Q. I know you’ve given a great deal of thought to the use of artificial intelligence – AI – in public sector finance. Could we start out by defining AI?

A. That’s a tricky question. But I’d say that AI is the use of technology to enhance your ability to understand your data and to automate processes using that enhanced knowledge. It covers a lot of different things. It’s machine learning. It’s robotic process automation. It’s a suite of intelligent technologies that allow you to improve existing processes or extend existing processes into new areas.

Q. Bearing that in mind, can you comment a bit on the utility of AI for the public finance community?

A. It helps to eliminate a number of processes that have required a lot of manual effort on the part of government workers — things like processing invoices, processing job applications, auditing. AI because it’s flexible can deal with lots of different potential scenarios and anomalies, unlike traditional ERP systems that regulate processes that are virtually the same in every case.

Q. You mention processing invoices. How can AI help deal with something that seems so mundane?

Sure. You need to match up the invoice to the payee, which could change year to year. And that can require a lot of manual effort. But tools like AI can take irregular processes like that and look for patterns and help integrate those different patterns into your standard financial processes. Also, with AI, finance officials can look at those patterns and say, ‘Hey, the last time this happened, something else happened.’ For example, the last time sales tax submissions dropped to this point, we had a recession and we had to cut spending by a certain amount. It can help to alert you to things that are happening so you can get ahead of them.

Q. That’s clear. Can you give us a real-world example of the utility of AI?

Pennsylvania, for example, felt their internal audit efforts were way too manual and they weren’t well staffed and they couldn’t do what they really wanted to do in terms of better targeting those activities they felt were likely out of compliance in terms of spending.

In the past, they would audit a lot of transactions that were perfectly in compliance, which was time consuming. But if they looked at the patterns of spending or transactions from the past, they could find those that were likely to be out of compliance and focus their efforts there. Our partner The Solutions Company used the SAP Business Technology Platform to develop an algorithm for them that can look at historical patterns and then identify those patterns in their current year spending and then say, ‘Hey, you should go focus your audit efforts here.’

Q. It would seem like AI would be helpful in detecting inefficiencies or even fraud.

A. That is very accurate. CFOs will often put out guidance about internal financial management practices, like procurement cards or travel. So, if state employees are all going to the same event, they should all travel together. Four people shouldn’t generally use four different fleet vehicles if they are going to the same place. But it’s tough to track that with many existing systems. Looking at data with AI, you can see that these four employees went to exactly the same place and all of them checked out a car on this particular date.

Q. That’s a great example. Another one?

Yes, one of our customers is Office of State Revenue in New South Wales, Australia, which is in charge of ensuring that once a taxpayer owes a debt then they are going to collect that debt. So, we looked at their historic collections data. And what we found was that a first letter would be sent out and there’d be no response. A second letter would get no response. And so on until the final letter was sent. And then there was a group of taxpayers, who would pay almost immediately after they got a letter that said this was the final one before they’d be taken to court.

So, they started to just send one letter, the final letter, and that accelerated their collections. And now they’re able to collect money earlier than before.

Q. That’s impressive. But what about people who simply couldn’t pay?

We were able to use the data to learn more about the circumstances that person might be in. Maybe that person had just lost a job or had lost their house because of a natural disaster. We have other data that can tell us this, so instead of taking them through this multi-step process the office would say ‘Hey you owe this debt. And we know that you just lost your job. So, we’re going to offer you a payment plan up front, because we know that you probably need one based on your current circumstances.

Q. What are the challenges to getting the most out of AI?

One of the biggest challenges is the data itself. Data quality is inconsistent from state to state or locality to locality. But in order to use AI you need clean data and not every government entity in the United States has really invested in managing their data as the asset that it is. Finance officers should welcome Chief Data Officers into the government C-suite because better, cleaner data will enable all these finance examples we discussed today.

Another big challenge is just getting access to the data. Government can be very siloed and the people in those silos can be very territorial about many things including giving other departments access to their data. You have to have a framework by which agencies or department can share data or allow another entity that’ working on a project to access the data it needs.

Interview conducted by Richard Greene, senior advisor, Government Finance Research Center

Q. Before we dive in, please tell us a little about the impressive project that you’ve been working on about cities and taxes.

Bloomberg Philanthropies and Results for America started a program called City Budgeting for Equity and Recovery. They had a cohort of twenty-eight cities that got access to a virtual learning program and peer network and customized technical assistance. That meant Aravind Boddupalli a research analyst in the Urban-Brookings Tax Policy Center, Lourdes Germán who leads the curriculum development for City Budgeting For Equity and Recovery effort and I had access to the equity frameworks and other materials that this group of cities have put together. It was a snapshot and a chance to see what they were up to. In addition, we canvassed fifty other cities that were roughly the same size.

Q. Did you find anything unexpected in your research?

Yes. It was surprising to us that cities are not as far along in thinking about how to apply equity to their revenue strategies as they are on the spending side. But we also found some promising new approaches. And we thought it was important to elevate the experiences of cities as the federal government delves deeper into advancing racial equity as part of President Biden’s Executive Order. Budget flexibility provided under the American Rescue Plan Act and Infrastructure Investment and Jobs Act also provide an opportunity for city leaders to think about revenues and equity.

Q. Let’s talk about the specific some of the specific lines of revenue that are troublesome from the perspective of equity.

Well, fines and fees immediately come to mind as disproportionately impacting low-income and Black and Latino people. And criminal justice debts can really stack up. There can be interest costs and late fees as well as penalties that are not monetary but have monetary consequences like driver’s license suspensions and vehicle impoundment. This can prevent people from getting to work and possibly cause them to lose their job, go further into debt, and further harm their life prospects and their families.

Q. Aren’t they typically a pretty small portion of cities’ revenue streams?

Yes, on average. But there’s a lot of variation. And the percentages can be quite large, especially in smaller jurisdictions that don’t have access to a wide range of revenue sources.

Q, Aren’t there some advantages to fees and fines?

Yes, but the concern is that places overuse them to make up budget shortfalls or in response to political pressure. This is what the US Department of Justice found in its 2015 investigation of Ferguson, Missouri and what other scholars have found in their research.

Q. So fines and fees are an issue. How about property taxes?

There are certainly a lot of well publicized cases of property taxes being inequitably administered. Some neighborhoods, for example are not reassessed frequently, and people in other neighborhoods, with wealthier populations are more likely to successfully appeal assessed values that that think are too high. The issues with property taxes that concern me are as much with the administrative side as with the design side.

Q. What are the challenges to cities that want to create more equitable systems for bringing in revenues?

One of them is lack of data at the state and local as well as the federal levels. A lot of people are very interested in knowing how different tax policies affect different kinds of taxpayers by race and ethnicity. And those data just don’t exist.

In our own work, we had to do some back-of-the envelope calculations to get a population weighted average for different kinds of tax burdens, just to get a rough sense about who was paying what taxes, which might also reflect where people choose to live or migration patterns.

So, the absence of data is a real issue

Q. Other challenges?

States limit revenue options that are available to local governments, so even if a city wants to move away from one revenue source, its choices might be limited.

Q. More?

One of the barriers is having a way to think about the kinds of tradeoffs and the equity implications of different revenues. But basic principles of tax policy provide a starting point. For example, policymakers are used to thinking about questions of horizontal equity or treating similarly situated taxpayers similarly. An equity informed framework might also take into account place-based or long-standing neighborhood level inequities.

Q. Can you suggest an example of a place that’s been particularly thoughtful about these kinds of things?

We looked at the example of sugar-sweetened beverage taxes in Seattle. They had a very involved process to get community input about who would be paying the tax, and who would be helped by the revenues that would be generated. And arguably that process made the revenue source more equitable. The overall impact of the tax in terms of consumption of sugar-sweetened beverages and the public health effects of that as well as how revenues from the tax are being spent may yet be unclear. But continuous evaluation and discussion of impacts by race and ethnicity make it a promising approach.

Interview conducted by Richard Greene, senior advisor, Government Finance Research Center

Q. How are people looking at the California budget as we reach the middle of March?

A. Big picture, most people are paying attention to the rapid growth in the state’s revenues, a trend that’s been in play for the last couple of years. Just to put some numbers to that, the governor’s proposal in January said that there would be $29 billion more in revenues than the state had anticipated when we enacted this year’s (2021-22) budget which was back in June of 2021.

The Legislative Analyst’s Office has now updated their own projections and they’re saying that they think that the unanticipated revenue will increase by $14 billion (within a range of $6 billion to $23 billion) on top of the Governor’s projections of $29 billion. In other words, state leaders will have in the range of $35 billion to $52 billion in unanticipated revenue (for context, the Governor’s proposed budget for 2022-23 calls for a $213 billion General Fund).

