Step 6: Category 1: Political, Internal Causes of Financial Distress

This category includes:

  • Governance Crisis
  • Excessive Personnel Costs
  • Past Awards of Unsustainable Retirement Benefits
  • Poor Morale and Commitment
  • Overexpansion
  • Economic Development Incentives
  • Implicit Development Subsidies

Governance Crisis

Governance encompasses the board, management, and approved policies and procedures. Strong governance is needed to confront difficult facts, encourage innovative solutions and adaptive behavior, and hold the staff, elected officials, citizen groups and anyone else involved in contributing to a strong financial foundation and thriving community accountable for their commitments. In short, without good governance, good decisions are unlikely. Without good decisions, a solid financial foundation is very unlikely.


  • Lack of political cooperation. Are members of the governing board, the chief executive, and/or other key management staff consistently able to work together and make joint decisions? Is board micromanagement avoided?
  • Multiple power centers.  A democratic organization requires checks and balances, but there is a difference between functional and dysfunctional dispersion of power. Separate legislative and executive authority is often functional. Fragmented executive or legislative authority can be dysfunctional. To illustrate, in one highly distressed city the position of city attorney was elected. The attorney claimed sole power to interpret the city charter, which effectively conferred legislative and executive authority to the city attorney. Are multiple power centers contributing to problems in your government like those listed below?
  • Unclear lines of authority. Do people know who is in charge? If not, it will be more difficult to commit to any clear strategy or to hold people accountable for their commitments. This can also create inefficiencies when more than one organizational unit is working on the same issues.
  • Excessive decentralization. Do operating departments have too much independent control over policy and budget decisions? If so, then economies of scale could be lost, departmental budgets may not support organization-wide objectives, and coordination can be seriously impaired.
  • Fragmented budgeting. Do funding sources and their associated regulations lead the associated programs to be siloed?  These programs still need to be evaluated in relation to the jurisdiction’s goals and objectives and whether they support or can be used to support them.
  • Excessive detail in governing documents (i.e., charters, ordinances). Do governing documents go into too much detail and overly constrain management flexibility? For instance, in one highly distressed city, the city’s charter required the city to provide a number of municipal services using its own municipal employees. This prevented outsourcing or sharing services with other organizations.

Excessive Personnel Costs

Labor costs comprise a high proportion of most local governments’ budgets. Excessive compensation costs can severely damage a government’s financial position. We will consider symptoms of excessive personnel costs in three major categories: salaries; headcount, and health care benefits. Pensions are discussed separately, later.

Symptoms of Excessive Salary Costs

  • Lack of a compensation plan. Does your plan include ranges (including upper limits) on total compensation (wages plus benefits) for all positions? Is it updated regularly based on market comparisons?
  • Paying above-market compensation without a strategy to justify it. Evaluate total compensation (including benefits) that are significantly above the median for comparable positions, given market rates. Is there an explicit human resources strategy that justifies above-market compensation?
  • Excessive overtime costs. Do operations that require 24/7 coverage have schedules or staffing plans that encourage overtime (i.e., not enough staff, ineffective use of part time labor)? Or is there a culture where some employees consider overtime an entitlement? The private sector usually does not pay overtime rates for evening or weekend work, while many government units continue to. Are there opportunities for removing these practices from collective agreements?

Symptoms of Excessive Headcount

  • High staffing-to-population ratios compared to other governments with similar services. Do any of your operations appear to be overstaffed in comparison? This is not a definitive indicator, but it is a clue where to look for where there may be opportunities to use resources more wisely.
  • Low flexibility in how labor is used. Can work be easily directed to the staff that has the capacity to perform it? Or does excessive departmentalization or constraining work rules prevent flexibility?
  • Under-skilled staff.  Are staff not properly trained or qualified to do their jobs? This might require more hours or people to get the work done than is really necessary.

