Local Governments Most Vulnerable to Rate Shock, Fitch Report Says; An Interest-Rate Shock Would Likely Hit Property Tax Collections, Which Buoy Local Revenues
Local governments in the U.S. are more vulnerable than states or the nation's transportation infrastructure to a potential interest-rate shock and resulting economic slowdown, according to a new report by Fitch Ratings.</br></br>Most local governments are still recovering from the effects of the Great Recession and a sharp rise in interest rates, combined with low growth, could negate the effect of incremental improvements in state funding and moderate revenue increases, Fitch said. A shock could lead to budget shortfalls and higher borrowing costs, in part because it would likely hit the property tax collections that provide about three-quarters of local government revenues, Fitch said.</br></br>"When you think about the impact of a recession or zero-growth environment, it's often lagged with local governments," said Olu Sonola, senior director at Fitch. "Most of them are just recovering, so if we do have zero growth induced by an interest-rate shock, the ones that are not fully recovered would suffer the most."</br></br>States would also face economic challenges in a low-growth, higher-rate environment, since income and sales taxes provide almost two-thirds of their revenue, the report said. While sales taxes have proven relatively resilient in times of economic stress, income tax receipts often become volatile. Stock market declines can also affect state governments, since those can impact the assets of pension plans and reduce capital gains tax collections that can make up a large part of income taxes.</br></br>States are still better positioned to cope than local governments, Fitch said. The federal government has provided states with some sort of aid during four of the past five recessions and states have repeatedly demonstrated the willingness to balance their budgets in the absence of federal assistance. That includes passing fiscal challenges down to local governments.