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SR-202-002 (22) Council Meeting: January 14, 2002 Santa Monica, CA TO: Mayor and City Council FROM: City Staff SUBJECT: Recommendation to Consider the Context in which the 2003/04 Budget will be Formulated, Hear Public Comment and Provide Staff with Direction Regarding Budget Preparation, Including Community Development Block Grant and Home Investment Partnership Act (HOME) Programs, and Authorize Staff to Advocate for Preservation of Municipal Revenue Streams from the State Of California. Introduction This report describes the difficult context in which the budget for FY 2003/04 will be formulated, discusses potential strategies for achieving balanced budgets for the next several years and recommends that Council take public input prior to providing staff with direction on preparation of the budget. Council is also asked to authorize staff to advocate for the preservation of municipal revenue streams as the State budget is formulated. Background Fiscal and Economic Status If one reads the news, watches the stock market, speaks with retailers or merely notes the interest rates on a savings account, the painfully slow pace of recovery from the impacts of the 9/11 tragedy and the national recession is readily apparent. 1 For Santa Monica, this is new territory. A unique concurrence of factors – the dot.com boom, the fresh appeal of the Third Street Promenade, the attraction of the community for the entertainment industry and the City’s appeal to visitors from across the nation and around the world – lifted Santa Monica out of the recession of the early 90’s in record speed and contributed to a decade of extraordinary revenue growth for the City’s General Fund. In contrast to that experience, local revenue is projected to grow over the next several years at a rate well below the average for the last decade. The recovery trajectory for both transient occupancy tax and sales tax proceeds is particularly disappointing, and other indicators such as office vacancies also give cause for concern. Volatility in the energy industry and changes in use patterns of telephone technology make Utility Users Tax revenue less predictable than in the past. Property Tax revenue remains strong in the current housing market, yet the State of California is grappling with an unprecedented deficit and the local share of Property Tax is at risk along with other sources of local revenue controlled by the State. Projected expenditure growth, absent intervention, will outstrip revenue growth by a significant factor as the following six graphics indicate. Two different types of cost contribute to the projected expenditure growth. The first are costs largely beyond the City’s control such as retirement contributions and medical insurance premiums. The second involves “discretionary” projects that the City undertakes. These result from new program initiatives without corresponding cutbacks in other workload or staffing. In 2 addition, the “discretionary” category includes currently funded but un-built capital projects such as a new Main Library, an expanded Virginia Avenue Park and a new Airport Park. These projects have associated ongoing operating costs . The following graphs show how the different categories of expenditures as well as revenue growth are projected to create an on going deficit in the General Fund – a gap between projected ongoing expenditures and anticipated revenues which will continue absent corrective measures for a period of years. This gap grows from $9.1 million next fiscal year to $22 million by fiscal year 2007-08. The projected structural deficit does not include any possible local revenue losses resulting from the State’s severe budget problem. 3 I.PROJECTED GENERAL FUND OPERATING BUDGET BASE SPENDING 226 222 218 214 210 206 202 198 194 DOLLARS (in millions) 190 186 182 178 174 170 Base Spending Base Spending 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS Graph I. shows General Fund “Base Spending” or what it would cost each year to continue current services if costs increased only 2.4% annually (the projected increase in the Consumer Price Index). Under this scenario, Base Spending increases from $151.7 million in FY2002/03 to $170.8 million in FY2007/08. 4 II. PROJECTED GENERAL FUND OPERATING BUDGET 226 EXTRAORDINARY INCREASES 222 218 214 210 206 202 TOTAL OPERATING 198 SPENDING 194 DOLLARS (in millions) 190 186 Operating Increases Operating Increases 182 178 174 170 Base Spending Base Spending 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS Graph II. adds to the base spending extraordinary costs largely beyond the City’s control: increased retirement system contributions due to investment losses by the State Public Employees Retirement System (PERS), health insurance premiums due to accelerating cost pressures in the health care industry, and workers compensation costs due to legislative changes. Other projected cost increases include bringing on- line several new major City facilities and the recent implementation of discretionary programs. . 