2016-17 Budget and Long-Term Projectionss

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budget-stockBy Dan Carson

(The following is a memo from Dan Carson to the Finance and Budget Commission. The bullet points listed at the beginning of this analysis were adopted by the Finance and Budget Commission at last Monday’s meeting.)

Quick Summary of Findings:

  • In general, the proposed 2016-17 budget is reasonable and sound and reflects significant improvement in the city’s fiscal stability.
  • The budget projections of improved property and sales tax revenues in 2016-17 are strongly supported by local, regional and statewide data and are consistent with projections by other agencies.
  • A proposal to devote $8.6 million in General Fund revenues in excess of the proposed budget reserve to pay down the city’s unfunded liabilities and support infrastructure projects is reasonable and begins the process of addressing some longstanding “deficits.”
  • The City Council may wish to consider $857,000 in technical adjustments that would make additional funding available, mainly on a one-time basis, for paying off unfunded liabilities, deferred maintenance, or high-priority capital projects.
  • The budget plan identifies $5.1 million for road and bike path rehabilitation efforts. However, my analysis indicates that the city would actually make more progress than that in fixing its roadways in 2016-17. About $8 million in proposed budget expenditures would either go directly for paving work or for transportation improvement projects that would take the place of future paving work.
  • The long-term projections through 2025-26 contained in the budget package are technically sound but should be interpreted carefully. Some important factors mean it is possible that the projections could significantly understate the city’s fiscal health, while others mean that the fiscal outcome might not be as good as the projections would indicate. Further analysis that a commission subcommittee has initiated of the “upside” and “downside” risks is clearly warranted.

Overview. In accordance with the commission work plan we discussed at our May meeting, I have reviewed the 2016-17 budget proposal presented to City Council at its May 17 and 24 meetings as well as back-up documentation provided to me by city staff supporting its long-term fiscal projections. City staff also provided helpful written responses to a number of commission and council questions about the budget plan and the projections which I review in drafting this analysis.

In general, my analysis indicates that the $200 million (all funds) budget proposal (including $53 million from the General Fund) is reasonable and sound and reflects significant and continued improvement in the fiscal stability of the City of Davis while moving forward on the set of goals adopted for city government by the City Council.

As recently as December 2013, the city was struggling with a projected $5 million annual structural deficit in its General Fund.  A series of staffing and budget reductions, voter adoption of the sales tax increase contained in Measure O, and an improved economy have worked in combination to improve city finances to the point where the city administration projects a General Fund reserve balance of $8 million as of the end of 2016-17.

My more detailed comments on various aspects of the budget plan and the accompanying projections of city finances to the year 2025-26 are provided below for your review at the June 13 commission meeting.

2016-17 Budget Projections of Property Tax Revenues Are Reasonable. My review indicates that the administration’s projections of property tax revenues are reasonable.

The budget plan assumes that property tax revenues will end up $435,000 or 3.8% higher than the budget originally adopted for 2015-16 at the start of the fiscal year. For 2016-17, the budget plan underlying growth in the city’s property tax revenue base of an additional $625,000 or 5.2% above that higher 2015-16 level of property tax funding.

The projected growth in property tax revenues reflects continued recovery of housing and commercial real estate market values from the 2008 recession and  activity from the resale of housing and new housing coming into the market (such as new homes at The Cannery) that are triggering reassessments of property to their full cash value under Proposition 13. For example, as of May, supplemental tax roll payments triggered by real estate sales have provided $322,000 in additional property tax revenues to the city in 2015-16, with two more months of allocations to go. These new revenues are not one-time – they will continue to benefit the city in future years.

At the time the city prepared its projections, it had received property tax allocations from the county for July through December 2015.  Newly released data I have reviewed covering an additional period through April 2016 – and representing 95% of the estimated allocations of secured property tax roll for the fiscal year – line up closely with city staff estimates that were prepared before this additional information was available.

The 2016-17 estimate in the city budget of 5.2% growth relative to the projected adjusted level of spending for 2015-16 is generally in line with other state and local projections. The state Department of Finance projects 6.22 % growth in 2016-17, while the Legislative Analyst’s Office (my former employer) has estimated growth of 6.6%.  While the Yolo County assessor will not release its specific estimate of growth in assessed values for the City of Davis until later this month, it foresees countywide growth (including Davis, other cities, and the unincorporated area) of about 5%.

