Municipal Finance in the Era of the COVID-19 Pandemic
States and cities in the US are facing an acute shortage of funding for critical infrastructure and services caused by the costs of COVID-19 response, which have only partially been addressed by Federal funding, and a decline in their traditional revenue sources. Now is the time for creative and thoughtful solutions to address revenue shortfalls and plan for the future. We propose micro/mini municipal bonds supported by the Codefi Assets digital platform as one tool municipalities can use to bolster their balance sheets.
COVID-19 is causing a historically extreme impact on our lives
The scale and rate with which the COVID-19 pandemic has impacted our lives is extreme, even when set in the context of over 100 years of economic history. A good proxy for the historically relative scale of its effects is the number of jobs lost. In the US, over 22 million people lost their job in the first half of this year, the largest decline on record, representing 1 in every 7 people who were employed.
Coinciding with severe lack of state and municipal resources
This is also the time when thoughtful community assistance will have the greatest impact on outcomes for decades to come. However, the resources state and local governments have at their disposal are plummeting. The National Association of Counties (NACo) estimates a ~$114Bn decrease in revenues derived from sales taxes, gross receipts and other charges. This represents an overall ~17% decline in county budgets. While incremental costs associated with COVID-19 response are estimated at ~$30Bn.
Aside from critical front-line services and long-term infrastructure investments, education and childcare are particularly exposed. A common fallacy is that US K-12 funding comes solely from property taxes, that being said, it does have an oversized impact. While it is typically true that a vast majority of K-12 funding comes from local and state budgets, the National Center for Education Statistics data for 2015-2016 suggests that public elementary and secondary schools got about 8% of funding from the Federal government, 47% from state governments and 45% from local governments. With about 81% of those local revenues derived from property taxes, just over a third (about 36%) of all school funding came specifically from property taxes.
But this still can result in skewed outcomes for a variety of reasons. For example, in Colorado only 6% of K-12 education is funded by the Federal government. State revenue, however, is matched to local standards of living. Thus funding is tied to often drastically different standards of living. For example, relatively affluent Aspen spends $14,090 per student, whereas Boulder spends $9,247 and parts of the Denver Metro Area spend as little as $6,958, according to a 2016 NPR study.
This disparity plays out across the United States, and it is in significant part driven by the interplay of local government funding from property taxes. Even in New York state, which has some of the highest and most homogenous funding of K-12 education in the US, you still have a huge range, with New Rochelle spending $18,809 per student, Highland Falls $28,198, and Onteora $42,715. This takes on a new urgency in 2020. NY Governor Cuomo started the year by proposing a 3% increase in local government spending to direct more funds into poorer school districts. Since the NY PAUSE order and the devastating impact of COVID-19, particularly on lower income and minority communities, Governor Cuomo is looking to the Gates Foundation for assistance to “reimagine” schooling. Nonetheless, NY along with many states is looking at a huge budget shortfall, which has not yet been met by Federal relief funding. The $150 billion Coronavirus Relief Fund can only be used by municipalities for “payroll costs for public health and public safety employees are payments for services substantially dedicated to mitigating or responding to the COVID-19 public health emergency”. Furthermore, unlike the Federal government, which has broad authority to print money; 49 out of 50 states have balanced budget requirements, which means they cannot spend above revenues brought in.
Besides a revenue shortfall created by lower fees, charges and sales taxes, states are also to varying degrees impeded by existing legislation. For example, Colorado’s Galaghar Amendment requires that 45% of the total amount of state property tax collected must come from residential property, and 55% of the property tax collected must come from commercial property.
Residential property taxes are fairly resilient to the COVID-19 pandemic since they are levied on the properties’ assessed values (which are typically significantly lower than market values, and, therefore, less volatile during financial crises). As a result, they present a more stable revenue stream. However, the commercial real estate market is far more volatile and can lead to decreases in commercial property tax collection, which then, under the Galagher Amendment, requires a decrease in the residential property taxes collected.
Taken together, Colorado now expects a 25% decrease in expenditures this year.
While the Federal government is effectively propping up the entire economy, including corporations, it has so far effectively excluded states and municipalities
The Federal government has released an unprecedented $2Trn+ stimulus. At the same time, the Fed signaled a “whatever it takes” approach to propping up the American economy, including supporting all corporate debt that was rated as investment grade prior to the COVID-19 pandemic. However, while indicating it might do so, the Fed has so far not taken such a stance towards states or municipalities, neither a program to purchase municipal debt, nor any other proposed form of relief beyond the Coronavirus Relief Fund.