5 III. PROJECTED GENERAL FUND CAPITAL MAINTENANCE PROJECT COSTS 226 222 218 214 Capital Maintenance Projects Capital Maintenance Projects 210 206 202 198 194 DOLLARS (in millions) 190 186 Operating Increases Operating Increases 182 178 174 170 Base Spending Base Spending 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS Graph III. adds the costs of capital projects to maintain or replace the City’s infrastructure assets. These projects include street resurfacing, street light retrofits, traffic signal upgrades, and emergency apparatus replacements. The minimum investment required is estimated to be about $10.0 million annually (increased by the CPI over the forecast period). Also included are subsidies to various other funds, primarily to maintain capital assets. The low amount of capital maintenance in FY2002/03 reflects a one-time shift to help finance construction of the new Library. 6 IV.PROJECTED GENERAL FUND CAPITAL IMPROVEMENT PROJECT COSTS 226 TOTAL SPENDING 222 218 Projects Projects Capital Maintenance Projects Capital Maintenance Projects 214 210 206 Capital Improvement Capital Improvement 202 198 DOLLARS (in millions) 194 190 Operating Increases Operating Increases 186 182 178 174 Base Spending Base Spending 170 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS In addition to the cost of maintaining capital assets, the City undertakes capital improvement projects that add to or enhance the City’s infrastructure. Graph IV. shows that over the forecast period only about $1.8 million in General Fund support is projected for these projects. The total projected General Fund spending for Base Spending, Operating Increases, Capital Maintenance Projects, and Capital Improvement Projects is represented in this graph. Total spending increases from $180.2 million in FY2003/04 to $220.5 million in FY2007/08. 7 V. PROJECTED BASELINE GENERAL FUND REVENUES 226 222 218 214 210 206 BASELINE 202 REVENUES 198 194 DOLLARS (in millions) 190 186 182 178 174 170 Baseline Revenues Baseline Revenues 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS Graph V. shows projected ongoing General Fund revenues under the “most probable” or baseline revenue assumptions. Total ongoing revenues are projected to increase by about 2.5% for FY2003/04 and by an average of about 3.6% annually over the remainder of the forecast period. 8 VI. PROJECTED GENERAL FUND DEFICIT -$22.0 m 226 222 TOTAL -$21.3 m SPENDING 218 214 -$21.3 m 210 206 Deficit Deficit -$18.5 m 202 BASELINE 198 REVENUES 194 DOLLARS (in millions) -$9.1 m 190 186 182 178 174 170 166 162 158 154 150 FY 02/03FY 03/04FY 04/05FY 05/06FY 06/07FY 07/08 FISCAL YEARS Graph VI. Compares projected Total General Fund Spending from Graph IV. and Baseline General Fund Revenues from Graph V. The gap between ongoing spending and ongoing revenues is the projected deficit. It ranges from $9.1 million in FY2003/04 to $22.0 million in FY2007/08. To preserve the financial integrity of the General Fund, the deficit must be closed through a combination of expenditure reductions and revenue increases. As indicated, the deficit increases to $9.1 million for FY 2003/04 and to $22 million for FT 2007/08. It has been the fiscal policy of the City to maintain a minimum General Fund balance reserve of 10% of total operational spending, and the maintenance of that reserve policy is built into the above projections. Setting aside such an amount is not only prudent financial management and a factor carefully looked at by the bond rating 9 agencies, but it also provides a reserve that would be needed to respond immediately should a catastrophic emergency occur in the City. The amount reserved has been questioned in the past, and may be challenged again in the current economic climate. Council and the community should be aware that the reserved amount represents less than two months of General Fund operations. Citizen Satisfaction As part of the annual budget preparation cycle, the City conducts a statistically representative telephone survey to determine how satisfied residents are with City services. This year, those survey data may prove particularly useful to Council in approaching difficult budget decisions. The report of survey findings will be available on the city website (along with the previous four surveys). Residents expressed generally positive views about City services, with 83 percent saying they are very or somewhat satisfied. Sixty-eight percent of the respondents feel they had the opportunity to voice their concerns to the City on major community decisions affecting their lives. When asked how the City could improve its services, respondents' top three answers were address homelessness (22%), improve traffic safety/congestion (12%) and provide more parking (12%). Community Voices – Human Services Planning Project Community Voices is a planning process that will guide City human service planning and funding priorities for the next three years. Community Voices provides data and 10 identifies new human service needs and trends; updates the community profile using Census 2000 data; and takes a special look at the needs of youth and young adults ages 11–23. Human service funding decisions will be both important and difficult given the economic