Aug 8 2011

Minority Draft Report of 2011 Tax Review Committee

Minority Report of the Piedmont Municipal Tax Review Committee

(Adopted by Steve Weiner, Tamra Hege, Eric Lindquist)

Introduction

Maintaining strong municipal services (police, paramedic and fire, streets, parks and sewers) is a crucial element in Piedmont’s quality of life. Correspondingly, maintaining the City’s ability to pay for high priority services, especially in a time of economic trouble and massive budget cuts at the state level and in other Bay Area cities, is vital.

The advisability of continuing the city’s (property) parcel tax beyond its current expiration date of July 1, 2013 is the issue under study by the Municipal Tax Review Committee (MTRC). Whether voters should approve continuation of the parcel tax necessarily requires an examination of the City’s overall financial condition and management.

The MTRC prepared projections of the City’s likely financial condition over the next nine years (including the period of 2013-2017 when a renewed parcel tax would be in effect.) These projections were prepared after considerable time spent discussing and agreeing upon reasonable assumptions and after much deliberation by the MTRC in concert with city management. We believe the MTRC is unanimous in approving these projections as our best effort to project the financial path of the City of Piedmont.  The conclusion to be drawn from these projections is that the city is on a path that is clearly not sustainable.

The MTRC’s “base case” projection shows that the continuation of current budgetary trends will lead to an accumulated city deficit on July 1, 2017 (the ending date of a continued parcel tax if approved by the voters) of $2.2 million dollars, $6.0 million dollars short of an adequate general fund reserve. These forecasts are troubling and should be a cause of deep concern not only to the Council but also to every Piedmonter.

In contrast, the “flat benefit expenditure” revenue and expenditure[1] projection produces a general fund reserve of approximately $3.2 million on July 1, 2017 (an improvement of $5.4 million over the continuation of current budgetary trends). Please note that the expectations for change in city policy and practice, as presented in this report, will produce adequate reserves for the city by the 2017/2018 fiscal year.

While there is agreement among the 9 members of the MTRC on many fundamental points, there is disagreement as to whether the City Council should be expected to make specific changes in budgets and financial management as a pre-condition to voter approval of continuation of the parcel tax. In this letter, those members of the MTRC who will not endorse voter approval until specific expectations are met by the Council, present five expectations for Council action.

Unless and until reforms are made in the City Council’s financial management, voters should withhold approval of a continued parcel tax. The major gaps in the Council’s current management relate to employee fringe benefits; assuring proper financial reserves to meet predictable future needs; setting and adhering to budget priorities; and  managing and minimizing financial risk in the conduct of municipal construction projects. In turn, these gaps reflect a more fundamental problem: the failure of the Council to plan the finances of the city within the context of five-year budget projections and analyses.

Fringe benefits

Expectation I: The Council will commission an expert, independent analysis of employee benefit obligations and that the Council (1) publicly adopt a clear limit on the costs of employee fringe benefits and (2) demonstrate that the limit they adopt is consistent with the long-term financial viability of the city. (See p.6 regarding multi-year financial forecasts).

Retirement costs for public employees are now much in the news. And for a good reason: many state and local governments have been overly generous in their promises of future retirement benefits and now find themselves suffocating under the un-funded liabilities that have resulted.

This is not a new problem in Piedmont, but it has been made worse in the last decade. In 1995-96, employee fringe benefits (primarily health benefits for current and retired employees and contributions to employee retirement plans) amounted to 29% of the amount paid in employee salaries. This was a fringe benefit ratio reasonably common in private and non-profit organizations. In 2003-04 the fringe benefit ratio was 33%. In the current year, these fringe benefit costs are at 53% of the amount spent on salaries. In absolute numbers, annual fringe benefit costs have gone from $1.387 million in 1995-96 to an estimated $5.181 million in 2012,an increase of 374%, an average increase of 8.6% per annum. In the same time period, salary costs have increased by only 208%, an average increase of 4.7% per annum.

