State and local government spending - IBISWorld

WWW.IBISWORLD.COM Special Report Month 2010 1
Municipal debt
Special Report
January 2011
State and local
government spending
By George van Horn
State and local governments’ financial health poses a risk to US
industries. IBISWorld maps out the significant sensitivities.
Revenue
generation is the
most immediate
short-term
problem
While the credit crisis had its origins in
consumer housing loans, contagion
quickly spread the crisis throughout the
financial system. For at least a short
period of time, nearly all classes of credit
were negatively affected.
In contrast to the collapse, the
recovery of different components within
the credit system can play out over vastly
different time frames. Unfortunately for
municipal creditors and other
stakeholders (employees and business
service providers), the financial health of
most municipal organizations is
challenged by both short-term and
long-term sources of budget stress.
In November 2010, IBISWorld
published a special report that assessed
which industries had a high sensitivity
to government austerity. That article
and the supporting data provided a
macro view of austerity and included
industries that had a measurable
sensitivity to any combination of federal,
state or local government spending. This
article will take a similar yet more
specific look at industries’ sensitivity to
state and local government.
Muni credit overview
For a credit market known for being
stable and boring, the municipal market
can’t seem to stay out of the news. While
much of the attention is well founded (the
economic downturn creating havoc with
near-term budget deficits, while large
underfunded pension benefits increase
long-term spending requirements) the
exact health of the municipal credit
market is difficult to generalize.
Looking in the rearview mirror puts
state and local debt loads in a favorable
light, but it also illustrates how much
debtors rely on economic growth and how
interconnected all debtors are. While the
aggregate debt load of state and local
government relative to GDP is not
excessive by historical standards (Figure
1), when everyone that state and local
governments depend on for tax revenue or
financial support has their own
significantly greater debt loads, the
process for restoring the financial health
of all parties involved provides little
margin for error.
Revenue generation is the most
immediate short-term problem for state
and local governments, but the increasing,
and significantly underfunded, social
demands of the aging population are
rapidly approaching. Unfunded pension
obligations are not included in Figure 1
data, and the size of these “off-balance
sheet” liabilities has the potential to
overwhelm the current level of state and
local outstanding debt.
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Municipal debt
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FIGURE 1
% change
Debt levels as a percentage of GDP
250
200
150
100
50
0
Year 1976 1979 1982 1985 1988 1991
Federal Reserve Board data pegs 2009
state and local government debt
outstanding at $2.4 trillion; however,
Northwestern University economists
recently pegged the size of underfunded
pension liabilities at nearly $3.6 trillion
($3.0 trillion of which relates to state
pensions and $574.0 billion in city and
county liabilities).
While many of the financial obligations
described previously are long term in
nature, recession-induced state and local
budget deficits leave few options to avoid
immediate austerity measures. While the
majority of states have implemented
budget cuts or tax increases since the
beginning of the recession, states are
widely expected to remain in fiscal
deficits through their 2012 fiscal year.
Industry conditions and impacts
As noted in the November 2010
Government Austerity report, within
IBISWorld’s database of more than 700
US industries, about 176 have a
measurable sensitivity to government
spending. The largest financial
exposures to government spending are
dominated by those sectors where both
federal and state and local sensitivities
are present: education, construction and
1994
1997 2000 2003 2006 2009
Household debt/GDP Business debt/GDP State and local debt/GDP Federal debt/GDP
SOURCE: FEDERAL RESERVE BOARD
medical. The military sector is unique
because of its concentrated reliance on
federal spending.
Construction
As summarized in Figure 2, the
construction industry’s sensitivity is
dominated by varied forms of
infrastructure activity. It is even more
noteworthy that the combined sensitivity
to government spending exceeds 40% for
the majority of industries; furthermore,
for nearly all industries, state and local
sensitivities are far greater than those for
federal spending.
Medical
There are 16 medical facilities and
practitioner industries that have
sensitivity weights of 20 or higher based
on federal Medicare and Medicaid
funding. While nearly all medicalrelated
industries have some sensitivity
to public expenditure, these industries
have increasingly relied on federal
expenditure relative to state and local
funding during the past 20 years.
Further, as an entitlement program,
total Medicare and Medicaid spending is
influenced by enacted legislation, not
the annual budgeting process.

