We're In the Endgame Now for Small Towns

My hometown of Brainerd, Minnesota is, like cities all over the United States, about to begin its 2021 budget process. Since we don’t know what the next four weeks are going to bring, it’s really hard to make projections about the future. Yet, we’ve constructed a process—again, like most cities and certainly all states—where we must make projections.

The more fragile you are, the less uncertainty you can entertain.

There are three numbers that are important here: How much do we raise in taxes, how much do we owe in debt, and how much aid can we expect from the state?

Local Taxes

Brainerd does not have a sales tax. More specifically, the state of Minnesota has a sales tax, and we have a local option voters approved to fund some wastewater scheme. That money passes through to pay debt and doesn’t show up on the budget.

We also don’t have an income tax. That’s not allowed for cities in Minnesota.

Our locally generated revenue comes primarily from property tax. This is good because property tax is one of the least volatile forms of taxation (a land tax would be better). In a process that contains dozens of tax classifications, exemptions, and special conditions, the city’s capacity to raise property taxes roughly correlates with property values.

Property values may change quickly in a market, but for taxing purposes, they are slower to move. The county assessor has a history of underestimating values, although that has changed in recent years (my current valuation is substantially higher than my market value). For practical purposes, the total number matters less than how it compares to other properties. If everyone is overestimated by 20%, the amount of tax I pay will work out the same as it would if everyone was underestimated by 20%.

We don’t have any of the weird levy constraints that other states do, so the city is free to set the budget they need, the accountants apply the formulas, and taxes are assessed to property owners.

In 2020, the city raised $6.1 million in property taxes. Of that, $4.1 million goes into the General Fund, the rest split between different funds that are either fixed obligations or so modest that cutting them would be borderline cruel (the library fund gets $150,000, for example).

There will be some non-payment, and I anticipate a reluctance to raise taxes on a relatively poor population in the middle of what might be a new Great Depression, but I’m comfortable assuming we can raise this money next year. 

Debt

In the Strong Towns Strength Test, we recommend that a city have debt service payment of no more than 10% of their locally-generated revenue. There’s some nuance to that, obviously.

For example, if a city extends debt payments out for a long period of time, they can reduce annual debt service costs, but that’s not a great practice. Pay off your debt in a prudent timeframe.

I’d also not count revenue that’s already dedicated to something else. The idea of limiting debt to 10% of locally-generated revenue is to not overextend your community, to give yourself some buffer if things change. Having debt takes away options. It limits flexibility. Disciplining yourself to stay below 10% forces difficult questions and a true inter-generational balancing of priorities.

Ten percent of $4.1 million is $410,000. The 2020 city budget lists $1.3 million in debt payments, three times what we’d recommend. I’m not sure exactly what this debt is for—the budget doesn’t say—and I don’t know how much longer we are obligated to pay it. I’m going to assume we have a similar payment due next year.

Unless we want to blow this thing up, the debt payment is non-negotiable. That means the General Fund is down to $2.8 million of locally-generated revenue.

State Aid

Here’s where most of the volatility comes in. This year, my little town received $5.1 million in what we call Local Government Aid (LGA) from the state of Minnesota. For every dollar local taxpayers contribute to the (non-debt) operation of the city, the state sends us $1.81.

Obviously, the city is paying large portions of the police department ($4.1 million), the fire department ($1.0 million), the parks and recreation budget ($1.2 million) and streets ($1.1 million) out of that allowance.

As I’ve said many times, without a generous annual stipend from the state, we’re done. We may feel like we deserve this money, we may argue that it’s not a big budget item for the state to have, but that doesn’t change our level of dependency. Brainerd is a ward of the state. That’s the opposite of a Strong Town.

The implications of being a ward of the state is that we’re very dependent on the health of the state. If I’m counting on my rich uncle to pay for my vacation, I might want to check on their health now and then. If I’m counting on them to pay for my mortgage and my groceries, I’m going to want to be very obsessive about how they're doing.

The state of Minnesota is fairly well run. The institutions are pretty sound and Minnesotans are generally offended by budget shenanigans (although we’re not immune). That being said, we’ve created an incredibly volatile system dependent on sales and income tax. Not good when people lose their jobs and stop spending.

To make matters worse, our sales tax is on discretionary products only. No food or clothing. No haircuts or doctors visits. We collect sales tax on the things people don’t do in a stay-at-home pandemic. We collect sales tax on things unemployed people don’t have the money to do. I understand why, but that makes things really volatile.

As of February, the state’s budget estimated a $1.5 billion surplus. We’re now estimating a $2.4 billion deficit. Since we’re halfway through the budget cycle, we need to find a way to close a 7.4% gap with half the money already spent. Effectively, that’s a 15% cut. There are rainy day funds to cushion the blow, but we’re still talking about real budget cuts.

