The city of Pequot Lakes was expected to lose money on all but one scenario. The only scenario they would not lose money on was one where the state highway bypassed the community with the city doing next to nothing, a giving up strategy that felt a lot like losing. In the alternative I personally supported, the city would spend $1.5 million and expect to see revenues, over the life of the improvements, of just $121,000. This just didn’t seem possible.
Yet, I had the numbers in front of me. I had set up the study asking a question I assumed I knew the answer to, yet had never seen calculated by any engineer, planner, or economic development advisor before. It was disorienting to look at the data in this way.
I became obsessed with understanding municipal finance. As an engineer, I knew how to calculate the cost of infrastructure. It had never occurred to me that I could calculate the associated revenues. I never needed to. Nobody had ever bothered to ask!
I started to look at projects I knew well. The first was my own home. At the time, my wife and I lived in a single-family house on a cul-de-sac with a paved road. When the road was surfaced, the city paid half the cost while my neighbors and I paid the other half. I ran the numbers; it would take 37 years of my neighbors and I paying taxes for the city to merely recoup the cost they had initially put into building the road.
That was longer than the road was going to last. It was a dead-end road; we were the only ones who used it. If my taxes weren’t even enough to cover the initial construction costs, who was ever going to pay to fix it? Again, how was this possible?
There was another city I was working with that had just completed a contentious road reconstruction project. It was more intensely developed than my cul-de-sac – smaller lots, higher density – and the properties were far more valuable. This was another dead-end scenario where the street existed solely to serve the property owners living there. If there were no homes, there would be no need for the street. There was not going to be any future building or extensions to other properties that could be developed. This was it; it was built out.
Based on the taxes the city received from the property owners on the street, it was going to take that city 79 years to recoup the money they had spent on a simple maintenance project. This was bizarre! It was basic maintenance, after all. I calculated how much taxes would need to go up if the city attempted to recoup enough money from these property owners to pay for the ongoing maintenance of their own street. It would require an immediate 46% increase in taxes, with annual increases of 3% over the rate of construction cost inflation for each of the next 25 years.
There was no way that was going to happen, but that was only a small part of the problem. I assumed in my calculations that every penny of taxes the home owners paid for street maintenance was spent on their own street. I knew that was absurd. That little local street was the cheapest bit of transportation infrastructure in the city. I was ignoring any contribution those property owners might be expected to make for all the collector and arterial roads that these homeowners depended on, investments that were far costlier to sustain. Where was that money coming from?
I subsequently modeled dozens of residential developments – urban, suburban, exurban, and rural – and I could not find one that came close to covering its own basic expenses, let alone the collector roads, traffic signals, bridges, interchanges, and other communal expenses those revenue streams were expected to support. Not a single one.
I shifted my efforts to commercial developments and found the same long-term insolvency. A business park I had worked on as a young engineer was, after more than a decade of development, nearly built-out; almost every lot was occupied by a building. The city felt it was so successful that they wanted to build another in the same configuration, on property adjacent to the existing site.
I assumed the new business park would cost the same, and yield the same tax base, as the existing one. If that were the case, the revenue coming in wouldn’t even cover the interest on a bond the city would take out to pay the up-front costs.
In examining the existing park, I found a number of sites that were not taxpaying, things like churches and public maintenance buildings. There were many more that received significant tax subsidies as an enticement to move into the park. The only way I could make the numbers cash flow for the proposed development was to assume that every lot would be developed within a year of the new business park opening, that every new building would be occupied by a taxpaying entity, that no property would be subsidized, and that all of the revenue would go to retiring the project debt.
If this were to occur, it would still take 29 years for the debt to be retired. That’s nearly three decades where taxes would need to go up for everyone else in the community to cover the snow plowing, crack sealing, police and fire protection, and all the other services needed within the new business park. And that’s with a wildly optimistic scenario; anything remotely realistic didn’t even cover its own debt payments.
I started to share this information with professional colleagues and public officials in the cities I worked with. In a sense, I didn’t believe my own data. I was convinced there was something I was missing, and my professional colleagues had plenty of theories.
The dominant critique was that I was not properly considering the value of job creation. I found this frustratingly absurd. Of course, job creation has a benefit and our cities will not last long without jobs, but where in the municipal revenue stream does a job show up? While some cities have an income tax, the ones I was looking at did not. Without a way to monetize the value of a job, there was no functional difference between a municipal investment that created a job and one that did not.
We’re conditioned to think otherwise, so let me explain this using an extreme analogy. Pretend there are two cities. The first we’ll call Housing City and the second we’ll call Job City. A thousand people live in Housing City. They each have their own home. Every day, those thousand people travel to Job City where they work in a call center located in a tent in the middle of a field.