The budget plan also assumes the city will receive about $1.2 million in property tax revenues in 2016-17 from the wind-down of its former Redevelopment Agency.  This is less than the amounts received in 2015-16 because a special one-time additional payment of $1.1 million in the current fiscal year from resolution of a dispute over the ownership of certain city assets. The city’s estimates of the ongoing revenues are reasonable.

I discuss longer-term projections of property tax revenue growth later in this analysis.

2016-17 Budget Projections of Sales Tax Revenues Also Reasonable. My estimates of sales tax revenues include both the city’s historical allocation of local sales taxes from the state plus another 1 cent in sales taxes added by the voters in steps in 2004 and 2014, most recently as Measure O.  My analysis shows them to be reasonable, given the continued economy recovery and certain one-time factors that are boosting the city’s sales tax receipts.

The budget plan assumes that sales tax revenues for 2015-16 will end up $2.2 million or 16% higher than the budget originally adopted at the start of the fiscal year. About $942,000 is a one-time revenue increase due to the phase-out of the state’s “triple flip,” a complex arrangement that shifted city revenue sources to help pay off certain state debts.  Most of the remaining $1.3 million in sales tax growth resulted from a more robust economy and catch-up payments from the state Board of Equalization of sales tax revenues due to the city from the Measure O sales tax increase adopted by voters in October 2014.

For 2016-17, the budget plan assumes the city’s sales tax revenues will be virtually the same amount as in 2015-16.  If you adjust for the unusual one-time payments from the state in 2015-16, however, the underlying growth in sales tax revenues would amount to $870,000 or 5.8%.

State Board of Equalization data I have reviewed for 2015-16 substantiates the city’s assumptions that the city’s sales tax revenues are currently showing strength. Moreover, the growth assumptions embedded in the 2016-17 budget proposal are consistent with the city’s historical rate of sales tax revenue growth in recent years. They are also in line with statewide projections of growth from this revenue source.  The state Department of Finance estimated in its May Revision that taxable sales will grow by 5.8% in 2016-17.  The LAO puts the growth rate for 2016-17 at 4.8%.  In January, the Board of Equalization, which administers the sales tax, advised local governments to expect sales tax revenues to grow in the range of 4.7%; an update was pending at the time of my review.

I discuss longer-term projections of sales tax revenues later in this analysis.

Technical Adjustments Could Provide Additional Budget Resources. As I noted earlier, my analysis below highlights several technical budgeting issues and strategies the commission and ultimately the City Council may wish to consider that would allow the council to devote an additional $857,000 to addressing the city’s unfunded liabilities and for fixing its infrastructure.

In general, my proposed approach is intended to use General Fund resources as a last resort and use other revenue sources where appropriate. My proposed approach also recognizes revenue in the budget over which there is little analytical dispute, and recognize that some expenditures are now deemed unlikely to occur, in order to ensure greater budget accountability and transparency.

I do not offer a specific proposal for expenditure of these additional funds. In general, because most of these monies represent one-time savings, most are an appropriate source of funding for one-time spending items that do not generate ongoing funding commitments. This could involve paying down the city’s unfunded future liabilities such as city staff retiree health care, or spending on deferred maintenance and capital projects.

Budget Plan Provides Substantial Investment in Paving Work.  The city staff’s presentation of the budget highlighted the proposed commitment of $5.1 million in funding to rehabilitation of city roads.  This total includes $3.9 million in new funding combined from the General Fund, construction taxes, and roadway impact fees, plus $1.2 million initially provided for these purposes in the 2015-16 budget that will be carried over into 2016-17.

However, other budget items provide additional city funding related to such projects in 2016-17.  For example, the proposal to use General Fund monies in excess of the required budget reserve includes several items that are related to the pavement rehabilitation program. Other items include major improvements and reconstruction of roads or bike paths that would effectively take the place of rehabilitation work that would otherwise have to occur in the future.

The spending package includes $1.5 million for bike path improvements near the H Street tunnel and the Little League fields; a $500,000 augmentation allocated directly for the capital improvement program (CIP) item for paving work; $870,000 for Fifth Street Reconstruction at Maintenance Holes; and $300,000 to plan renovation or reconstruction of the Russell Bike Path west of Highway 113.

