Litigation: a real budget buster for many U.S. municipalities.

• Author: MacManus, Susan A.

Confronted with a litigation price tag of billions of dollars annually, local government budget officials are searching for both preventive and reactive mechanisms to get these costs under control.

The CEO of Deloitte & Touche recently estimated that the total cost of litigation in the United States is around 3 percent of the gross national product--and rising. In the private sector, the cost of litigation is routinely built into the price of various consumer goods. Some even equate the cost of litigation (insurance, lawyers and trials) to a hidden "litigation tax." Only recently have public finance officers scurried to make the same type of cost calculation for public goods.

Local government budget officers, confronted by a litigation price tag running in the billions of dollars annually, are becoming much more attentive to the fiscal impacts (real and potential) of rising litigation costs.(1) There is a fast and furious search underway for both reactive and preventive mechanisms to get this "cost center" under control.

The author's research into the nature and extent of this problem includes a survey of the membership of the National Institute of Municipal Law Officers (NIMLO) in the fall of 1992. The 234 respondents closely mirrored NIMLO's membership in terms of local government affiliation--96 percent are counsel to municipalities. Forty-six states were represented among the respondents.(2) The survey results, reported in this article, not only reveal the magnitude of the litigation cost problem but also offer some insights into coping strategies that are being utilized to lessen the fiscal squeeze brought about, at least in part, by the litigious nature of American society.

Cost Escalation

The rate of increase in litigation expenses has sent shock waves through many budget offices. In more than half the respondent jurisdictions, litigation costs have increased 10 percent or more during the past two years; for 19 percent, the increase has exceeded 30 percent; and for an unfortunate 7 percent, there has been an increase of more than 50 percent. Only 12 percent reported no increase. Clearly, in most cities, litigation costs have risen at a rate far in excess of the inflation rate.

The data also show that litigation costs have risen fastest in cities in the worst fiscal shape. Forty percent of the cities experiencing 50 percent or greater increases in lawsuit-related costs classified their financial condition as poor or only fair, compared to only 8 percent of those which experienced no increases. It is impossible to discern whether rapidly rising litigation costs precipitated the weak fiscal environment or vice versa. It is less difficult to conclude, however, that large, unexpected expenditures most likely cause the greatest budgetary stress where the financial picture is dimmest. Strain on Budgets

Predictably, litigation, the fastest growing "uncontrollable" expense, has affected government budget priorities and processes. For an indication of the relative impact of litigation costs on budgets, the survey questionnaire asked, "To what extent have litigation costs (including damages and awards) affected your local government's budget this past year?" Results are tabulated in Exhibit 1. In one-fifth of the municipalities, litigation costs had "a lot" of impact. In another two-thirds, there was "some" impact. Only 13 percent reported no budgetary impact at all.

The budget impacts of litigation costs seem to hit cities at each end of the size continuum the hardest, as seen in Exhibit 1. Twice as many very small (below 10,000 population) and very large (one million or more) cities reported that litigation costs impacted their budgets "a lot" than said they had no impact at all.

Need for Mid-year Budget Amendments. Forecasting litigation costs accurately is very difficult, perhaps the most difficult to estimate next to predicting costs stemming from an unforeseen natural disaster or civil disorder. The "long tails" nature of much public-sector litigation makes forecasting particularly difficult. The "long tails" problem, according to the U.S. Advisory Commission on Intergovernmental Relations, surfaces when governments are involved in activities where liability is hard to predict and legal action often takes place long after an event has occurred.(3)

The difficulty of accurately predicting litigation expenses, for whatever reason, is driven home by the fact that in more than one-third of the respondents' jurisdictions, unpredicted litigation-driven, mid-fiscal year budget adjustments had to be made. More than 60 percent of the cities experiencing major fiscal impacts from litigation reported they had to make moderate mid-fiscal year budget amendments; another 26 percent indicated these adjustments were large relative...