So, the key issue here, and generally a good problem to have, is that while state leaders are trying to enact the budget, state revenue collections keep coming in higher than expected. That may slow down now if the stock market continues to be affected negatively by what’s happening in Ukraine, gas prices, and inflation. But, as of now, state leaders have ample revenues to allocate, with one major caveat…

Q. People have been describing that $29 billion, or whatever it ends up being, as a surplus, but is that really the right way to describe it?

A. No, though its being covered in the media as a surplus. I wouldn’t use that term, because a surplus is the money that’s left over at the end of a fiscal year. This is unanticipated revenue that state leaders are authorized to allocate as part of the annual budget process.

Q. What is the major caveat you mentioned?

A. State leaders don’t have as much authority to allocate the additional revenues because of a set of constitutional requirements, approved by California voters over the years, that are misaligned and either dedicate the funds to specific places or restrict the choices available to state leaders.

The biggest issue is a state spending limit passed by voters in 1979. In most years, growth in the state budget hasn’t bumped up against the limit. But the rapid revenue growth in recent years, combined with other factors, is resulting in the state having exceeded the limit in the prior and current fiscal years, and potentially exceeding the limit over the next few years.

There are two other constitutional obligations that interact with the spending limit in ways that limit state leaders’ options. First, we have a minimum funding guarantee for K-12 schools and community colleges that was enacted by voters in 1988. Second, we have a rainy day fund requirement that was enacted by voters in 2014, requiring that a portion of state revenues be deposited into the state rainy day fund and when capital gains revenues exceed a certain threshold that the excess has to be deposited into the rainy day fund as well.

Q. Can you tell us what portion of this huge amont of revenues is really one-time money, which should be spent on one-time expenditures?

A. It’s hard to put a percentage on it. But there’s definitely a large percentage of the $29 billion, in terms of what the Governor is proposing, that will go to one-time spending on pandemic responses and infrastructure. There are some proposals for ongoing spending, but it’s a smaller percentage of the total. The Governor and state legislative leaders have signaled consistently that much of these revenues are one-time because of the state’s progressive tax system and that this is not permanent funding that will always be there. And then, of course, there are requirements that I just outlined which require that a lot of these revenues go to infrastructure, most of which can be one-time.

Q. So, it’s important that much of this money be spent on one-time expenditures instead of ongoing commitments. Do leaders in the state understand how volatile the revenue streams in California are?

A. I think they do. At least the folks with the most power and authority do, including the governor, the Speaker of the Assembly, the Senate Pro Temp,  and the respective budget committee chairs. I think it is widely understood that there is a lot of fluctuation in the state’s economic and fiscal picture from year to year and that some care has to be taken with how ongoing expenses are balanced with one-time expenses.

I think that based on the proposals that have been put forth by the governor, and the ways in which the legislature is responding, they are talking mostly about one-time expenditures and there is greater worry that not enough is being done to address ongoing needs.

Q. For example?

A. They’re talking about one-time increases in public health expenditures to address the pandemic. There is one-time funding proposed for deferred maintenance of infrastructure. By definition, deferred maintenance means we haven’t been keeping up with ongoing operating costs.

Q. That sounds entirely sensible. After all, when you defer infrastructure maintenance that just means that you’ll have to pay more in future years as the roads, bridges and buildings continue to decay. Right?

A. Yes, but I think the biggest concern right now in California is actually that there will be too much emphasis on infrastructure, and not enough emphasis on some one-time and ongoing uses of funds to meet urgent needs like public health, homelessness, and helping the individuals and businesses that were most harmed by the pandemic. I think there is a worry that there is too much emphasis on the infrastructure side because there’s so much attention to this issue of spending money on one-time versus ongoing expenditures, and living within the constitutional requirements that allow for infrastructure spending over other uses.

Q. And what about putting money into the rainy day fund?

A. The state has already filled up its primary rainy day fund (Budget Stabilization Account) to the 10% cap that is set in the constitution. And actually, the rainy day fund itself is higher than 10% because both Governors Brown and Newsom made some supplemental payments to it beyond the constitutional obligations. Those supplemental one-time deposits don’t count toward the cap. So, that rainy day fund will be in the range of $20+ billion one way or another. The state also has another set of rainy day funds – one for K-12 schools and community colleges, one for safety net programs, and a special fund for economic uncertainties (for example, wildfires). The Governor’s January proposal called for another $15 billion in those funds – or about $35 billion in total across all four rainy day funds. Those numbers will likely increase by the time we enact a state budget in June.

Q. It sounds like, as a close observer of the California budget, you’re reasonably positive about the wisdom of the approach the state seems to be taking. Is that accurate?

A. I generally feel positively about how state leaders are trying to manage the state’s fiscal situation right now. I think that there has been solid fiscal management of the state under Governor Brown and Governor Newsom, in partnership with the legislature. A lot of lessons were learned from the Great Recession and the fiscal mistakes made prior to that. Since then, we have had consistent fiscal leadership, even with changes in those holding office. The state has paid down debts, built up rainy day funds, and made investments in the people of California through strategic ongoing investments. If anything, there is often more critique of state leaders for not having been aggressive enough with their ongoing investments because of their focus on fiscal caution.

My biggest worry is that constitutional restrictions, many of which were enacted in prior eras when California was a very different state with different needs, will get in the way of state leaders’ ability to make smart decisions in the years ahead.

Interview conducted by Richard Greene, senior advisor, Government Finance Research Center

Q) We know that the Government Finance Officers Association is concerned with helping communities find new sources of revenue. Do they really need it now?

A) They do get a little breathing room because of the ARPA funds and the other federal funds coming in. But their revenue systems, which are based on agricultural or industrial economies have been eroding over time. And we’ve seen issues in places that haven’t been able to keep up with the needs of their citizens.

Q) Why not?

A) Local tax systems were originally built around property taxes, and, and that was a pretty good measure of wealth in the 1800s when they were created. But now wealth is often not in property. And sales taxes are based on goods not on services, though in many ways we’ve moved to a service economy.

Q) But don’t a lot of people think that cities, counties and states are overflowing with cash, and so there’s no need for concern?

A) Most finance folks are thinking more long-term, so these issues are resonating with them. Anybody who has been trying to do government budgets or long-term financial plans realize the limitations of the current local government system.

Q) Some places have turned to fees to help build up their revenue streams. Is that a good idea?

A) They can be good or bad. An example of a bad fee is found in communities that have become dependent on traffic violations or court fees. But court fees are very regressive way of bringing in money, and if you’re a community with 40% of your revenue from traffic violations there’s an incentive to find more traffic violations, which doesn’t necessarily serve the public well and, as we’ve seen, result in unintended consequences.

Q) And what about an example of a good fee?

A) One of my favorite fees is for stormwater systems, when they’re based on reducing the amount of impervious surfaces – which is to say surfaces like asphalt or concrete that don’t absorb water and so put a greater load on stormwater systems, increasing flooding and polluting rivers and streams. With stormwater fees, rebates can be offered to feepayers who cut down on the number of impervious surfaces. That, in turn, creates an incentive for them not to have a bigger parking lot than you need, which means there’s less water running off causing flooding, overflowing sanitary sewer systems, or polluting rivers.

So that’s one that makes sense.

And even when fees do make sense, they can still be regressive so we’re actually looking at an approach called segmented pricing that Shane’s Kavanaugh, our senior manager for research has done some analysis on.

Q) That sounds intriguing. What’s the idea?

A) For someone making a fair amount of money, a $50 parking ticket may just be a cost of doing business. But for someone else $50 is a big hit. So maybe the first violator should be ticketed for $250 and the second one should get a ticket that’s somewhat smaller, but still meaningful because the goal should be to manage parking for local merchants and residents.

Q) I know that GFOA’s big initiative, Rethinking Revenues is important to you. And, in fact, the GFRC director, Deborah Carroll co-wrote a PATimes piece with you and Shayne about it.

A) Yes. And the work falls into three buckets. For example, we’re looking at payments in lieu of taxes. Boston did a great job of increasing those. And that’s the kind of thing that’s in the first bucket. The second involves pushing the limit on some existing taxes. For example, expanding sales taxes to include services. And then the third bucket would include new revenues. We’re looking at things like vehicle mileage taxes, social impact bonds, urban wealth funds and others.

Q) You’ve established six principles for the kinds of taxes that would best suit American communities. Would you tell us about them?

A) Well, the first is fairness to taxpayers and ratepayers, which involves making sure the burden doesn’t fall disproportionately on one part of the population.

Q) O.K. That’s number one.

A) And then number two is accountability. That’s one thing some people like about property taxes. People get a billed once or twice a year and can see the value of the property that’s being taxed. I think that it’s important that people feel like there’s accountability about revenues – how they’re being collected, how the rates are set.

Q) Number three?

A) That’s adequacy. We’ve found that because the current revenue system is not based on a modern economy, when there’s a recession or something entirely unpredictable like COVID, it can be much harder to raise enough revenues. The question is this: With your current revenue system can you raise enough funds to meet the basic needs of your community through economic cycles?

