WASHINGTON -- Welcome to the world of municipal budgeting in the 1990s.

Over the past several years, major cities have struggled to balance their budgets as lean times have replaced the wealth and growth of the 1980s, but now the message is coming home for more prosperous local governments. The days of expanding budgets and services are over, say local government officials. It's time to downsize.

"I'm urging every state and local government to consider a permanent down-sizing," says Parris N. Glendening, county executive for Prince George's County in Maryland. "We're rethinking the role of what local government should be. The question is what are the essential functions."

Local government officials, in random interviews around the United States, say they are looking at a variety of ways to trim operations without riling constituents. At the same time, there is a feeling that voters are fed up with tax increases, angry with government, and uneasy in an economy that continues to languish.

In Prince George's County over the past year and a half, officials have slashed county payrolls 25%, to 4,700 from 5,900. They have cut a wide range of jobs outside the school system in administration, personnel, finance, health, and social services. Three quarters of the cuts have been made through attrition or early retirement, and the remaining quarter have been in firings.

Across the Potomac River, in upscale Fairfax County, members of the Republican board of supervisors swept into office in off-year elections last month face a $197 million budget deficit. Salaries of school and county officials have been frozen for a year, and no one knows where the money will come from next year to close the gap.

The political terrain for cutting budgets is hardly friendly, said Mr. Glendering, who is a top official of the National Association of Counties and an expert in municipal budgeting. "What this recession is doing is pitting one group against another or pitting taxpayers against public employees," he noted.

"There's a sense of frustration," Mr. Glendening added. "There's a sense of bitterness. And it's swelling up in the middle-class constituency even more than among the wealthy and the poor. Every recession has its own unique signature, and this one in particular has tended to hit the middle class, small business, and the suburban areas muchd dmore than other recessions that were concentrated in the urban and industrial areas."

On Wall Street, municipal analysts say it is clear local governments will have to find ways to reduce the scope of their public responsibilities as lean budgets force tough decisions.

"Downsizing one way or the other is being demanded in many political jurisdictions," said Bob Chamberlin, director of municipal research at Dean Witter Reynolds Inc. "The places that are the most heavily staffed are the ones that are going to cut back the most."

East Coast jurisdictions with large unionized work forces are one example, he suggests. He also predicts more localities will seek ways to trim personnel and benefit costs by privatizing clerical, tax, and other administrative tasks.

To be sure, there are some bright spots for local government leaders, notably low interest rates that cut the cost of bond financing and a continuing public willingness to tap the municipal market for funds.

The recession, lower inflation, and a series of moves by the Federal Reserve to ease monetary policy by adding cash to the banking system have combined to bring down interest rates throughout the year. Municipal bond yields are the lowest in four years. The average yield on The Bond Buyer's index of 40 municipal bonds settled in last month at around 6.80%, down from 7.50% a year earlier.

The downturn in rates has attracted municipal issuers seeking to come to market with new bonds or wishing to refund old debt at higher rates. Municipal bond volume in 1991 has boomed.

Through the first nine months of the year, new municipal bond sales totaled $119.14 billion, up 25% from $95.14 billion for the same period in 1990, according to figures compiled by Securities Data Co./Bond Buyer. Such a sales pace, if it continues, would mark the second-highest annual total on record.

Refunding issues jumped to $28.18 billion in the first nine months, up 46% from $19.33 billion during the same period last year.

And despite the sour political climate created by the recession and the ongoing financial stress for many municipal governments, voters in November showed they remained ready to take on fresh debt for projects they thought were worthwhile. Voters authorized 70% of the tax-exempt bonds on the ballot as approvals for several large issues offset disapprovals for a number of smaller issues.

Survey Says...

A survey by The Bond Buyer found voters have the nod last month to 139 bond proposals out of 290 on the ballot, or issues worth $5.45 billion out of $7.77 billion. The approval rate of 70% was a much better showing than last year, when only 14% of a 12.33 billion slate got the go-ahead, although it was still below the 80% to 90% approval rate that was typical of the 1980s.

"I'd make a case that the municipal sector is behaving in a counter-cyclical fashion that is helpful to the economy," Mr. Chamberlin said. "These figures say implicitly that people will vote for debt at a time when they might not incur debt themselves."

Moreover, municipal analysts say, not all regions of the United States are continuing to suffer from recession. The Midwest, with its industrial base and a variety of firms that have been found export markets overseas, has largely escaped the fiscal stress of the Eastern seaboard and California. Texas, which has successfully diversified in recent years from its dependence on oil and gas, is generally stable.

But the latest economic reports have not been encouraging. Industrial production, according to the most recent report from the Federal Reserve Board, has basically been flat since July. Retail sales -- a critical measure of consumer spending and a major source of municipal revenue -- have also been flat since the summer, according to the Commerce Department. Consumer confidence is off sharply.

Only the housing sector seems to be edging up, apparently with the help of lower interest rates.

Until a few months ago, the Bush administration spoke confidently of economic recovery in the second half of the year -- a view that was widely shared by many private economists. With recovery, state and local governments could bank on rising personal income and retail sales to restore tax receipts. There also were hopes that commercial and retail sales property values would stabilize and help tax collections.

Now, economists say, if there is a rebound it will be sluggish, and municipal governments have to plan for more lean times. Demand for services is not going away, and tax receipts are weak despite increases in rates in many jurisdictions.

Downgrades on the Rise

"State and local governments faced budget problems last year and did a number of things to balance the budget," said George Friedlander, managing director of Smith Barney, Harris Upham & Co. "The problem is that many moves involved one-shot, stopgap measures, and the economic picture has not kept pace with the assumptions used."