Symptoms of Excessive Employee Health Benefit Costs

  • Plan benefits are out-of-line with other governments. How does your government’s employee benefit plan compare to what other governments in the area offer? In addition to benefits being too rich, could you be offering too many plans? This can complicate administration and contribute to adverse selection problems.
  • Contracting for service providers not sufficiently competitive. Are the firms that provide services for your health plan exposed to competition (e.g., rebidding) enough to ensure good pricing?
  • Not sufficiently proactive in healthcare cost containment. Are you using strategies like self-insurance, high deductible health plans, disease management, and/or on-site clinics?

Past Awards of Unsustainable Retirement Benefits

Contributed by Girard Miller 

Unsustainable retirement benefits plans ignore future costs, and either ignore actuarial methods or manipulate them. In the case of retiree medical benefits, the chief problem has been a multi-decade history of pay-as-you-go financing, long after public pension plans moved away from that model because it was proven to be unsustainable.  In the case of pension plans, specious reasoning and actuarial gimmicks have sometimes been used to justify benefits increases that were unaffordable.  

It has been all too common for local governments to award retroactive unfunded pension increases. Often, these deals were struck to settle collective bargaining agreements, while avoiding an immediate budget appropriation. Similarly, some local governments have offered early retirement programs to fix an immediate budget problem, and thereby increased the liabilities of the pension plan without paying for them.  


  • Declining pension funded ratios. The pension funded ratio compares accumulated plan assets to the actuarial accrued liability. Consider funded ratio trends over time. What direction has it been heading and at what speed?
  • Falling short of required annual contributions. The annual required contribution (ARC) recovers the cost of pension (or OPEB) benefits earned by employees during the period. Are you covering your ARC every year?
  • Insufficient employee contributions. Do combined pension and OPEB plans’ employer contribution rates exceed 200 percent of employee contributions?
  • Financially unsustainable decisions. Has your government made decisions that make the pension problem worse? Examples could include; unfunded retroactive benefits increases; frequent ad hoc cost of living adjustments are made; granting benefit increases to reach agreement on labor contracts; no CPI or dollar ceiling on the OPEB plan for medical cost inflation.
  • Early retirement plans. Are early retirement incentives charged to the pension plan rather than expensed?
  • Overly generous plans. Does the pension plan have a payout multiplier of more than 2.5 percent (times years of service times final compensation) coupled with an employee contribution rate of less than 7.5 percent? Or, conversely, an employee contribution rate of less than three times the pension multiplier for civilians? (Benchmark with 4x for first responders eligible for retirement before age 60 – 5x for those below the age of 55 – unless funded by a dedicated pension tax.)


Poor Morale and Commitment  

Contributed by James Garnett

During the recovery process, is the time when strong employee morale and commitment are most needed but are typically at their lowest. For example, being left out of the loop by management creates employee anxiety and loss of morale. Also, in the absence of effective communication, rumor mills fill the gap and excessive attention gets devoted to conveying or rebutting these rumors.


  • Rumor mill heats up. Is too much time and effort spent scuttle-butting about what is happening and when the axe might fall? Are rumors about potential cuts more numerous—and sometimes more accurate—than official communication?
  • Casting blame. Is the blame game adding emotional stress to fiscal stress?
  • Free-exiting increases. Are the most valuable employees—those with other job options—jumping ship or showing declining morale?


Growth of public services is often attractive to government officials and constituents, but when undertaken without a compelling purpose it can create financial distress later. Expanding programs is particularly dangerous when not supported by an ongoing revenue stream or strong public demand. Overexpansion can also stretch staff resources and distract managerial attention.