Q) Four?

A) That’s the cost of actually collecting the revenues. We’ve found, especially with court fees, that in some places it costs more to collect them than the money they’re actually bringing in. The cost of administration shouldn’t be more than the revenues that are being raised.

And number five is impact on the behavior of taxpayers and ratepayers. People might take property taxes or other local taxes and fees into account when they’re deciding to move to an area. So, you have to aspire to developing a revenue system that will not discourage economic development or growth in population.

Q) One to go.

A) That’s the intergovernmental piece. For example, sales taxes can be location based, and that gets communities fighting with one another for the new Walmart. So, you’d like to create a tax system that promotes intergovernmental cooperation.

Q) All of those sound great. But isn’t it very difficult to change tax systems, when people tend to fear that whatever you do, it’ll be worse for them?

A) Yes, I think there’s a bias toward the status quo. And that’s another outcome of a lack of trust in government. People would rather just keep the devil they know than the one they don’t.

So, we feel like it’s important to get out there with education about the impacts of the current system, the problems it’s causing and some possibilities for change

People may just want to fix around the margins, and that’s progress. But there’s also wholesale change. I feel that’s something that public finance officers should care about and be talking about. And so, we at GFOA, want to give them the tools and the data and the information so they can have those discussions.

Interview conducted by Richard Greene, senior advisor, Government Finance Research Center

Q. How are state budget officers feeling as the new year begins?

A. I would say they are feeling more optimistic than they were last year at this time.

Q. Well, that’s good news. Can you tell us why?

A. States are in a much stronger position today than they expected to be, in large part due to the federal stimulus and direct aid to states during the pandemic. Of course, they’re still facing a number of challenges, including questions about the long term, after the stimulative effects of federal money wear off, and concerns about the pandemic, which has increased the uncertainty everyone feels about the economy. It’s much more uncertain than at any other time in the recent past.

Q. Tax revenues have remained strong in the states, I know. Can you explain how that came to pass, even while the pandemic rages?

A. Yes, 47 states reported that their revenues in fiscal year 2021 came in stronger than expected in their enacted budgets. States rely mostly on income and sales taxes for revenue and one of the reasons collections were stronger than anticipated was high-income earners were, broadly speaking, able to continue working. Federal stimulus helped boost taxable personal income as well. Also, the pandemic’s effect on economic activity largely curtailed consumption of services and much of that spending shifted to goods. Since most states get significantly more revenue out of spending on goods than on services, that really helped.

Then there were other factors that were specific to individual states. For example, the four states that tax food from grocery stores benefitted from the fact that people have been eating more at home during the pandemic, and some states tax unemployment insurance benefits.

Q. Any other thoughts?

A. An important thing that we haven’t talked about is the impact of the tax deadline shift.

Q. Will you explain that please?

A. The federal government decided to delay the income tax filing date from April of 2020 to July of that year, in order to give tax filers more time to get their books in order during the pandemic, and almost all states that collect an income tax followed suit. While some states still counted this delayed revenue in fiscal year 2020, a number of states recognized these deferred payments in fiscal year 2021 instead.

As a result, there was a dip of revenue in 2020, and larger growth in 2021 as states saw that revenue coming in. Though that was an important factor, it’s easy to forget it even happened.

Q. General fund spending is on track to grow 9.3 percent in fiscal 2022 over fiscal 2021. Why is that?

A. There are a number of reasons. It’s important to recognize that some of that spending includes the restoration of spending cuts from the prior year that were made when states were particularly concerned about the stability of future revenues.

In addition, because revenue came in at higher levels than expected in fiscal year 2021, a number of states had large surpluses and they’re spending down those unexpected revenues in the current fiscal year.

Q. Are these spending levels sustainable?

A. We don’t expect to see these levels of growth going out into the future. It doesn’t need to be sustainable though because a lot of it was for one-time expenditures.

Q. How much of the money that wound up showing up in surpluses was the result of revenue estimators underestimating their forecasts for 2021, leaving extra money on hand at the end of the fiscal year?

A. I would hate to be a revenue forecaster now.
Here’s something that I said anecdotally in one speech, and that I find myself repeating all the time when people talk about how the revenue forecasters have gotten it wrong: I think that at the beginning of the pandemic if someone had predicted that the stock market would be behaving as it has been they would have been laughed out of the room.

What’s more, models for projecting revenue during a pandemic simply didn’t exist. You couldn’t turn to another state that had a model to do that and see how it worked out.

Additionally, the federal money that came into the states wasn’t a given. It’s easy to forget that now. But when you look at fiscal 2021 budgets, they were set prior to the American Rescue Plan Act or stimulus passed in December 2020. For most states that stimulus brought more money in during the last quarter of the 2021 fiscal year. So, their budgets and revenue estimates were set without being able to take that stimulus into account.

People may say that revenue forecasters should have been able to foresee what would have happened, but if you put yourself back in the moment when they were making forecasts for fiscal 2021, nobody had any idea what was to come.

Q. Revenue is expected to decline in fiscal 2022 compared to fiscal 2021 levels, even as spending is projected to increase. Can you help us to understand that?

A. To begin, those year over year comparisons are still being impacted by that tax shift, which led to an artificial bump in 2021 revenues.

So, though reported revenues may appear to decline, we expect to see ongoing revenue continuing to increase.

Also, the decline showing up for fiscal 2022 is also driven by differences in the timing of estimates. The data for fiscal 2021 represent final revenue collections, determined after the close of the fiscal year (June 30 for most states), whereas enacted revenue projections for fiscal 2022 for many states were developed early in the 2021 calendar year, before the most recent uptick in collections.

Q. How are rainy day funds faring?

A. They’re faring very well. We were all very concerned that states would need to drain their rainy day funds because of the pandemic. But due to the better-than-expected revenue collections, we’re seeing rainy day funds increase. At the end of fiscal year 2021, rainy day fund balances were at 12.1 percent as a share of general fund spending, which is a new record level.

Interview conducted by Richard Greene, senior advisor, Government Finance Research Center. For more information from NASBO, see its Fall Fiscal Survey of the States, released last month.

Q. What would you identify as among the major changes in public sector procurement in recent years?

A. A number of things have happened just in the last five years including an emphasis on technology. Public procurement is a regulatory process with a number of steps and touchpoints in terms of completing steps in the process. Technology has allowed individuals to automate some of those steps. And that leads to better efficiency.

Q. Any concrete examples?

A. Technology gives us the ability to analyze actual data in fulfillment, using spend management analytics. . So, rather than buying the same product multiple times which is offered at different prices, spend management helps to show us how and where we can get the better price through contract consolidation.

Q. The move to more technology must mean that there are new alliances in government. Is that right?

A. The Chief Information Officers and the Chief Procurement Officers have to work closely together. When I’m on the speakers’ circuit, and I talk about technology, people in procurement say that IT won’t get me the information I need to make better buying decisions. And I say that the answer is that there has to be data sharing between the two disciplines.

Q. We hear a lot about the shift from low bid to best value procurement. Can you comment on that?

A. You see the shift occur where the solicitation is fairly complex, like something new and innovative that a government wants to try out. Of course, you continue to look at price as a consideration. But it’s also important to consider questions of longevity, the useful life of a product, the cost of maintenance, and residual values.

Q. Other advantages of best value?

A. I’ll give you an example. If you’re talking about personal printers, you could buy a fairly inexpensive color printer, but the cost of the supplies – the ink cartridges – might be significantly higher. So, in best value, you’re not just looking at the cost of the printer, but also at the cost of the ink we need to buy to use it.

Q. What about the reliability of the vendor?

A. Of course, that’s important, and you don’t necessarily need to be using best value to consider it. You can build standards for reliability into a bid and proposal process.

The phrase we use is that we’re looking for the best responsive responsible bidder. A responsible bidder is one who can do the work if they are awarded the contract. So, you can build into the solicitation minimum requirements such as the number of years the vendor has been in business and the size of their staff.

There’s less risk when you’re buying office supplies. But think about building a bridge or a roadway, which has to handle a certain amount of traffic. You have to make sure the supplier has the capability to deliver on that contract; that it’s not  two guys developing responses to your questions in the back of their garage. Similarly, you wouldn’t want to do a janitorial contract for a vendor that is going to clean hundreds of thousands of square feet of office to a supplier with just two employees.

You can build these kinds of factors into the requests for proposal (RFPs). For example, you can say that you are only accepting bids from companies that have been in business for at least five years and have 25 employees doing this kind of work.

Q. Of course, you can always check to make sure a supplier is being honest about its number of employees and years in business. But are there other kinds of due diligence you can do to find your way to the best bidder?

A. Yes. Fortunately, in public service we are not competitors with one another. So, you have the ability to call a colleague in the next town over and say “we just did a bid and here’s the name of the company that’s going to most likely get the contract. You’ve done business with them, and I’d like to know if you think there may be a problem.”

