Despite the costs for goods and services being at historic highs, state and local governments are in a solid place to withstand the many economic headwinds blowing their way; still, it appears best to proceed with caution.

The Good

Most municipalities are in good shape with strong rainy day reserve funds thanks to Federal programs like the American Rescue Plan Act, the Infrastructure Investment and Jobs Act, and State and Local Fiscal Recovery Funds. Add to that benefits from increased sales revenues and a hot housing market (although signs are pointing to it cooling down), and state and local governments are in as good a place as any to weather economic and financial storms.

Earlier this year, the Volkner Alliance and Penn Institute for Urban Research hosted a briefing on inflation and recession risks. Moody’s Analytics chief economist Mark Zandi said, “State and local governments are in good shape to navigate whatever … path we go down.’’ New York Governor Hochul reiterated this mid-year, indicating the state is prepared for the worst and in a good position to weather downturns. According to the National League of Cities, Federal programs have bolstered cities’ ability to deal with inflation and “led to consistent spending for normal government operations and services, helping local governments keep their communities running with minimal interruption.”

The Bad

The cost of capital projects and services is up and while a certain amount of inflation is factored into estimates and budgets, the current environment is prompting questions about whether projects started can be finished; whether projects should be cut or delayed; and whether there are other funding that can help keep projects moving. At the same time, some municipalities are experiencing low-to-no responses for construction Request for Proposals (RFPs) and are finding it tough to compete with so many other options available to construction companies that are more flexible and don’t include fixed budgets.

Then there are salary, pension, and other benefit costs – they’re going up and not an option as municipalities compete with the private sector to attract and retain much-needed talent. How far they go and whether they’re sustainable remains to be seen.

Will It Get Ugly?

It depends on what happens next and how well-prepared each municipality is.

There are potential impacts on credit. As reported by S&P Global, how credit quality is pressured depends on “the duration of elevated inflation growth” and “state law and revenue mix.” Overall, municipalities could see higher social service spending, but should be able to withstand pressures on credit quality at least in the short term.

Increases in food insecurity are already occurring, and there are expectations that Medicaid and unemployment trust fund costs may go up. Increasing benefit costs for retirees and existing employees could seriously impact future pension liabilities. Whether there are local income taxes, capital gains tax revenue, caps on annual revenue increases, debt and other factors also come into play.

As reported by the  Federal Reserve Bank of Richmond, rural areas are feeling inflation more than urban areas, so municipalities may be experiencing differences depending on location. An Iowa State University report reiterated this finding, noting that those living in non-metro areas with populations under 2,500 or in the countryside are struggling more than their urban counterparts.

Disparities based on the demographics are also coming into play. NBC News reported, “A recent study from University of California San Diego found minority households are being hit especially hard because they spend a larger portion of their income on essentials like housing, electricity, transportation, and food.”

In some states, like New York, residents are taking things into their own hands, migrating to lower-tax states in bigger numbers, having the potential to negatively impact sales and tax revenues now and in the long term.

Still, as reported in the weekly Deloitte Insights issued August 15, July inflation showed signs of slowing; producer prices are decelerating, and labor costs may not be as bad as some think. Month to month and even week to week, the story changes. Whether things end up good, bad, or ugly remains to be seen. For now, the consensus is municipalities are in as good a place as any for what comes next.

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