Aug 8 2011

Majority Draft Report of the 2011 Municipal Tax Review Committee

Executive Summary Piedmont Municipal Tax Review Committee Report

(Adopted unanimously)

Mike Rancer (Chair), David Brown, Bob Hosler, Tam Hege, Eric Lindquist, Robert McBain, and Steve Weiner present (Ryan Gilbert and Steven Hollis absent)

Overview and Essential Recommendations

Since passage of the City’s current parcel tax nearly four years ago, the condition of Piedmont’s municipal finances has substantially deteriorated.  Although the financial crash of 2007-09 created a difficult external environment (nationally, within California, and locally) that virtually wiped out growth in City revenues in recent years, the larger part of the problem is rooted in spending commitments (and the difficulty in predicting and controlling these commitments) that Piedmont has taken on with neither multi-year planning nor reference to future impacts.  In recent years these commitments have exceeded available funding, resulting in a serious decline in fund balances.  However, the greater challenge to the City is in the near future when projected expenditures threaten to so much exceed revenues that essential City priorities will be at risk.

Parcel tax revenue has become an essential component of the City’s fiscal picture, totaling about $1.5 million annually in a general fund expenditure plan of about $21.5 million.  This committee, while recognizing the importance of a four-year extension of the parcel tax at the current level, has determined that current City expenditure trends are not sustainable and so it must immediately take action to control and reduce future spending commitments while it still has the ability to do so, without adversely affecting basic priority programs such as police and fire protection, and maintenance of streets, sewer services, and other critical infrastructure investment.  Concurrently, the committee recommends the City review “best practices” and work methods in all departments to explore ways to reduce costs without sacrificing service, or to do more work with the same cost.


The Fund Balance Problem

In relying on fund balances to meet current expenditure commitments, and agreeing to undertake new commitments without an assessment of future costs, the City is on a path that is clearly not sustainable:

  • Expenditures and transfers out have exceeded revenues and transfers in to the general fund (the City’s main operating fund) 4 of the last 5 years despite using capital funds for operating needs.
  • The primary margin between revenues and operating expenditures, which was nearly $3 million in FY 2006, has barely been in balance in the years since.
  • As a result of these trends, the general fund balance has dropped by more than 50% since FY 2006 and is now at an imprudent level versus annual expenditures.
  • Additionally, other second tier funds are also at dangerously low levels given the capital and equipment needs of essential services expected over the next several years.  The aggregate balances of the City’s approximately 20 other funds have dropped by nearly half since 2007.
  • A significant contributing factor to the problem was the need for the City to cover the overruns on the Piedmont Hills utility under-grounding project at a cost of over $2 million, about $500,000 of which came directly from the balance in the general fund.


The Revenue Problem

Lacking the commercial and/or industrial base of other cities with more diversified local economies, Piedmont essentially relies on a single source for most of its revenues:  taxes on residential property.  Approximately two-thirds of the revenue to support City operations comes from property-based taxes:  real property taxes, property transfer taxes and the parcel tax.  Unfortunately, real property tax revenue has grown by little more than 1% annually for the past three years.  Property transfer tax revenue actually declined by almost 50% between FY 2006 and FY 2009, and, while recovering in the last two years, it is still about 25% below the peak.  Parcel tax revenue has essentially been at its maximum for the past four years, with a nearly flat growth line due to very low inflation in the economy.  Total City revenues over the last three years have grown by less than 2% per year on average.


The Expenditure Problem

If two-thirds of the City’s revenues come from the single undiversified source of residential property, the problem is exacerbated by the fact that three-quarters of its expenditures are devoted to salaries and benefits for City employees.  This assessment should not in any way be interpreted as criticism of Piedmont’s public service professionals who do an outstanding job in meeting the high standards set by our citizens.  However, due to decisions made by the City within the past 10 years, compensation costs have increased faster than the primary property-based revenues discussed above (and faster than any reasonable measure of City activity).  Since FY 2006, the general fund salary budget has grown by over $2 million or by about 4% per year (about 26% in total).  During that same period, the benefits budget has grown by about $1.8 million or over 7.5% per year (about 55% in total).  Benefits that equaled about 19% of general fund expenditures in FY 2006 now consume about 24% of the City’s main operating budget.