Q. That makes sense, though it’s a very informal approach. Is there any way to systematize the efforts to get that kind of information?

A. You’re starting to see software being developed that shows a weighting of suppliers. The idea would be to provide a rating criterion that would help you to validate that a vendor has the capacity to do that which it’s promising.

I would think of it as a kind of Yelp for procurement. When consumers are looking for a restaurant or a dry cleaner, they can go to Yelp to see who are the best. Translate that into the public sector, where we could have multiple inputs from multiple public procurement offices.

Q. There’s been lots of talk about problems with procurement because of broken supply chains. Would you comment on that?

A. Covid disrupted the supply chain because the manufacturers reduced production. They had been producing 5,000 widgets, but when the demand decreased during Covid, they only needed to produce 1,000 widgets, so they reduced both their inventory and the cost of production. But you have a cycle. When demand increased, there was not sufficient supply so the manufacturer had to increase production at a time when they couldn’t hire enough people to increase production to meet the demand.

Our issue on the public sector side is understanding the volatility of the supply chain. All too often we were relying on a primary supplier, and we assumed they were going to always be able to deliver, because they were always spot on in terms of when and how they could deliver. But, increasingly that’s not the case – sometimes because their own suppliers aren’t as reliable as they were in the past.

Q. How does this play out in the real world?

A. Decide whether you need to purchase goods now or can wait until the supply chain returns to normal. For example, this may not be the best time to buy laptops, because some of the components in the laptops are not up to the quality standards. . There’s a quality control issue that will eventually get straightened out.

Q. How do you think the recently passed Infrastructure Act is going to influence the world of public sector procurement?

A. We’re going to have to take the pulse of how this is going to influence the different levels of government; federal, state, and local. And then you have to consider how the work is going to be performed and whether options such as public-private partnerships can be utilized.

In all cases, there’s going to be an increase in demand, whether it’s for bridges, rails, pipes or the internet. There’s going to be demand on all fronts at the same time. But we don’t know whether the states are going to manage the solicitation and award process or shift this responsibility to the local governments. For now, we just know there’s going to be an increase in demand.

Q. This lack of predictability must present some problems, right?

A. For commodity purchases, we’ve been able to predict, through algorithms what demand was going to be. And because it was predictable we moved to just-in-time inventory. Instead of storing many months of supplies in warehouses – which increases the cost of carrying that inventory – we knew our contractor of record would be able to produce and deliver the supplies when reorder points triggered our demands

But now, we’re much more aware of how important it is to consider multiple contractors who can provide suppliers. And we’re aware of the importance of strengthening relationships with distributors.  The interpersonal relationships can’t be automated.

Interview with Rick Grimm conducted by Richard Greene, senior advisor, GFRC

You’ve written that story-telling is an important way to communicate financial information. Why do you think this is true?

People are narrative-making machines, they are not calculating machines. So, it makes sense that if you explain your numbers with a story, you’ll get people’s attention. It’s a better way to communicate than just to provide abstract data.

It would seem like it might be a challenge for finance officers to put their messages in story form. Aren’t many accustomed to thinking in numbers?

Like anything, it’s a skill you can learn. Developing a facility for using metaphors is an important skill. That way, people can link the data to real-world experiences.

Could there be pushback from people who are highly numerate? 

I’ve yet to meet anyone who says people don’t like stories.

Is part of the reason this is important is that many people just have difficulties understanding numbers in the first place?

One of my favorite quotes is this: “’Narrative is the currency of the elected official.” But it’s not the currency of the finance people. They would prefer using their currency, which are the numbers. But they must convert their thought processes into stories, in order to communicate with other people, notably the elected officials themselves.

Do any examples come to mind of a good story – or a good image – that helped explain data? 

I’ll tell you a story about a government, working on a long-term plan, that had put together underlying data showed they were running out of land for future development. They had data on the number of acres available and other pieces of information you’d expect to have from a quantitative perspective.

To supplement the data, they put together images showing specific parcels of land that used to be available that were no longer available. That helped get across the message that there was a reduction in the amount of land available for development.

You’ve written that psychological research shows that people often misunderstand and/or misuse numbers to create a narrative that favors their point of view.

Yes. This problem creeps up. Finance officers must recognize that there’s an ethical responsibility to represent numbers accurately when telling the story behind them. For example, you could tell stories or paint a picture that makes a problem look worse than it is to spur the elected officials into taking action. And then the other option is to represent the information in a way that makes it look like it’s not so bad because elected officials might be angry.

Are there any techniques for avoiding the possibility that people will buy into misleading information?

People tend to be a blank slate, and we tend to believe the first thing that we’re told. So, it’s important for finance officers to get accurate news out first.  If inaccurate bad news gets to people first, the finance officer will have to come along later and dislodge all that information. So, it’s a lot better to get your message out first, and that way you won’t be in the position of dislodging or overriding inaccuracies later on.

People sometimes use the phrase “overconfidence bias,” in connection with the way we use and hear stories. Would you please explain that phenomenon?

People can be overconfident in their abilities, including their abilities to communicate. There are surveys that show that 25 percent of people think they’re in the top 1 percent of the population for likeability. And I’ve come across surveys that show that 50 percent of people in business think they’re in the top 10 percent of ethical business people.

How does that work when it comes to people using stories to communicate complex messages?

People have overconfidence in the ability to be understood. Let me tell you about a pretty cool experiment — a game that you and I could play. My job, in the game, is to tap out a song on a desk. Maybe it’s Happy Birthday to You. And I’m confident that you’ll know the song I’m tapping out because I know it. It sounds like Happy Birthday to me.  But sometimes it just doesn’t sound that way to you.

[Interview note: As Kavanaugh told this story, he did indeed tap out the tune of Happy Birthday. The interviewer, however, thought he heard an entirely different tune.]

Any more thoughts about the hazards of overconfidence in relaying financial information?

There’s overconfidence in how the future will turn out. People think that the future will look a lot like the past. And if you’re telling a story about what the future looks like, that story could be rooted in how things are now.

That kind of thing could be a problem when people consider how to spend American Rescue Plan money. They may implicitly assume that this level of resourcing is going to last forever. And that would be a mistake. Beyond that, there can be overconfidence in revenue forecasting generally. If people assume that the future is going to look like the past, they’ll frequently make errors in the revenues that they anticipate will come in over future years – both on the positive and negative sides.

Is there a way to overcome this pitfall?

One approach is to bring in an outside view, including data from other jurisdictions. Or there’s a thought experiment that’s one of my favorites. If a financial officer thought about a situation in which he left the organization, what would that person think the new financial officer would think. That’s a way of getting a second opinion from yourself.

It’s also helpful letting people know that whatever stories you tell about the future you’re not 100 percent certain.

Interview conducted by Richard Greene, senior advisor, GFRC

Today is officially your first as director of the Government Finance Research Center. As a long-time public and nonprofit financial management expert, this seemed like a good time for you to share some of your thinking about the world of state and local government finance.

For starters, one of the areas you’ve been most interested in are ways that states and localities can create more stable revenue streams. Any thoughts?

I’m a great believer in revenue diversification, and we’ve certainly seen states and localities attempt to diversify their revenue structures over time. The key here is to create a structure that’s a good mix of high-yield and highly stable tax and nontax streams.

For example? 

Notably, we’ve seen local governments use local options for sales taxes. We’ve also seen an expansion in the use of user charges and fees. Those have been the most popular ways for localities to diversify

Another thing we’ve seen beyond diversifying revenues has been for states and local governments to build up their reserves, so they’re not caught short as they were during the Great Recession.

But states can be an impediment to localities expanding their tax structure, right?

That’s been a real issue over time. Historically, we have seen states place restrictions on local governments and that’s created quite a challenge for them to generate revenues. The majority of states have some form of tax limitation that’s imposed upon local governments, and those limitations really curtail their ability to generate more revenue from existing sources in addition to preventing them from tapping new sources.

Is there anything localities can do about that?

There’s not a lot. But we have seen a proliferation of special districts that have allowed local governments to get around restrictions imposed by the states. Christopher Goodman, an assistant professor of public administration at Northern Illinois University, wrote a blog item for the GFRC not long ago, in which he pointed out that the number of independent districts in the U.S. grew from about 8,000 in 1942 to nearly 39,000 today.

Can you comment about the changes in the fiscal status of states and localities as a result of the pandemic?

I think we really haven’t seen the long-term impact of the pandemic yet, and how it’s going to play out.

It has been something of a surprise to see that states are in a better economic condition than we would have anticipated because taxable income has held strong. We’ve even seen an unexpectedly robust housing market which has, to some extent, been propped up by moratoriums on foreclosures, and that has helped local governments in terms of their property tax revenues.