WWW.IBISWORLD.COM Special Report Month 2010 3
Municipal debt
FIGURE 2
Construction industry sensitivity weights
Water well
Transmission line
Roadway services
Roadway maintenance
Roadway construction
Municipal building
Heavy infrastructure
Pipeline
Bridge and tunnel
0% 20% 40% 60% 80% 100%
State and local Federal
SOURCE: IBISWORLD
Education
University and college education and
primary and secondary (public) schools
dominate the Education sector’s reliance
on government funding (IBISWorld
sensitivity weightings of 30.0% and
40.0%, respectively). Of the estimated
$1.1 trillion that was spent nationwide on
education at all levels for the 2009-to-
2010 school year, the vast majority came
from state, local, and private sources. At
the elementary and secondary level, the
Department of Education estimates that
about 89.5 percent of school funding
comes from non-federal sources.
Other sectors sensitive to
state and local spending
The privately owned Correctional
Facilities industry has the largest
dependence on state and local
government clients (74.0% sensitivity),
which is more than any industry outside
of construction. While the demand for
correctional facilities in total (private and
public) will continue to grow, total direct
expenditures on correctional services by
governments will expand at a more
constrained rate. Private operators will
face the same challenges as their public
counterparts in constraining or lowering
the cost of operating facilities.
Environmental industries
Municipal governments that do not own
or operate their own landfill or disposal
facilities require the services of a private
operator. Over time, local governments
have been privatizing their waste
collection services and their waste
disposal sites. Local governments are
increasingly looking at methods other
than landfill for waste disposal. Since the
construction and operation of waste-toenergy
plants is complex and capital
intensive, local governments will likely
outsource waste disposal to private
industry operators.
While trends in outsourcing of public
operations may support various waste
management industries, it is also highly
likely that smaller municipalities will join
forces in contracting services to improve
their negotiating power; only the largest
operators will survive. These contracting
conditions will also affect many other
industries that are sensitive to state and
local government spending.
Financial
State and local governments remain a
significant force in the Retirement and
Pension Plans industry, in terms of the
assets involved, and more importantly,
because of their continued reliance on

WWW.IBISWORLD.COM Special Report Month 2010 4
Municipal debt
FIGURE 3
National health expenditure
2500
2000
$ billions
1500
1000
500
0
Year 1960 1980 1993 1998 2000 2002 2004 2006 2008
Private Federal State and local
SOURCE: CENTERS FOR MEDICARE AND MEDICAID SERVICES
defined benefit plans. The private sector
has moved toward defined contribution
plans (i.e. 401[k] plans), but sponsors of
defined benefit plans remain saddled
with higher cost plans that are exposed to
the financial risks associated with
investment returns and the cost of future
benefits.
While municipal government pension
benefits will likely be curtailed in the
future, any significant progress in
increased pension funding (reducing
underfunded obligations) will benefit a
handful of financial industries.
Retirement and pension assets will grow
along with the services provided to
manage these assets (i.e. portfolio
management or custody, asset and
securities services).
Other
The cloudy outlook for municipal financial
conditions threatens a longer list of
smaller municipal contractors, from
surveying and mapping services to
landscaping, gun and ammo
manufacturing, and even computer repair.
One sub-sector that has a relatively
high concentration of government
spending sensitivity is the Independent
Performers and Creative Artists industry.
While small in scale, the sensitivity to
government spending for performing arts
and independent performers stands at a
relatively high 25.0%.
Summary
State and local governments continue to
lag behind private enterprises in terms of
“right-sizing” their operational footprint
to the financial realities of the credit crisis
downturn. More importantly, increasing
and underfunded pension obligations
require long-term austerity commitments
that play a significant role in stabilizing
the health of municipal finance.
While this report has identified
industries that have measurable
sensitivities to state and local
governments, the magnitude of potential
austerity measures will likely expose any
state and local government supplier to
reduced revenue and profitability.
The financial fallout will hit smaller
businesses particularly hard as local
governments increasingly band together
when collectively negotiating contracts.
To remain competitive in these
constrained markets, smaller operators
will need to scale up or merge with others.

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