Economies Of Scale Vs. Scope of Government

One of the greatest mysteries to me is why we see no economies of scale the bigger cities get and the bigger governments get.  And I think that I am on the brink of resolving that mystery for myself finally.

For our example, we will take two municipalities of obviously different size: Johns Creek and Atlanta.  Both have the same state government, operate in the same environmental and economic environments and co-exist 15 miles or so apart.

And without evening providing the numbers that support the statement, we all know that it is much more expensive from a tax perspective to live in Atlanta than Johns Creek.

I have decided to provide the numbers after it was suggested that they were important.

Brief back of the envelope calculations shows that the City of Atlanta spends $1265 per resident while Johns Creek spends $637.  And on property taxes. the City of Atlanta has a millage rate 30% higher than Johns Creek.

As a more or less rational thinker, this has left me puzzled more often than not.  What is it that makes it more expensive per capita to provide services to the public, which seem to defy the concept of Economies of Scale that function flawlessly in other aspects of our life?

And then it hit me.  It’s NOT the economies of scale that are at question.  It’s the scope of government services provided.

At this point I am going to add another city to our conversation.  This one is fictional, but we all have a good understanding of how it is defined: Mayberry.

The city of Mayberry provided the most basic of services for the common good.  Court, jail, police, fire and education.

All the residents were potential beneficiaries of these services.

But when a city gets larger, like Johns Creek has, then more services are provided. Wants seem to morph into needs.   And these services may not benefit all citizens but a sub-section.     At first, it might be that a new service benefits 90% of the public. We tax all for the benefit of those 90%.  And 10% pay for services they never use.

Then the City grows larger.  Soon we add additional services, and then more additional services until the new services aret being used by 10% or less of the population and are being subsidized by the 90% that are not using them.

The larger the city the smaller the beneficiary group as a % of the whole needs to be.

Much to the chagrin of dog lovers, I’ll use the example of dog parks.  (and I love the name of the Chattapoochie Dog Park in Gwinnett so I am not a total grump).  Here’s a service provided by municipalities that only benefits dog owners.  More specifically, it only benefits that sub-segment of dog owners that want to take their dogs to a park to roam around.  If 1 in ten residents in Johns Creek have taken their pooch to the park more than 6 times in a year, I’d be shocked.

Were Johns Creek to get large enough, we’d likely have a different park for small dogs, and big dogs.  Even larger and we would have one for medium sized dogs.

We see the same effect with Arts Centers, Aquatic Centers, Nature Centers (insert the others you know are coming here).  We also see it with other services the City decides that they must provide such as bulk recycling.  The list becomes endless as long as there are funds to start the program.  And they never end. Get a few federal or state dollars to start and it’s a certainty to get started and be with you forever more.

Which brings us back to my original observation.  There are no economies of scale for bigger and bigger cites because the scope of the services these cities provide expand in such a way that there are fewer users as a % of the population, forcing the majority to subsidize them.  By the end the 99% are funding programs for the 1% that use them.

How does one reign in the “service creep” that cities seem to engage in the larger they get?

One answer would be to set a minimal level of actual users that a city expects to see from this service.  Fifty per cent would be a good starting point for discussion’s sake.

Another answer would be to cut the funds flowing into the cities that fund such projects of such a narrow scope.  To do so you will need to be ready to speak up to your local government and say “NO!”.

As a Libertarian, this is exactly why I am for  a smaller government.  Let’s do the things that we need to do for everyone’s benefit, and do them the best we can.

Then we could see economies of scale.  We could lower our taxes, and those with dogs, for instance, could fund their own private dog park with their own dollars.

Otherwise, where does the “Service Creep” end?

That’s my opinion.  I’d love to hear yours.


This Time, It Is Going To Be Very Different

The Federal Reserve today ended it’s meeting without raising the Fed Funds Rate.  As you can see by the chart below (Time-wise it reads from right to left), the Fed Fund Rate has been near zero for a long time.

So long, in fact that it has seen the peak of our most recent economic upswing (Much shallower than the last peak AND shorter in duration) and our return back to the shores of recession, all without a single rate hike.

Those that have followed my conversations in the past will recall that I firmly and unquestionably believe that the single greatest indicator to the health of the economy is Business Profits After Taxes, as reported by the Bureau of Economic Analysis.  This number cannot be as easily manipulated as GDP.

It does not give the false pretense of improvement because of government spending. Government spending does not produce profit.

What the number does reflect is after all is said and done is what have businesses earned that they get to keep from all of these efforts.   This is where the real motivation to grow, hire and expand your business originates from.

