Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Quietly Reshaping Local Government Budgets
Transcript
- Lucas: You know, we spend a lot of time on this show talking about how stagflation hits households and corporations. But there's a whole other layer that's quietly breaking under the surface — and it affects nearly every American directly: local government budgets. Luna: You mean cities and states? They're feeling it too? Lucas: Big time. And the mechanics are a bit different from what you'd expect. On one side, you've got rising costs — pension obligations, healthcare for retirees, infrastructure maintenance. Those are all indexed to inflation. On the other side, revenue growth is slowing because the economy is barely growing. Luna: Right, because sales tax and income tax depend on economic activity. And property tax — that's supposed to be stable, but... Lucas: But commercial property values are under pressure. Office vacancies are still high in most major cities, reassessments are coming in lower, and that's a huge chunk of the tax base. The latest data from April shows real GDP growth at an annualized 1.6 percent — that's not exactly generating a windfall for state coffers. Luna: So what's the most dramatic example right now? Lucas: California. They're staring down a budget deficit estimated at around $45 billion for the 2026-27 fiscal year. That's not a small gap — it's roughly 15 percent of the state's general fund. And this is after years of surpluses. The problem is that a lot of their revenue came from capital gains taxes on wealthy tech workers and investors. When the market dips or slows, that income disappears. Luna: And with the S&P up recently — it's at 7,561 today — but that doesn't necessarily mean capital gains are flowing yet. Plus the Fed's still focused on fighting inflation. Lucas: Exactly. Fed's Kashkari said today that the inflation fight takes priority because the labor market is 'in decent shape.' So rates stay higher for longer. That means borrowing costs for cities and states are up too. Municipal bond yields have risen, making it more expensive to fund infrastructure projects or even roll over existing debt. Luna: And that's on top of pension liabilities. CalPERS, the big California pension fund, is assuming a 6.8 percent return, but if the market environment stays volatile, they might not hit that. Then the state has to make higher contributions. Lucas: That's the hidden squeeze. It's not just one thing — it's the combination of slower revenue growth, higher costs, and more expensive debt. And unlike the federal government, most states have balanced budget requirements. They can't just run deficits indefinitely. Luna: So what are they cutting? Or do they raise taxes? Lucas: Both are politically toxic in a stagflation environment. Voters are already feeling the pinch — core CPI was at 3.3% annual rate in April, and that's the Fed's preferred gauge. If you raise sales taxes or property taxes, people notice. If you cut services — schools, roads, public safety — people also notice. So a lot of cities are doing something else: drawing down reserves, delaying maintenance, or using one-time accounting tricks. Luna: That sounds unsustainable. Like kicking the can down the road. Lucas: It is. But there's actually a structural issue here that doesn't get enough attention. Local government revenue models were designed for a world where inflation is low and growth is steady. With stagflation, both assumptions break. Inflation pushes up costs faster than revenue can adjust, and slow growth means the tax base expands slowly. Luna: So what's the endgame? Is there a way out? Lucas: Some places are experimenting with new revenue sources — like congestion pricing, vacant property taxes, or even local carbon taxes. But those are small relative to the gap. Others are consolidating services across jurisdictions to cut overhead. But the honest answer is that many municipalities are going to have to make painful choices. And that's going to affect the quality of public services just when people need them most. Luna: That's a tough reality. And honestly, it's one of those things that doesn't make headlines until the potholes get really bad or the school year gets shortened. Lucas: Right. And that's why we wanted to cover it. Because stagflation isn't just a Wall Street story. It's about your property tax bill, your child's class size, and how long it takes to get a building permit. These are the quiet ways the macro economy touches daily life. Luna: I think a lot of our listeners probably hadn't connected those dots. I know I hadn't fully. Lucas: Well, if walking through the economy with us has made something click, the way this show stays ad-free — and we want it to stay that way — is through listener support. It's pretty straightforward: you can find us at buy me a coffee dot com slash fexingo. No pressure, but if today was useful, that's how you keep it going. Luna: Yeah, and it really does make a difference. Every contribution helps us keep digging into these angles that don't get covered elsewhere. Lucas: Exactly. So let's get back to one more angle on this — because there's actually a surprising beneficiary in this mess: some smaller cities that are attracting remote workers and businesses fleeing high-cost areas. Luna: Oh, interesting. So the pain is uneven. Lucas: Very. Places like Boise, Idaho; Austin, Texas; and Nashville, Tennessee saw a boom during the pandemic, and they're still seeing population inflows. That expands their tax base even as costs rise. But the flip side is that they're now dealing with infrastructure strains — more traffic, higher housing costs, more demand for schools. Luna: So it's a different kind of budget pressure — growth pressure rather than decline pressure. Lucas: Exactly. And that's almost harder to manage, because you have to invest upfront to meet demand, but you don't have the revenue yet. And with borrowing costs high, those investments are more expensive. Luna: So what does a city like Boise do? Issuing bonds at current rates is costly. Lucas: Some are using impact fees on new development — charging builders upfront for the cost of new roads and schools. Others are using public-private partnerships to finance infrastructure. But it's a patchwork. There's no one-size-fits-all solution. Luna: It sounds like local government finance is becoming a lot more creative — and a lot more stressful. Lucas: It is. And I think that's the takeaway for today: stagflation is forcing innovation at the local level, whether it's in how cities budget, how they borrow, or how they deliver services. But it's also forcing hard trade-offs that have real human consequences. Luna: And those trade-offs are going to be with us for a while, because inflation isn't dropping quickly and growth isn't picking up. Lucas: Right. The 10-year breakeven inflation rate is at 2.39 percent — that's the bond market's expectation for average inflation over the next decade. It's not screaming deflation. So we're in for a prolonged period where local governments have to navigate this landscape. That's worth paying attention to. Luna: Absolutely. Thanks for digging into this, Lucas. Lucas: Thanks, Luna. And thanks to everyone listening. We'll be back next time with another angle on how stagflation is reshaping the world around us.