784 Case: The City of New York
54 Part 4 Additional Cases
unfunded mandates from federal and state governments to provide additional services,
pressures to increase the quality of public services provided (without increasing costs),
and competition between municipalities to attract new businesses.
Much of the infrastructure for older U.S. cities such as New York was provided during
the Depression. For example, the public works projects of the New Deal provided for the
construction of municipal roads, bridges, and some public buildings. The 1970s saw a
shift from maintenance and replacement of this infrastructure to increased social ser-
vices. As a result, infrastructure deteriorated and by the early 1990s often required
A second ´¬ünancial challenge facing older U.S. municipalities arose from stagnant
revenue bases and increased cost structures. Many municipalities in the Northeast and
the Midwest had stable or declining populations, and had seen key businesses move to
City of New York
less costly areas of the country. As a result, their revenue base was stagnant. Compound-
ing this problem, their costs had escalated during the 1980s and early 1990s. For exam-
ple, medical costs increased at rates signi´¬ücantly higher than in´¬‚ation during this period.
This increased signi´¬ücantly the cost of medical bene´¬üts for municipal employees, as
well as the cost of providing health services to older and poorer residents through public
A third factor affecting municipal governments had been the increase in unfunded
state and federal government mandates to provide additional services. For example, state
and federal governments required local governments to accept increased responsibility
for undertaking such services as police and safety, mass transit, housing for the indigent,
and special education, without necessarily providing the full funding for these services.
The 1980s and 1990s also saw increased product and service quality in many areas of
the private sector. For example, there were signi´¬ücant product improvements in the com-
puter and auto industries, faster customer response times due to overnight delivery, faxes,
and E-mail, as well as opportunities for home shopping and banking. Taxpayers fre-
quently expected the same types of quality improvements in public services, leading to a
growing expectations gap between taxpayers and public service providers about the qual-
ity and cost of services. As a result, there was widespread pressure on local governments
to improve productivity and to make existing resources stretch further.
Finally, there was increased competition among local governments to attract new
businesses to their community. In many cases, local governments offered tax incentives
and commitments to provide infrastructure to companies considering locating in their
communities. For example, in late September 1993, after months of negotiations with at
least 30 states and municipalities which were willing to provide attractive location pack-
ages, Mercedes-Benz announced that it had decided on Tuscaloosa, Alabama, as the site
of its new $300 million plant. The plant, which was expected to open in 1997, would em-
ploy 1,500 and manufacture 60,000 sport utility vehicles per year. The city of Tuscaloosa
committed as much as $30 million for land acquisition and site preparation; Mercedes
would be allowed to buy this package for $100 million, implying that the deal cost local
taxpayers roughly $20,000 per new job.
Case: The City of New York
Part 4 Additional Cases
FINANCIAL REPORTING BY MUNICIPALITIES
Financial reporting standards for municipalities were developed by the Government Ac-
counting Standards Board (GASB), as well as by the Financial Accounting Standards
Board (FASB) and municipal laws. There were a number of differences between ´¬ünan-
cial reporting for municipalities and reporting by for-pro´¬üt organizations. Some of these
differences were differences in terminology. For example, the income statement was
called the Statement of Revenues and Expenditures and Changes in Fund Balances, and
owners equity was termed the ÔÇťfund balanceÔÇŁ in government organizations. However,
there were also substantive differences, including the use of fund accounting and modi-
´¬ücations to accrual accounting.
City of New York
Fund accounting required separate funds reports to be maintained to account and report for
many of the different activities of government. For example, separate statements were typ-
ically created for the local public hospital, for new capital projects, for debt service, for pub-
lic employee pension funds, and for general government operations. Each of these activities
was viewed as a separate entity or ÔÇťfundÔÇŁ and received its own allocation of resources. For
many funds these resources were restricted, and could only be used for speci´¬üc purposes.
Separate ´¬ünancial reports are therefore prepared for each fund account so that users can
monitor whether the resources allocated to the funds were used in the way intended.
For municipalities there are three major classes of funds: governmental funds, pro-
prietary funds, and ´¬üduciary funds.
