Local Government Finance: Capital Facilities Planning and Debt Administration by Alan Walter Steiss

GOVERNMENT RESPONSIBILITY FOR CAPITAL FACILITIES

Two fundamental government responsibilities stem from the broad objective to "promote the general health, safety, morals, and public welfare": (1) the regulation of the action of individuals to ensure that they will not be detrimental to the general public; and (2) the provision of public services and facilities for the mutual benefit of all or a majority of citizens. The imposition of regulations and controls in the public interest is as old as history itself. Of more recent origins, the provision of public facilities and services has become widely accepted as a basic responsibility of government in contemporary society. Segments of the public may complain when taxes are increased to provide new schools or to expand public welfare programs. It is generally acknowledged, however, that significant economies can be derived from such government activities--economies that could not be achieved if each citizen had to provide for these facilities and services on an individual basis. The availability of public facilities can have a profound effect on the form and functioning of a community. Such facilities represent very large investments of public resources, usually exert their effects over period of many decades, and are not easy to modify once built. Therefore, a systematic planning effort is vital in making decisions about the construction and financing of public facilities.

Components of Capital Facilities Planning

Capital facilities planning can assist public officials in the development of long range capital investment strategies by:

(1) forecasting population needs and economic conditions;

(2) analyzing future revenue and expenditure requirements;

(3) evaluating the costs and benefits of alternative investments; and

(4) assessing various fiscal policies and methods of financing capital facilities.

Capital facilities involve expenditures of a non-recurring nature, designed to provide new or expanded government capacity for the delivery of public services. The primary objective is to guide the provision of major public facilities of large-size, fixed nature, and/or having a relatively long life within the limits of available public resources. Thus, providing capital facilities in the most effective and efficient manner must involve planning, programming, and financing, and debt administration.

The Planning Phase

Long-range planning of capital facilities has lagged significantly behind other development in the field. As governments began to assume greater responsibilities for the provision of public services and facilities, only the most evident needs were addressed, and these needs often were dealt with in somewhat haphazard fashion. As recently as 1910, state and local governments made no provision for the overall supervision public expenditures through a comprehensive budgetary process. Urban development during this period was characterized by the uncoordinated construction of public works. If any financial resources remained after the most obvious obligations were met, other projects might be initiated.

Long-range capital facilities planning provides a means of assuring that projects will be carried out in accordance with a well thought-out and defensible system of priorities reflecting both public needs and the government's ability to pay. It promotes coordination among the various departments and agencies of government and thereby helps to circumvent overlapping or conflicting programs. It protects against undue influence by pressure groups, representing special interest, which may attempt to force the adoption of "pet projects" at the expense of more urgent or more meritorious improvements.

Through capital facilities planning, required bond issues or other revenue-producing measures can be foreseen and action taken before the need becomes so critical as to require emergency financing measures. Advanced planning extends the period of time available for the proper technical design of facilities and permits a continual, systematic appraisal of personnel and equipment needs, resulting in a number of economies. And finally, the planning of capital facilities may provide justification for the advance acquisition of properties needed for improvements, thereby taking advantage of lower market values.

Capital facilities planning should be built upon a continuous assessment of client/community preferences, an identification of goals and objectives, demographic estimates and economic forecasts, and projections of development expectations. Data on future community needs must be sufficiently reliable to justify decisions that involve relatively large, long-term commitments of financial resources. The following elements should be included in this planning framework:

(1) External factors--such as demographic shifts, changes in economic activities, social trends, scientific and technological change, emerging land use patterns, and so forth--that may influence the service programs of the community or organization.

(2) Total service demands. Assumptions, standards, and criteria used to quantify and project facility and service needs must be clearly identified and tested against available trend analyses.

(3) Service delivery responsibilities. Present and future roles of various levels of government, as well as private enterprise, in the provision of facilities and services must be examined. Such an evaluation may include recommendations regarding the elimination of overlapping responsibilities through coordination or realignment.

Forecasting Community Growth and Change

The demand for public improvements is a function of growth. This emphasis on meeting growth demands does not imply a "self-fulfilling prophecy," however. In situations of service crisis, local governments may be panicked into uneconomical investments and overdevelopment. Comprehensive capital facilities planning can help avert these crises, thereby contributing to more realistic and rational patterns of growth.

To anticipate the types of improvements required, the population to be served should be delineated to the fullest extent possible. An aging population, for example, will require specialized health facilities and housing. Young adults just starting families will require schools, day-care centers, and recreational facilities. Income levels, household size, and other demographic and economic characteristics also provide vital information as to facility needs and service expectations.

Demographic projections often are based on an age-cohort survival model, which analyzes the population by narrow age categories (cohorts) according to vital statistics on births, deaths, and net migration patterns (inflows or outflows of population). Further breakdowns can also be made by race, sex, income, and so forth. These forecasts are not merely linear projections of past conditions. It is important to understand the current demographic composition of the community in order to identify any unique characteristics that may influence future population structure. For example, the transient student population of a college town is influenced by factors other than typical demographic elements and cannot be "aged" in the cohort structure with the resident population.

