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American cities are preparing for the worst and bracing for ‘stagflation and a possible economic downturn’

Nico de Pasquale Photography—Getty Images

It isn’t only Wall Street warning about a recession. Even local city governments are getting nervous.

Economists and major business leaders have been talking about a recession for months now, as inflation remains persistent, and the Fed continues to raise interest rates to try to bring it down. Former Treasury Secretary Larry Summers said recently it is “more likely than not” the U.S. will be in recession within the year, while JPMorgan Chase CEO Jamie Dimon said this week that the U.S. economy will be in recession “six to nine months from now.”

Companies and CEOs are already preparing for an economic downturn, with many preemptively considering layoffs.

But recession fears are also starting to play out in local politics, with a growing number of U.S. city governments concerned about their finances and planning out more conservative budgets for the year ahead, according to a new survey released Wednesday by the National League of Cities, an advocacy group.

In planning their budgets for the 2023 fiscal year, only 70% of city-level finance officials are optimistic that their local financial needs can be met, according to the survey. It’s a steep drop from last year, when 90% of city governments felt comfortable about their finances, as a growing number of cities are concerned that an economic slowdown is set to hit their budgets.

The “looming fear” of a recession has forced many cities to downgrade their income and sales tax revenue forecasts for next year and adopt more conservative budgets.

Sales tax receipts are expected to fall by 2.5% this year, while income tax is projected to stay flat, according to the report. And while property tax receipts tend to make up a much smaller portion of budgets in most cities, these too are forecasted to fall by 4% this year, in response to a historic housing market correction brought on by higher mortgage rates.

“We still face a challenging few months ahead,” Clarence Anthony, CEO and executive director of the National League of Cities, wrote in the report.

“While the fiscal impacts of abnormally high inflation rates remain to be seen, America’s cities are bracing for stagflation and possible economic downturn.”

Cities prepare for recession

City governments are increasingly factoring in the chances of a recession by downgrading their expectations of how much tax revenue they are expecting for the 2022 and 2023 fiscal years, the lifeblood of local budgets.

That’s because budgets come from tax income, and most municipalities are preparing for steep declines in their revenues from income and sales tax this year, with a recession threatening to send unemployment up and bring consumer spending down.

It’s a far cry from what cities have been experiencing over the past year. The gradual lifting of pandemic-era restrictions, combined with significant federal stimulus cash flowing through the economy, increased consumer spending and decreased unemployment in 2021. This translated to a “strong rebound of city revenue sources” in the form of larger sales and income tax revenues, according to the report.

Cities also benefited directly from federal recovery programs, including last year’s American Rescue Plan and Biden’s major infrastructure bill, the report said.

But the economy is now flashing warning signals, and cities are already starting to suffer. Annual inflation has now risen to a new 40-year high in the U.S., which has quickly eaten into cities’ larger budgets.

“Our cities, towns, and villages still face an uphill battle as abnormally high inflation rates have nearly canceled out the tax revenues these governments gained in 2021,” the report read.

And the pain could be just beginning. GDP growth has declined for both of the past two quarters—normally a clear sign of a recession. And while unemployment is still low and consumers continue to spend, that situation could change quickly.

Last week, ex-Secretary Summers said that the unemployment rate would need to go as high as 6% from 3.5% today to rectify current levels of inflation. And while most Americans have been able to tap into their large pandemic-era savings over the past year, those savings might be dwindling.

Last July, Moody’s Analytics predicted that lower-income Americans would start running out of savings to spend by the end of 2022. And last month, the Bureau of Labor Statistics revised its estimates of how much cash Americans still have stored away, revealing that the U.S. personal saving rate is now at its lowest point since the early days of the 2007 financial crash.

This story was originally featured on Fortune.com

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