Going forward, I think we’re going to see some big shifts as a result of pressures placed on the service industries. The lockdowns closed many service-based private sector entities, so cities that are most reliant on services have been impacted to a particularly great extent.

You mentioned the robust housing market. Is affordable housing more of a problem now than it has been?

I don’t think so, but the pandemic has shed more light on the issue.

We’ve been learning more about the large gap in terms of income inequality over time. And we’re seeing a shift – if not a mass exodus – of people moving away from very expensive places like San Francisco, Seattle, New York, even Chicago, to places that are more affordable. But it’s the wealthier people who have the means to re-locate. People in the middle class are still confronting the need to pay for hosing in areas that are particularly expensive.

What do you think are the biggest challenges for states and localities as they decide how to spend their Rescue Act money?

The biggest challenge is that ARPA funding is only available through 2026. So, they should avoid using this one-time money on expenses that will continue into the future.

One particular concern is this: Even though there are restrictions that are supposed to stop states from using this money to cut taxes, those prohibitions don’t apply to localities, and I believe using the money that way would be a mistake.

Now is not the time to reduce taxes, particularly when the reductions are based on revenue that won’t keep coming in indefinitely. A lot of what I’m seeing suggests that the revenues localities will continue to bring in won’t make up for revenues that would be lost by tax cuts now. All they’ll be doing is creating budget gaps down the road.

As you take the helm of the GFRC, would you please comment a bit on the work that’s already been done?

I think the GFRC, under the leadership of Mike Pagano, has done a great deal of useful work.

I see the major focus issues so far as economic development, infrastructure, fiscal policy, and long-term obligations, like pensions.

We’ve done some particularly interesting research looking at state aid to local governments during the pandemic, using infrastructure investment as a counter-cyclical tool, and using state banks for economic development.

I’ve also been pleased, from the outside, to see the great variety of blog posts coming out every couple of weeks, written by some extremely accomplished people. These blogs make our research particularly accessible to practitioners and the general public.

What grand plans do you have for the future?

I’m really focused on ensuring the long-term financial sustainability of the GFRC, as well as elevating the recognition of the work we do, so it becomes more of a household name.

And then, I’d like to expand into some areas of research. One is looking at environmental policies at the state level. I recently did some work, for example, on a carbon tax at the federal level. However, Politico had a really great article recently that said it’s unlikely we’ll see that come to pass. So, I want to see what can be done by the states.

I also think that police-civilian relations is an important topic. And, while racial inequities and social injustice are important aspects of this topic, there are also real economic consequences here that are largely being ignored. For example, investigating allegations of police misconduct is expensive. Bringing cases against the police up through the court system is expensive. These are real costs for localities that are unnecessarily incurred by taxpayers.

Finally, what five words would you use to describe your vision of the GFRC?

Five words? I’d say: Ambitious, impactful, collaborative, inclusive, and informative.

Interview conducted by Katherine Barrett and Richard Greene, senior advisors GFRC

From your perspective, what flaw in the budgeting process is particularly available for improvement?

The budget process at the federal, state and local levels often has the executive agency proposing a budget and then the legislature reviewing it, and then changes are made and then the legislature authorizes, and the executive branch implements.  Typically, this can take two or even three years for an agency’s budget to be passed after the agency originally proposed it.

So, there’s lots of lag time?

Yes, lag time is a good way to put it. Another issue is not just the time, but the number of players involved. You need to have a certain level of review but depending on how many proposals and reviews are involved, there can be many steps between the agency’s proposal and a final budget document, and all the players involved do not necessarily add value to the budget.

Can you give a good example of how this could be remediated?

At the executive level there’s usually a budget office, a chief financial officer, a legal office, and more. They each have a perspective from which they review the agencies’ proposals. On the legislative side, there’s reviews at subcommittee, legislative and staff level.

They could create a budget with team-based approaches with offices reviewing in a collaborative way, rather than setting up a daisy chain where each office reviews everything individually.

How could this work?

A good process that has been demonstrated as effective gets everyone in a room – a real room or virually – at one time.

Would everyone involved be present?

You need to ferret out who needs to be in the room to make the decision, and who needs to be informed but is not critical to the decision process. In the federal government, for example, an inspector general’s office may need to look at ten percent of the items in a budget. But the office doesn’t need to be involved in the decision-making process for the other 90 percent. There’s a difference between people making a decision and giving people the information they need to know. Determining the key people who need to be in on the decision making, relative to and the people who ought to know about it but don’t need to be in the decision process.

And then?

You could envision a lead committee or office model, where one organization takes the lead for the process and then coordinates with other groups, so you don’t need to have several levels of reviews.

But isn’t it difficult telling people that they’re not going to be in the room where the decisions are made?

People who have a heads up on something may not need formal sign off. Of course, you send a proposal out to everyone and invite comment. Many groups will appreciate the chance to comment. They may give you an OK or they may ask you to add X or Y as you make progress.

It’s basically understanding the difference between decision makers and stakeholders. Government processes often lead to risk averse actions, setting up the process to make sure everyone who has a stake in one part are involved in advance in all parts.  That creates lots of processes and lots of time and resources.

Other reforms?

You can use technology to make the process more transparent and faster. Right now, budgets tend to be produced in PDF files that get passed along from person to person. But distributed technology platforms can have people come together and do the kinds of reviews that used to take weeks and months as you passed paper from one person to another.

Is the technology enough to make major changes?

No, you need an agile team, not just technology.

Can you help to describe what you mean?

An agile team for budgeting brings together key representatives from each organization involved in a particular decision and produces a vision of where they want to go, for example, in developing spending priorities for a particular program. And then they use an iterative feedback process with other stakeholders, in order to develop a spending plan.

You also don’t necessarily have to seek authorization for the full amount for a program. You can budget in increments, in pieces. And you can take the lessons learned from the first increment as you develop a plan for allocating the subsequent sets of funds.

Do biennial budgets help or hurt in creating a more flexible budget?

Biennial budgets are often open to flexibility in the second year. Biennial budgeting can be a good way to focus on the spending level in one year and then the management level in the other year.

Just to kick things off, what do you see as the broader issues being discussed among people who study state and local pensions.

Overall, we see the continued balance government employers are trying to make between comprehensive, quality retirement benefits and underlying benefit costs. While this focus is not new, it now comes against the backdrop of the COVID-19 economy and its impact on government budgets and pension plan financial health.

 What have been the big surprises recently?  

State and local pension funded ratios have been relatively stable. According to a brief released by SLGE and the Center for Retirement Research (CRR), for state plans, in 2020 they have an average funding level of 72 percent and for the locals they’re at 71 percent. Under expected scenarios, by the end of 2025, state plans will be funded, on average, at 68.2 percent, and local plans will be at 64.6 percent. With more muted assumptions, the ratio for states would be at 65.2 percent and locals at 61.7 percent.

So, are those projections troublesome?

While many governments will have to make larger contributions to the defined benefit retirement plans they sponsor, even with more conservative investment returns through 2025, we expect the vast majority of local and state plans to not have any cash flow issues. That said, for a small subset of plans with the lowest funded ratios, in the absence of substantial benefit reform, they may have cash flow challenges shortly after 2025.

So, as you alluded to in answer to my first question, is it true that the sustainability of benefits in a down economy will require adjustments by the city and state plans?

Yes. For many plans the employer and employee contributions may have to continue to go up. At the same time, we likely will see increased interest in retirement benefit arrangements that adjust contributions and benefits based on the underlying fiscal health of the plans.

What impact might that have on the workforce?

For many positions, wage compensation in the public sector is lower than for similar private sector jobs. So, if you are increasing the costs to employees to support their retirement plans, absent increased wages, you may be decreasing the attractiveness of public sector jobs. We’ve seen evidence of that phenomenon in surveys of HR directors. 85% of state and local HR directors believe retirement benefits offered are competitive with the labor market

That’s quite a conundrum, right?

I think of it as a Rubik’s Cube of challenges.  We have seen a wave of pension reform over the past decade that often has reduced the generosity of benefits and increased employee contributions with a focus on improving the financial positions of these public plans – which is important. But many miss that retirement benefits are workforce management tools that help with recruitment and retention – so changes that reduce the overall value of these benefits may impact governments’ ability to develop their current and future workforces.

All in all, despite all the alarming articles about public sector pensions, you don’t appear to be concerned. Is that right?

The sky is not falling. Public Pensions have gone through three economic downturns in 20 years and the vast majority are on sustainable paths, with the understanding that future reforms may happen. Looking forward, given all of the changes that have gone on in the public sector pension space, which may decrease the overall value of these pension benefits for many public sector workers, it is important that we continue to focus on the role of supplemental savings to ensure these workers have secure retirement and financial wellness to assist these workers in making sound financial decisions overall for the short and long term.

Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC; hyperlinks added by Joshua Franzel, subsequent to interview.

