Keep An Eye on the Economy During the City Budget Planning Process

By Deborah Lynn Blumberg

Minnesota’s economy, much like the U.S. economy, has made great strides in recovering from the impacts of COVID-19. Both have returned to pre-pandemic paths of growth, jobs markets have improved, and wages are up. But the speedy recovery just three years after the pandemic began also presents significant risks.

The continued increasing prices of goods and services has set the U.S. Federal Reserve on a persistent mission to cool growth and bring prices down by raising interest rates. The U.S. economy, however, has resisted, holding strong despite 10 consecutive rate hikes from the Fed. Many economists, however, see the U.S. economy finally relenting this year, and they’re forecasting a recession later in 2023.

In this challenging, unpredictable environment — as Minnesota cities embark on their budget planning process — officials need to plan for a potential downturn and a difficult climate of shrinking consumer and business spending.

“These are uncertain economic times, and cities have to be more exacting,” says Mark Ruff, finance director at the League of Minnesota Cities. “Contingency planning becomes that much more important.”

Minnesota’s economic climate

According to Minneapolis Federal Reserve Regional Outreach Director Ron Wirtz, Minnesota reflects the national economy well in terms of both trends and the state’s overall mix of industries. Still, while economic growth in Minnesota has vastly improved since the worst of the pandemic, it has tended to lag the overall U.S. recovery in both its gross domestic product (GDP) and employment market.

For example, Minnesota’s GDP rose 1.3% in the fourth quarter of 2022 versus 2.6% for the U.S., according to the Bureau of Economic Analysis. The most recent data show the U.S. economy grew at a 1.1% rate in the first quarter of 2023. In Minnesota, the corresponding data have yet to be released, though signs suggest Minnesota saw flat or slight growth.

Minnesota’s consumer spending has not disappointed, however. “Generally speaking, we’ve seen very strong consumer spending in Minnesota,” says Wirtz. The most recent figures show Minnesota personal consumption expenditures at some $277 billion in 2021, up from around $252 billion in 2020.

Minnesota’s employment market is much improved, having returned to its pre-pandemic level. From the depths of the pandemic low, job growth has been steady, Wirtz says. In January 2019, the state’s employed population was at 2,976,000. By February 2023, it rose to 2,983,000.

“We’re still seeing strong job postings, and that’s a good sign,” says Wirtz. “It’s a very strong signal for the market. To be out in the market looking for full-time workers is a signal that employers see some optimism in the future.”

Wirtz gives frequent talks to business audiences, and he takes the opportunity to survey attendees on a variety of metrics, including labor demand. “Overall, businesses consistently say their businesses are hiring in some capacity,” he said.

The Minneapolis Fed’s formal survey work consistently shows healthy labor demand from businesses. In a mid-April survey of more than 250 construction companies, a majority of whom were from Minnesota, almost half of respondents said their companies were hoping to add to their total headcount over the coming six months. This, despite the fact respondents also reported that the sector was seeing some signs of slowing.

“Their overall sentiment for hiring is quite positive,” Wirtz says. “Employment markets are still healthy and that’s a great sign. Whether that continues depends on inflation, higher interest rates, and all the other things businesses are still dealing with.”

That includes potential economic weakness spurred by the banking sector, following significant banking failures like that of Silicon Valley Bank and Signature Bank.

One trend to keep an eye on, Wirtz adds, that’s prevalent nationally and in Minnesota, are overall lower rates of labor force participation. It’s a development that’s driven in part by retiring baby boomers and lower birth rates, with younger generations tending to have fewer children, leading to a declining population of working age people.

“Minnesota has always had a higher rate of labor force participation,” says Wirtz, “but it’s been in decline.” Recent data show U.S. labor force participation at 62.6% in March 2023, while Minnesota’s participation was at 68%. That’s down, however, from a recent high of 72% in June 2020 and nearly 76% in spring 2001.

How an economic downturn could impact city budgets

For Minnesota cities, it’s important to remember economic impacts tend to lag for local governments, Ruff says. So, in terms of budgeting for 2024, city officials should remember that even if a slowdown does hit, its effects — including potential real estate market weakness — likely will not materialize until a few years later.

