When citizens think about where local taxpayer money goes, they often assume it pays for things like public safety, snow removal and trash collection — routine operating expenses that come with running any big city. And that’s mostly true. But what they rarely realize is that legacy costs also eat up large portions of the typical city’s budget. Debt accumulated over many years, contributions to employee retirement systems and the expense of fixing long-neglected infrastructure all take a significant toll.
Merritt Research Services provided Governing with data on current debt service, pension costs and other post-employment benefit (OPEB) expenses for cities with populations exceeding 500,000. These three cost drivers collectively averaged nearly a quarter of total governmental fund expenditures in recent years. What’s worrisome is that legacy costs are rising, taking up ever-larger shares of budgets. For the large cities reviewed, the three line items accounted for a median of 22.4 percent of fiscal 2016 governmental fund spending, up from 19.8 percent in fiscal 2011. In some big cities, the increase has been much greater. Consider Jacksonville, Fla. Debt, pensions and OPEB made up less than 20 percent of expenditures there in 2008. Since then they have climbed to about 32 percent in recent budgets.
As legacy costs continue to rise, cities have less money for public safety, health care and other essential services. “The trend continues to squeeze out other operating expenses over time,” says Richard Ciccarone, president of Merritt Research. “Many cities are going to have to increase taxes to retain current levels of services.”
The largest legacy line item for many localities is debt. Older cities with outmoded infrastructure typically have to borrow more than newer cities, especially if they operate transit systems or public utilities. But newer cities that need to accommodate growth are also finding that their borrowing costs can rise quickly.
Milwaukee is a prime example of this legacy problem. It utilizes more short-term debt than most other cities — debt service alone took up 34 percent of fiscal 2015 governmental fund spending, according to the city’s comprehensive annual financial report. Once pensions and OPEB contributions are factored in, legacy costs accounted for an average of 43 percent of spending over the past three fiscal years, the highest share of any city reviewed.
Depending on the circumstances, high-debt loads don’t necessarily signal mismanagement of a city’s finances. “There are good and bad capital projects,” says Tracy Gordon, a senior fellow with the Urban-Brookings Tax Policy Center. But, she adds, “places that are poorly run could be taking on more debt than they can afford.”
Some states and localities impose strict limits on debt or restrict the purposes for which it can be issued. That’s the case in Boston, which limits debt to 7 percent of expenditures. Boston, which spent an average of 14 percent of its recent budgets on debt service, pensions and OPEB, is one of the cities on the low end of the legacy cost spectrum. Seattle’s legacy costs were the smallest of all larger jurisdictions reviewed, accounting for an average of just over 12 percent of fiscal 2013-2015 expenses. Generally speaking, small and mid-size cities tend to be less saddled by legacy costs than the biggest ones.
Pension payments figure prominently along with debt in siphoning funds from routine government operations. Pension and OPEB contributions accounted for roughly a quarter of Los Angeles’ expenditures in recent years, while they’re less than 10 percent in about a dozen other large cities. But a low number for pension costs isn’t always a sign of civic health: Some governments shortchange pension contributions to stave off cuts in other areas when times are bad. Moody’s Investors Service recently reviewed a sample of state and local pension plans, finding 57 percent failed to make contributions sufficient to keep their net pension liability from increasing if all plan assumptions held. Contributions can also fluctuate dramatically from year to year, as they have in Detroit and several other major cities.
For all these reasons, legacy costs that cities are paying now don’t necessarily reflect future expenses. Additional legacy costs not included in Merritt’s data are very tricky to estimate. Perhaps the most difficult is deferred maintenance on infrastructure, which comprises everything from bridge and road repairs to upgrading IT systems.
No matter what a city’s legacy cost situation may be, local officials must consider just how much more of these expenses they can afford to take on. Jurisdictions suffering population or job losses will be hard pressed to direct more of their budgets to costs largely unrelated to current operations. Others with expanding tax bases are better positioned to minimize the crowding-out problem. “Having high fixed costs in San Francisco is very different than having high fixed costs in a place like Detroit,” Gordon says. Steep cuts in state funding also have compounded legacy issues much more significantly in some parts of the country than in others.
Natalie Cohen, managing director of Wells Fargo’s municipal securities research, cautions that policymakers shouldn’t think about legacy costs such as pensions separately from investments in future growth. “We have to think about economic development and not only what funding pensions is going to do,” she says. “If you have economic growth, then you have more resources to pay down your pension obligation.”
Going forward, the scenario for many cities appears to be less debt, but more pension and OPEB costs. “There has been a noticeable reduction in the amount of debt that’s out there,” Cohen says, “but the pension and OPEB pressures are likely to continue to trend upward.”
How Legacy Costs Add Up
Debt service costs and contributions to pensions and other post employment benefits account for a sizable portion of many large cities’ budgets. Their share of total governmental fund spending, averaged over the past three fiscal years, is shown for cities with over a half million population: Figures were provided by Merritt Research Services from comprehensive annual financial reports: some numbers were standardized to ensure consistency across cities. Percentages don’t account for spending on business-type activities, deferred maintenance on infrastructure or other expenses. Three-year averages for fiscal years 2014-2016 are shown for all cities except for 2013-2015 averages for Baltimore, Chicago, Milwaukee and Seattle. Complete data was unavailable for Louisville.