I’ve taken the data from the BEA (which anyone has access to) and created a spreadsheet with both 3 and five year rolling averages of the AGR(Annualized Growth Rates) for business profits after taxes.  This data is so simple to comprehend that I would even bet that you can see without highlighting it the last three recessions that we have had.  You can also see clearly when we exited those recessions.

And, if you look at where we are today, you understand what is about to occur.  Which brings us back to the Federal Reserve.  If you look at the chart carefully you can see that each time we were in a recession( and we admitted it), the Fed cut rates, which has the effect of giving businesses a boost to profits.

This time, it is going to be very different.  The Fed has no room to cut rates.  We are near zero already.  Business profits year over year have plummeted, and the Federal Reserve continues to tell us things are getting better.  Read their latest comments here:

Do you think they are clued in?   I do not think so.  I think if they were, they would know that they are on the cusp of a major crisis.

There are a few more things I’d like to point out here.  The 7.5% line is the approximate level at which year over year profits need to rise in order to stimulate real economic growth.  Anything less and we contract, right-sizing the economy until we begin to grow again.   We have a tendency to always use a baseline of zero as the indicator that things are or are not improving.  This is not the baseline to use in most cases.

Three and Five year AGR for Business Profits After Taxes

Three and Five year AGR for Business Profits After Taxes

This data reflects the most recent data available (Four quarters ending 1st quarter 2015)  Business profits after taxes also represent all businesses across the US from mom and pop down the street to Apple and Amazon.

Were you to accept what I have written, and you agree that businesses do go in business to earn profits, and the goal is indeed higher profits year after year, then what needs to be done for a strong, healthy economy because rather clear.

1)  Create an environment for businesses where the regulatory and fiscal burdens are reduced-not increased- for all businesses.

2)  If new legislation is passed that reduces a company’s bottom line, do so knowing that it will indeed have a negative effect on both business expansion and job creation.  So make damn sure that the reason why you are doing it is worth it.

3) The longer business profits after taxes increase and stay above the 7.5% line, the stronger the recovery.  So it is in our best interest to try to promote that outcome rather than detract from it.  Too often governments see that improvement and decide that they can take some of those dollars with no ill effect.  They are wrong.

If you see the chart as I see it, then you will see what is coming.  Ask yourself what will accelerate profit growth for businesses over the next 1-3 years?  What is the catalyst?  And if the Fed cannot cut rates, how long will this next down turn last?

I encourage you to be prepared.  Yes the markets are near all time highs.  But do not be fooled.  Total dollars of profit by the Dow 30 companies are on track to drop more than 9% year over year.  Hard to spin that as a healthy and growing economy.  The smoke and mirrors are being supplied by-yep you guessed it- The Federal Reserve.  The low rates are fueling record share buybacks, increasing per share earnings and therefore share prices.  I believe that you will agree that this is not a positive chart.

Dow 30 Profits Analysis 20150717

The solution to what ails us is clear.  Government needs to reduce the burden they are generating for businesses, so that if the businesses can meet the market needs of customers, they have the potential for higher profits-not less.

Only then we will see the US economy have an opportunity to restore it’s economic engine to more than idle speed.

These are my opinions.  I would love to hear yours.  Please post or comment or email me any questions.



Johns Creek: Foolin’ Ourselves

The residents of Johns Creek, Georgia have lots of things going for it.  Excellent housing, many of the best schools in the state for kids, and income levels that surpass nearly every other community.

Those positive attributes, however, have led to a flow of tax dollars into the City’s Coffers that is now doing more harm than good.

Since 2006, the year the city formed, the City has amassed $54,348,545 at the end of the fiscal year 2014, according to the City’s Certified Audited Financial Report.  That represents an increase of almost $7,000,000 per year of revenue over expenses.  With a population of around 80,000, that works out to more than $670 per every man, woman and child.

That’s an astonishing amount of money to be held per capita, and it’s growing.  Last evening, the City Council, under the lead of Mayor Mike Bodker voted to maintain the City’s millage rate at it’s current level, despite the property valuations rising sharply over the last year.  More money will be flowing into the City’s coffers again in 2016 coming directly out of the pockets of the residents.  And while it may not seem like a big deal to many outside of Johns Creek(after all, they can afford it), it is creating problems that will soon become more and more apparent as time passes.