What is happening at the federal level around disaster spending and how does that affect states?

Federal spending on natural disasters is on the rise. Since 2005, the federal government has spent $460 billion on these events. As a result, there have been federal initiatives in recent years that seek to control that growing spending.

That’s an important issue for states, since spending on disaster assistance is highly intertwined across all levels of government: federal, state, and local. That means any change in disaster assistance policy at the federal level will affect state and local budgets. Our research has focused on the fact that the spending debate is happening without a clear idea of how much state and local governments actually contribute due to a lack of comprehensive tracking of disaster spending. That risks shifting costs from one level of government to another—instead of reducing overall spending.

Is this an issue that’s becoming more important over the years?

Yes, absolutely. In the last year, we have seen record setting wildfires in western states, hurricanes in eastern states, and flooding in the Midwest. Every single state has had a federal disaster declaration–the mechanism through which states become eligible for federal aid–since 2015.  

And, as more levels of government become involved in paying for a disaster, the more complicated it gets. Although FEMA leads these activities, altogether 17 federal agencies spend money on disaster assistance. Others include Housing and Urban Development and the Department of Agriculture. It’s a similar situation at the state level, with over a dozen different agencies and departments involved. 

That makes comprehensive tracking of that spending a challenge, but one worth surmounting, since governments can’t make strategic decisions about that spending. For example, with more information on what each state and local government is spending on each of phase and type of disaster, officials would be able to consider cost-saving initiatives like investing in mitigation before a disaster strikes. 

Have any states taken the lead in this important area?

When we first started our research in this area, 23 of the 50 states were able to provide some data about their disaster assistance spending—none of it comprehensive. Since then, several states have implemented policies to capture their total spending on these events.  

The first was Ohio, which established a system through its Office of Budget and Management and Emergency Management Agency to capture cross-agency disaster costs every time the State Emergency Operations Center is activated. Agency officials collect expenditures on personnel, equipment, state-owed infrastructure damage, and grants and loans to local governments for response and repair costs. Then, they send this information to the state’s Emergency Management Agency.

Virginia took a different approach. Its legislature passed legislation mandating more regular reporting of disaster expenditures by state agencies from the state’s Disaster Recovery Fund as well as contracts executed for disaster needs, to make sure that the lawmakers were kept well aware of what was happening with disaster relief around the state. 

What has your research shown about what states are doing in terms of paying for disasters?

While we don’t have a clear idea of how much states spend on disaster assistance, we do know that they use five common budgeting tools to fund that work. There are preemptive mechanisms that allow states to put money aside for future disasters; these include statewide disaster accounts and rainy day funds. State also employ responsive budgeting tools, which allow them to move money around during and after a disaster; these include supplemental appropriations and transfer authority. Another mechanism—state agency budgets—can be used either way. 

While most states use a combination of these budgeting tools—all 50 states use at least three of them—they do so in different ways. We believe that understanding those differences can help state governments assess if their current budgeting approaches are able to meet future needs. 

What should states be doing in light of the challenges of paying for disaster costs?

We have three primary recommendations for state officials to better manage their spending on natural disasters. First, states should track how much they are spending on disaster assistance—ideally broken down by type of disaster and phase of disaster (mitigation, preparation, response, and recovery). You can’t manage what you don’t track, and this is the clear first step for states to start tackling this problem.

Second, officials should examine how they pay for disasters, compare those strategies to what other states are doing, and then decide if they need to make any changes to be better prepared for future budgeting challenges. Disasters are becoming more frequent, expensive, and severe, and now is the time for government leaders to plan for how they will cover these costs in the years to come.

And third, states should consider cost-saving strategies like mitigation projects, such as elevating buildings or retrofitting infrastructure to reduce the impact of future events. Research from the National Institute of Building Sciences has shown that every federal grant dollar invested in these efforts saves $6 on average in post disaster recovery costs. We expanded on that work to show that this savings varies by state and type of disaster, from $7.33 in savings for high wind projects in New Hampshire to $2 for earthquake projects in Idaho and Indiana as well as fire projects in Arizona and New Jersey. Although the savings varied, mitigation activities in every state for every type of disaster saved at least double per dollar invested.

Can you help us understand the benefits of mitigation with a concrete example?

One example is performing earthquake retrofits of infrastructure. Another is elevating or acquiring flood-prone buildings. For example, North Dakota spent $226 million on flood control in state funds on flood control projects from state fiscal year 2012 to 2016. These activities are all about making investments on the front end to minimize future risk and save on future recovery costs.

Are there any states in particular that don’t need to consider disaster preparedness?

Not at all. Although people often associate disasters with hurricanes in Florida or wildfires in California, this is a 50-state issue. As I mentioned, since 2015, all 50 states have received a federal disaster declaration, the mechanism through which they are able to get federal aid.

And as every state faces the fiscal impacts of the COVID-19 pandemic, understanding the full impact of disaster costs—and how to manage them—is more important than ever.

Are any states acting on Pew’s recommendations related to disaster spending?

Yes, in addition to Ohio and Virginia, North Carolina is another example. After a devastating series of hurricanes officials in that state formed the North Carolina Office of Recovery and Resiliency to coordinate the recovery. Part of their mandate is to provide statewide reporting on how dollars are being spent and report on those expenditures. These are all important steps toward closing the data gap related to what we’re spending on disasters, which is critical to creating forward thinking solutions to manage rising costs.

At a time when state and local budgets are a mess thanks to COVID, do other alternatives come to mind in lieu of raising taxes or cutting services?

One anticipated effect of COVID might be increased pressure on municipalities to sell off certain infrastructure systems or assets. While the fiscal effects of COVID are still unfolding, cities have already honed the monetization of infrastructure – leasing or selling toll roads, bridges and other facilities, like parking garages – as ways to fill pressing budgetary gaps. I think those approaches are going to be very tempting in the coming months and years.

Of course these transactions require agreement between the governments that need money and private sector buyers, right?

Earlier rounds of infrastructure privatization in the 1990s and 2000s were met by willing bidders in the form of investment banks, infrastructure funds, sovereign wealth funds and the like. It is an open question of whether the desire to sell public assets will be met on the market side this time. What’s the appetite for risk? COVID will likely heighten buyers’ attention to the inherent uncertainties of some municipal systems. Not only are there still general uncertainties regarding how long COVID-related shutdowns will last, but certain kinds of activities may rebound more slowly than others. For example, public transit has been hit hard by declines in ridership so it’s going to be hard to see how public-private partnerships would work to the advantage of cities as a way raise new funds. If commuting patterns remain disrupted in the medium-term, then investors may not be excited to get involved in sale-leasebacks or other kinds of arrangements that depend on ridership growth.

So, is there likely to be resistance to public private partnerships currently related to COVID?

The generation of infrastructure deals in the mid-2000s raised a lot of concerns that cities were getting the raw end of the deal. That has translated into a lot more scrutiny for P3s.

Take airports as an example. Chicago tried twice to lease Midway Airport to private consortia. The first time, the financing fell apart in the aftermath of September 2008, when the stock market was in dire straights. The second time, the City responded to political pressure by adopting stricter rules on deal terms including a shorter lease and greater transparency around the deal. The result was almost no bidders were interested, and the city canceled the process. While cities may be under tremendous pressure to do infrastructure deals to address the revenue effects of COVID, the political landscape may be more contentious than it was 15-20 years ago.

This isn’t the only example of why the market may be wary of supporting public sector investments, is it?

There is certainly the question of how financial market volatility will affect buyers’ appetite for deals. After Chicago sold its street parking and downtown underground parking to Morgan Stanley in the late 2000s, the investment bank found itself facing tremendous losses in 2008 and re-chartered as a more traditional bank holding company to access federal support programs. This limited its ability to take on new partnerships. After the market downturns of March and April 2020 I think a lot of investors are similarly focused on repairing their balance sheets and riding the storm rather than aggressive expansion. While we see rumors in the financial press of large private equity firms amassing billions of dollars to purchase “distressed” assets, I don’t know that those firms will see value in partnerships with the public sector.

Is there a future in cities bringing in cash from private public partnerships?

Yes. Even if the landscape for big infrastructure deals has been shaky for some time now, we see emerging partnerships between cities and high-tech firms. Here, the infrastructure isn’t what you typically think of – roads, bridges, rail, sewers, etc. Rather, it is systems like closed circuit television or sensors embedded in the built environment to generate data about urban flows and conditions. Chicago’s Array of Things project is a good example; it is a public-private partnership involving Microsoft, Cisco, and Motorola. The revenue streams that are being capitalized in these partnerships aren’t user fees but data streams that can be sold back to cities to help them better manage urban problems like congestion, security, or air quality. Alternately, in examples like Google’s Fiber initiative or its proposed Quayside development in Toronto, revenue comes from enhanced predictive analytics that allow the firm to better target its advertising products. With the idea of contact tracking becoming so important in the post-COVID environment, I think there will be an explosion of interest in these kinds of sensor- and surveillance-based infrastructure partnerships.

