We’ve been warning about the coming local government fiscal crisis for months now (see this paper and  event we did with the National League of Cities (NLC) last fall). Now, the crisis is no longer coming. It’s here. Just check out the headlines from the relatively resilient Mid-Atlantic region.

Last week states from New Jersey to Maryland and Virginia began rolling out tough new budgets constrained by major declines in sales, income, and property tax revenue, and not surprisingly they are imposing sharp cuts to local aid and school and public safety budgets as they seek to curtail spending and balance their own budgets. New Jersey, for example, proposes cutting local aid by 10 percent--or $466 million. Similarly, Maryland Gov. O’Malley wants to extend more than $400 million in aid cuts into 2011. And for its part, the Virginia General Assembly adjourned its annual legislative session after adopting a two-year, $82 billion budget that cut millions from education, health care, and public safety--all accounts of special local concern--while curtailing state spending more aggressively than any assembly in generations.

Yet the state cuts are only part of the story. That fiscal stress would inevitably hit cities, counties, and municipalities has always been clear. Initially sales tax revenues dry up in a slowdown, but only with a several-year lag do property tax receipts fall off in a sort of one-two punch to local government coffers. And now that is happening, with predictably ugly ramifications.

Montgomery and Prince George’s counties, in Maryland, home to two-thirds of the state’s population, made public their own proposed budget cuts last week and there is going to be plenty of pain. Montgomery County will be forced to reduce its total outlays for the first time in 40 years, instituting pay freezes, cutting more than 200 positions, and requiring 10 days of furlough for employees. Prince George’s, facing a $44.5 million cut in state aid, expects smaller layoffs and shorter furloughs but will keep all vacant positions--currently running to one-sixth of the full workforce--unfilled. The situation is so dire that customarily “untouchable” realms like public safety and education are on the chopping block. Montgomery County will lay off of 22 community police officers. Safety net services like outreach to the homeless will be scaled back just when the recession renders them more important than ever. Prince George’s County, for its part, will be forced to spend $21 million less on education this year and increase class sizes by two pupils.

On the other side of the Potomac, Virginia counties and towns will now formulate their own budgets in light of the sharp states cuts. Fairfax County, Va., Supervisor Jeff McKay laments that Governor McDonnell’s budget, adopted this week by the Virginia state legislature, “just passes the buck” and shifts the burden of adjustment onto local governments. As a public relations gimmick that reflects the frustrations being felt by local governments across the country, a commissioner in Frederick County, MD, recently floated a proposal to secede from the state in protest of plans to shift the burden of some teacher pensions onto counties.

So what are we to make of these developments in a region that’s not even one of the hardest hit by the revenue crisis? The first thing to note for the benefit of federal policymakers is that cities’ and localities’ problems matter for the nation.

Cities and their surrounding suburbs are important economic agents that not only provide services important to the functioning of regional economies, but also serve as major employers in their own right. Across the 100 largest U.S. metros, for example, local government accounts for some 10 percent of total non-farm employment. What is more, local government has grown relatively more important in recent years as a source of jobs and wages. All of which means that expenditure cuts, layoffs, and delayed capital projects among city, town, and suburban governments will place a serious drag on the current halting, uneven recovery depicted by our national MetroMonitor index of recession and recovery. That’s why we continue to believe federal policymakers will eventually need to pursue measures that will lessen the extent to which cities must take actions that harm the economy. Congress and the White House really should be thinking about direct temporary fiscal assistance to cities. And they should consider transit operating aid, or a special tranche of Community Development Block Grant money, such as we recommended a few months ago.

Otherwise, and this is a word to local leaders, the current downturn should be viewed not as a temporary aberration but as an element of what a recent NLC panel called “the new normal.” Output may return to pre-recession levels rather soon, but consumption, employment, property values, state aid, and local government revenues will likely not. Not only will property tax collections lag even the slow pace of recovery, but any cushioning effect that was felt from the massive $787 billion federal stimulus package will now begin to recede. And so the smartest local government leaders--assuming revenues won’t return to pre-crash levels for a long time--are going to want to try to turn the current crisis into a moment of fundamental governance adaptation.

Some leaders are moving early to recognize the depth of the crisis and make needed cuts, while educating the public. Others are looking at the revenue as well as the expenditures side of the budget so as to minimize mindless cutting and avoid further harm to the local economy and needed government investment. And finally, a few leaders are trying to use the crisis to really and truly modernize delivery systems to better serve residents and support greater growth and prosperity over the long haul. They’re reengineering for the new normal and different future. In this way, the best local leaders will seek to do more than just muddle through. But it clearly won’t be fun.