And the state’s budget forecasters will admit, I’m fairly certain, that they’re being optimistic. They estimate a 6.4% reduction in income tax collections. Unemployment is already at 8.1%, and this is the busy season here in the frozen North.

They are also relying on some rosy economic projections. From the state’s budget update:

IHS Markit (IHS), Minnesota’s macroeconomic consultant, is now forecasting a three-quarter recession, resulting in a 5.4 percent decline in real GDP in 2020. In February, they had forecast 2.1 percent annual growth for 2020. Temporary business closures and stay at home orders, volatile financial markets, rising unemployment, and declining wage income contribute to a forecast 5.5 percent decline in real consumer spending in 2020. The contraction is further fueled by a collapse in oil prices, an auto industry shutdown, and a global recession this year. 

IHS expects the spread of COVID-19 to peak and then dissipate in the second calendar quarter of 2020, allowing social distancing restrictions to be lifted during the third quarter. Economic recovery begins in the third quarter, and real GDP growth turns positive in the fourth. Real GDP growth in 2021 is forecast at 6.3 percent.

That’s the aggressive “V-shaped” recovery CNBC talks about every fifteen minutes. They are projecting over 6% growth in 2021, something we have experienced only once (1984) since the 1960’s. Not even in the dot.com boom did we see 6% growth! Here’s what that projection looks like (shown in orange) compared to historical growth rates (shown in blue). These are unprecedented times, but we’ve deluded ourselves if we’re counting on that kind of a recovery.

The Future of Small Towns

Minnesota is the home of Hubert Humphrey and Walter Mondale. We’ve long been a bastion of the most liberal kind of politics. Yet, a recent poll—the Minnesota Poll, which has a history of oversampling Democratic voters and thus underestimating Republican support—puts President Trump within four points of presumptive Democratic nominee Joe Biden.

Minnesota has slowly evolved into the hard rural-urban political split seen across the country. I live in the heart of that red area, but I’m aware of the total cultural meltdown that would take place in Minneapolis and St. Paul if this state’s electoral votes went to the incumbent president. It would be thermonuclear if that tipped the national election.

In 2020, Minneapolis will receive $79 million in Local Government Aid. They have a $1.5 billion budget. St. Paul will get $65 million in LGA. Their budget is $636 million.

If LGA were eliminated, it would create a budget gap of 5% for Minneapolis and 10% for St. Paul. They are not wards of the state. It’s also important to recognize that the representatives they send to the state capital aren’t hostile to government spending, though I can see them easily becoming hostile to more subsidies for rural highways or for subsidizing more sewer lines to rural Walmarts. That’s especially true if those rosy economic projections don’t come to fruition and we’re confronted with more hard choices.

In contrast, if LGA were eliminated, it would destroy Brainerd’s budget. Even a 10% cut in LGA—and how can there not be a 10% cut—would mean more than a 5% cut in Brainerd’s total budget, an amount equalling half the streets budget. We should anticipate a lot more than a 10% cut.

And grading on a curve, Brainerd is not even that bad. The city of Chisholm (population 4,900) passed a $1.8 million levy for 2020 and will receive $3.2 million in aid from the state. The little city of Remer (population 388), a place close to my heart, levied $208,000 and will get $460,000 in state aid this year.

All of this completely glosses over the fact that none of these cities can come anywhere close to maintaining their essential sewer and water systems. None of them can fix all those miles of roads and streets without additional state and federal assistance. 

And while I’ve chosen to live in a small town, none of these places are offering a life of opulence. Sure, we might mow the weeds so a local band can play in the park, and we might spring for some fireworks on the 4th of July, but all the basic services that most mid- and large-size cities take for granted are absurd to even ponder in most of America’s small towns. What prosperity we have, we create ourselves, despite the general decline.

My hometown of Brainerd is a ward of the state. So is nearly every small town in America. Our large cities are financial wrecks, but they at least have a path to fiscal redemption. They have some sense of financial productivity. And, in a pinch, they don’t need state benevolence to keep the water running and the lights on.

A decade ago I said, as a guest on Minnesota Public Radio, that we were going to lose half of Minnesota’s small towns. Hundreds of cities were just going to close their doors. They’d unincorporate or dissolve or simply stop being functional entities. I got a lot of blowback here locally for that comment. I’ll double down on it now.

We’re in the endgame now for small towns. I’m not sure what comes next, but it’s not going to be more of what we’ve been doing. The days of running pipes and roads all over, desperately chasing growth, subsidizing anyone who would possibly come to town, pretending we could be a more modest version of a major metro area, is over.

For a large city, a Strong Towns approach is the difference between a good and prosperous life and one of decline and struggle. For many small cities, it’s a matter of survival.

It’s time to get serious about building a Strong Town.

Cover image via Flickr.

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