Other areas?

Energy savings and climate change. Chicago has committed itself to reducing the city’s carbon footprint by retrofitting its own buildings with energy conservation measures. But the city couldn’t afford to go to the bond markets to borrow money for these investments; they had to find a way to finance the investments that was off balance sheet. So they turned to an arms-length financial consortium that borrowed money to install energy conserving measures (ECMs) which it repaid by pledging future energy savings. This doesn’t show up as new debt for the city. This is a different kind of privatization than roads or bridges, in that it targets not whole assets but selected parts of building systems that are sold off or pledged to private investors.

But what if the savings are lower than anticipated?

The fixtures are installed by a third-party energy services company (or ESCO) that also provides an energy savings guarantee; this means the city sees no “downside” risk if savings don’t materialize as the ESCO has assured a minimum level of savings. However, those assurances come at a cost, in the form of a financial return to the ESCO that is built into the capitalization of the deal. That means the city doesn’t necessarily see any actual energy savings at all throughout the 14-year life of the deal, as they are pledged to repay both the initial capital loan and the cost of the savings guarantee. The new fixtures may lower the city’s carbon footprint, but its utility bills are simply recommitted to private sector partners as debt service. Further, the deals introduce new kinds of counterparty risks; should the ESCO prove insolvent at any point, the city would have to take the capital loan back onto its books.

What do deals pursued in recent years tell us about the overall trends in the market?

In contrast to the marquee deals of the mid-2000s, what we’re seeing are smaller deals and the repurposing of many of the financial models/approaches to new applications like surveillance and climate change.

Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC

We’re dealing with a sudden and deep economic impasse, largely as a result of the coronavirus outbreak. Do you have any general comments about this national experience?

The big question mark is whether everything freezes now and goes back to normal when the economy opens up again. Or whether there will be longer-lasting economic and fiscal implications. Are we just hitting a pause button? Likely not, there are jobs that are not coming back, state, and local revenues that won’t be recovered and consumer behaviors that are changed for good.

The fast drop in economic activity, coupled with an enormous amount of uncertainty about the return of the virus make comparing this to other recessions very challenging. In this environment, projecting revenue shortfalls for cities is not easy, either from the national perspective or for those working in local government.

But we do have some indications about how specific city revenue structures respond to what’s happening in the economy, and that, combined with projected unemployment, is what we use to project how city finances will fare over the next few years.

Any particularly specific findings?

First, the revenue structure is highly variable from city to city, with some relying more on sales or income taxes, some more heavily on property tax revenue. The health and economic impact of coronavirus was also very uneven across the country. Put them together, and you’re looking at $100 to $150 billion in potentially lost revenues this year alone.  That’s roughly 20 percent of cities own revenues and fees.

Also, there are likely going to be big cuts in state aid, as the states are filling their own budget gaps. But our projections don’t include declines in state aid, meaning the fiscal problem may be even worse than we project.

Property tax is still a huge component, but it tends to lag the economy.  So, the vast majority of the shortfall is in sales taxes, income taxes, fees and services. 

That’s right. We’re finding that cities that rely most heavily on sources like sales, income and fees are feeling the brunt of loss of revenue right now. Cities that rely on property taxes are more likely to feel the brunt over the next year. But regardless of structure, given the broad economic impact, we know that nearly all cities are feeling constrained, whether it’s a pinch or a tight squeeze.

Anything more?

Cities are suspending and deferring fees, charges and taxes as economic stimulus. In addition, even when not deferred or suspended a lot of people can’t pay them.

Are raising taxes, to fill budgetary caps, a feasible solution?

From that perspective raising taxes may not be feasible. If, for example, you raise the sales taxes and everything is closed, it’s not going to make a difference. Also, many cities don’t have the authority to raise taxes on a whim, their ability is controlled by the state.

What about user fees?

Many of the activities for which those are used aren’t there at this point. That includes things like library fees and, many parks and recreation activities, that have been closed. Then there are summer camps, which can be a huge revenue generator.  But many have closed.

Just think of all the services cities provide, particularly in the summer months. In addition to the services themselves simply not being offered, we’re finding that cities are more in the mode of reducing financial burdens on residents and businesses, not adding to them with additional fees.

So, then is the only real alterative to be found in cutting services?

Personnel are being affected. Because that is the largest part if a city’s budgetary expenses. And for cities, when personnel takes a hit with furloughs and layoffs like we’re seeing, that equates to diminished services. Not just in parks and recreation, but also in less anticipated areas like public safety include fire, police and emergency medical technicians.

Is there any good data out there to give us a solid idea of the impact of cuts being made?

It’s been an interesting time to collect data! Cities have been very willing to share their experiences with us, from the types of service cuts, impacts on expenditures and budget shortfalls that they are facing. It’s also budget season, so they are trying to figure out a lot of this just as we are. We have a survey out now about local impacts of the coronavirus and will also release our City Fiscal Conditions survey this later summer, which will give us better look at how services and budgets are being affected.

What can cities anticipate from a third coronavirus package?

Federal support is certainly on the minds of state and local government leaders and advocates. We are hopeful that federal support will be available directly to cities of all sizes and be flexible enough to not only cover expenses directly related to corona virus mitigation, but also to help cover revenues lost as a result of swift economic decline. Providing this stability and certainty to cities as they prepare their own budgets will be crucial to a successful recovery.

Until the cash is in hand from the federal government are cities counting on it in forming their financial plans?

While we have good indications that cities will receive additional support, there are a number of questions out there. Most cities are not certain and are not forging ahead assuming they’ll be getting more from the feds

With a well-known legacy of outstanding work in fiscal affairs, David Merriman has been concerned about understanding the interplay between good data and society’s efforts to combat coronavirus. Merriman is Stukel Presidential Professor in the Department of Public Administration at the University of Illinois at Chicago and is leader of the Institute of Government & Public Affair’s (IGPA) Working Group on the Fiscal Health of Illinois. He is a member of the GFRC faculty advisory board.

This interview was edited with the approval of both GFRC and Merriman for clarity and accuracy.

How much of a problem is it when cities, states and the federal government lack current, accurate data about coronavirus?

I’m trying to understand the economic effects of the pandemic and its fiscal implications—what will happen to state and local government revenue and spending. I’ve been working with Cook County about its revenue estimates. But it’s incredibly difficult. Even though we’ve shut the state down for almost two months, we do not know the prevalence of coronavirus—how many cases there are in the general population. Since we do not know that, it is it hard to know when we can open the economy. Without knowing when the economy might open it is nearly impossible to predict the effect on government revenues and spending.

But the cost of figuring this out—getting good estimates of prevalence—is a pittance compared to the benefit. Anyone who has any idea of how to get this data should be funded. The money shouldn’t be a difficult challenge, because it’s so important.

You’ve said that it’s “nearly impossible,” to make smart economic policy if you don’t know its fiscal effects. What kinds of knowledge about fiscal effects are most critical?

The first thing you have to get right is what the disease will let us do in terms of economic activity and how long it will go on. The current way we are trying to figure that out seems to be trial and error. The analogy I like is that we’re putting our hands closer to the flame but if we get too close to the flame we get burnt.

And what happens then?

We head back a few steps in the adjustments we’re making.

What’s the one big question we should be able to answer?

Government hasn’t done a good job of communicating why we don’t have a better picture of the presence of the disease in the population. Without this kind of information, it is very difficult to do any other kind of policy analysis.

Aside from the obvious deficits of that kind of data for dealing with the pandemic, has the government failed in other data-related ways?

Government hasn’t done a good job at communicating why we haven’t gotten a better picture. The absence of certainty in the information the public receives endangers trust in the way people perceive government efforts. But if we made a better effort to explain why the numbers are often missing, that would help people understand what is really going on here; and could reduce the risk that some might believe the facts are being hidden.

Aren’t there alternatives to testing the whole population, one person at a time?

People in my field, economics, none of us can understand why there is not more random sampling. Maybe it is just too difficult. But I think that someone with a background in statistics could create a methodology that would lead us to some answers that are far better than those with which we’re working now.

Are there major obstacles to random sampling?

The barrier to doing random sampling is that when you do the sampling in one state or metro area, you’ll get different answers than you will from another. And you have to know many of the various factors that differentiate one place from another.

Creating a random sample is likely to be difficult. But statisticians and epidemiologists can figure out how to do it.

Are there other routes, in addition to a statistical sample, that could get us the numbers we most need to make policies that would lead to fiscal betterment?

One thing I think government has failed on is getting better information from the private sector including credit card companies, utilities, banks and telephone companies. These companies have lots and lots of data.

Can you give us a simple example of a particular kind of data the government could get from private companies that might help?