realities outlined in this report. Staff will return to the Council on January 28, 2003 with recommendations to guide the upcoming funding cycle and set a framework for the Request for Proposal process for non-profit applicants. The amount of funding available for human services grants will be determined in the course of the budget preparation process. It will likely be reduced from prior years’ levels. Staff is also preparing the annual Action Plan, which allocates federal Community Development Block Grant and Home Investment Partnership Act funds to various human service and housing programs. The Action Plan will be presented to Council with the FY 2003-04 budget. Budget Strategies While Council will ultimately act in June on a single fiscal year’s budget (2003/04), staff will prepare budgets for at least one additional fiscal year, (2004/05) so that Council and the community are aware of longer-term trends and how they are related to short-term budget decisions. 11 Preserving the good will of City residents, the viability of the business community and the attractiveness of Santa Monica as a destination could become competing objectives in a period of slow revenue growth and potentially significant expenditure growth. Every choice among and between potential expenditure reductions and revenue increases will have proponents and opponents. “Simple” solutions will likely be floated in the coming months and must be subjected to careful analysis. None alone would likely correct the ongoing expenditure/revenue gap and each would likely have consequences that may not be acceptable. The State of California’s recent experience is instructive. By postponing difficult decisions last year, the Governor and legislators contributed to a worsening of the deficit and consequently face the unhappy prospect of deeper cuts and steeper fee and tax increases than might otherwise have been the case. Some voices assert that raising revenue is the only appropriate response to the State’s problem, while others clamor for program elimination and expenditure reduction. For Santa Monica, the right response is likely to be a mix of expenditure reductions and measures to increase revenue. While the budget balancing strategies staff brings forward in the next months will likely vary, to grasp the magnitude of the task ahead, it will be instructive here to contemplate a budget which is balanced with roughly equivalent expenditure cuts and revenue increases. For FY 2003/04, that would mean $4.5 million in expenditure cuts and $4.6 million in revenue increases to cover the projected deficit of $9.1 million. To cover the additional $9.4 million gap in FY 2004/05, 12 it would mean an additional $4.7 million in expenditure cuts and $4.7 million in revenue increases on top of those achieved in 2003/04. Because the City has made careful policy choices in the past, it may be possible to “cushion”, only in part and only for some period of time, the effects of these reductions and increases. Some potential measures are discussed below. Expenditure Reductions The City staff has been challenged to identify operating efficiencies that would reduce the cost of providing services – changes in practice, methods, materials and/or equipment that would reduce ongoing expenditures – and to identify programs for which participation or constituent support has dwindled so that reallocation of funds can be considered. The magnitude of employee-identified cost saving measures will determine the extent to which less strategic measures must be considered. Should the identified efficiencies be inadequate, the potential ongoing savings measures could include: ? Hiring Freeze A hiring freeze is an effective way to reduce staff costs, which comprise over 70% of the General Fund operating budget. It can, however, have random and unpredictable effects on service delivery. An “exception” process would be included in a freeze to mitigate those effects. Based on normal position turnover, a hiring 13 freeze might be expected to produce roughly $3 million in savings per year, assuming that the positions are not restored subsequently. ? Across-the-Board Cuts Last year, in an effort to bring expenditures into line with reduced revenue, all departments were called on to identify cuts totaling 2% of their budgets. The cuts finally recommended, totaling $2.2 million (1.5% of the General Fund operating budget) affected departments differentially. This is a common result of attempts to institute across- the-board cuts. The public, for example, may criticize any reduction in public safety budgets, regardless of the actual impact of the proposed reduction on service and safety. In contrast, libraries, parks and recreation, human services and internal services such as Human Resources, Finance and Information Systems are far more likely to be affected by across-the-board cuts. Those functions customarily suffer deeper cuts so that public safety budgets can be preserved. A 2% across-the-board cut would produce $3 million in savings and a 5% cut $7.4 million annually, but would very likely involve considerably steeper cuts in some departments and significantly less impact in