The Second Order Effects of Work From Home
Buy the rumor, sell the news
Municipal finances are brittle and don’t adapt well to sudden changes.
Cities generate revenue in a few ways, including via taxes, bond issuances, and transfer payments from their state and/or federal government. When taxes decline due to exogenous factors such as covid-induced work-from-home policies that employers have put in place, cities have to find a way to offset that lost tax revenue. These options are mainly:
issue more debt
receive more money from the state and/or federal government
reduce spending
some combination of the three options above
But cities can’t easily reduce spending because many of their expenses are mandated by law: payments to city workers, funding pensions, maintaining jails, public hospitals, public schools and universities, transit, etc. Cities often can’t receive more money from their state and/or federal government due to political concerns at the state and/or federal level. The ability to issue more debt is a function of the city’s credit rating, alternative uses to which investors’ money can be put (more creditworthy opportunities), and other capital markets factors beyond the city’s control.
Unlike with private companies, municipalities can’t dynamically adjust their expenses to offset declining revenues. When companies encounter tough times, they often radically restructure their labor force through mass layoffs. Cities can’t easily lay off many people due in part to labor protections, but due, as well, to legal requirements that they provide certain services to taxpayers.
Cities, therefore, have a balance sheet problem. I wrote a Twitter thread about this problem this morning:
To summarize: cities have balance sheets, just as companies do. Cities’ assets grow mainly through tax revenue, and their liabilities grow by legislative diktat. This means that, unlike with a business, a city has very little flexibility when tax revenues decline. When tax revenues decline, then flow to the asset side of the balance sheet declines, as well. This is the situation in which New York City presently finds itself. Because a lot of the city’s tax revenue is derived from commercial tenancy, the collapse of the commercial real estate market due to covid-induced work-from-home policies has meant that the city’s tax revenue, and so asset base, has declined.
Yet the city is still required to spend enormous amounts of cash on running schools, hospitals, transit, government employee salaries and benefits, pension payments, etc. Where a company can restructure itself through the bankruptcy courts, and emerge leaner and more flexible (in theory) on the other side by shedding debts, cities can’t easily do that.
And, even if cities are able to reduce their liabilities, they don’t have an easy way of increasing revenues and therefore assets, bar taxation.
If a structural shift in employment has occurred such that demand for conventional office space is in permanent decline, then New York City’s tax revenue will look very different going forward. Cities don’t have the flexibility that private businesses do: if a revenue source dries up for a city, they can’t easily enter a new market, acquire a competitor or otherwise grow their revenues.
So, anyone who proposes a solution for New York City’s current woes must contend with the decline in the asset side of its balance sheet. Either revenues, primarily created through taxation, have to increase to pre-pandemic levels, or the liabilities side has to decrease proportionately. But because those liabilities are tied up in legislative processes, and therefore have political import and implication, reducing those liabilities is not as simple as firing people en masse, discontinuing product lines, hiving off business units, or raising new capital,.