Well, for example, banks have data about how people are spending their money. No one is going out to eat now but we might want to know to what extent people are ordering food for takeout, to what extent they are purchasing things like clothes on-line. Google or other search companies could even tell us the extent to which people are searching for cars, houses, furniture, and other big purchases even if they are not actually making the purchases at this time.  That data could provide an early indicator of the economic activity we might expect as the economy opens up again.  All of that could help governments figure out what to expect in terms of sales tax and other revenues.

So, why aren’t we doing that? 

I’m not sure if industry has refused to provide it or if governments haven’t gone out to ask for it; It’s hard for me to see how there’s any threat to the proprietary nature of this data. While, for example, credit card companies, have long been paid a great deal of money for sharing data—sharing the type of data governments need in aggregate form should not inhibit sales of the more disaggregated data that the companies generally sell and providing it to governments now would be an important public service.

Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC

An interview with Rick Mattoon, a senior economist and economic advisor in the economic research department of the Federal Reserve Bank of Chicago. He is also an advisory board member for the Government Finance Research Center. He and his colleagues have long been concerned about understanding why Chicago’s economy frequently performs differently than other large cities. Here he discusses the evolution of his thinking. This interview was edited with the approval of both GFRC and Mattoon for clarity and accuracy.

What is the classical thinking about cities with thriving economies?

In the traditional literature, density is an advantage. This is referred to as agglomeration. At an industry level agglomeration is found in so called “clusters,” which supports productivity both within the cluster and across the city economy. That’s because they have an abundance of specialized labor as well as the ability to share key inputs all in one place. So, though a city can be more costly to live in, it is also more productive.

Can you help us define clusters?

First, a cluster isn’t an individual industry. It’s a group of industries agglomerating to a single output. For example, glass manufacturers or tire manufacturers are part of the same cluster as Ford, GM or Chrysler.

So that sounds like a great thing. Why hasn’t it seemed to apply in Chicago (and we presume elsewhere)? Has it applied in Chicago?

It’s really not so much a matter of having clusters, but how the clusters relate to one another across the economy. Do the clusters actually complement each other, or do they compete with one another? For example, Chicago has large consulting sector, and a large financial services sector. They compete with one another for computer or advertising services, and that bids up the prices for those services. The cookbook approach has been that all you want is to have more clusters and bigger clusters are better, but that doesn’t work for all cities.  The key question is do the clusters complement each other or compete with each other.

How should the city react to this notion as they plan for economic development?

You have to understand what resources the cluster is going to need. In Boston and San Francisco, they grew very large industries for which they didn’t have the necessary human capital. But they were able to produce the human capital because, as we termed them, they were high amenity cities.  High skilled workers have choices in where they want to work so they tend to select cities with great amenities.

That’s good news for Chicago, isn’t it?

Chicago does have amenities, and we’re cheap. But it’s really the legacy industries in Chicago that can be problematic, like finance, insurance and real estate as well as mature food and package goods companies. Legacy industries can still be profitable but aren’t fast growth.

So, how should Chicago take advantage of that?

The city must understand where demand comes for its economy. They have to advance train for growth in new fields.

Can all cities apply this approach?

It’s an illusion that every city can compete. According to most of the literature, human capital is the most important thing for predicting the economic vitality of a city. A city must either produce and retain it for key industries or be able to attract it. One of the reasons Chicago has always had a particular strength in accounting is that University of Illinois has always had one of the best accounting schools in the country. Firms end up chasing workers, they have to go where human capital is.

Of course, human capital isn’t the only factor, right?

Right. It’s important to see where your assets are and seeing where you have an advantage. In Chicago, for example, you have O’Hare Airport, and that leads to strengths in knowledge-based service industries. These types of professional services are what Chicago can trade with the world, but these workers need to be able to get to these markets. O’Hare is city controlled and is a hub for both American and United, in addition to its international terminal. You can’t say the same think of Akron, for example, because people and goods can’t easily get there quickly.

 But you’ve indicated that Chicago has often underperformed other cities. Has it made appropriate use of O’Hare?

O’Hare has evolved to support Chicago industries that trade across the US and the world.  However, much of Chicago’s historic trade is supported by truck and rail and focused on serving Midwest markets.  As the Midwest has shrunk in its relative economic position, you need to pivot to serving markets that are fast growing.

 Has Chicago’s economy begun to change to a faster growth model?

Even 10 years ago Chicago had a negligible tech sector.  Today, the Fulton Market neighborhood has become a magnet for investment by technology companies and even older firms such as McDonalds who relocated their headquarters to this amenity rich neighborhood.  In almost every case, firms that chose this location suggested that the ability to attract high-skilled human capital was the number 1 factor in the selection.

Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC

An interview with Josh Drucker, Associate Professor of Urban Planning and Policy, University of Illinois at Chicago, faculty advisor to the Government Finance Research Center, and long-time researcher into and writer about economic development. This interview was edited with the approval of both parties for clarity and accuracy.

Why should we care about economic development?

One reasonable perspective is that everything comes down to economic development. For example, people may think of the environment as being in conflict with economic development, but well-thought out development can positively impact the environment. On the other hand, without taking the environment into account, development can be a negative factor.

The fundamental thing that places do for economic development is to get people jobs. That’s a pretty broad area, jobs. But ultimately, politicians are judged by whether their communities have plans to create opportunities for people.

At what levels of government are there the most thought and control over economic development? For example, how about the federal government?

We should have more planning for our economy at the federal level. But there’s a belief there that it’s the private sector that should be directing the economy instead of the government. The last time the federal government was deeply involved in charting the course of the economy was during the Great Depression, when massive regional projects such as the Tennessee Valley Authority were integrated with creating jobs.

Almost every other developed country has an industrial policy. Though we have industrial policies that affect different industries, we have no intentional, coherent economic plan for the nation as a whole.

And the states?

The states are picking up much of the slack. They direct the activities of public universities, they award science and technology grants, and even the money that they invest from their pension plans – that forms de facto industrial policy. They are much more directed toward building their job base than is the federal government.

Cities and counties?

Very large cities like Chicago and New York can act like states. They have good universities, staff expertise, lots of resources and assets.

For many other cities and counties, I think there is a great deal of innovation in terms of developing their economies effectively. New ideas and approaches often bubble up from the local level, with policies from dedicated manufacturing zones to targeted venture capital funds to innovation districts. The politicians who run cities are often judged by whether they create quality job and career opportunities for residents.

In smaller localities, though, many of the economic development departments are stretched to do more than keep up a website, answer requests for information, and refer inquiries about state programs.

Is there a conflict between the ways in which economic development serves citizens versus companies?

Politically, we focus on satisfying the needs of employees and the needs of employers, and we need to do a better job matching the two. But we separate the two systems. I think we can do a better job of matching people’s talents with the jobs that are available.

Too often, a city will say we want to develop a particular industry, say biotechnology, but the city is in a location that doesn’t produce many biotech-qualified employees. Governments should be in the long-term business of training people for the jobs that are or will be available.

Workforce development most often focuses on individuals. Economic development tends to support corporations. We need both to work in concert.

Should we be putting more emphasis on specific skills learned at universities, rather than liberal arts degrees that may not prepare someone for particularly needed positions?

I don’t think so. Liberal arts degrees can be effective for economic development. Employers want students to be skilled at reading and writing. They also want them to possess numeracy, computer skills, and so on. And then they can move on from there. In fact, lifelong learning is really crucial for improving the whole of the employee-employer matching process. We need to coordinate community colleges, workforce training programs, recertifications, and so on.

Government can subsidize and support these programs, perhaps by providing tax credits to train people. Or certification processes can assure that the programs people enter are genuinely high-quality.

As new needs develop in the economy, are there any particular obstacles to people changing their lives to fill them?

Yes. For one thing, we currently have a tight labor market, with fewer people looking to make changes to fill shortages. And tightened immigration lessens our opportunities to bring in well-skilled or well-trained employees from abroad.

How much of a problem is interjurisdictional competition, through incentives?

Incentives mean that governments forgo revenues that could fund important areas, like education. When neighboring communities are doing exactly the same thing as one another in order to attract jobs, neither secures an advantage, and it prevents the kind of cooperation among communities that can benefit all of them. It’s inefficient. When nearby cities or counties compete, they can easily wind up in a worse spot than if they were able to work together.

For example, Amazon recently asked almost every state in the country to make some kind of incentive bid for its new headquarters. It wound up originally choosing northern Virginia and New York City (Queens), which didn’t offer the largest incentives packages but did present attractive environments, including highly educated workforces, advanced infrastructure, and urban amenities. Yet Amazon was surely able to push the incentive packages they got upward, by creating competition from coast to coast.

Our legal system doesn’t have a ready solution to this issue. In Europe some countries outlaw this kind of competition. But in the United States, state and local governments cannot achieve lasting détente, and our federal government doesn’t have the aspiration to impose it from above.

Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC.