Detroit has highlighted the problem local governments across the country face. They spend more money than they receive in taxes.
For 2013, local governments will spend about $1.6 trillion, while revenue totals about $1.1 trillion. The resulting deficit is partly financed by transfers from the federal and state governments. Some of the shortfall is funded with the sale of municipal bonds.
Federal deficits have been the focus of attention, but local debts deserve equal attention. Cities like Detroit have pushed the problem off as long as possible, but eventually, deficit spending must be addressed.
Just like at the federal level, these deficits have led to debts. While the federal debt tops $17 trillion, less noticed, but equally problematic, is the $1.8 trillion in debts owed by local governments.
Unlike the federal government, cities and counties are not allowed to print money. Repayments are dependent on tax revenue.
Local governments can increase taxes, often with little difficulty if the costs are passed on to non-residents. This is commonly done in the form of hotel taxes and fees on tickets at local attractions.
Unfortunately, higher tax rates do not always lead to increases in revenue. Since 2011, local tax revenues have actually declined. This is partly due to decreasing real estate values, which lower property tax receipts.
As real estate recovers, local governments may be tempted to increase taxes, which would decrease values again.
Home affordability, and subsequently values, is determined by the monthly payment relative to income. Income is growing slowly, which means any increase in taxes will need to be offset by decreases in home values so that mortgage payments for homebuyers remain steady.
Reduced spending is the only long-term solution for the debt problems that plague the federal government and local communities. Unless spending is cut, Detroit will only be the first of many municipal bankruptcies in the news.
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