The primary cause of this growth in benefit costs was the City’s decision in the first years of this century to opt for the highest employee pension levels offered by the state’s system (CalPERS).  This decision, combined with the increasing cost of health care benefits for employees and retirees, has approximately doubled the ratio of benefits to salaries in the City’s compensation budget.  It is important to note that, the City having chosen a high level of retirement benefits, the annual rate of contribution is no longer under City control.  Rates are set by CalPERS, based on their actuarial studies and their investment returns.  In the current year, for example, the City’s CalPERS contribution rates are about 8.5% above last year’s levies.  This is because the CalPERS options are all defined benefit plans, which are lifetime guarantees to current employees and retirees.  These plans are distinct from the defined contribution plans (e.g., 401k) more common the private sector, where employers can set their rates based on available resources and limit their exposure to future uncontrollable costs.  To put comparative numbers to these two concepts, the CalPERS rate for Piedmont’s public safety employees is an amount that is more than 40% of salary, and for other employees it is over 20% of salary.  In a defined contribution plan, the employer rate would almost certainly be less than 5% of salary.  (It is important to note that Piedmont City employees have long had access to a similar tax-deferred savings option, known as a 457 plan, though with no City contribution to it; funds in this plan come exclusively from employee pre-tax contributions.)  The committee concludes the City must take decisive steps to end its unsustainable approach to employee benefits, as discussed in more detail later in the report.


Unmet Needs

In addition to the reality of sluggish revenue growth and accelerating expenditures, the City faces unbudgeted needs in the coming years for the replacement of critical equipment, the maintenance of facilities, and other essential capital expenditures for which it has set aside very little money.  Some of the assets in question are in public use, such as recreation installations; others are needed for emergency response by police and fire; while still others are aging buildings used for administrative purposes (e.g., City Hall) that will eventually need repairs such as roof replacement or other infrastructure updating.  Consultation with City staff indicates that the long-term need for capital expenditures is about $1.3 million per year.


Where Is the Budget Headed From Here?

The Municipal Tax Review Committee (MTRC) has attempted to develop a workable projection of City revenues and expenditures over the coming years of the current decade.  It is important to note that this is not prediction or a forecast, but, instead, is a set of reasonable assumptions about the growth of revenues and expenditures based both on the very difficult economy of the past five years and on the longer term trends that seem to underlie certain categories of revenue and expenditure.  Our projection is basically an outline of a multi-year financial plan, which is something the City has not routinely used to help guide its budgeting.  Details of the projection are summarized in the report chapters on revenues and expenditures.  Our conclusions are as follows:

  • Based on our projections, which include renewed revenue growth but also more sustainable funding for capital and equipment replacement items, it is unlikely the City will be able to meet its current commitments and maintain essential services, even with an extension of the parcel tax and considering that we have already assumed significantly lower salary and benefit growth rates than have been historically seen over the last 10 to 20 years.
  • Based on the revenue assumptions (which include parcel tax renewal at the current level, to be levied at its full amount every year) and the need to replenish reserve funds, we estimate that the City is facing a shortfall of about $6 million over the life of the next parcel tax .
  • Piedmont has a long history of providing exceptional “priority services” for its citizens, such as prompt and responsive public safety, well-maintained streets, sewer systems, parks and City spaces; all with prudent financial management and access to government officials.  However, it has also taken on commitments and risks that it cannot sustain over the longer term.  Beyond the issue of employee benefits, there are several that stand out:
    • It has committed $380,000 to provide a 50% subsidy to year-round pool operation.
    • There are no procedures in place to prevent a repeat of the Piedmont Hills under-grounding overrun, not only on other under-grounding projects, but on other large capital projects as well.
    • Of greatest current concern for the future is the proposed sports facility at Blair Park, which has both large capital costs as well as substantial but as yet undetermined operating and maintenance costs.  This committee offers no conclusion whatsoever about the wisdom or value of Blair Park project.  We limit our comments to an assessment that the City does not and will not have the resources to subsidize the construction, the operation, the maintenance, or future capital renovations of such a facility.
    • Given the above, the committee agreed unanimously to the following conclusion:
      • The current and long-term financial problem facing the City is not a revenue problem but is instead primarily an expenditure problem.  There is agreement that a continuation of the parcel tax is necessary and supportable assuming the City takes certain actions to control long-term costs.  Specific recommendations on expenditure controls are laid out below in two groupings.


