This is part two of a two-part examination of how New Jersey’s system of government – and its fiscal oversight mandates – make it unlikely that any Garden State municipality will fall into a Detroit-like financial crisis leading to bankruptcy.
Towns, schools get billions in state aid
State Aid: A large part of the state budget (44 percent) is returned to local governments – with the majority of the money provided to school districts. In addition to direct aid payments to school districts, the state pays the school district’s share of pension and health benefits for retirees, as well as the employer’s share of Social Security contributions for current school district employees. This fact significantly lessons local government fiscal exposure. No other state pays for all three of these current and long term commitments — a policy decision that further limits the potential for local government bankruptcy.
The total amount appropriated for school aid in FY 2014 is $12.4 billion – representing approximately 37 percent of the entire state budget – and is approximately $2 billion greater than the amount appropriated in FY 2011.
State aid for municipalities and counties is much smaller. In FY 2014 the amount appropriated from all sources, including energy tax receipts, is $2.0 billion – an amount which is slightly greater then appropriated in FY 2011. In total the state provides $14.4 billion in aid to all levels of government. (1)
Local governments in distress: New Jersey has a long history of providing special assistance to cities in fiscal distress. Special programs dating back to the mid-1960s included formula-based programs such as “Urban Aid” and the “Safe and Clean Neighborhood Program.” These were followed in later years by discretionary allocations called Distressed Cities and Special Municipal Aid.
Today, the state’s Division of Local Government Services administers a program called “Transitional Aid.” This program provides assistance, based on applications, to the state’s most fiscally distressed municipalities. Transitional aid for FY 2014 is $95 million.(2)
The name of the program suggests that such aid is not intended to be permanent but rather “transitional,” based on the premise that municipalities receiving such aid will not need special monetary assistance from the state in the future. In fact, however, given the size of the aid to some of cities, it is doubtful that some municipalities will ever be able to construct a budget without this extraordinary state aid — a fact recognized by past and current administrations.
A short history of the Transitional Aid Program is in order as it is now the principal state aid program for the most distressed municipalities.
Prior to FY 2011, the state had three municipal grant programs that provided special aid. One program provided $35 million to the state capital, Trenton; a “Special Municipal Aid” program disbursed $117 million to 12 municipalities; and an “Extraordinary Aid Program” disbursed $25 million to approximately 50 municipalities.
Beginning with the FY 2011 budget, the newly elected governor determined that some of these programs had virtually no conditions or criteria for awarding the grants and no specific accountability. The governor directed that these grants be consolidated into a new program called “Transitional Aid to Localities.” The intent was to award these funds only to municipalities in severe fiscal distress that agreed to pursue structural budget reforms and agree to state oversight.
Consolidating programs, setting fiscal constraints and reforms as a condition for receiving the grants , and allocating staff to enforce the new paradigm not only changed the focus of the program, but reduced the number of applications from more than 75 to fewer than 50 in FY 2011 and only 17 in FY 2012.
Most of the 75 municipalities that once received aid with little or no oversight chose to take steps necessary to balance their budgets rather than apply for aid and become subject to state oversight. Furthermore, of the 22 municipalities that successfully applied for Transition Aid in FY 2011, half have “graduated” from the program and no longer need or desire state funding to balance their budgets.(3)
The Division of Local Government Services publishes detailed descriptions of the application process, as well as conditions of assistance and specific oversight provisions.
Debt Structure of Local Governments(4): As noted, state law imposes limits on the debt of municipalities, counties and school districts. Specifically, once a jurisdiction reaches a debt level in excess of a certain percentage of the assessed value of property in the community, they must apply to the Local Finance Board for permission to issue additional debt. During this process, the Local Finance Board examines the budget, the audit and other financial documents to determine if the jurisdiction has the resources to fund the debt.
The state also has a number of programs to assist school districts and municipalities with debt management and debt payments. For example:
Formula-based aid to pay for the debt service of certain school districts, especially districts with less valuation per pupil.
Construction aid totaling $12 billion to qualified districts to repair or replace aging buildings and facilities. The program is oriented toward the “Abbott” districts, but other school districts are also eligible.
Qualified Bond Program (see discussion below under Municipalities for program description) Newark and Jersey City school districts are serviced by this program.