The basic mathematics of the age-cohort-survival model are fairly simple. Five-year cohorts, in turn, are "stepped up" through each iteration (see Exhibit 1), and the results of this "aging" of cohorts are then modified by adjustments for births, deaths, and net migration. Making appropriate assumptions about birth rates, death rates, and migration is not an easy task, however, and many projections turn out to be inaccurate or unrealistic in terms of actual demographic data.

Mistakes in projecting population can be quite costly. The baby boom, for example, which began in the late 1940's and lasted until the early 1960's, produced huge increases in public school enrollments. In the 1960's and early 1970's, many localities assumed the trend would con-tinue into the foreseeable future, and made substantial investments in new school buildings. In fact, however, enrollments peaked a few years into the 1970's and then started downward. Today, many school districts are still paying off the bonds on school buildings which have significantly declining enrollments. And many communities are willing to dispose of school buildings at a fraction of their cost to buyers who will convert them to other uses, such as housing, retailing, or offices.

Exhibit 1. Age-Cohort Survival Model: City of Rurbana

Age Cohorts Population Age Cohorts Surviving Population
Base Year Base Year Survival Rates* Plus 5 years Plus 5 Years
Under 5 6,656**
Under 5 6,047 0.99173 5 to 9 5,997
5 to 9 6,782 0.99780 10 to 14 6,767
10 to 14 6,705 0.99777 15 to 19 6,691
15 to 19 7,543 0.99537 20 to 24 7,508
20 to 24 9,689 0.99382 25 to 29 9,629
25 to 29 6,398 0.99299 30 to 34 6,353
30 to 34 4,608 0.99136 35 to 39 4,568
35 to 39 4,124 0.98795 40 to 44 4,074
40 to 44 4,233 0.98127 45 to 49 4,153
45 to 49 4,081 0.97099 50 to 54 3,962
50 to 54 3,564 0.95468 55 to 59 3,402
55 to 59 3,239 0.93271 60 to 64 3,021
60 to 64 2,939 0.89949 65 to 69 2,643
65 to 69 2,400 0.85451 70 to 74 2,051
70 to 74 1,776 0.78990 75 to 79 1,403
75 to 79 1,272 0.69571 80 to 84 885
80 to 84 757 0.54790 85 to 89 415
85 to 89 371 0.37028 90 to 94 137
90 to 94 108 0.17810 95 to 99 19
95 to 99 20 0.08608 100 + 2
100 + 3
Totals 76,660 80,336

* Application of Reed-Merrell Tables on the probability of dying to actual mortality data

Children Under 5 Born to Females of Child-Bearing Age

Percent Number
Age Cohorts Base Year Plus 5 Years Fertility Rate Children Under 5
10 to 14 48.8% 3,301
15 to 19 48.8% 3,268 220 719
20 to 24 43.8% 3,289 280 921
25 to 29 43.3% 4,168 594 2,476
30 to 34 49.4% 3,141 544 1,709
35 to 39 50.3% 2,298 195 448
40 to 44 51.9% 2,114 181 383
Total 6,656

Economic Forecasts and Projections

Economic forecasts are an important factor in the preparation of demographic projections, since assumptions concerning population growth or decline are based in part on economic activities. A locality experiencing rapid industrial growth, for example, will likely experience a wave of worker in-migration. The age and socio-economic characteristics of these new groups must be forecast to ensure adequate provision of basic public facilities and related services.

Economic projections and forecasts, in turn, must be translated into public improvement needs. The attraction of young workers and their families to an area experiencing industrial growth will likely result in increased demands on the educational system. The momentum of economic activities will be adversely affected if these demands are not addressed. Future economic conditions also determine the financial capacity of a community to pay for capital improvements. Economic indicators--including data on employment, cost of living, disposable income, building activity, and bank deposits--can be used to analyze trends and to suggest the future revenue capacity of the community.

Economic base studies, widely applied in capital facilities planning, divide the local economy into two broad categories:

(1) Basic or export industries--those industries producing goods and services (and capital) for distribution to markets outside a defined local economic area; and

(2) Nonbasic or service industries--those producing goods and services that are consumed within the local economic area (see Exhibit 2).

A distinction is made between economic activities that bring new money into the community (basic industries) and those that simply result in the recirculation of money (service industries). An underlying assumption of this approach is that expansion of basic activities usually results in growth of service activities and thus, growth in the total economy. Forecasts of economic growth are based on multipliers that relate local activities to exports.

As suggested in Exhibit 2, employment data of some industries or firms must be apportioned between the basic and nonbasic sectors. Once these data have been sorted, ratios can be calculated to reflect current conditions in the local economy. Various assumptions can be tested, using these ratios to determine the impact of increases or decreases in employment in the basic sector.