Recommendations for Improved Financial Controls and Decision Making

  • To better improve fiscal controls and discipline going forward, and to help the current and future City Councils make better financial decisions in good and bad times, we recommend instituting a five-year annual planning process, created by City staff, that will enable City Councils to see a clearer picture of the fiscal impacts of their decisions.
  • The City should establish a new Municipal Financing Planning Committee (“MFPC”) made up of volunteer citizens (serving staggered terms) to annually review the five-year plan and provide guidance to the Council.  The MFPC charter would focus on providing for the long-term sustainable financial future of the City.  This new committee would not replace the quadrennial parcel tax committee, but would meet only a limited number of times each year to review the 5-year plan and provide a “check” of the plan for the Council, as well as to provide a financial review of any new program commitments in excess of $250,000 annually.
  • Economic cyclicality is a certainty and steps should be taken to characterize revenues received over specified levels and long terms growth rates as “temporary” with such amounts listed as such in budget documents and Council presentations and ideally specifically set aside in reserves.  We believe City staff already tries to operate this way, but a more specific presentation would highlight the amounts as non-sustainable for future City Councils and identify the risks of committing these revenues for long-term commitments.
    • Transfer Tax – Starting from a base of $2.5 million per year, any annual growth above 2% should be considered temporary revenue
    • Property tax revenues growing over the FY 2010-11 base year at more than 4% should be considered temporary revenue
    • These levels should be periodically reviewed by future Municipal Tax Review Committees
    • The committee recommends that the City undertake a prioritizing of City services and modify the detailed budget presentation designating certain services (costs, etc) as “essential” and other services as “non-essential” in order to assist future Councils to create a priority of funding
    • The City should adopt formal objectives for the appropriate fund balance levels of funds related to capital and equipment replacement and use these levels as guidelines in allocating revenues.
    • In the wake of failure to properly control the costs of the Piedmont Hills under-grounding project, the City must establish procedures for executing large capital undertakings (costing over $250,000) to the highest standards of professional project management, covering all phases including design, specification, contracting, construction and inspection.


Specific Expense Reduction Recommendations

  • The committee has reviewed several areas where expenses can be reduced from current trend lines:
    • Employee costs – specifically benefits
    • Net cost of non-essential services
    • Possible work rules changes, particularly in the Fire Department
    • As noted above, employee benefits have substantially outgrown revenues and any reasonable measure of service, as well as other categories of expenditure over the past decade, and although the City employees provide excellent service, the benefit costs are not sustainable into the future.   The committee recommends significant immediate action with regard to employee pension and other benefits to cap these costs and to ultimately make changes that reduce these costs as a percent of salaries.  Although the committee was not able to study the costs and implications of various potential benefit plans in depth, the committee recommends the City undertake a thorough review of long term projected pension and other benefit costs given likely conservative investment returns, medical cost growth rates, actuarial studies based on likely hiring, etc., and implement one or more of the following:
      • Institute a two-tier benefit system that at a minimum would apply lesser (and less expensive) CalPERS pension options to new employees.  Since the City already offers a deferred compensation program (similar to a 401k), employees will still have the option of supplementing their pension plans with a tax-deferred private savings vehicle.
      • Negotiate to reduce current retirement benefit costs/growth rates by increasing employee contribution levels and strengthening the cap on the City’s contribution so that the City’s benefits budget allocation remains constant going into the future.
      • Implementing significant changes could result in impacts to current services.  Although the committee does not recommend cuts in current services, it does understand that making the changes proposed could result in service disruptions/hiring difficulties during any adjustment period.  The goal is to reduce overall compensation cost growth rates and reduce the uncontrollable components of those costs – salary and defined contribution costs are controllable, defined benefit costs are not.
      • In addition to employee benefit commitments, the City is currently evaluating or has recently undertaken several new programs including as noted above:  operation and subsidy for the swimming pool, a possible major new sports complex at Blair Park, and continuing/expanding the library commitment, as well as other services/projects. Although the committee recognizes the multi-dimensional nature of the discussions around these programs, the committee feels it is very important for the City to understand the differences between these services and essential City functions from a fiscal perspective.  Further, the City should take steps to make sure the costs of any new commitments are fully understood and paid for out of user fee revenues and not general fund revenues/parcel tax.  Specifically,
        • General fund expenditures for the pool should be reduced to zero both in terms of actual costs and potential liabilities.
        • Blair Park should be structured so as to have zero impact on the future budget in terms of actual construction, long-term operation, capital maintenance and replacement; before committing to build the Blair Park facility, the City must secure a professional estimate of construction and maintenance costs, and commit to a user fee schedule that will recover all operating costs.
        • In the event there is evidence of a strong community interest in subsidizing these sorts of user-specific programs, the City should consider seeking a public vote for individual parcel taxes to support them, recognizing that the two-thirds vote required for passage would be the ultimate measure of public support


