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« The Growth Ponzi Scheme, Part 4 | Main | The Growth Ponzi Scheme, Part 2 »
Wednesday
Jun152011

The Growth Ponzi Scheme, Part 3

So far this week we have examined how the American development pattern of the post-WW II era entices cities to exchange the near-term cash advantages of new growth for the long-term maintenance obligation of new infrastructure. This is a bad trade, because as we also looked at yesterday, the pattern of development costs more to maintain over the long run than it produces in revenue. In short, our development pattern is not productive enough to sustain itself.

A new development goes in. The developer builds the street and then turns it over to the city for maintenance. Houses are built and the city sees its property tax receipts rise. Imagine for a moment that the city took and saved the portion of those new receipts that was to be used for street maintenance. If the city did that every year throughout the life of the street, adding the new tax receipts to those already saved, and then used the cumulative savings to repair the street, here is how the cash flow diagram would look.

Cash Flow Diagram for a single street. Revenues are from collected taxes and expenses are due to infrastructure maintenance costs.Everything looks great until the end of the street's life cycle. At that point, the cost of the repairs far outweighs the revenue collected. If the city were reduced to this one street, it would be insolvent.

But a city is not one street. A city has many Peters to rob in which to pay Paul. For example, if the project modeled above were repeated every other year -- a condition where the city was growing at a steady rate -- the cumulative cash flow diagram changes substantially at the end of that first life cycle. By adding the tax receipts from multiple projects together, here is what it would look like.

The cumulative cash flow of multiple projects in succession.

So growth "solves" the insolvency problem. As long as a city continues to grow, as long as it can continue to exchange near-term cash flow for long-term liabilities, it will be just fine. Or so it may appear at the end of the first life cycle.

Here is what happens during that second life cycle. The model I am using assumes that growth continues at the same moderate pace, with a new development of similar size added every other year. 

The cumulative cash flow of multiple projects in succession over two life cycles.The results are obvious and devastating. When the private-sector investment does not yield enough tax revenue to maintain the underlying public infrastructure, the balance can be made up in the short term with new growth. Over the long run, however, insolvency is unavoidable.

We need to pause here and point out a couple of important things. First, this is actually a model of a well-run city, one that puts money away for future improvements. I've yet to see one that has such fiscal discipline. We can spend all day blaming politicians for wasting money on "big government" or giving unwarranted tax breaks to "the rich". These debates are ultimately tragic sideshows to the underlying lack of productivity in our development pattern.

Second, this model shows the impact of continuous and steady growth. In reality, that is not the pattern most cities experience. Most cities have a phase of rapid growth followed by stagnation and then decline, as described by Jane Jacobs in The Economy of Cities. Superimpose the financial underpinnings of the American model of development and the results are even more devastating - a flood of liabilities all coming due right at the time that growth is starting to wane.

I know I promised "rational responses" for tomorrow, but I need to put that off until Friday. Tomorrow we will examine how America has responded to the economic reality of our places thus far.

 

Strong Towns is a 501(c)3, non-profit organization run by three professionals volunteering their time and resources to change America. If you would like to help us spread this important message, consider making a supporting, tax-deductible donation.

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Reader Comments (5)

The problem seems to me more that people are unwilling to pay the true cost of the infrastructure they are using and that cities are unwilling to say exactly how much sprawling suburban development really costs. Maybe we should carry signs: "Keep the government out of my infrastructure." ... I wonder how much a private company would charge?

Thanks for your extremely informative articles!

June 15, 2011 | Unregistered CommenterAndy Nash

The life cycle costs are hidden and so people don't factor them in. It is not that they are unwilling to pay (although they would be if they were asked to pay the full cost), it is that our system never asks them to.

We are not making rational decisions on how to build our places because the cost structure is so distorted.