others. Those departments and functions subject to the greatest reductions would undoubtedly suffer employee layoffs and users of the affected services would be aggrieved. ? Salary Freeze In the recession of the early 1990’s City staff went without a cost of living increase for one year. Such a measure would result today in $3 million in annual savings if 14 the cost of living adjustments were not restored in subsequent years. With contracts in place for three of ten bargaining units, a salary freeze would have to be negotiated. A salary freeze might or might not be preferred by employees to the layoff of colleagues or the increased workload that a hiring freeze imposes on the remaining staff. ? Benefit Structure Changes The City could seek to reduce the range of health care options offered to employees, freeze or reduce the types and levels of benefits, and/or increase deductibles. Other options for controlling insurance expenses might include covering employees only, covering only a significantly reduced portion of the cost of family coverage and/or declining to provide an in-lieu cash benefit to employees who opt out of insurance coverage. Benefit changes are a mandatory subject of collective bargaining, the potential for achieving cost savings is difficult to predict and equity issues are involved in any tradeoffs. ? Avoiding/ Eliminating New Discretionary Costs The projected additional operating and programming costs of a new Main Library, Virginia Avenue Park and Airport Park are approximately $3 million annually. All projects are scheduled to open in the next two years. Should the City decide not to proceed with one or more of those high-profile projects, corresponding reductions in the expenditure trend line would be realized. A number of other currently budgeted capital projects that have lesser associated ongoing operation costs have been 15 identified and will likely be recommended for indefinite deferral. Clearly, the City can choose not to undertake new capital projects that involve ongoing operating expense increases over the next several years. Revenue Increases City employees are also responding to the challenge to finding ways to increase General Fund revenue. They have been asked to rethink the methods by which we collect and handle revenues, to consider changes that would enhance existing revenue sources and to identify new revenue streams. In addition, staff is reviewing the cost allocation plan that charges other funds for services provided by the General Fund to ensure that the General Fund is being fully reimbursed. There are significant constraints on the Council’s ability to generate revenue. Under Proposition 218, new or increased taxes are subject to a vote of the people - a simple majority (50% plus 1) is required for a general (unspecified) purpose tax and a super majority (66 ?%) for a specified purpose tax. New or increased fees and fines are revenue measures within Council’s discretion to effect in the short term. Council could also reconsider various policies that restrict or constrain existing revenue sources. A range of potential revenue options is discussed below. ? Fee Increases Fees are charged for specific services that benefit individual users rather than the public at large. The City undertakes a comprehensive review of fees approximately 16 every 5 years and most fees are adjusted in the intervening years by a cost of living factor. The last comprehensive fee update occurred in 1999. More recently there have been two updates of development permit fees to more nearly recover the costs of those services from users. This leaves limited potential for fee revenue increase, but staff is reviewing any and all fees that have not been adjusted for the past several years and will develop recommendations accordingly. A particular focus of the review will be the potential for fee increases in those funds that are currently or may in the near future be supported by the General Fund. Those include the Airport, Pier, Cemetery, Civic Auditorium and Beach Funds. Staff may propose fees to cover fire/life safety inspections of commercial and multi-family structures. No estimate of fee revenue potential can be made at this time. ? Fine Increases Fines are assessed as a deterrent to violation of the law. The City recently adopted schedules of fines and penalties associated with aircraft noise and code enforcement. Citations for traffic violations and certain parking violations are set by the State and cannot be adjusted by the City. No adjustment has been made to parking violation fines under the Santa Monica Municipal Code since 1993, when the cities of West Hollywood, Culver City, Beverly Hills and Santa Monica entered into a cooperative arrangement for the adjudication of parking citations. A study of current parking fines in surrounding jurisdictions was recently undertaken. By increasing fines for various combinations of violations to be more consistent with surrounding jurisdictions, the City could realize from $1.2 million to $3.1 million in 17 increased revenue. This potentially significant revenue benefit must be weighed against the public aggravation that parking