The election was clearly a seismic political event that portends big political changes in the year to come, but most of the year was actually a reflection of the Federal Reserve’s success in (essentially) taming the inflation monster and stabilizing interest rates. State and local government budgets and finances were affected most of all by the Fed this year, not by the national election. So let’s reflect now on those developments in retrospect and save the noisy future-facing political-economic outlook and fiscal analyses for the new year.
Last month’s state-level election outcomes were mostly status quo as far as the overall partisan balance of governorships and legislative majorities go, but one notable election outcome was the approval by voters in eight states of ballot measures to limit property taxes. That was not the outcome in every state that had the issue on the ballot, but it was a clear indication that the dramatic increases in residential property values of recent years have resurfaced the fears of many local taxpayers that they cannot afford their own homes if tax and insurance costs keep escalating. Except for possibly Georgia, where local officials must opt in, none of these property tax limitations were capable of having nearly as radical and potentially distortive an impact over time as the infamous Proposition 13 that Californians adopted in 1978.
On the commercial side of the property tax collector’s ledger, softening office tax receipts remain a drag on municipal revenues. Local officials in some states will have some budget adjustments to make, but aside from center sanctuary cities caught in Trumpian political crosshairs and situationally specific city budget issues like San Diego’s, most localities should be able to cope with modest revenue constraints without drastic measures such as layoffs, at least in 2025.
Looking back, inflation remained an issue at all levels of government, but it wasn’t the price of eggs and voter sentiment about household budgets that held the attention of state and local government budget departments. Rather, it was the delicate balance between modestly higher tax receipts from all sources combined vs. personnel costs in a full-employment labor market. Helpfully, public-sector labor unions generally refrained from making gargantuan pay demands similar to those of dock workers, Boeing machinists and auto workers. That public-sector bargaining restraint filters all the way into public pension costs, stabilizing employers’ payroll contribution rates.
State budgets did take a fiscal hit this year as the backwash of the COVID-19 revenue wave came home to many. The sales tax surge emanating from federal helicopter money in the previous two years was followed by a 2024 revenue shortfall that most states were able to navigate, but the next year looks to be potentially more problematic, especially in light of likely intergovernmental austerity and downward cost-shifting expected from the 119th Congress.
Operating budgets were also helpfully aided by high short-term interest rates as the Fed held tight to its monetary policies longer than markets had expected in its ongoing campaign to rein in headline inflation and expectations. Overnight interest rates finally declined but not quite as much as most market pros expected. The U.S. Treasury securities yield curve is now the flattest it’s been in ages and materially below 2023 levels. That allowed many public treasurers and cash managers to deliver a net fiscal positive from money market interest income. Over-extended treasurers with underwater cash portfolios were finally bailed out with lower anticipated 2025 interest rates — and thus higher portfolio prices — in the final quarter of 2024 as they continued to burn off their portfolios’ maturing low-yield losers from 2022.
Debt managers had a relatively stable year, as record-low municipal bond interest rates of prior years were already repriced upward at higher levels in 2023, in parallel with the U.S. Treasury bond market. This did raise the long-term financing cost of new infrastructure projects, including those funded in part with federal matching money from the 2021 infrastructure law. But for 2024, the cost to muni issuers of new tax-exempt borrowing ended the year relatively unchanged, a welcome outbreak of normality after rising somewhat in the summer and then falling a bit before the election.
Debates over Data
Public finance professionals continued to cogitate about how best to prepare and present budget and financial information for public consumption; a lot of this so-called “rethinking” of financial reporting is still going on. Friction is mounting between the traditional format of financial statements required under longstanding “governmental GAAP” accounting rules and the views of municipal finance officers as to what kinds of information are actually useful and desired by the people who ultimately read these reports — taxpayers as well as investors. That stew continues to simmer.
A related policy debate is likewise starting to bubble up from the federal Financial Data Transparency Act’s implementation process, where proposed rule-making is yet to become settled law. Just how much financial reporting information will be required from states and localities in machine-readable formats is yet to be decided — with the municipal professional associations having reiterated their position that less is more. There’s a lot of noise from practitioners about unfunded mandates, although the eventual shift toward digitalization is now pretty much inevitable.
This brings us to the companion issue of ownership of all kinds of public information collected and assembled by government agencies in the new era of artificial intelligence. It has become increasingly clear to entrepreneurs and investors that in the “AI Age,” information is the new gold. State and local governments have plenty of data ore to provide in this mining process, and it remains to be seen how much of that mother lode can be extracted by private companies for profitable use without paying royalties for its use. It’s still unclear how many state legislators, public-sector managers and local governing bodies have caught on to this issue; my sense is that most have not.
Pensions’ Hits and Misses
Public pension funds have greatly benefited from the stock market’s two-year gains of more than 45 percent, which should ultimately flow through into slightly lower contribution rates required to amortize their unfunded liabilities. Their balance sheets should soon look a bit healthier, tamping down the negative publicity so often hurled at them for actuarial and investment shortfalls
But while there were mostly hits inside the pensions’ portfolios, there were a few misses. On the plus side, while commercial real estate remained a headache, stocks went up, bond prices went down, private credit did well, some hedge funds beat the market and money market cash outdid inflation. The ugly unspoken issue all year for some pension funds was the cash-flow headache from hefty private equity portfolios that largely failed to deliver lucrative payouts on pace as modeled. Since such distributions were expected to pay retiree pensions for aging plans that are cash-flow negative, a few systems were forced to sell holdings in the secondary market. Overall, however, on balance it was a welcome and better-than-average year for most pension portfolios — at least on paper.
There was one troubling culture war issue for pensions: environmental, social and governance investing (ESG). ESG has become an increasingly hot topic in legislatures, and now looks to take even more heat in the next year with the red-state political backlash creeping into Washington, D.C. Another likely thorn in the sides of pension advocates is the growing overconfidence of amateur investors with encouragement from political ideologues to put more money into defined-contribution plans for employee amateurs to play with at the expense of traditional defined-benefit pensions. We’ve come to that inflection point in both market and political cycles where the advocates on Capitol Hill usually start exhorting the wonders of capital markets vs. the socialization of income security.
In retrospect, however, 2024 was a pretty good year for public financiers, budgeters and investors. A lot of decisions and developments went right, for a change. Time will tell whether we will look back on this year with nostalgia, bewilderment or indifference.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be construed as investment advice.
