The Strategy, Part Two
July 13, 2010 9:58 AM
Now's the time to build things.
Yesterday I blogged about my belief that a second large federal stimulus bill was the right thing to do in order to keep us moving toward economic recovery. Today, I want to write about the implications of that point of view for the city of Madison budget going into next year.
The first thing we need to understand is that most every government has two kinds of budgets, an annual operating budget and a long-term capital budget. The operating budget covers annual costs for running the city, mostly salaries and benefits for our employees but also supplies, routine maintenance on our buildings, fuel and utilities, etc.
By contrast, the capital budget is for long-term investments like a new library or fire station or rebuilding our streets or sewers and water pipes. Basically, by our rules here in Madison, any significant purchase that will last at least ten years goes into the capital budget.
You can think of it as the difference between your monthly household budget for groceries, utilities and the like (your operating budget) versus your house mortgage (your capital budget). The two are related though because you pay your mortgage through your monthly household budget. In just the same way, the city pays back its long-term borrowing through the annual operating budget.
The two budgets, capital and operating, demand very different strategies because they deal with very different time frames. Since capital borrowing is paid back over ten years, we need to consider what kind of shape our budgets will be in over a decade, not just next year. Unless you think this recession will go on for the better part of a decade, it might make sense to invest now when interest rates are low. So sometimes, this means that we should do things that are counterintuitive: that is, make aggressive investments in infrastructure just when a bad economy is making us cut back in other ways.
This is particularly true right now. Intuition might tell us that we shouldn't be borrowing for long-term projects in a recession, but I think it would be a mistake to cut back now and here's why. Take street repair. We know that streets wear out over time and, in fact, we know that as of a couple of years ago about a quarter of our arterial streets were in substandard condition. We're going to have to rebuild them soon, but here are the advantages of rebuilding them now. First, interest rates are at historic lows. The same dollar we might borrow in a few years will cost us a lot more to pay back. Second, people need jobs now. In some trades, one out of three workers is unemployed. Third, there's a ripple effect. When those trades people go back to work they spend money on food, housing, clothing and more. Fourth, because contractors are looking for work, we can get very competitive bids. So, making capital investments during a recession can make sense because it's work that will need to get done anyway, but we can do it now when prices are low, we can borrow money at low rates and people need the work.
The same strategy doesn't hold for the annual operating budget, though. The operating budget isn't about the next decade - it's about the next calendar year. If there isn't much hope for recovery in the next twelve months, then it makes sense to restrain spending and even cut it back where we can. But having said that, I'm not for slash and burn cuts. In fact, in this last recession year, we managed things well enough that we didn't have to make any major cuts in services. We even added a new paramedic unit and a new crime and gang unit. That will be our strategy going into 2011. No major program increases, some modest cuts, but, if we can swing it, no major reductions in basic services. The idea is to maintain the high level of services we have and ride out another year toward recovery without making any major new spending commitments on the operating budget side.
This brings me to one last important difference between the operating and capital budgets. Capital investments are essentially one-time commitments. When we finish University Avenue, for example, we might not have to rebuild it again for two or three decades. Not so with the kinds of things we pay for with the operating budget. Just by the nature of politics, once we create a new program in the operating budget, it develops a constituency, and it becomes virtually impossible to reverse it. Imagine trying to layoff cops or close a fire station or defund a popular nonprofit organization. So we have much more real control over increasing and decreasing capital budgets to respond to economic conditions than we have over operating budgets.
Next time we'll discuss what I think the city's recession recovery strategy should be related to private businesses.