School Bond reserve program of $140 million — a state fund that guarantees the debt service payments on all school-issued general obligation bonds.
Qualified Bond Program. Under this program the state channels state aid payments directly to the bond holders of approved municipal and school district debt authorizations approved by the Local Finance Board, thereby assuring the debt service payment will be made. Moody’s rating agency has guaranteed an AA rating for all bonds issued under this program. To date this program has serviced 19 municipalities.
Recent efforts to improve local government finances
Beginning in 2011 and through 2012, the governor and the Legislature approved significant legislation to address the underfunding of all pension funds; to reduce the costs of health benefits for employees; to control the growth of the local property tax; and to bolster oversight of local governments. The most significant actions are summarized below.
Cap law: It is generally expected that the law will provide a significant “governor” on spending by municipalities, counties and school districts. Unlike the 4 percent property tax levy cap enacted in 2007, which had many exceptions, the revised 2 percent cap on the tax levy has a limited number of exceptions (capital construction, debt service and emergencies), and sets limits on pension and health benefit spending. The cap can only be exceeded by a vote of the people in a referendum.
Since its initiation, statewide property tax levy growth has averaged 2.1 percent — a significant reduction from the average of 5.6 percent in the previous five years.(5)
Pension reform: The problems with funding of New Jersey’s pension systems had been growing for approximately 20 years. The unfunded liability of all state-administered pension systems (all local units are members of state-administered systems), had become seriously underfunded. In the aggregate, the systems were only 55 percent funded – a shortfall of $54 billion.
Of curious note: The municipal portion of the system was 71 percent funded – better than the pension for state employees — principally because the Division of Local Government Services insisted that municipal budgets contain the proper appropriation except when legislative action in a few instances allowed municipalities to fund a smaller percentage.
To address the underfunding, a series of actions were taken, including increasing the retirement age for new employees to age 65, increasing employee contributions from 5.5 percent to 8.5 percent — and, quite dramatically — discontinuing annual Cost of Living adjustments (COLA) for retirees until the funded level of individual funds reaches 80 percent .
Today the municipal pension system is 77 percent funded. The Teachers Pension system is funded at 63 percent.(6)
Health benefit reform: To reduce the cost of health benefits to public employers, including municipalities and school districts, several changes were initiated, including increasing employee contributions. Prior to the new law, public employees contributed at most 1.5 percent of salary. Under the new law employees pay the greater of 1.5 percent — or a percentage of the cost of the premium, ranging from 5 percent to 30 percent, depending upon the salary and coverage of the employee.
No actions were taken to reduce the cost of post-employment medical benefits for retired employees or those already eligible,, and no actions were taken to require funds be set aside for the cost of retiree health benefits. Presently, the unfunded liability is in excess of $15 billion for municipal and county employees and $31 billion for education employees and retirees.(7)
Arbitration reform: Legislation was enacted to limit arbitration awards for all local employees, including police, fire and teachers. In addition to the limits imposed by the 2 percent property tax levy cap, the law stipulates that no arbitration award can be in excess of 2 percent. This legislation expires at the end of this year; there has been no discussion about what the next steps might be.(8)
Best practices: As part of the state’s extensive fiscal oversight authority over local governments, the Division of Local Government Servicers in 2010 initiated a “Best Practices Inventory Questionnaire” which is a constructive way to encourage municipalities to consider and embrace a range of “best practices” to improve financial accountability and transparency. The most recent inventory consists of 50 questions and requires certification by the Chief Financial officer concerning the results. The completed form must also be discussed at a meeting of the municipality’s governing body meeting, to make sure local officials have been apprised of the response.
In addition, the FY 2013 and 2014 Appropriations Acts tied 5 percent of various state-aid payments to the results of municipalities’ response to the questionnaire. Perfect scores are not required to receive the final 5 percent of aid and credit is provided where municipalities are acting in good faith to implement the “best practices.” Initially, only six municipalities received aid penalties due to their responses.(9)
State mandates: There are always complaints about mandates imposed on local governments by state governments. But there is, perhaps, something unique about the issue in New Jersey.
In 1995, the people approved an amendment to the state constitution. It said that, subject to several limitations, new statutes, administrative rules and regulations promulgated by state agencies could not impose unfunded mandates on counties, municipalities and school districts. In certain circumstances, it requires reimbursement from the state for costs incurred as a result of the provisions.