In a system where municipalities are funded by a property or land tax, Housing City has no jobs, yet it has a thousand homes it can tax and receive revenue from. Job City has at least a thousand jobs, yet the tax base of the tent in the field is relatively tiny by comparison. Regardless of how much those jobs pay, Job City will not receive any revenue from their existence. The public officials and professional staff in Job City might be happy to have so much employment but, without the tax base from the housing, they are not going to have much revenue to pay their bills.
The same can often be said of sales tax. In Minnesota, we do have sales tax, but – except in some limited and special circumstances – the money goes to the state, not the local government. A city can have a massive collection of big-box stores and car dealerships, sucking transactions out of all the surrounding region into its own commercial strip, yet without a sales tax, those transactions don’t show up in the municipality’s revenue stream.
While I hadn’t at the time, I’ve now had the opportunity to look at systems where sales and income taxes are collected by local governments. While there are some modest differences, the overall effect is the same as with property tax systems; the revenue streams generated are insufficient to meet base infrastructure liabilities.
Beyond job creation and sales taxes, the critiques I was getting from professional colleagues fell along the lines of “people want it,” as if that was some kind of holy blessing. People wanted cul-de-sacs, spread-out development patterns, drive-through restaurants, and lots of parking. And because people wanted it, they will find a way to pay for it, and that was all the justification needed to get going.
Coming from professionals who were compensated for building all this stuff, that attitude seemed stunningly self-serving. Don’t we have an obligation to make sure that what we built could plausibly be sustained by future generations? It was Upton Sinclair who said, “It is difficult to get a man to understand something when h
is salary depends on his not understanding it.” With a few notable exceptions, I found Sinclair’s observation maddeningly insightful.
For me, the evidence was pointing to a conclusion I found difficult to believe, yet impossible to ignore: The more our cities build, the poorer they become.
The Municipal Ponzi Scheme
When local governments need professional assistance, they often issue what is called a request for proposal (RFP). Consultants like myself respond to the RFP and, if successful, there is an interview. I’ve done many such interviews, answering questions from city staff as well as elected and appointed public officials.
One might expect such interviews to delve into the competence of the professional seeking to provide services, but I was never asked about my engineering or planning expertise. There were only two questions public officials were interested in, and they are closely related:
How good are you at getting funding for a project?
How good are you at working with the public to sell the project we want to do?
These questions would be asked in different ways, but it was always the same. For example, funding might involve a federal grant application or a routine property assessment. Even though this had nothing to do with the engineering of the project, I was expected to show confidence in being able to fill out the right forms, meet with the right people, and score highly in whatever process the city wanted to pursue.
When it came to the public, we would be briefed on the (perceived) uninformed malcontents who were sure to oppose the project, or the sensitive cultural concern unique to the community, and queried as to how skilled we were in making these people feel listened to – or at least provide the outward appearances of such – while still shepherding the project through.
In the end, it was all about growth. The common denominator was that every city wanted to grow; my job was to help them do that. It was clear how this benefitted me – I got paid to do the project – but what wasn’t clear to me, now that I had mounds of data, was why cities wanted to grow if it was going to make them poorer.
I understood that a growing city looked good. That new street without a crack or weed looks like prosperity compared to the old, rutted road. That new house in the new subdivision has an aura of prosperity that is lacking in older neighborhoods. Is our obsession with growth merely superficial? That felt incomplete.
I also understood the allure of ribbon cuttings and grand openings, the ability to convey a sense of progress by an act of political theater. There is something viscerally satisfying in blaming the morally compromised politician who can bring home the pork-barrel project. Yet, this answer also felt incomplete. I worked with a lot of politicians, and a lot of other professionals, and while few would pass up an opportunity for self-congratulation, I never got the sense that was the motivation. There is something more.
In a macroeconomic sense, I’m going to explain that “more” in greater detail in the next two chapters. For local governments, it actually becomes quite simple: New growth provides local governments an opportunity to receive additional cash in the short term in exchange for taking on unpayable, long-term liabilities. The mechanism is stunningly simple.
Consider the ideal scenario: a developer who comes to town and is willing to invest their own money to bring a project to fruition. This developer seeks no public assistance or subsidy. They are willing to follow all the rules and regulations of the community. They will, at their own expense, build all the residential homes and commercial buildings within the development. They will install and pay for, to the municipality’s standards, all the required roads, streets, curbs, sidewalks, pipes, pumps, valves, and meters.
The only thing the developer asks for making this investment in the community is that the local government – steward of the public balance sheet – agree to take over the long-term responsibility to service and maintain this new development. All the city must do is provide police and fire protection, maintenance the of the infrastructure, and the other general services provided to all residents and businesses within the city.