Clearly, fringe benefit costs have been increasing nearly twice as fast as salaries. The increase in fringe benefit costs was accelerated in the 2004 and 2008 as a result of Council decisions to sweeten retirement benefits for city employees in the state’s PERS retirement system. For example, public safety employees in Piedmont now have a pension plan providing a pension of 3% of salary, at age 50, multiplied by the number of years of service. A Piedmont public safety employee employed by the City after 25 years of service, retiring at age 50 (with several decades of life expectancy remaining) will receive 75% of his or her final salary per year in retirement (3% multiplied by 25) with annual cost of living adjustments.

As previously noted, in 2003-2004, fringe benefit costs were at 33 % of salaries. If that fringe benefit ratio had been maintained, then the City of Piedmont would now be paying $1,954,000 less than it is currently paying for fringe benefits. By comparison, the entire proceeds of the city’s parcel tax for this fiscal year is estimated to be $1,550,000. It is fair to say that the ramp-up in employee fringe benefits is a major reason why the parcel tax [2] is now viewed by many as a permanent element in the financing of the City of Piedmont. This is unacceptable.

We are informed that the City Administrator is now in negotiations with employee organizations on new contracts, including fringe benefits. We are also informed that the city’s goal in these negotiations is to achieve greater employee contribution to the cost of fringe benefits. We don’t know the specific changes under consideration. To this point, the Council has not stated what its goals are in reducing city costs for fringe benefits. But we can say that marginal steps to ease the taxpayer’s burden for fringe benefits are not sufficient.

In our view, what is needed is a firm cap on city expenditures for fringe benefits. Given the extraordinary increases in taxpayer costs for employee fringe benefit plan in recent years, we favor serious consideration of a city policy that Piedmont taxpayers not continue to increase our cost for fringe benefits  beyond the 2011-12 budgeted amount of $ 5.18 million and that additional costs for a very generous fringe benefit plan, in future years, will be borne solely by employees. The Council has a number of options for achieving such a cap (including but not limited to greater employee contributions to their fringe benefits and a two-tiered retirement system that provides less generous retirement benefits for future employees.)

 

Reserves

Expectation II:  The Council will adopt a requirement that a transfer to three reserve funds (equipment replacement, capital improvement, and physical facility maintenance) of at least $1.3 million per year will be made in the annual budgeting process.

The City of Piedmont maintains separate funds (in effect, savings accounts) for a variety of purposes. Collectively, these funds are known as the city’s “governmental funds” and they include a “general” or “unreserved” fund. Since June 2007 the governmental funds held by the City of Piedmont have dropped dramatically from $ 15.8 million to an estimated $ 8.5 million at June 2012.

The issue of reserves came into sharp relief in early 2010 when in excess of a $2 million cost overrun from the Piedmont Hills undergrounding project was paid from the City’s general reserve. The current City general reserve is now $ 2.19 million, well below the 15% (of annual expenditures) reserve that the MTRC believes is prudent.

The City has no general policy for the maintenance of reserves and thus makes contribution to various reserve funds on an annual, “as needed” basis and when funds are available in the current year city budget. Of major concern is the lack of any reserve fund for the maintenance and repair, such as roof replacement, of city-owned buildings including city hall, the police department and the fire department. The failure to set aside funds for the inevitable maintenance and repair costs leads to a temptation to postpone needed repairs and face more costly and disruptive projects in the future. We recommend that a combined total $1.3 million be transferred each year from city revenues into the equipment reserve ($300,000), the capital improvement reserve ($200,000) and a new reserve for maintenance of physical facilities ($800,000).

Because strengthening these reserve funds is a matter of prudent financial management, the MTRC included these transfers in all of its financial projections.