June 15, 2011 | Unregistered CommenterCharles Marohn

I'll restate what I posted for Part I - the unwillingness (either to pay, or to inquire as to the cost) is a perfectly rational economic response on the part of taxpayers. No one expects to be in the same area or community 30 years down the line (whether or not they actually are is of course irrelevant - the don't EXPECT to be). Businesses seeking to maximize profit by off-loading their external costs are only too willing to request/demand public improvements since once the bills come due they can move to the neighboring community (who will of course only be too happy to "provide jobs" in the near term). Rational solutions to the problem are easy to come by. Implementing those strategies will be impossible. Sustainability? As the man said "In the long-run, we're dead." Still, I really enjoy your articles and forward them to friends and family. I have a feeling I'm going to get a lot of emails asking me to stop depressing them. Keep up the good work.

June 16, 2011 | Unregistered CommenterMWBrown

I am a supporter of smart growth but I think you have crossed the line so many extreme conservative and liberal groups have done, you are trying to scare people with dialogue that ignores or twists the facts. It would be great if you could support this view with some real facts. Andy is right. If you double the revenue in both of your graphs the "Ponzi" effect is eliminated. Since the life of an average street or sewer line is 20 to 40 years (depend ending on the climate and how bad you are willing to let things get) cities like Houston, Atlanta, Phoenix, Los Angeles, etc that began their suburban surges in the 60s would be good examples. How many of them went bankrupt or in near default? These cities have struggled financially with the ebb and flow of the economy but to my knowledge none have defaulted. Ironically the prime example of a City in near default because of debt is New York. Getting yourself into a "Ponzi" scheme infrastructure crisis is a function of willingness to pay (or having the foresight to know what to pay) which is a human behavior that has little to do with suburbia. Research about 1) the cost per capita of lifecycle infrastructure costs in different built environments and 2) the actual experience of cities in funding or not funding infrastructure and maintenance, would be extremely useful for foresight in any community. But equating our current national financial infrastructure crisis to a suburban "Ponzi" scheme is a suburbia scare tactic based on twisted facts. The current crisis is just as real for highly urban places as it is for suburban places. It is a result of unwillingness to pay. I applaud your enthusiasm but I would ask you to do a better job than our current crop of political extremists in furthering the smart growth mission. .

June 29, 2011 | Unregistered CommenterRay Quay

Ray,

Check out the Case Studies from Day 2. Ours is not a gratuitous bash of the suburbs. We've looked at many, many projects and compared the actual expense to the revenue collected to cover that expense. It is not even close. Where does the gap come from? The answer is: new growth.

It is tough to say that, because there has not been a default, our premise is incorrect. Most cities won't default, at least in the near term. They will just defer maintenance and, ultimately, start to crumble and fall apart. There is a ton of evidence of that. Even so, I suspect we will also seem so defaults soon among outliers.

I'd also point out that Americans have never used the type of rigor to justify the current approach that you suggest we use to affirm our premise. All projects are financed on a cash flow basis. We are not aware of any city or town that does full, life-cycle costing when they build a project. What makes us so sure this works?

If you look at debt levels, the increasingly-preferred way to finance infrastructure maintenance, they have risen at the local level dramatically in the second life cycle of the suburban experiment. At the local level, we don't take on debt to fund police protection. We take on debt for infrastructure. We've simply asked the question: How does the revenue generated by the places served by this infrastructure compare to the overall cost. The answer is: not even close.

I'll agree that Andy is right -- if people just paid more in taxes, this problem would go away. Problem is, they are not and, as our premise states, if they had been asked to account for the real cost of their living arrangement as part of their original financial transaction, the suburbs would not exist the way they do today. They are not asked to account for it because those are long-term costs and we don't worry about them. The new growth today makes it cash-flow, so long-term insolvency becomes irrelevant to the conversation.

Tell someone paying $500/year to their city in property taxes that they need to pay $2,000 more per year to maintain the infrastructure serving their property and they will say no. Okay, but what then? We can say this is a problem of people not paying enough, sure, but it is really a problem of the costs being hidden and people not making fully-informed choices. The Ponzi Scheme mechanism -- where cities use revenue from new growth to pay off old liabilities -- is a primary way we hide these costs.

-Chuck

June 29, 2011 | Unregistered CommenterCharles Marohn
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