Also built into the regular CIP budget are these items that provide funding for road and bike path maintenance and transportation improvements:

  • $500,000 from the General Fund for various improvements to Third Street;
  • $92,000 from the General Fund to finish various improvements to L Street; and
  • $100,000 in Community Development Block Grant funding for street improvements for the disabled that are a part of many paving projects.

It is not always clear from city budget documents what the city would be able to avoid spending on paving work if these transportation improvement projects were to proceed. However, my analysis suggests that a total of roughly $8 million allocated in the budget plan for 2016-17 would either be spent directly for paving projects or would take the place of such projects in the future.

Given the high priority of catching up on the city’s backlog of projects in this area, and the potential significant avoidance of future costs by doing preventative repaving work before more expensive road repair work is needed, I believe these projects are an important city priority consistent with its adopted goals. The progress in this area that will be made in 2016-17 is commendable.

However, it should be noted that much of the funding allocated in 2016-17 under the budget plan would be available on a one-time basis. Ongoing funding to maintain this level of activity remains uncertain for subsequent years and the discussion of strategies to bring about a greater commitment for these purposes should be an ongoing part of city budget deliberations.

Interpreting the Long-Term Fiscal Projections. The ten-year projections presented in the 2016-17 budget package through the 2025-26 fiscal year provide useful information for evaluating how past and present budgetary decisions affect the long-term fiscal stability of the city’s General Fund.

My analysis indicates that the projections are generally technically sound and appropriately reflect a reasonable estimate of what would happen under current city policies. By their nature, such projections are intended to reflect the current revenue structure and spending commitments. They deliberately do not include the impacts of future fiscal policies for which commitments have not yet been made.  However, the projections of baseline revenues and spending contained in the budget package does provide a useful tool for policymakers to evaluate how specific policy changes they may considering to revenues and spending may change the city’s fortunes, for good or bad, over time.

In general, the latest set of projections paint a portrait of a city that, with spending constraint and foresight, could remain fiscally stable for many years. The numbers, as presented, suggest that the city would carry sizable General Fund balances throughout the entire projection period, and would have an ending balance on June 2026 of more than $16 million, equivalent to 27% of General Fund expenditures.  This would be the case

even though the authority to collect 1 cent in sales taxes – a considerable component of the city’s tax base – would expire in December 2020.

Some Factors Suggest the Projections Understate the City’s Future Fiscal Performance

Some components of the forecast understate the city’s potential fiscal strength.

First, the long-term assumptions of property and sales tax revenues are fairly conservative compared to the growth the city has experienced in the past and is experiencing now.

Specifically, the long-term fiscal projections through 2025-26 that accompany the budget plan assume 5% growth in property tax revenues in 2017-18 but 3.5% growth in this revenue source for the remainder of the projection.  This estimate is lower than the more than 5% rate of growth the city has been experiencing in recent years. It is also considerably lower than the LAO’s projections of statewide growth in 2018-19 and subsequent years. Adoption of less conservative growth assumptions would add millions of dollars annually more to the city’s revenue base by 2025-26 than is shown in the published projections.

Likewise, the long-term fiscal projections for sales tax revenues through 2025-26 assume 2.5% growth for 2017-18 and the next few years afterward. This estimate is conservative. This growth rate would be considerably slower than the more than 5.4% rate of growth the city has been experiencing from this revenue source in recent years. It is also considerably lower than the LAO’s projections of statewide growth for 2017-18 and subsequent years. Adoption of less conservative growth assumptions would add millions of dollars annually to the city’s revenue base by 2025-26 that are not reflected in the published projections.

Moreover, because the estimates appropriately reflects current law and city ordinances, the plan further assumes that the full 1 cent in sales taxes added by voters phases out of existence after it expires in December 2020. The projections thus assume the loss of $9.2 million from the city’s sales tax base by 2023-24 and thereafter.

However, the loss of all of these revenues seems unlikely. The original half-cent add-on sales tax was originally enacted in 2004 and renewed by voters multiple times, and they would probably do so again. Renewal of part or all of this funding would dramatically improve the city’s fiscal condition compared to the projections included in the budget plan.

