal Restructuring and Reorganization

With an eased pathway for consolidation and dissolution of municipal units and mounting fiscal pressure stemming from the COVID-19 crisis, one might reasonably expect to see an increase in municipal consolidations and dissolutions. For several reasons, however, I think it is more likely that New York’s distressed local governments will continue the strategy of “muddling through,” relying on budgetary control measures rather than pursing restructuring options as significant barriers to structural reorganization remain:

1. Shared services are already extensively utilized and the barriers that block service sharing are equally likely to impede restructuring.

First, there is already an extensive sharing of services among New York’s local governments. In other words, much of the “low-hanging fruit” opportunities have already been maximized or enacted. The same barriers that impede the sharing of services are at play in the consolidation or dissolution of governmental entities: state procurement and prevailing wage rules, restrictive labor agreements, and the requirement of approval at public referenda. In the case of New York, when dissolution is pursued it is most commonly a citizen-initiated effort to lower the local property tax burdens. Where there is already a significant sharing of services between village and town governments, or where many core services are already provided by the town, dissolution tends to be less contentious and more successful. Proposed village dissolutions which require the elimination or consolidation of police and emergency services, on the other hand, are among the most contentious. While shared services are likely to continue and increase as communities seek efficiencies, shared services may also present a competing policy option—that is, they can sometimes serve as an alternative or first-step option that discourages consolidation or dissolution efforts.

2. The uncertain relationship between fiscal stress and municipal reorganization.

Only a handful of villages that have had dissolution activity (petitions filed or a vote on dissolution) have registered on the stress scale. For every small or economically struggling village that has dissolved, dozens more persist. Relatedly, the easiest targets for consolidation or dissolution (villages) have lower rates of fiscal stress, particularly relative to cities and counties.[1] From a snapshot taken in February 2018, for example, the average fiscal stress score for villages statewide was just 7.78 (on a 100-point scale). Those villages that do register on the Office of the State Comptroller’s fiscal-stress monitoring system (FSMS) also tend to move in and out of stress and no-stress categories, sometimes by a substantial point swing.

The overall flat trend of state and federal assistance has been a persistent concern for New York’s municipal governments. Figure 1 summarizes the net impact of the enacted budget on local governments since 2009 according to the Division of the Budget’s (DOB) financial plan summaries. The fiscal crisis stemming from COVID-19 has worsened the fiscal outlook for local governments at least through FY 2024. The enacted budget for FYE 2021, which was revised from earlier executive projections to reflect the fiscal crisis, the sharp decline in tax receipts, and lack of federal relief, produced a net negative impact of $350 million for local governments across all categories of local assistance. The greatest negative impact is on counties and school districts (neither of which are subject to the eased pathways for consolidation or dissolution under the Empowerment Act).

General revenue sharing through the Aid and Incentives for Municipalities (AIM) program held the funding for towns and villages to its prior-year level, but authorized the state’s budget director to make additional cuts if required.[2] In June 2020, the DOB withheld a combined $75.9 million in state assistance from more than two dozen local governments.[3] Because federal assistance for state and local governments still has not materialized, the state has now implemented the 20 percent across the board reduction in AIM funding and has frozen state spending and payments for a broad array of programs.

Figure 1. Net Impact of Enacted Budget on Local Governments:
DOB Enacted Budget Financial Plans

 

SOURCE: “Budget Archives,” NYS Division of the Budget, accessed September 16, 2020, https://openbudget.ny.gov/budgetArchives.html.

The 2021 budget, as enacted, retained state funding for restructuring initiatives—indeed, it included a 150 percent increase over FY 2020 results, indicating the state’s commitment to reorganization and efficiency initiatives. However, funding for CREG study grants appear to be among the suspended programs. So, while growing fiscal pressure and reductions and state-aid create incentives for local restructuring, the loss of state funding will undoubtedly impede those efforts. Indeed, a point of concern among residents in many village dissolution debates is whether the CETC tax credit will carry forward indefinitely which may factor into the local calculus of potential savings to be had through consolidation or dissolution.

3. Local control.

Ultimately, however, the most substantial barrier to local government restructuring continues to be local control. While changes to New York’s procedures have made it easier for citizens to initiate consolidation or dissolution through lowered petition thresholds, final approval still rests with the voters in a public referendum.

There is a disconnect between the competing goals of cutting costs and providing services in the way that the taxpayers prefer. The citizens’ preference for local control and psychological attachment to their village government frequently overrides any potential cost-savings benefits. While the number of village dissolutions has increased since the passage of the Empowerment Act, the rate of approval at referendum is lower than it was under the previous law. Most dissolution studies have found that dissolving would produce some potential savings to village residents (often accompanied by small-to-modest increases to the town residents outside of the village, who do not have a vote on the matter). Even with projected savings, residents are often unpersuaded, fearing a corresponding loss or diminution of services, and concerns for intangibles such as community history and shared identity. So long as the decision to dissolve remains a purely local question, it is unlikely that municipal restructuring will emerge as a reliable policy solution to municipal fiscal stress without additional state-level intervention or policy directives.

Conclusions

The great unknowns are the duration and severity of the current economic crisis and whether additional, substantial federal assistance to state and local governments is forthcoming. The DOB predicts that, without substantial federal help, “nearly every activity funded by state government in the aid-to-localities budget…will face steep cuts.” With limited options, restructuring may become more attractive and a politically palatable option for local governments. In states like New York, where the pathway for restructuring has been eased and the state has dedicated substantial resources to incentivize municipal consolidations and dissolutions, the stage seems set for an increased interest in structural reorganization. Significant barriers, however, remain. For local government scholars, the looming crisis presents an opportunity to better understand how local governments respond to fiscal stress.

ABOUT THE AUTHOR

Lisa K. Parshall is a fellow at the Rockefeller Institute of Government


[1] Village governments are the municipal unit most directly impacted by the Empowerment Act for several reasons. First, they are general-purpose municipality within another general-purpose municipality. When they dissolve, their property and administration is transferred to the surrounding town(s) of which they are already a part. Village residents already pay taxes and take part in the elections of both the village and town. More than two-thirds of New York’s villages are small, with population less than 3,000 and many already share significant services with their town(s). But most importantly, villages are the only general purpos e municipality which, under state law, can be incorporated or dissolved by purely local action—that is, by a vote of its residents and without the input of town-outside-of village voters, and without county- or state-level approval.

[2] FY 2021 Enacted Budget Financial Plan, 140. The Budget grants the budget director the authority to reduce aid-to-localities appropriations and disbursements by any amount needed to achieve a balanced budget, as estimated by DOB. The budget is deemed out of balance for the fiscal year, and the director’s powers are activated, if actual tax receipts are less than 99 percent of estimated tax receipts, or actual disbursements are more than 101 percent of estimated disbursements, as measured at three points during the year (April 1-30, May 1-June 30, and July 1-December 31). Upon identification of an imbalance, the budget director would transmit a plan to the legislature identifying the specific appropriations and cash disbursements that would be reduced. The legislature would then have ten days to adopt, by concurrent resolution, its own plan for eliminating the imbalance. If no plan is adopted, the plan submitted by the budget director would take effect automatically. The process exempts certain types of local assistance appropriations from uniform reduction, including public assistance and Supplemental Security Income (SSI) payments (See FY 2021 Enacted Budget Financial Plan, 42).

[3] This included a withholding of 20 percent of the AIM funding from 12 cities and 20 percent of Video Lottery Terminal (VLT) assistance from 15 counties, towns, cities, and villages. Restoration of withheld payments and AIM funding is contingent on additional federal assistance to state and local governments.

 

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