Many states and municipalities are approaching preventable disaster.
Gabriel Petek, a municipal bond analyst at Standard And Poor's, wrote in April 2017 that changes in demographics and the economy have left "institutions inadequate" to correct against financial excess.
He continues:
There is an asymmetry to the new era for state finances. While the budgetary gains to states during the current expansion have been subdued, recent downdrafts have been severe. In the aggregate, from 1951 through 2001, state tax revenues never posted year-over-year declines, but have done so three times in just the past 15 years.
A February 2017 analysis from the Pew Charitable Trusts helps to understand the asymmetry more directly.
States’ recovery from tax revenue losses since the onset of the recession has varied widely. In seven of the 27 states in which tax revenue had recovered by the second quarter of 2016, receipts were more than 15 percent higher than at their inflation-adjusted peak before or during the recession. Conversely, collections in five of the 23 states with below-peak tax revenue were down 15 percent or more, after adjusting for inflation.
These unprecedented revenue declines come as many cities still have not regained firm financial footing since the financial crisis.
A 2017 Survey from the National League of Cities shows that general fund revenues still have not recovered since the 2007 recession, and stood at 97.7% of 2006 levels. General funds are used to support cities' general operations and represent 55% of total city spending on average.
Cities represent one of the bright spots. The National Association of Counties 2016 economic report describes the growing disparity between rural and urban:
Large county economies — in counties with more than 500,000 residents — have the highest rate of full recovery (41 percent). In contrast, more than three quarters of small county economies, in counties with fewer than 50,000 residents, still have not reached their pre-recession peaks across all four indicators by 2016.
These challenges have not gone unnoticed by municipal analysts. PNC's Tom Kozlik writes:
State governments still have a significant amount of control over revenues and spending, but the problem is they are not using that control. With pensions, state control is often limited. As a result, U.S. state credit quality is deteriorating. Further, by and large I am not seeing the necessary pension reforms that could correct this credit deterioration.
I would go so far as to say that the rating agencies, despite the downgrades and the noted warnings, are still underestimating the stress pensions are—and will be—putting on state and local government credit profiles. I believe one reason is because of how difficult it will be for states with substantial pension burdens to reverse course, and improve their credit standing.
Currently, Moody’s has seven state ratings with “Negative” outlooks and S&P has eight state ratings with “Negative” outlooks. Expecting near-term political solutions to solve these financial circumstances may be optimistic.