Governmental funds included the general fund (where resources were unrestricted),
special revenue funds (which were restricted to outlays for speci´¬üc purposes other than
major capital projects), capital project funds (where funds were restricted to use for cap-
ital expenditures), and debt service funds (used to accumulate funds to pay interest and
principal on outstanding debt).
Proprietary funds were for activities that were intended to be operated like a business.
They included enterprise funds (such as hospitals and water and sewer operations),
which provided goods and services to outside parties and which were intended to be self-
supporting. Proprietary funds were also created for operations that provided goods or
services for other parts of the government.
Fiduciary funds were assets held by a government unit in trust. They typically in-
cluded pension funds for government employees.
Financial statements for municipalities presented separate results for all three classes of
funds. Also, separate group accounts were reported for debt obligations and ´¬üxed assets.
Modifications to Accrual Accounting
For proprietary funds, the traditional accrual accounting system was used. However, for
governmental funds several modi´¬ücations to accrual accounting were made. These
786 Case: The City of New York
56 Part 4 Additional Cases
modi´¬ücations (for revenue recognition, accrual of interest, and depreciation), made gov-
ernmental fund accounting closer to a cash basis of accounting than accrual accounting.
The ´¬ürst key difference between governmental accounting and traditional accrual ac-
counting was that revenues for governmental funds were reported when they become
measurable and available, rather than when they were earned. For example, property
taxes were recognized as revenue when levied rather than when they were earned. A sec-
ond major difference was that interest on long-term debt was not recorded until it be-
came due, rather than when it was accrued. Thus, if quarterly interest payments on
municipal bonds outstanding were due on January 31, a municipality with a December
31 year-end would not accrue interest owed to bondholders for the months of November
and December. Finally, while depreciation was recorded for business-like activities (pro-
prietary funds), for governmental funds new capital outlays were effectively expensed.
City of New York
As a result, the balance sheet for the principal government fund, the general fund, typi-
cally included only current assets and liabilities.
THE CITY OF NEW YORKÔÇ™S FINANCES
New York City had a checkered ´¬ünancial history. In February 1975, the New York Urban
Development Corporation was unable to repay a $100 million short-term note to Chase
Manhattan Bank. This triggered a crisis that resulted in the City being shut out of the
credit market. Its bleak prospects eventually forced bankers, unions, and government to
work together to reach an agreement. City management took on three sacred cows (low
transit fares, CUNY tuition, and subsidized housing); a special agency, the Municipal As-
sistance Corporation of the City of New York (MAC) was created as a vehicle to issue
new municipal debt; State legislators agreed to provide a 28 percent increase in
intergovernmental aid; the banks deferred debt and interest payments and provided ad-
ditional ´¬ünancing; and municipal employees accepted short-term pay cuts and layoffs
(many through attrition) and agreed that their pension fund would invest in new MAC
Subsequent analysis attributed the CityÔÇ™s ´¬ünancial collapse to a dramatic increase in
short-term debt (from $747 million to $4.5 billion in only six years). The New York State
Charter Revision Commission explained that:
Since 1970-71 every expense budget has been balanced with an array of gim-
micksÔÇ”revenue accruals, capitalization of expenses, raiding reserves, appropria-
tion of illusory fund balances, suspension of payments, carry-forward of de´¬ücits
and questionable receivables, and ´¬ünally, the creation of a public bene´¬üt corpora-
tion whose purpose is to borrow funds to bail out the expense budget.1
As a result of the management and budgetary changes discussed above, by 1981 the
City had balanced its budget again, and has since recovered from the ´¬ünancial crisis.
1. See R. Herzlinger, Public Sector Accounting , Prentice-Hall, Englewood Cliffs, NJ, 1996, p. 316.
Case: The City of New York
Part 4 Additional Cases
Exhibit 1 presents General Fund Revenues and Expenditures for the City during the
period 1992 to 1996, the 1996 budget, footnotes, and management discussion of perfor-
mance. Revenues were generated from a variety of sources, including real estate taxes,
sales taxes, income taxes, as well as funding from the federal and state governments. As
reported in Exhibit 2, in 1996 real estate tax rates for the City were 10.37 percent of as-
sessed property values, and 1.88 percent of their market values. This difference re´¬‚ects
the CityÔÇ™s practice of assessing property at less than its full market value.2 The ratio of
the assessed value of property to its market value (called the Special Equalization Ratio)
had declined steadily from 29.7 percent in 1993 to 22.1 percent in 1996.