With real estate, “it’s often less about the fact that values are going down than it is about which types of property are going down most dramatically,” adds Ruff. Is it commercial, owner-occupied homes, or residential rental? Cities should talk with their assessors to learn about changes in their community’s values, and run scenarios about likely tax impacts for each group months ahead of setting the 2024 or 2025 budgets. Also talk to the county and the school district to see what their plans are for their tax levy. Coordinating tax levy changes and messaging with other jurisdictions can help ease overall tax burdens.

Minnesota cities in recent years have been fortunate to experience consistent construction of single-family homes and apartments, which has meant building permit revenues have been consistent too, Ruff says. But in the current economic climate, “building permit revenues could dry up in a hurry and strain city budgets if corresponding expenses can’t be ratcheted back quickly.”

“We’ve had a long period of time with steady growth,” adds Ruff, “and that could lull people to sleep a bit.” It shouldn’t. Officials need to strategize now about how they’d respond to a pull-back in building permits, sales taxes, fees, or other forms of revenue more immediately tied to changing economic conditions. Being cautious about forecasting these revenues in 2024 is a good hedge given today’s uncertainty.

Similarly, officials should not rely on increased investment income due to rising interest rates to fill big budget gaps. That’s risky, says Ruff, because if a recession comes, rates could fall — maybe even sharply.

More broadly, city officials need to have contingency plans to identify where they can cut if these revenues unexpectedly drop mid-year, he says.

“You have to be thinking — can I live without adding a new staff member, buying that new fire truck next year, or getting the new street sweeper? Cities need to agree internally ahead of time on things they’re OK cutting.”

Wages remain high, job market strong

Considering the still strong jobs market in Minnesota, Ruff says cities should be careful when looking at wages as a potential area in which to cut back. “I think people will continue to demand higher levels of compensation,” he says, “and I wouldn’t necessarily count on lower wage increases as being a given if a recession hits.”

Filling open city positions, in particular, could continue to be a challenge, adds Lisa Sova, assistant finance director with the League. “It’s a very challenging market right now as far as attracting and retaining employees because there are so many opportunities,” she says.

Cities are struggling to fill open positions more than they have in the past, and that may not let up any time soon. To avoid overburdening current staff, cities “need to look at delivering services that residents expect in different manners,” says Sova. This might include using technology to a higher degree than cities have in the past, streamlining services, looking for synergies to reduce procedures, and doing more with less.

Planning projects and expenses during unpredictable times

Cities also have to weigh the costs and benefits of continuing with planned capital improvement projects if a recession hits, Ruff says. He cautions, however, against a knee-jerk reaction to halt all projects amid a slowdown.

“Just because there’s a recession, that doesn’t mean there should be no investment whatsoever,” he says. Instead, evaluate situations on a case-by-case basis and get creative. For example, instead of paying cash to complete a major construction project, borrow money and pay off the bond over the next three years.

Don’t try to time the market, though, he says, by waiting for a recession to come before embarking on a project because you think building and borrowing costs will fall. “We can’t assume construction costs will be cheaper in two years,” he says. “Start your project or borrow the money you need when you and your community are ready for it.”

Sova says cities that still have American Rescue Plan Act relief funds to spend should be conscious of upcoming spend deadlines. Any project to which cities want to apply funds needs to be underway by year-end 2024.

Another helpful exercise for cities, adds Ruff, is to think about where a city may be purchasing its goods or services. Which types of expenditures are more predictable, based on the item — computers, police cars, for example — and how do you procure the items? What’s your relationship with the vendor?

“This can be a different way of prioritizing your spending,” Ruff says. “Relationships and history still matter when it comes to predictability. When you know your budgeted cost is likely to be the same as the actual cost, you may prioritize this expenditure over another item that could be 50% higher when the bids come in. This gives you time to explore your options.” What’s more, a better way to solve a budget shortfall is to adjust several line items as opposed to one or two. “That requires work ahead of time,” says Ruff.

Grants can help fill funding gaps

Finally, grants and similar types of funding will matter more in the coming year for cities — especially since most pandemic-related funding has ended.

The League’s Grant Navigator helps cities that find the grant search and application process to be overwhelming, or that lack staff to research, prepare, and submit an application. The pilot program has allocated $500,000 to assist cities of all sizes in hiring grant writers to help find and write grants for projects. Program applications are reviewed on a rolling basis. “This is a good time to be looking at grants,” Ruff says.

Adds Sova, “Cities always try to find grant money, but it’s time consuming. Now, more than ever, it’s worth putting that effort in to bridge the gaps.”

Deborah Lynn Blumberg is a freelance writer.