  • Priorities of government are ill-defined. Do explicit priorities provide context for deciding between different proposals to use government resources? Almost all proposals for new or expanded programs have something to recommend them. When government knows its priorities, it has a stronger basis for making the hard choice to say “no” to some of these programs.
  • One-off decision making. Decisions on resource allocation should only be made with analysis of the complete comparative context of the jurisdiction’s goals and objectives and all of its responsibilities and unfunded liabilities.
  • No policy on one-time or volatile revenues. Expansion of services is particularly dangerous when the expansion is supported by revenues that can’t reasonably be expected to continue into the future. Do you have a policy on the use of one-time or volatile revenues to prevent this?
  • No policy on use of grants. Grants can hurt a grantee’s financial position if they entice expansion into service areas that are not well aligned with the grantee’s priorities. After the grant ends, the grantee will be left with the entire cost of the program. Do you have a grants policy to prevent this?
  • Hidden subsidies or in-kind contributions. Are the costs of support to external organizations explicitly disclosed? For example, property tax exemptions are often used to help independent organizations in delivering services that might otherwise be delivered by a government. But the financial impact in effect disappears or can become perpetuated, even though the type of work done by those organizations might change over time or no longer meet the original purpose.
  • No standard for program effectiveness. Many public policy challenges are notoriously difficult to positively influence. Does your government rigorously investigate whether programs are having their intended result? Without this standard, programs that sound good in theory but fail to deliver in practice can continue to consume resources.
  • No inventory of programs that the government offers. Do you have an inventory of the programs or discrete services that the government offers? Without an inventory it is impossible to know what services the government provides, exactly. After completing a program inventory, many governments have found duplications of service within their own government and/or with other nearby agencies.

Economic Development Incentives

Economic development incentives can be harmful to a local government’s financial position.[1] First, they involve large amounts of money and often commit governments to multi-year obligations. Also, empirical research shows that most economic development incentives are ineffective and often pit governments against each other in a race to the bottom. Finally, the impact of these incentives on public finances are often not clear. For example, foregone revenues from an incentive that forgives taxes does not show up in the budget as an expenditure (though they are addressed in annual financial reports).


  • The effectiveness of economic development incentives are not rigorously evaluated. Empirical research suggests that 25 percent or less of the incented jobs owe their existence in the local area to the incentive. Job creation figures and tax revenue predictions are often calculated as if none of the incented jobs would have occurred “but for” the incentives. Yet, more than 75 percent of the new jobs would have been created locally without an added incentive. Does your government evaluate incentives to see if they are money well spent?
  • Incentive deals cover a long-term period. U.S. and Canadian businesses tend to make location or expansion decisions focused on short-term profits. The tax abatement or tax credit provided in year 10 or year 15 of the project has little effect. Does your government push the costs of the incentives into the future, making it more likely that the total cost of the incentive is too large?
  • Incentives are justified based the assumption that most new jobs go to local residents. Research shows that, on average, about 10-30% of new jobs go to local residents who are not employed, and the other 70-90% to in-migrants. Are your incentives based on overestimates of the number of new jobs that will go to existing residents?
  • The evaluation of the incentive undercounts the costs.  Do your evaluations of incentives only look at tax revenue impacts, and ignore effects on public spending? If we only look at tax revenues, incentives may appear to be self-financing. However, new development often entails new costs to serve a growing population.

Implicit Development Subsidies

Some development produces more in tax revenue than it costs in public services. This development is a net contributor to the local government’s financial position. Net contributor development then subsidizes other development that doesn’t have a net positive impact on financial position. If a community skews too heavily towards non net-contributing development, then it will be difficult for that local government to have a solid financial foundation.

For example, in one city, a new housing development was built in a low-lying area. This development required many more sewer lift stations than other parts of the community. Yet, all customers of the municipal sewer utility paid the same sewerage rate. Thus, this new development was essentially being subsidized by the rest of the utility customers in the city. Hence, this city had approved a new development that would be net-negative on the city’s financial position.

Another common example is parking. Zoning ordinances often require blanket minimum parking space standards. Parking takes up valuable real estate yet is often assessed at a far lower rate than the building. Furthermore, depending on how the development is designed, parking could add frontage to the property. This requires more roads, more utility piping, etc. all while providing minimal additional tax revenue.


  • Blanket minimum parking standards in zoning ordinances. Do your development requirements require too much parking? Parking does not produce much tax revenue and often does not contribute adequately to the upkeep the streets that cars use.
  • Land is not used intensively enough. Are a high portion of buildings in your community worth less than the land they are built on? If so, that is wasted tax potential the public services those properties use must be subsidized by other taxpayers.  In almost every local revenue system, land and how it is used, will directly or indirectly determine local government revenue and costs.
  • Fiscal impact of development not considered as part of land use planning. Are developments approved without consideration of the total cost to provide public services to the development?