However, there is a rationale for the city’s staff decision to build more conservative estimates into both the longer-term property and sales tax projections than I have suggested. Given the maturity of the national recovery from the 2008 recession, and thus the increased risk of an eventual recession that could slow recent economic gains, the city’s long-term projection assumptions are a reasonable approach that can be reassessed next year when they are updated to reflect current economic conditions.

Other specific factors indicate that the fiscal outcomes for the city could be better than portrayed in the projections:

  • The projections do not include new revenues — $300,000 annually and growing as new hotels are built and expanded — from the increase in the Transit Occupancy Tax approved by Davis voters as Measure B. Nor, as city staff has pointed out, do they include revenue increases that would be likely to result from updating city fees for recreation programs and development impact fees.
  • The potential positive net fiscal impacts of local economic development projects, such as the hotel/convention center and other new hotel projects that are now being considered, have not been incorporated into the projections. This is an appropriate decision, given that the hotel/convention center remains under legal challenge and that no decisions have been made regarding adding further hotels. However, it should be noted that these projects could eventually generate hundreds of thousands of dollars in annual net fiscal benefit to the city plus millions of dollars in one-time funding that are not captured in the projections.
  • The projections do not appear to reflect the cessation after four years of a $450,000 annual program to catch up to unfunded liabilities for employee leave time and replacement of its fleet of vehicles. When that program ends, it means some additional resources could be redirected to support other city programs.
  • The projections do not appear to capture potential future savings to the city’s own energy and water bills from the planned implementation of a Community Choice Energy program and water efficiency projects. Some of these savings would be a benefit to the General Fund while others would help hold down costs for city enterprise operations.

Some Factors Suggest the Projections Overstate the City’s Future Fiscal Performance

Other factors suggest that the projection overstates the future condition of the city’s General Fund.

For example, the employer pension contribution rates incorporated into the forecast assume that the rates in place as of 2020-21 would remain the same for the duration of the forecast period. However, this assumptions warrants further review and discussion.

Notably, the city’s Comprehensive Annual Financial Report estimates that, as of 2014-15, the city had an unfunded pension liability for its current and past employees of $53 million. While the long-term forecast takes into account the full payment of the rates that the state pension system now plans to charge employers for the pension program under its existing policies, the state has been considering whether to change its policies in the future to collect additional funding to help offset these potential future costs.

Some changes have already occurred. The CalPERS governing board has already put in place a policy that would result in larger employer contributions than would otherwise apply following years in which pension fund investment earnings have been unusually high. In addition, the Legislature has already passed pension system reform legislation that provides a reduced level of retirement benefits for all newly hired employees that could help offset growth in pension costs.

However, the full impact of these changes on future city contributions to the CalPERS system is not yet clear. If CalPERS takes further actions to increase employer pension contributions, the costs to the city of paying pension benefits could someday be millions of dollars higher annually than shown in the forecast, depending on how well pension fund investments perform and what unknown specific future actions the state pension system takes to address the unfunded liabilities that remain.

The outcome of future collective bargaining with city employee groups is also interrelated with the city’s future costs for pensions as well as for pay and other benefits. As city staff have noted in their budget presentation, the forecast does not reflect any further pay raises or benefit increases for city staff beyond those negotiated for the 2015-16 and 2016-17 fiscal years. Negotiations with two employee groups with which the city has not reached agreement remain pending, and the existing agreements with employee bargaining groups would expire during the early part of the projection period.

While the outcome of future  negotiations is unknown, it is highly unlikely that the city would be able to forego any increases in compensation for its workers between now and 2025-26, as the projections assume. The city will have to compete over time with other local and state agencies, and it will have to comply with state collective bargaining mandates.  Even modest pay increases could trigger increased annual pay and pension costs that could amount over time to millions of dollars annually.

Moreover, the projections do not adjust for increases in the state minimum wage to $15 an hour in steps over several years under recently enacted legislation. This could affect city parks staffing costs, among other areas.

