Municipal Finances Persevere During Recessions Dana Sparkman, CFA, Senior Vice President/Municipal Analyst, The Baker Group As we move through 2023, the possibility of a recession is at the forefront of most investors’ minds. Fortunately, most municipalities are in a good starting place for a downturn. Tax revenue has soared recently, and federal aid has also helped to boost the balance sheet of state and local governments. Many issuers have reported record-high budget surpluses and/or all-time high reserve levels. Municipal bond defaults have been very low at only 0.04% in 2022, down by over 21% from 2021 levels according to Bloomberg data. Further, municipalities generally have weathered economic downturns very well, largely due to resilient tax revenues.Chart 1 Most local governments rely heavily on ad valorem, or property, tax revenue as shown in the chart above. Property tax revenue rarely declines on a broad basis, but when it does, it tends to lag the economy. Federal Reserve Economic Data (FRED) reveals that while median home sales prices fell by over 6% in 2008 and 2009, property tax revenue increased at the same time, was flat in 2010, and fell by only about 1% in 2011 before it continued a positive trajectory. This is the only time total property tax revenue has declined since at least 1992. Given the recent boom in home prices, it is unlikely that assessed valuations would decline if we encountered a mild recession in 2023.Chart 2 Sales tax revenues, the second largest source of tax revenue for both state and local governments, also declined for the only time since 1992, during the Great Recession: 5.6% in 2009 and 2.3% in 2010. Sales tax revenue experienced a slowing of the growth rate, but not a decline, during the 2001 and 2002 recessions. However, income tax revenues, a major revenue source for state governments but not usually local governments, are highly correlated with economic activity. In two of the last three recessions, aggregate income tax revenues declined significantly: 11.3% in 2002 and 17.6% in 2009. Despite these declines, state revenues recovered quickly and have since grown tremendously. On the other hand, economic downturns can worsen existing credit issues and impair elastic revenue streams. Moody’s reports that the frequency of municipal bond defaults increased during and after the Great Recession, with an average of five new issuer defaults per year from 2008–2017 compared to an average of two new defaults per year over the past 50 years. According to Moody’s, there were 38 defaults from 2008–2017, excluding Puerto Rico. From 2018–2021, 24
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