Moreover, Senate Majority Leader Mitch McConnell stated on April 23rd that he “would certainly be in favor of allowing states to use the bankruptcy route…we’re not interested in solving their pension problems for them…we’re not interested in rescuing them from bad decisions they’ve made in the past.”
This has resulted in the Bloomberg Index of Moody/S&P, AAA-rated, 30yr callable Municipal bonds trading at ~60bps spread to 30yr Treasury bonds. This is two standard deviations above its average of ~8bps over the past decade.
Moreover, Apple’s recently issued 30-year bond with a yield at 2.60% is roughly inline to Georgia on a tax-equivalent basis. As Harley Bassman points out, “while it is a near certainty that Georgia will pay off its obligations (just raise taxes), the same cannot be said about Apple. Recall that Motorola, Nokia, and Blackberry at one point also offered a ‘must have’ phone.”
In plain terms, as a result of the Federal government’s moral hazard qualms, states and municipalities have a tougher time raising capital to fund immediate needs such as an effective COVID-19 response, education, and child-care, than corporations do.
It comes down to local communities, but communities often lack scalable mechanisms by which to fiscally recover by themselves
Unless the Federal stance changes, local communities will have to come up with creative and thoughtful solutions to avoid revenue shortfalls impacting critical services.
While we have witnessed many uplifting stories of generosity from private donors such as the Gates Foundation, there remains an urgent need to address the crises at a larger scale.
Codefi can help local communities with targeted fundraising campaigns using blockchain technology
Crowdfunding platforms such as Kickstarter and GoFundMe have proven successful at connecting product and mission oriented individuals with projects they care about and would like to support. As we look across our digital asset ecosystem globally, we find a strong sense of community and desire to help locally.
With this in mind, we have created Codefi for Municipalities, a funding platform tailor made for municipal finance built on top of the Codefi Assets platform, to enable residents to support and participate in their community’s development.
Local community investment has significant room for improvement
Municipal bond issuances today are relatively challenging to invest in, even when the denominations are at $5,000. The paperwork is certainly less than intuitive, and usually relates to large general uses, rather than project specific raises that would be likely to engage a local resident. As a result most local resident purchasers purchase municipal bonds through a broker dealer or registered investment advisor. By contrast, Codefi is designed with a great deal of focus on being inclusive and easy to use with a familiar feel to mobile banking, while still ticking all the compliance boxes.
There is undoubtedly investor interest in this kind of approach to financial technology. Breaking down accessibility barriers has created explosive growth for user-friendly brokerages like Robinhood, which has more mobile monthly active users than Fidelity, Etrade, TDAmeritrade and EdwardJones combined. Mobile banks such as NuBank have about the same number of monthly active users as Chase Bank with user growth doubling each year, compared to Chase’s ~10% annual growth rate. We believe there is an even greater opportunity in the municipal space, given that investments in local projects have a concrete and tangible impact on their residents’ lives.
Digital platforms bring greater transparency to municipal financing and lays the foundation for other opportunities to increase civic engagement. Codefi can enable residents to track and have an opinion on how the funds are used. For example, with proposed integration into blockchain voting functionality, through either hard or soft voting, local investors can voice their opinions on everything from the color of the slide in the local playground funded through Codefi, to broader concerns around whether the funds are being used effectively. The platform can also be used, with a digital identity solution to give access to particular events, viewings and other ways of participating in the funded project.
Furthermore, municipalities which issue debt to fund local projects often do not have direct access to their investors. This makes ongoing investor engagement difficult and hinders the dissemination of project related information. Similarly, investors are often large asset managers who are not directly impacted by the use of the funds outside of the bond’s financial return. Codefi provides municipalities with up-to-date investor information so they may engage their local residents in the fundraise.
Finally, issuing bonds directly has historically meant cities had to deal with significant back and front office complexities, which due to cost, skill gaps, and/or lack of available technology, either prevented municipalities from self-issuing or limited the offering to original discount issues, high denomination bonds, and physical certificates. Codefi automates bond issuance and many back-office processes, thereby empowering the city to self-issue debt in denominations as small as $100, although Codefi can equally be used as part or the whole of an underwritten offering.
Written by Emma Channing, Alex Kostura, and Tim Pusnik Jausovec