Once a troubled Rust-Belt City, Duluth turns its finances around.

• Author: Ruff, Mark

Before it changed course, the City of Duluth, Minnesota, suffered the same economic fate as other Rust Belt cities during the latter part of the 20th century The region's economic woes, its aging population, and its antiquated infrastructure weighed heavily on the city's budget. But today, the city's finances have stabilized and the economy is strong. To handle the influx of new workers at one of several new and expanded businesses, a major focus of the city's current budget and staff resources is increasing the stock of new, moderately priced housing. Duluth's 2014 general fund budget highlights include no property tax levy increase, a net increase in staff, and no draws on reserves. Bond ratings are up--AA from Standard & Poor's and Aa2 from Moody's. Of course, the city made several tough choices to get to this point.

When the city's current mayor took office in 2008, he and the city council faced several seemingly insurmountable revenue and expenditure hurdles. Specifically, state aid and other intergovernmental revenues made up more than half of general fund revenues; property taxes, the main revenue source directly controlled by the city, contributed only 10 percent of the general fund budget, while sales taxes made up less than 20 percent of general fund receipts. These revenue ratios were similar for all the governmental funds. By 2010, annual state aid to Duluth decreased by $5.2 million. Sales taxes and investment earnings fell as the Great Recession deepened. In 2008, the city faced a $4.4 million budget deficit, and most revenues were flat or declining. General fund reserves fell rapidly from 2006 to 2008.

On the expenditure side of the budget, the city faced a major obstacle: post-employment benefits other than pensions, known as OPEB. Retiree medical costs were eating up almost 15 percent of the city's annual general fund budget in the mid-2000s and were projected to rise $1 million per year. Moody's put the city's bond rating on a negative outlook in 2009, citing structural imbalances in its general fund. At the time, these themes were not uncommon for post-industrial urban centers.

This article explains how Duluth was able to overcome the economic stresses that other Rust Belt cities have not escaped, and the role the city took in nurturing the recovery.

FISCAL DISCIPLINE

Duluth's retiree medical liabilities were the proverbial elephant in the room. In a 1983 deal to keep wages down, the city agreed to cover all medical costs for employees and their spouses and dependents for life at the same level of coverage as active employees. It seemed like a good idea at the time, but 25 years later the city was administering more than 100 health plans for 1,500 retirees and their dependents. The complexity of medical coverage has increased significantly, and health-care costs have sky-rocketed. The city's projected OPEB liability was a dark cloud hanging over it, but there was no clear way to reduce the obligations, especially since unions have always been strong advocates for workers in Duluth. (See Exhibit 1.) Nevertheless, in 2008, the city did alter the historical interpretation of the 1983 agreement, streamlined the administration of health coverage, and standardized benefits for all workers. In 1998, retiree health benefits were less than $2.9 million per year, but by 2009, the budget included more than $10 million for retiree health claims--with a general fund budget of $80 million. The retirees viewed these changes as dramatic reductions in benefits and took the city to court.

The city prevailed at the State Supreme Court level three years later. One phrase was at the heart of the decision; as explained in the majority opinion of judges:

At issue in this case is the interpretation of approximately 60 collective bargaining agreements (CBAs) between the City of Duluth and its employees. Subject to certain conditions and exceptions, the CBAs guarantee retired city employees health insurance benefits 'to the same extent as active employees.' The dispute centers...