citations generate. ? Parking Meter Rate Increases On December 17, 2002, the City Council gave conceptual approval for an increase in parking meter rates last adjusted in 1991, and to the addition of parking meters in various areas. Staff presented the results of a survey showing that Santa Monica’s rates ($.50 per hour or $.35 per hour in most locations) are lower than those in other communities. Increasing meter rates to $1 in high demand areas and $.75 in other areas would result in an additional $3 million in annual revenue. With conceptual approval, staff is developing specifications and preparing bid documents so that if Council gives final approval to increased rates at mid-year, new electronic meters can be obtained and installed on a timely basis. The one-time capital investment will mean that the full benefit of the revenue increase will not be realized until FY 04/05. The Chamber of Commerce has expressed concern that higher meter rates may result in fewer shoppers and hence prove counter-productive. ? Transient Occupancy Tax (TOT) Santa Monica’s TOT, a “bed tax” charged to visitors on their hotel bills, is currently 12%, set strategically below Los Angeles and Beverly Hills where the rate is 14%. In particular for group travel, the lower bed tax helps to offset the relatively high room rates that Santa Monica hotels have charged. Under Proposition 218, a tax increase for general (unspecified) purposes must be placed on the ballot in a 18 general election and must receive a majority vote (50% plus 1) to be imposed. An increase in TOT to 14% would result in approximately $3 million in additional revenue annually, however, the next general election is not until November 2004. A half-year of proceeds would be realized in 2004/05 and a full year in 2005/06 if the measure received public support. The interval prior to the election would provide additional time to gauge the extent of recovery in the tourism sector, the likely business effects of an increase, and strategies to mitigate any adverse effects. Active promotion of Santa Monica as a desirable, walkable destination remains an essential objective in support of recovery and consideration will be given to enhancing Convention and Visitor’s Bureau marketing initiatives. ? Business License Tax Santa Monica’s Business License tax was last studied and restructured over a decade ago. Because the composition of the business community changes over time and because the dynamics of individual business sectors are also subject to change, periodic review and restructuring can increase revenue and also identify and correct inequities in the tax structure. A review, including associated interaction with the business community, will likely take up to a year. Resulting changes can be imposed only upon achievement of a majority vote (50% plus 1) in a general election if the proceeds are to be used for general (unspecified) purposes. With the next general election scheduled for November 2004, there is time to gauge potential impacts of tax increases on business recovery. It is not possible to anticipate the revenue gain from such a review, although the last restructuring resulted in $2 19 million in increased annual revenue. Any resulting revenue increase from the new review would be realized in 2005/06 and beyond. Staff will likely recommend that such a study commence shortly. Policy Changes The City has maintained certain fiscal policies that could be reevaluated to make additional ongoing revenue available to the General Fund. The Civic Development Fund was established to receive one percentage point of the proceeds generated by the th TOT (currently 1/12 of the annual amount collected) to be used for improvements to the Civic Center. Approximately $1.5 million annually could be provided to the General Fund if that policy were abandoned either temporarily or permanently. Changing the existing policy would eliminate a potential funding source for public improvements associated with the Civic Center Specific Plan. No financing plan currently exists to realize the extensive park and public plaza improvements. Should the City be able to proceed with development of the Village Green housing envisioned in the plan, the Civic Development Fund could help to cover interim landscaping improvements to the north and east of the housing sites that would enhance the new neighborhood’s surroundings. The City’s policy has been to budget the full amount of salary and benefits required for authorized employee strength. Because vacancies occur, and the civil service system makes rapid refill difficult, salary savings are realized in virtually every budget year. Those savings, which average $2 to $3 million annually, are sometimes referred to as a “surplus.” Council has found it useful to designate those funds for one-time purposes 20 that could otherwise not be funded, making those designations in Year-End or subsequent Mid-Year budget actions. This year, given the significant uncertainty surrounding the State Budget, the savings may provide the City with the flexibility to respond to potential take-backs from local government by the State. Preserving financial