Already, Mr. Friedlander notes , the number of rating downgrades in the municipal sector is rising, and more are probably on the way. According to Standard & Poor's Corp., bond downgradings in the third quarter totaled $18.8 billion, compared with only $200 million in upgrades.

"Tax collections seem to have taken a downward turn in October in line with everything we've read about the economy," said Claire Cohen, executive managing director of Fitch Investors Service. "It doesn't look too rosy to me over the next six months."

Each municipality has its own special budget requirements, but "clearly the governments that are having the most difficult time are those that provide the most service," Ms. Cohen said. Even bareknuckle budget states, such as New Hampshire, are having to cut back.

Analysts also note that there is a lag time of many months between market changes in property values and local tax assessments. As a result, cities can expect to see further reductions in their property tax base.

"We still have not seen the complete impact of the depressed real estate market on local property tax revenues," says Doug Peterson, senior policy analyst for the National League of Cities. "Getting some life back into the property market is critical for improving the revenue flows of cities as well as being a sign of economic health for many local communities."

"It's a ticking time bomb," says Steven Wechsler, president of the National Realty Committee, which represents commercial property owners. "The bottom line is assessments will be lowered, and localities are going to be forced into raising tax rates or cutting services."

State cutbacks in aid to cities can also be expected to be a problem as long as the economy is slumping, Mr. Peterson said. "The states will be providing less money while requiring the same services, which means they'll take out somewhere, and we're always the logical candidate," he said.

Already, California is struggling with a potential budget is shortfall of $3 billion in fiscal 1992, and New York faces a $3.6 billion deficit. Both states recently went through gut-wrenching budget fights that resulted in large cutbacks and tax increases. Now they are looking at more of the same.

Meanwhile, federal mandates for city spending continue to demand more money. In the annual report on city fiscal conditions released last summer by the League of Cities, more than one-third of the cities surveyed cited budget problems stemming from compliance with U.S. rules for solid waste, drug enforcement, and other federal programs.

"There will be unrelenting pressure on urban budgets in the years immediately ahead," said Mr. Chamberlin in a market letter to Dean Witter clients.

Tightening the Belt

Many cities have already had to lay off employees, raise fees, and contract out for services. Nearly three-quarters of the cities surveyed recently by the U.S. Conference of Mayors said they have postponed capital improvements, often financed by bonds. But still more belt-tightening and cutbacks in services are in store as localities struggle to maintain their bond ratings.

In Boston, city officials say a weak economy is bringing a loss of $85 million in corporate, personal, and sales tax receipts in a total municipal budget of some $1.3 billion. The slowdown in real estate is also trimming revenue from new office buildings, says Tom Snyder, chief financial officer.

On March 1, Boston laid off 527 municipal employees, leaving a work force of 11,800. So far the city has avoided cutting back in the number of police and other public safety officials, Mr. Snyder said. But, he warned, "I don't see how we can avoid affecting public safety in the coming year."

Madison, Wis., meanwhile, is fighting to keep its coveted triple-A bond rating, said Mayor Paul Soglin, but he added that "there will be cuts in services, there's no question about it."

The city, which has a budget of $114 million and saw spending go up only 2.7%, was forced to raise property taxes 7%.

Madison is experiencing an influx of poor people who have left Chicago and Milwaukee and need a whole range of social services. Meanwhile, state payments are being cut back. Even though the local economy remains fairly prosperous, the budget remains a challenge.

"It's real hard to go around and tell people you're raising their taxes 7% and reducing their services," says Mr. Soglin.

In the farmland of Richland County, N.D., a part of the country that has escaped the recession and seen general fund receipts rise 4.1%, to $3.69 million, officials are worried about rising costs. Health insurance premiums for county employees jumped 8.3%, and taxpayers seem in no mood to fund even routine water projects, says county Commissioner Kaye Braaten.

In Denver, the focus is on holding the line. The city is already committed to completing bond-financed projects of $2.4 billion for Denver International Airport, $241 million in highway improvements, and $62 million in highway projects.

Denver Turnaround?

The Denver region's economy shows signs of turning around, says Mike Dino, an aide to Mayor Wellington Webb.

"Now we're trying to keep the city viable." Mr. Dino adds: "The mayor senses that the people of Denver are tired of voting for bond issues, and it would be foolish to bring another issue forward," with the possible exception of school bonds.

Despite all the talk of how localities will have to get by doing more for less, some analysts say the situation can create opportunities.

One approach being explored increasingly by cities is privatization of administrative, waste, and other services that have traditionally been in the municipal ring of responsibility. In the League of Cities report on city fiscal conditions, nearly 37% of the 525 cities surveyed said they had contracted for outside services. That was more than the number reporting layoffs and hiring freezes.

"Contracting out for services has been going on for years," says Michael Basham, managing director of Smith Barney, which is one of two Wall Street investment firms seeking to promote privatization in municipal finance. The other is Goldman, Sachs & Co. "It's becoming a more viable policy alternative for governmental entities in an economic environment of limited means," he added.

Mr. Basham, who until recently served as the Treasury Department's deputy assistant secretary for federal finance, says his firm is looking at a variety of ways local governments can work with private firms to provide services and develop capital-intensive projects.

Mr. Glendening of Prince George's County, Md., says cutbacks in stat aid are forcing local governments to tough out their own course and set priorities.

"Local governments might actually come out of this a little bit stronger," he says. "They'll be more independent, fiscally sound, and certainly more tightly managed."

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