Assume, for example, that the current basic to nonbasic ratio is 1 to 1.5 (each job in a basic industry generates 1.5 jobs in the service sector). A new economic activity that adds 100 jobs to the basic sector will increase total employment by 250 jobs. If 35 percent of the total population is in the labor force, the ratio of basic employment to total population will be approximately 1 to 7.

Economic base multipliers and location quotients can be generated for various measurements, including: (1) employment data, (2) payrolls, (3) value added, (4) value of production, (5) physical production, and (6) dollar income and expenditure accounts. [1] Each of these measures has shortcomings, and therefore, all feasible techniques should be used in any economic base study. The capacity to predict future conditions can be further extended and refined by adding other measures and indexes.

Employment growth generally fosters population growth because job opportunities attract new residents. But the process works the other way too. Population growth creates employment in retailing, wholesaling, personal services, and related activities. In fact, the relationship goes still further because pools of labor and capital built up to serve a local population, in time, may foster the growth of manufacturing and other activities which are not directly related to servicing the local population.

The Local Infrastructure

Land use studies are a part of planning for capital facilities. It is not possible, for example, to plan for sewer construction without having definite ideas about what areas of the community need to provided with sewers. Land use studies also are important for identifying land suitable for various types of capital facilities and for estimating the cost of such public improvements--the cost of sewers, roads, and other facilities can be greatly influenced by topography, subsoil conditions, and the like.

The results of the land use studies such be consistent with the economic and population forecasts. If a land use study does not indicate enough developable area to accommodate projected population and employment increases, for example, the planner should think seriously about scaling down those projections.

Financial Planning and Fiscal Policy

A capital facilities plan will not solve all of the fiscal problems of local government. It may or may not result in a reduction of taxes or public debt. Planning assists in the provision of suitable responses to public needs, of appropriate quality, when and where they are required, resulting in a more expeditious and wise expenditure of public funds, whereby each dollar spent yields a more effective return in terms of desired public improvements.

The demand for services and facilities increases and changes as a function of growth and the social and economic characteristics of the community. However, local revenues have tended to increase at a slower rate, creating an ever widening fiscal gap for many localities. The inelasticity of local revenues is attributable, in part, to the tax structure which forces local governments to rely heavily on local property taxes, which have proven to be relatively unresponsive in meeting increasing demands for public services and facilities.

Other taxes have also not been very productive at the local level. Unilateral taxation of income, sales, or business by local governments often results in a shrinkage of the local tax base. That is, if one municipality introduces such taxes, economic activities tend to locate beyond the taxing jurisdiction (for example, major shopping facilities located just outside the taxing jurisdiction of cities).

Government services tend to be labor intensive and not readily amenable to the substitution of capital for labor. Thus, while there have been massive increases in productivity in manufacturing, transportation, and agriculture, increases in public sector productivity have been much less significant. Hence, the cost of public services have risen compared to many other goods and services. Instruction in the public schools, for example, is delivered in roughly the same way as it was fifty years ago--one teacher in front of a class of 20 to 30 pupils.

As the expenses of local government have risen, taxpayer resistance has also risen--the most notable example being manifest in Proposition 13, passed in California in 1978. Comparable, although not as severe, tax limitations were subsequently passed in a number of other states.

Thus, it is not difficult to understand the fiscal bind in which many municipalities find themselves. Taxpayers demand good schools, adequate police and fire protection, and other public services. At the same time, however, they resist any increases in local taxes to pay for these services.

Most intergovernmental aid is from the state rather than the federal government. Much of the state funds received by local governments, however, is really "pass-through" money. As federal transfers to the states diminish, state generosity to local governments is very likely to decline. For all of the above reasons, careful estimating of revenues and planning of expenditures is important.

Revenue and Expenditure Analyses

A sound revenue policy must be based on the basis of a thorough assessment of public service and capital facilities needs. Estimates should include an analysis of the revenues to be collected if existing fiscal policies are maintained. New revenue sources or shifts in yields from current sources under alternative policies should also be analyzed.

Sources of revenue should be disaggregated into appropriate categories and projected over a number of years. Demographic and economic forecasts are important in estimating the size of the tax base in the future. The impact of inflation must also be considered in estimating the magnitude of revenue sources such as sales and property taxes. The availability of intergovernmental aid also must be estimated. Considerable uncertainty is involved in such analyses, and the likelihood of any municipality accurately projecting its revenues over the next decade is quite small. Nevertheless, there is no good alternative to the use of such projections.

Expenditure data should also be separated into major categories. Data from past fiscal years assist in determining appropriate multipliers for each expenditure category. For example, past data might be examined to project the cost per pupil of primary school education. Population projections for the community provide enrollment estimates in future years. This yields a first approximation of the real costs. The projected costs might then be adjusted for projected inflation to yield the actual dollar costs. Note that one uncertainty (projected cost per pupil) is being multiplied by a second uncertainty (number of pupils) and then by a third uncertainty (changes in the value of the dollar). Therefore, the results of such analyses are necessarily only very rough approximations.

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