 

Risk Management and Spending Priorities

Expectation III. After public hearings, the City Council will promptly make a public statement as to the changes in city policy that are required and make those changes drawing, as appropriate, from the recommendations of the League of Women Voters’ Task Force on Undergrounding and the members of the Council’s Audit Subcommittee

Expectation IV. The City Council will secure and publicly release an independent, expert estimate of the initial construction costs for Blair Park and a forecast of on-going maintenance costs including the planned replacement of the artificial turf playing fields and the maintenance of sewer lines and other public infrastructure associated with Blair Park. These construction and on-going cost estimates will include the cost of city employee time directly devoted to Blair Park. The City Council will officially resolve that no construction will begin on Blair Park until a) the sponsors of Blair Park project have transferred to the city sufficient funds to pay estimated construction costs as determined by independent experts; b) the sponsors agree that the city will impose fees for the use of the park sufficient to cover all on-going costs including capital replacement, c) the sponsors agree to pay all city legal fees if, as anticipated, legal action is initiated to challenge or stop the Blair Park project and d) the city adopts a policy that, under no circumstances, will the city subsidize the operation of Blair Park.

Expectation V:  The City Council will resolve that no city subsidies will be paid for the operation of the swimming pool after July 1, 2012 unless there are offsetting reductions elsewhere in the city budget of an amount equal to the subsidy for the pool.

In March 2011 the Piedmont League of Women Voters Task Force to Investigate and Report on the Piedmont Hills Undergrounding District issued a report that documented the City’s lack of preparedness in conducting undergrounding projects and the causes of a $2- $3 million cost overrun including legal fees. This cost was borne by all Piedmont taxpayers even though the vast majority of Piedmonters are not residents of the undergrounding district in question. The importance of understanding and reducing risks on city construction projects is made even more pressing as the Council moves into the latter phases of approval of a much larger and more complex project in Blair Park.

The undergrounding cost overrun was a major financial setback for the city. One would have hoped that this setback would have created a sense of urgency within the City Council to conduct a thorough inquiry, publish its findings, and undertake whatever remedial steps were required to prevent such errors and overruns on future city construction projects. Such a sense of urgency has not been evident. The Council formed an Audit Sub-Committee to study the cost overrun on March 1, 2010. It took 17 months, after the public revelation of the overrun, for the Audit subcommittee to publish its “draft final report,” four months after the League of Women Voters report. Even after this extended delay, the sub-committee was unable to set forth a coherent set of recommendations, but rather, provides a list of more than 30 recommendations proposed by individual committee members but with no unified sense of direction for future city policy.

Of similar concern, major civic controversy has arisen over the proposed Blair Park project to provide new athletic fields. The Blair Park project is relevant to the work of the MTRC only to the extent that such a project will have effects upon city finances. The MTRC offers no conclusion whatsoever about the wisdom or value of the 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, operation, maintenance or future capital renovations of such a facility.

In this regard, the sponsors of the Blair Park project have estimated the cost of initial construction, including provisions for pedestrian and auto traffic, as approximately $6 million. The sponsors of Blair Park have assured the public and the MTRC that they will bear the full costs of construction and that the on-going maintenance of the Blair Park complex will be borne by donations and user fees from both the current sponsors and user fees from others. Thus, the proponents of Blair Park say that the project will not impose costs on the city either in the short or long run. To date, there has been no independent assessment of the initial construction costs nor is there any guarantee that the full costs of construction will be donated. This leaves open the possibility that taxpayers will, as was the case with undergrounding, be forced to pay to complete a project initially described as free of cost to the city.

On July 1, 2011 the City Council took over operation of the city’s swimming pool that had previously been managed by the Piedmont Swim Club. The city now anticipates that, over and above fees paid by the users of the pool, that this new arrangement will cost the city approximately $380,000 per year. Additionally, no reserves have been set aside for pool facility maintenance or refurbishment[3]. This arrangement runs contrary to the city’s general policy that recreation facilities should be paid for by users. Expectation V, stated above, remedies this problem.

 

Multi-year Planning Process for City Finances

In considering options for assuring the city’s financial strength, the MTRC  established a minimum requirement that the city be able to (1) meet its basic expenses in coming years; (2) provide $1.3 million per year toward funding the inevitable costs of equipment replacement, capital improvements and maintenance of the city’s physical facilities; and (3) achieve a general fund reserve of at least 15% of the annual budget by the end of the fiscal year 2016-2017 ($3.8 million for a projected 2016-2017 budget of $25.4 million in expenditures).