The state constitution amendment also required establishment of a “Council on Local Mandates” which consists of nine members — four appointed by the governor, four appointed by various leaders of the Senate and Assembly, and one by the chief justice of the state Supreme Court. The council is to review and issue rulings on complaints by local governments, including school districts. The council’s decisions cannot be appealed.
Furthermore, a recent executive order of the governor directed state agencies to not issue any regulation containing any unfunded mandate unless expressively authorized in writing by the governor.(10)
Unfunded mandates are always an issue between the state and local government. But the existence of the Council of Local Mandates provides New Jersey with a mechanism for constantly looking at the problem and keeping the Legislature and the governor aware of the issues.
There has been no formal evaluation of the council’s effectiveness or the types of matters it has reviewed or decided.
Summary: Observations on future risk
All New Jersey municipalities have an extraordinary dependence on the property tax to support their operations. In fact, New Jersey has the highest property taxes in the country as measured by most criteria.
A large part of the state budget—approximately 42 percent — is appropriated for state aid, mostly for school districts. Without such aid, property taxes would obviously be much higher.
What’s more, the recent 2 percent “tight” property tax levy cap will pressure local governments to reduce costs and develop imaginative ways (sharing and regionalized services) to deal with this potentially stark fiscal reality.
Some New Jersey municipalities face financial risk, particularly Camden and Trenton. Other municipalities that receive “Transitional Assistance” also bear considerable watching to insure they do not become high risk. Furthermore, municipalities — because of their past fiscal problems and the pressures of unemployment and poverty — such as Newark and Paterson require special attention by the state.
But New Jersey has a very long and effective history of monitoring local government finances. As noted, the state, through the Division of Local Government Services and the Local Finance Board, keeps a constant watch.
As also noted, the Division of Local Government Services exercises strict oversight and approval of all critical financial activities of local governments. Furthermore, a staff of advisors provides help to municipalities in need of technical and management assistance, and statutory provisions allow the Local Finance Board to step in and manage a municipality that is in severe stress.
Finally, through its targeted “Transitional Aid Program,” the state can provide additional aid to municipalities in need of extraordinary financial assistance.
Finally, a relatively new Office of the State Comptroller is conducting required reviews of local and state contracts, conducting audits of government and management practices, and reporting on waste and abuse of public funds.(11)
The financial status of local governments need constant oversight to insure they do not become an “albatross” dragging down overall state finances and do not worsen to a point that could that could lead to bankruptcy proceedings.
While no one can say with certitude that such problems cannot emerge, New Jersey state government has the apparatus – both legal and operational – to step in and lessen the risk to the financial health of both state and local governments.
How well it continues to function in these times of economic stress will be the test of its effectiveness. But prior actions suggest that local government finance in New Jersey is under watchful eyes.
1. FY 2014 Appropriations Act for the State of New Jersey. See website of the NJ State Office of Management and Budget.
2. FY 2014 Appropriations Act for the State of New Jersey. See website of the NJ State Office of Management and Budget.
3. Interviews with Marc Pfeiffer, former Deputy Director of the Division of Local Government Services. June 2012 and subsequent dates.
4. See Web site of the NJ Division of Local Government Services.
5. For a series of articles and publications on the NJ Cap Law see “Hot Topics” at the website of the NJ Division of Local Government Services.
6. For details of the pension law (and Health Benefits Law), see Chapter 78, PL 201 o the NJ Statutes. See also website of the NJ Division of Pensions and Benefits].
7. Ibid, see Chapter 78, PL 201 of the NJ Statutes.
8. For details of the Arbitration Law see, NJ statutes at Chapter 105, PL 2010. See also press release from the Office of the Governor, dated December 21, 2010, titled Governor Christie Signs Reform Legislation to Transform System on Long-Overdue Arbitration Reform.
9. For additional details on the Best Practices procedures and the Questionnaire see www.nj.gov/dca/divisions/dlg.
10. For more details on unfunded mandates, see the legislation enacted to implement the provisions of the constitutional amendment at N.J.S.A 52:13 H.
11. For a more detailed discussion of the powers of the State Comptroller see, www.nj.gov/comptroller.