I have never encountered a local government that wouldn’t immediately accept such an offer. In fact, in many places it would be illegal not to, assuming all the local standards were met. Generally, developers ask for concessions or subsidies making the deal worse than what I’m presenting, but stick with this ideal scenario and follow the cash flow over time.
In the first year after the new development is built, everything is brand new. The streets, sidewalks, and pipes don’t need any maintenance at all. Revenue from the new development pours into the city coffers. Some of it is spent on public safety, some on parks, some on running city hall, and some is spent on fixing and maintaining infrastructure in other parts of the city.
Pretend that maintenance money is sequestered. Instead of having it go to fix the street in front of the mayor’s house on the other side of town, it’s set aside and saved for the day when the city must go out and make good on the promise they made to fix and maintain the street in the new development.
Every year, more tax revenue is added to the fund. For decades, nothing is being spent. A 5-year-old road isn’t costing the city anything. A 10-year-old sidewalk presents no immediate expense. A 15-year-old pipe is just fine sitting there in the ground. It’s only when we get a generation out, when the city is expected to go out and perform maintenance or rehabilitation of that infrastructure, that the insolvency is revealed. It’s at this point that cash flow runs far into the negative (Figure 3.1).
Figure 3.1 Municipal Cash Flow over One Life Cycle for a Single Development
Cities don’t sequester money in this way. Some are prohibited from doing so and, even if they were allowed, it’s very questionable whether society would want local governments hoarding capital. Nonetheless, what this demonstrates is that, for two or three decades, the city was receiving cash from this new development that they were free to spend elsewhere, despite the looming, and easily predictable, maintenance obligation.
For cities in need of cash, new growth provides it. In the pattern of development we’re experimenting with today – one that is government-led, spread out, and mostly homogenous across the entire continent – new growth gives a local government decades of free cash flow. That makes it easy to understand the natural reaction of city leadership, as well as American society in general, when those liabilities come due and the insolvency starts to bite: pursue more growth.
The general attitude is to return to what worked, or what appeared to work in the memories of those assembled to evaluate such things. When the city was growing, things looked successful and there was excess cash available; let’s get things growing again. That’s a powerful argument, particularly because it’s not without some basis in reality.
Go back to the model developer, the one who offered to build everything if the city will only maintain it. Pretend that this developer returns a couple years after the first project with a similar proposal. Then every other year from that point forward, a developer comes forth offering likewise. This is the ideal scenario for any city: nice, steady, continuous growth.
Instead of spending that free cash flow, if the local government took that money and set it aside in order to make good on the promises they are making, Figure 3.2 shows how tax revenue would accumulate for that same 25-year time period.
Figure 3.2 Municipal Cash Flow over One Life Cycle for Multiple Developments in Sequence
There is a lot of growth happening here, and so a lot of cash accumulates. In terms of infrastructure maintenance, each development contributes revenue without adding any immediate expense. With all the growth happening, revenues accelerate upward. After two decades of saving, this local government is sitting on a huge pile of cash.
And in year 25, when the maintenance liability for that first development comes due, the city is required to draw on the savings to make good on the promise, but it’s not a big deal. The money is there because of all the growth.
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The growth creates an illusion of wealth, a broad, cultural misperception that the growing community is become stronger and more prosperous. Instead, with each new development, they become increasingly more insolvent. When a city loses money over the long term on every project it does, it doesn’t make up the difference in volume. The more time that passes, the more downward pressure there is on the budget (Figure 3.3). Continuing to grow in this pattern only buys time. And time only makes the urgency to grow even greater.
Figure 3.3 Municipal Cash Flow over Two Life Cycles for Multiple Developments in Sequence
Local governments now exist in a time defined by their past promises. The liabilities from decades of unproductive development are coming due. All those miles of roads, all those pipes and pumps, all the bridges, the storage systems, the buildings . . . all of it must now be maintained. Our cities are so spread out and denuded, the wealth is not there to pay for it all.
The growth that was supported by all this public investment did not result in enough prosperity to maintain all that was built. And if our cities could somehow come up with the money – for example, if the federal government tried to bail out every city struggling to maintain cul-de-sacs, frontage roads, and water loops – they would only be doubling down on a wealth-destroying series of public investments, buying time in a race to the financial bottom.
Public pensions are frequently cited as the municipal crisis of our time, but even they are merely symptoms of incorrect assumptions about our development pattern. When cities ran short of cash yet needed to negotiate contracts with their employees’ unions, it was straightforward for everyone to forgo salary today for an increased pension tomorrow. The city would invest those savings in growth, which, everyone assumed, would pay off, making those pensions easily affordable. Tragically, they were wrong.
Strong Towns Page 6