Parcel Tax Recommendation

Although the committee in concept supports renewal of the parcel tax in its current amount and structure , the committee had much discussion concerning whether or not conditions should be placed on its recommendation.  Fundamentally, the City’s projected revenues and current expense commitments don’t align and the committee recognizes that passing the current parcel tax without addressing expense commitments is not fiscally prudent.  Further, the committee understands that certain expense reductions recommended above will take time and negotiations to implement – more time than is provided by the committee’s current schedule for submitting its report.  The committee has grave concerns that without implementing the above steps, not only will the parcel tax not cover planned expenditures, but also that committee members likely won’t support the parcel tax renewal.  The committee therefore suggests that Council may want to defer the parcel tax vote from the current planned February date and instead put it on the ballot at a later time, preferably June (but November if necessary), to coincide with state elections.  The City can use that extra time to accomplish the key spending constraints proposed in this report.  This delayed election would apply only to the general parcel tax, not to the sewer tax proposal discussed immediately below.


Sewer Tax Recommendation

As described in separate chapter in this report, Piedmont (as a constituent in the East Bay MUD district) is under mandate from the federal Environmental Protection Agency to make substantial additional investments to maintain and improve the town’s sewer system, and to monitor system quality to a higher level in future years.  The City’s sewer rehabilitation and replacement have been successful so far and are about half-way completed.  Thus there is light at the end of the tunnel once the EPA mandate has been met.  Consistent with the recommendations in the sewer system chapter of this report, the MTRC recommends a 50% increase in the sewer tax rate, to be levied through the end of the EPA-mandated construction period and until reserves in the City’s sewer fund return to and can be maintained at their historic level of about $2 million, but for no longer than 10 years without a public vote to re-authorize.


Current Spending Trends Result in Growing Annual Deficits

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Implementing Tax Committee Recommendations Results in Balanced Budgets

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Fringe Benefits Have Increased from 25-33% of Salary to 53% of Salary

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2 Responses to “Majority Draft Report of the 2011 Municipal Tax Review Committee”

  1. city employees should make substantial contributions to their pension and health care, rather than placing it all on the taxpayer.

  2. For those of thus unable to parse through the long, though we are sure accurate, text which describes this report, is it possible that a spreadsheet summary or set of graphs exist which would allow those of thus unfamiliar with the details to grasp the size of the various income and expenditure categories to which this report refers? I’m sure these aids must exist and were used by the committee. Can someone point us to the source?

    Editors’ Response:

    Thank you for the suggestion! Two spreadsheets and a chart have been prepared by the Tax Committee:

    1. Budget Projections with Current Spending Trends reflecting increasing budget deficits
    2. Budget Projections incorporating Tax Committee Recommendations reflecting positive budget balances
    3. Fringe Benefit Graph showing increase from 25-30% to over 50%

    They now appear directly following the Tax Committee’s report.

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