Some additional factors mean the city’s fiscal condition could end up being worse than projected:

  • A series of expert analyses procured by the city indicate that the city faces significant additional costs, beyond the additional investments proposed in the 2016-17 budget, to maintain and repair city infrastructure and build new infrastructure that is needed to maintain current services. Some of these costs – especially for parks and transportation projects – could weigh heavily upon the General Fund. As discussed earlier, the additional funding proposed in the 2016-17 budget for capital projects is one-time and additional funding would be needed in future years to meet the city’s needs for deferred maintenance and capital projects.
  • In recent years, growth in employer health care costs has moderated. However, the growth trend has historically been volatile, sometimes resulting in double-digit annual premium increases for employers. That volatility poses a risk to the long-term assumption in the forecast that the underlying costs of providing health coverage for current employees and retirees will grow at 8 percent annually. The projections assume only 4% annual growth in costs for the city because employees must shoulder half the growth in these costs under current collective bargaining agreements. However, future federal health care policy changes could change the trajectory of growth costs, for better or for worse.
  • At the time this analysis was prepared, the outcome of the recent vote on Measure A to authorize Nishi Gateway project was unknown, the proposed Mace Ranch Innovation Center was again being considered for the November ballot, and a third innovation center near Sutter Hospital remained on hold. All of this means that it is now uncertain whether the city’s dispersed innovation center strategy, intended to provide a more diverse and resilient revenue base for the city, will continue. In the long term, the risk to the city’s revenue base from a downturn in the economy will be greater than would otherwise be the case if the innovation center strategy does not move forward and if alternative new economic development strategies are not pursued successfully.

A complete balancing of these positive and negative fiscal factors is beyond the scope of this analysis. However, as commissioners are aware, a commission subcommittee has been assigned the task of creating a 20-year forecast for the city that could assess these contradictory fiscal pressures in more detail and consider alternative “upside” and “downside” scenarios. This work could provide fresh insights into the future prospects for fiscal stability of our city. Some council members have also expressed an interest in modifying the forecast to display potential unfunded liabilities not now presented as part of the forecast.

City Council Deliberations on Budget.  The City Council has already begun deliberations on the budget plan and has asked staff to examine several key issues likely to be of interest to our commissioners. In particular, council members:   

  • Asked city staff to examine a proposal presented by Commissioner Williams to borrow at low rates from the city’s own enterprise and special funds to immediately pay off the city’s estimated $60 million unfunded liability for providing health coverage for retired employees. In theory, the costs to the General Fund and enterprise funds of an ongoing city program to “catch up” on these liabilities could be reduced, freeing up resources that could be used to deal with other obligations.
  • Expressed an interest in an assessment of how funding identified in the projections that is in excess of General Fund reserve requirements could be programmed in the future to help address the city’s backlog of capital outlay projects.
  • Sought budget information indicating what part of the City Attorney’s budget reflects the costs of specific ongoing litigation. That information is contained in the budget package that will be presented to the City Council on Tuesday.
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2 thoughts on “2016-17 Budget and Long-Term Projectionss”

  1. nameless

    Excellent report.  One extremely important point, clearly highlighting the continuing need for economic development:

    At the time this analysis was prepared, the outcome of the recent vote on Measure A to authorize Nishi Gateway project was unknown, the proposed Mace Ranch Innovation Center was again being considered for the November ballot, and a third innovation center near Sutter Hospital remained on hold. All of this means that it is now uncertain whether the city’s dispersed innovation center strategy, intended to provide a more diverse and resilient revenue base for the city, will continue. In the long term, the risk to the city’s revenue base from a downturn in the economy will be greater than would otherwise be the case if the innovation center strategy does not move forward and if alternative new economic development strategies are not pursued successfully.

    This suggestion I find worrisome:

    “Asked city staff to examine a proposal presented by Commissioner Williams to borrow at low rates from the city’s own enterprise and special funds to immediately pay off the city’s estimated $60 million unfunded liability for providing health coverage for retired employees. In theory, the costs to the General Fund and enterprise funds of an ongoing city program to “catch up” on these liabilities could be reduced, freeing up resources that could be used to deal with other obligations.”

    I understand the reasoning behind it, but it reminds me too much of the federal gov’t raid on social security.  At some point, when a gov’t starts pillaging its own funds, it cannibalizes the very programs it is supposed to be providing.

  2. GenX

    The problem is that we are being penalized 7.5% on the unfunded liabilities, while earning only ~0.1% on our other funds.  What Commissioner Williams is suggesting is only to use our ‘bank account’ to pay off our most expensive debts.

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