flexibility is a priority for the City. The City could alter current policy by budgeting for a particular rate of vacancy - essentially building salary savings in to the operating budget. Budgeting for the full average salary savings would reduce financial flexibility substantially and staff would likely recommend using half or less of average savings as the budget factor should this policy change prove necessary. One-Time Mitigation Strategies The City’s financial policies have provided financial flexibility that has, in the past, enabled the City to undertake projects that would not otherwise have been possible. In the current challenging economic environment it may be appropriate to exercise that flexibility to cushion, in part and over a defined period, what would otherwise be substantial expenditure reductions and revenue increases. It is imperative to recognize that the use of one-time resources to cover the projected General Fund deficit will merely “mask” the longer term effects of the projected deficit. The State budget experience is a prime example of the consequences of this form of denial. Only ongoing expenditure reductions and revenue increases will cure a persistent deficit. Therefore, the following measures would be proposed only in conjunction with significant ongoing expenditure and revenue measures, as they do not constitute ongoing revenue streams. 21 ? Capital Project Deferral/Elimination In recent years, the City's capital program has consisted largely of ongoing programs to maintain or replace city infrastructure and assets. Much of the revenue growth over the last decade was dedicated to projects that involve one-time improvements or the creation of new facilities. Some of these as yet to be constructed, one-time projects could be reduced, eliminated or deferred to future years when discretionary funds may again become available. To reduce ongoing costs, new projects that will significantly increase annual operating costs are being evaluated in particular for long-term financial feasibility. Projects under consideration for deferral include further phases of crosswalk improvements, upgrades to downtown parking structure restrooms and lobbies, the second phase of the park building improvement project, creation of Euclid Park, the development of a Pier breakwater, and the renovation, expansion and seismic upgrade of City Hall. Deferral of these projects and others could result in one-time cost savings of $10 million or more. ? Reserved Funds The City maintains a cash liquidity reserve as required by the City Charter “for the purpose of assuring the payment of the operating expenses of the City on a cash basis.” The amount of the cash liquidity reserve is approximately $3.5 million. This reserve has been designated above and beyond the 10% General Fund reserve that the City maintains by policy Should it be necessary, a portion of the cash liquidity reserve could provide a one-time infusion of revenue, but it will be seen as a 22 significant change in fiscal policy and a loss of financial flexibility by the broader financial community, including ratings agencies. ? Civic Development Fund The funds currently accrued in the Civic Development Fund ($4.0 million) could be put to one-time use. As with diversion of the ongoing Civic Development Fund revenue stream, this action would preclude use of the funds for improvements associated with the Civic Center Specific Plan, including any interim landscaping improvements that would enhance the experience of Village Green residents when the housing elements of the plan are realized. Conclusion Much of the public input this evening will, if past January budget sessions are a predictor, entail requests for additional services and funding. As Council considers those pleas it will be important to balance them against the necessity for the deeper cuts and steeper revenue increases that are the only way to accommodate them. Adjusting to a new financial situation will be difficult for our community, Council and staff. But it is a process that the State and our neighboring public institutions are also grappling with. The State budget process in particular will be dynamic and it will be imperative to respond quickly to attempts to divert or reduce municipal revenue and staff should be provided with Council authorization to do so. 23 Council is not asked to select among the budget balancing strategies presented in this report. Staff will propose an array of appropriate measures as the budget process progresses. It would, however, be helpful to identify at this time any strategies that would not likely receive majority support of the Council. Recommendation It is recommended that the City Council take public input, provide staff with general direction for proceeding with development of a budget and longer term plan for closing the revenue/expenditure gap, and authorize staff to advocate for preservation of local revenue sources as the State budget is considered. Prepared by: Susan McCarthy, City Manager Mike Dennis, Finance Director Gordon Anderson, Assistant City Manager Mona Miyasato, Assistant to the City Manager for Management Services 24