The Challenges of Being a Municipality Under the Laws of Pennsylvania
September 25, 2013
The Challenges of Being a Municipality Under the Laws of Pennsylvania
by David Unkovic and Timothy J. Horstmann
Reprinted with permission from the September 24, 2013 issue of The Legal Intelligencer.
© 2013 ALM Media Properties, LLC.
Further duplication without permission is prohibited. All rights reserved.
If you are a municipality in Pennsylvania, you do not have an easy life. In many ways, you operate like a small business: you have revenues, expenses, assets, liabilities and cash flow. But you also operate under a set of rules pursuant to state statutes. These rules are made by your “creator” – the Commonwealth of Pennsylvania. Your creator operates in a political environment in which many of the entities with whom you deal have more influence with the creator than you do. The rules under which you operate are often slanted against you.
When it comes to revenues, you rely primarily on real estate taxes and earned income taxes. In more mature communities, like cities and boroughs, the ability to raise taxes is limited. Combined with significant poverty populations and declining industry, these mature communities can experience revenue shortfalls even in flush years. Raising taxes may not always solve the problem; at some point, tax increases will result in lower collections. Many smaller cities or boroughs are also county seats, with significant portions of the land owned by governmental entities or nonprofit corporations, such as hospitals and colleges, which are generally exempt from taxation under state law.
On the expense side, typically 70% of your budget is earmarked to pay for labor costs in the form of salaries, benefits, pensions and post-employment heath care. Under state law, you are often forced into an arbitration process with uniformed employees in which your ability to pay the award is not taken into account by the arbitrators.
The recipe of a limited revenue stream and uncontrollable expenses results in a “structural deficit” – on an ongoing basis, the municipality’s revenues consistently are less than its expenses. If you talk to municipal managers these days in Pennsylvania, you will find that they all feel the pressures of limited revenues and uncontrollable expenses. Even some fairly wealthy municipalities that do not (yet) have structural deficits have begun to experience the problem.
If you have a material structural deficit, the usual reaction is to cut expenses, raise taxes and increase efficiency. At some point, however, the cuts become so deep, and taxes so high, that you compromise your ability to operate and provide needed services. You then turn to the only other option available: exploit assets and liabilities to generate current cash flow.
Municipal assets may be exploited in many ways to convert them into current cash. You might sell an asset, such as a public works building, to a municipal authority in exchange for cash up front, and then lease the building back for continued use with regular rental payments. You might enter into a public-private partnership, or P3, and lease public facilities, such as parking garages, to a private entity who will pay you a combination of upfront cash and recurring lease payments. You might also take money which is intended for specific purposes, such as sewer rental receipts intended to improve the sewer system, and apply it towards the deficit.
You can also incur new liabilities to generate current cashflow. In Harrisburg, for example, this was done by the city charging “guaranty fees” whenever it guaranteed a bond issue of one of its authorities, or by accepting an upfront payment whenever it entered into an interest rate swap transaction. These cash payments were used to plug the city’s structural deficit in specific years.
These strategies may mask the problem for a time. But, eventually the problems catch up to you: the additional debt you create results in new debt service on top of the old, and ultimately larger deficits. Meanwhile, your sewer system and other assets, which you have not maintained, start crumbling.
Things become dire when cash flow problems develop. You literally do not have enough cash on hand to make payroll, pay debt service on bonds, and pay vendors enough to keep them at bay. You probably also have long ago run through whatever rainy day fund you may have had. You then need a loan to keep going. If you are lucky, you find a local bank that will make the loan, or you may have to deal with a hedge fund and get a really expensive loan. But eventually, when your luck runs out, you cannot get a loan from anyone, and you’re faced with a series of tough decisions: pay your employees or risk danger to your citizens, pay your bondholders or risk being locked out of the debt market, pay your vendors or have no gasoline, tires, insurance, paper, pencils, computers, etc.
For municipalities in Pennsylvania faced with this set of dire choices, the only feasible option available is to seek relief under Act 47, the Municipal Financial Recoveries Act. Since the enactment of Act 47 in 1987, at least twenty-seven municipalities have sought relief under Act 47. And, Act 47 has worked well in some respects – it has kept distressed municipalities from completely melting down. But while Act 47 has succeeded in preventing complete financial meltdown, it has largely failed when it comes to the more important goal: getting municipalities back on solid financial footing and out of distress. To date, only six municipalities have successfully exited the Act 47 Program, with some preferring to remain under the program’s oversight to better manage their finances.
Why has Act 47 failed in this regard? The simple reason is that municipalities who can get out of Act 47 would return to the same set of unworkable “regular” laws governing municipalities that put them into Act 47 in the first place. Thus, for some municipalities looking to bring their revenues and expenses in line on the way to financial recovery, Act 47 perversely has become the goal, rather than the vehicle to accomplish the goal.
Changes in state law are needed in order to give municipalities the tools they need to not only survive, but to thrive. A fundamental change would be to “right size” the delivery of certain services that would be delivered better on a regional or county basis. Except for Illinois, our state has the largest number of local governments in the nation. Certain services, such as police, fire, water and sewer, could be delivered on a regional basis with taxes or charges imposed and collected on a regional basis. All of the municipalities could continue to maintain local roads and deliver other services that make sense at the local level.
Changes are also needed to balance the interests of municipalities and public employees. In arbitration proceedings with police and fire unions, the ability of the municipality to pay should be an important factor taken into account in making an award. Laws mandating defined benefit plans need to be reviewed and changed to bring them in line with the realities of today’s economy. Public employees should have the same type of defined contribution plans as are common in the private sector. Municipalities simply cannot afford defined benefit plans in the long run.
The General Assembly has held hearings to examine the operation of Act 47, and has considered several bills that would change the process by which municipalities borrow money. A more comprehensive approach is needed, however. The fate of our municipalities is one of the great public policy issues facing the Commonwealth of Pennsylvania. Nothing affects our daily lives more than the delivery of basic municipal services in our communities. The proper functioning of our local governments also has a tremendous effect on the ability of our state to develop and attract successful businesses, and ultimately on our ability to compete in the global marketplace.
For too long, municipalities have been an afterthought under state law. Their interests need to be given more consideration when balancing all of the interests at play in our Commonwealth.
David Unkovic and Timothy J. Horstmann are public finance lawyers with McNees Wallace & Nurick LLC, in Lancaster and Harrisburg. Mr. Unkovic previously served as the first state-appointed receiver for Harrisburg. The firm represents state and local governments and agencies as issuers of revenue bonds and general obligation bonds. The firm also routinely serves as underwriter’s counsel and counsel to conduit borrowers, banks and trustees.