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As Long as We Remember...

May 29, 2012

Austerity: A Bitter Pill or One for Fiscal Health?

Earl 'Rocky' Mackintosh

"Austerity" was named the word of the year by Merriam-Webster Dictionary in 2010. (It’s nice to know that the global economy has a stronger influence on Webster’s top words than the urban dictionary.)


Wikipedia provides a more robust definition of austerity, as it relates to economics: “In economics, austerity refers to a policy of deficit-cutting by lowering spending often via a reduction in the amount of benefits and public services provided. Austerity policies are often used by governments to try to reduce their deficit spending and are sometimes coupled with increases in taxes to demonstrate long-term fiscal solvency to creditors.”


Austerity policies are controversial, even among economists, and can be tricky to impose.


Unfortunately, extreme austerity measures are often enforced as a last resort to prevent imminent government defaults. By and large, if a government has already spent itself to the brink of bankruptcy, the opportunity to effectively leverage massive spending cuts has passed. In a poorly performing economy, austerity can result in contraction instead of expansion, which triggers the type of public outrage we are witnessing in Spain and Greece.


Given a lighter approach and the right timing, however, spending cuts can encourage private consumption and trigger economic growth. At the very least, they go a long way to ensuring a government’s future fiscal solvency.


So, what does the unfolding austerity drama in the European Union have to do with the economy in Frederick, Maryland?


Everything, actually…like it or not, this is a global economy we are operating in.


Frederick County government has taken its approach to reining in spending. As controversial as it has been, there is no question that the county now sits with a surplus versus the serious deficit it was facing two and a half years ago.


On May 17th the City of Frederick Board of Aldermen adopted a budget for fiscal 2013 that increased both spending and debt service by double digit percentages. The budget passed with a 4-1 vote, with Alderman Shelley Aloi providing the lone dissenting vote.


“At the time we were discussing and voting on this budget, there was a run on Greek banks resulting in 700 million Euros leaving Greece, and investors also took one billion Euros out of banks in Spain. We don’t know what the future holds for the global economy. And yet, the City of Frederick just passed a budget that is not remotely conservative,” said Alderman Aloi.


“Spending increases by 18%, debt service increases by nearly 68%, and the pension and OPEB liabilities continue to be the gorilla in the room that we ignore. I am committed to completing the Carroll Creek project, but can’t we fund it with dollars left over when we close other projects? As it stands, it is 100% funded by bond debt.”


She’s not saying it was all bad. Alderman Aloi was pleased with the agreement reached with Frederick County for the new tax differential system, and with changes to water and sewer impact fees.


“We campaigned to end double taxation, and there is still more to that conversation, but we have taken a significant step in the right direction.


“We’ve been moving forward with changes to the water and sewer impact fees by allowing individuals to pay over time and switching from fixture unit count to flow rate.


“However, we need to take a closer look at line items in the Water and Sewer Enterprise Fund and how the calculations are made on bond payments. We can’t continue to impose these burdensome fees and expect businesses downtown to flourish. And at some point, we need to start telling the State of Maryland ‘no’. It’s unreasonable for the MDE (Maryland Department of the Environment) to keep passing mandates requiring our citizens to empty their pockets to fund the Chesapeake Bay clean up. Mandates should come with equivalent dollars to fund them.”


By far one of Ms. Aloi’s biggest concerns is the massive liability the city faces from underfunded pensions and Other Post Employee Benefits (OPEB). Currently, OPEB is underfunded by $128 million and pensions are underfunded by $92 million. That's $3,372 for every man, woman and child who reside within the city, or about a four cent ($0.04) onetime property tax assessment on the six billion dollar tax base on all land, commercial and residential real estate taxable base.


“Actuarial recommendations are that the city should be funding OPEB by $11.7 million per year to sustain it, but we are able to fund less than half of that annually. We need to look at the entire budget, and decide what we can contribute to OPEB, and then tailor OPEB to meet what we can afford. Otherwise, we will have to take dollars from other city services to fund it,” she said. “My dissenting vote is in part that we haven’t yet addressed this issue.”


Already, nearly 40% of the city’s annual budget is allocated to pensions, OPEB, and debt service. If even more city taxpayer dollars are funneled into liability payments, there will be little left to fund the services Frederick’s city government is meant to provide.


Local governments that are able to do little beyond paying employees and servicing debt with tax revenues are simply not sustainable. Just ask any number of municipalities in California. That leaves a reform of pension and OPEB benefits as the most viable solution.


According to Alderman Aloi, at the direction of the board, an ad-hoc committee was appointed by city staff this year to analyze OPEB, and is expected to come back in June or July with recommendations for restructuring and cost savings.


“It is my hope that we act quickly to follow through with the committee’s recommendations,” said Ms. Aloi. “There has not been consensus or a strong political will to address the reform of these liabilities. The lack of decision making and follow through is costing city taxpayers several million dollars each year that we put it off. We can’t keep kicking this can down the road.”


Frederick, watch carefully as our city officials weigh their options regarding funding and restructuring of the OPEB liability. Making tough, smart choices about this issue could well be the single most important legacy this Board of Aldermen will leave behind.


Fiscal austerity is least painful when it is a measure we take because we can, not because we have to.


Rocky Mackintosh is the owner of a land and commercial real estate firm based in Frederick. He is also the editor of the MacRo Report Blog.


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