As noted earlier, projections prepared by MTRC are critical to our findings and recommendations:

The “base case” scenario would continue the existing pattern of city expenditures including approximately $380,000 in a city subsidy for the swimming pool. In the base case scenario we also assume:

  • No lay-offs of city employees, no reduction in the number of employees, no furloughs of employees and employee salary increases of 2% per annum for the period 2013-2017.
  • Fringe benefits continue to grow at a rate 3% above the rate of total salary increases (this would bring fringe benefits to more than 60% of the salary expenditure in 2016-17)
  • No city subsidy for the construction or operation of Blair Park
  • Voter approval of a four-year extension of the current parcel tax

The “base case” projection shows an excess of expenditures over revenues for each future year leading to an accumulated general fund deficit of $2.2 million at the end of the 2016-17 fiscal year. This end result would thus fall short of the required 15% reserve by $6.0 million ($2.2 million plus $3.8 million needed for a 15% reserve). Thus, the current trends in municipal expenditure are unsustainable even with continuation of a parcel tax.

In order to achieve the minimum acceptable financial condition by July 1, 2017 we then considered a “flat benefits expenditure” scenario that differs from the “base case” in two important respects:

  • The city subsidy for the swimming pool will cease by July 1, 2012
  • City expenditures for employee fringe benefits would be capped at $5.18 million and not allowed to grow beyond that number (as described above on p.3)

The “flat benefits expenditure” scenario produces a cumulative general fund reserve of $3.3 million by July 1, 2017, an amount that falls short of the 15% general fund reserve requirement by only $300,000. However, by the end of 2017/2018 fiscal year the city would have achieved a general fund reserve that exceeds the 15% by more than $1 million. Note, in particular, that implementing the “flat benefits expenditure” scenario reduces the cost of employee fringe benefits from 53% of the salary budget in the current fiscal year to 48% in 2017-2018 and that this percentage continues to decline thereafter.

The “flat benefits expenditure” scenario thus became the basis for the recommendations for changes in city spending, reserve funds and risk management described earlier in this letter.

 

Conclusion

The City Council acts upon annual city budgets without engaging in the multi-year projections and analysis that provide the basis for MTRC’s recommendations. We believe that such projections are essential for sound financial management and a five-year planning process should be instituted as part of the city staff’s preparation of the 2012-13 municipal budget.

Several members of the MTRC disagree with the stance we have taken in this letter although not with the two financial forecasts that form the basis of our recommendations. In part, their disagreement is based upon a belief that the Council can not meet the five expectations before the deadline for ballot arguments (November 18, 2011) for a February, 2011 parcel tax vote. If time pressure is an issue for the Council, then we would support postponing the parcel tax vote until either June 2012 or November 2012 when statewide elections will be held. Even if the public vote were delayed until November 2012 there would still be more than seven months remaining before July 1, 2013 when the current parcel tax expires.

In recent years the Piedmont City Council has failed to maintain adequate reserves to meet essential expenses; it has failed to properly anticipate the risks of a major construction project or to adopt policies to avert cost overruns in the future; and it has undertaken new expenses, most notably for employee compensation, without adequately weighing the long-term costs. These facts contribute to a lack of confidence in the Council’s financial management and planning.

Two necessary actions emerge from our analysis:

1)   A continuation of the current parcel tax for the 2013-2017 period; and

2)   More proactive and disciplined management of the city’s finances starting with meeting the five expectations presented in this letter

To do one, without the other, would be a serious mistake.

 Attachments (not available at this time)


[1] The “flat expenditure” projection assumes that no increase in total city spending for employee fringe benefits after the current fiscal year. See p. 3

[2] The property tax, the property transfer tax and the parcel tax combined account for 66% of City of Piedmont revenues

[3] The swimming pool is 45 years old.

 

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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