Sales taxes arose from the CityÔÇ™s 4 percent sales tax as well as the stateÔÇ™s 4.25 percent
retail sales tax. In addition, the City levied a personal income tax on residents and on
earnings made in the City for nonresidents, and a corporate income tax on companies
City of New York
doing business in the city. Other revenues were generated by fees paid to the City for
issuing licenses, permits, and franchises; interest income; tuition fees from city-run col-
leges and universities; and rents collected from city-owned property and airports. In
1995 the City included in Other Revenues $200 million from the recovery of prior year
FICA overpayments for Social Security and Medicare, as well as $120 million from the
sale of upstate jails to the state. Other revenues in 1996 included one-time receipts of
$170 million from the New York City Health and Hospitals Corporation, and $28 million
from the New York City Housing Financing Agency.
Most of the federal and state funding provided to the City was in the form of categor-
ical grants, which were earmarked for speci´¬üc activities. These included expenditures
for welfare, education, higher education, health and mental health, community develop-
ment, job training programs, housing, and criminal justice. The City also received a
modest amount of unrestricted federal and state aid, which could be used for general-
purpose expenditures. However, this support had been declining.
The CityÔÇ™s major General Fund expenditures were for social services, education, pub-
lic safety, debt service, health, and pensions. As reported in Exhibit 1, the difference be-
tween General Fund revenues and expenditures, the General Fund surplus, was $5
million for the three years 1994ÔÇ“1996. However, this surplus did not tell the whole story,
since the City was required to balance its budget each year. The reported surplus there-
fore included discretionary transfers and expenditures used to cover a de´¬ücit or to elim-
inate any surplus. Operating surpluses before discretionary transfers and expenditures
were $570 million, $371 million, $72 million, $71 million, and $229 million in the pe-
riod 1991 to 1996.
New YorkÔÇ™s ´¬ünancial plan for the period 1997 to 2000, presented in Exhibit 3, shows
a steadily growing gap between General Fund revenues and expenditures. By 2000 this
gap was projected to be $3.4 billion. To meet this de´¬ücit the City had embarked on a
series of programs to contain costs and increase revenues. The new programs were
2. Revenues from real estate taxes are limited by the New York State Constitution, which requires real estate revenues
to be no more than 2.5 percent of the average market value of real estate for the most recent ´¬üve years.
788 Case: The City of New York
58 Part 4 Additional Cases
expected to provide revenues and cost savings by reducing entitlements, by restructuring
City government through consolidating and privatizing operations, by increasing federal
and state aid, and by selling assets. In addition, for 1997 the City projected a savings of
$150 million in pension fund costs from changing the actuarial assumption on invest-
Other studies, however, suggested that the CityÔÇ™s problems may be more serious than
of´¬ücial projections. For example, a May 1996 report by the City Comptroller identi´¬üed
between $1.176 billion and $1.546 billion of potential risks for the 1997 forecasts. These
included uncertainties about $100 million of assumed state aid, $160 million in pro-
posed revisions to Medicaid bene´¬üts, $40 million from changes in entitlement programs,
$319 million in airport-related payments which had been the subject of ongoing unsuc-
cessful negotiation, and as much as $400 million from unidenti´¬üed cuts in education.
City of New York
These concerns were echoed in staff reports from the OSDC and the Control Board. The
OSDC report, published in May 1996, concluded that the City had a structural imbalance,
and only succeeds in balancing the 1997 budget by including $1.4 billion of one-time
items. The study pointed out that the CityÔÇ™s structural problems did not appear to have
diminished by workforce reductions of more than 20,000 employees, the lowering of
public assistance and Medicaid costs, and the scaling back of tax reduction proposals.
In addition to its 1996 operating outlays of $32 billion, the City made capital outlays
of $3.8 billion. These were ´¬ünanced through the issuance of bonds by the City and City