[read more=”Read more” less=”Read less”]Incredibly, the Reserve Growth has grown at an annualized rate of 27.35%.  Mayor Bodker and the rest of the City Council have been asked numerous times why are our reserves growing so rapidly?  What will this money be used for?  From listening to dialogue at the City Council’s work session, the perception is that the public just doesn’t understand.   I think we do. I think we also know that other cities, operating under the same general rules as Johns Creek, are not rolling up such large sums of money.

Of course, some of this money is used for day to day operations as a float for paying bills and salaries as funds come and go.  But if we did not have such a large reserve fund, there would be some other financial tool to deal with  cash flow, for instance.  There would be a cost to that technique, of course.  And there are the recommendations of how much to set aside, just in case.  But it seems to me that we have more than enough set aside for a city like Johns Creek that is collecting 10 % more than they are spending year in and year out.  In fact, we have a greater margin of error than a city that barely collects enough revenue to cover expenses.

So there is absolutely no reason that the reserve funds continue to grow at such an astonishing rate without a clear explanation.  And I firmly believe that this Reserve Fund’s size is doing much more harm than good.

The size of this Reserve Fund has not kept Mayor Bodker or the City Manager, Warren Hutmacher, from speculating that one of the wealthiest cities in Georgia has a sustainability issue (despite the rapid growth of the reserve fund).  A wish list of projects was created that totals more than $180 million dollars,which would indeed suggest there is a problem.  There would be if all of these wished for items were approved.  But they haven’t been.  And like a cloud hanging over the City, this wish list is negatively influencing the decisions of the City Council.

First, there is no sustainability issue if the City of Johns Creek sticks to what it is supposed to be doing, rather than dreaming of exceptional projects that have not been proven to be desired by the majority of residents.

Second, the Reserve Fund allows for the perception that we can afford lots of lower cost projects, regardless of the return on the investment(something cities apparently are not as concerned about as the private sector).  Consequently we see 100’s of thousands of dollars allocated for purposes that might not otherwise be approved if we had a lower reserve fund and managed our decisions much more wisely.

Many residents have attempted to point out the lopsided salary structure of the City’s Employees.  They have been met with dismissive attitudes(I am being polite) and promises that this will be looked into.

Residents have pointed out that we are overpaying for certain services, and that we are wasting funds on various projects that benefit only a handful of residents or that the residents already have access to via other means.

Residents have scrutinized the City’s financial results, offering observations and asking questions that go largely unanswered.

As the monies continue to roll into Johns Creek’s coffers, there is simply no pressure to address these concerns.  The residents and the business community are both left paying for this malinvestment.

In an effort to “move the needle” on the City’s revenue sources (too much of the load is on property owners and not enough on business), the concept of a Central Business District was launched.  Several hundred thousand dollars was voted on an approved to explore this “idea”. An outside firm, Urban Design Associates, was hired to bring the concept closer to reality.

The Central Business District has morphed from a :hypothesis” that was going to generate enough revenue to help offset the $180 million in projects on the wish list to being financially accretive.

DEFINITION of ‘Accretive’

The process of accretion, which is the growth or increase by gradual addition, in finance and general nomenclature. An acquisition is considered accretive if it adds to earnings per share.

Applying this word to our situation, if it costs us $10,000,000, and we generate $10,100,000, then it was accretive.  However, that is a very low bar for performance and a horrible return on investment.

This City Council needs to apply the brakes, and hard.  The hard earned money that they are collecting from residents at these levels, which are not being spent on services deemed needs by the residents, and is inducing the Council to approve projects that offer little return on investment, needs to be returned to its rightful owners.

That means cutting the tax rates for both businesses and residents.

One of the Council Members spoke of his concern for residents where even $30 a year makes a big difference.  He voted for a rollback.

I suggest he think about the $670 already collected from those very same residents.

Johns Creek has been a city too long now to keep finding excuses as to why we do not have the budget tools in place to have a firm and clear grip on our fiscal health.

Johns Creek pays the professionals too well to expect anything less than the best analysis from the beginning.  A 10 year financial forecast that would have landed you a D in your college finance course should not be acceptable to anyone, even as a “draft”.

The performance bar must be raised.  We have too much at stake to have sub-par performance from the very same people we are paying top dollars for in compensation.

Below is a chart I adapted from their ten year financial forecast.  I have included some crucial elements that needed to be included, for context.  Prior year data is from the Johns Creek CAFR report, 2015 data comes from the Mid Year Budget Report and years 2016-2025 are from the 10 year financial forecast.

Click on it and have a look.

Reserve Growth, Expense, Revenues, and Capital Expenses

Reserve Growth, Expense, Revenues, and Capital Expenses

These are my opinions.  I’d love to hear yours.