By Len Wood
Can localities avoid the feast-or-famine cycle of expansive spending during good years and then, during bad years, of scrambling to make cuts or find more revenue? The short answer is yes, local governments can act to steel themselves, at least in part, against inevitable future economic declines.
Localities are most vulnerable when times are good. This is when big-ticket items are usually approved. Elected leaders are more apt to approve an expanded program, bend to generous employee compensation demands, or embark upon costly capital projects.
Perhaps the most critical period is when the economy starts to improve. At the first sign of recovery, elected officials are barraged with pent-up demands from powerful community groups, residents, and employee unions. Officials tend to forget that the good times will not last and the years of plenty are followed by economic downswings.
While constant vigilance is important at all times, it is especially important at this point. Before committing to a new program or increased expenditure, an agency needs to identify the total cost impacts (direct and indirect) of decisions and whether the department or agency can really afford them today and in the future.
Here are eight strategies local governments can pursue to avoid the pitfalls inherent in the feast-or-famine economic cycle.
1. Build and maintain adequate reserves. For many years, local governments were criticized for maintaining what were thought to be large general fund reserves (anything larger than 5 percent of expenditures). Yet, reserves play a significant role in maintaining financial stability.
A reserve equivalent to six months of general fund operating expenditures should be a minimum. Agencies must be vigilant in resisting raids on these reserves and in educating the public on the vital purpose of these monies.
2. Distinguish recurring from nonrecurring funds. It is absolutely critical that a local government identify which revenues are recurring (can be counted on each year for funding programs) and those that are nonrecurring (one time). For example, the property tax, which can be counted on year after year, is recurring revenue. Typical federal grants are nonrecurring revenues that usually sunset after a few years.
Other nonrecurring revenues are monies derived from building and engineering permits for a new housing tract. Building booms can create huge spikes in development-related fees. These fees should not be used to finance such ongoing expenses as police and fire personnel. Only recurring revenues should be used to fund recurring expenditures.
Nonrecurring revenues should be used for such priorities as building reserves, paying down debt, and improving infrastructure.
3. Require a structurally balanced budget. In the minds of many officials, a budget is considered balanced if revenues exceed expenditures, regardless of whether the revenues are recurring or nonrecurring. We now know that local governments can wind up with a real fiscal mess when guided by this mindset. At some point, monies run out and the agency is left with a huge general fund deficit.
Local governments need to strive for a structurally balanced budget that requires recurring revenues equaling or exceeding recurring expenditures. If cities and counties cannot achieve structural balance, they need to publicly identify how much is supported by one-time money and how they intend to bring the budget into structural balance.
4. Prepare long-range financial operating plans. Local government operating budgets cover a one- or two-year period. Often, they do not adequately reveal the information needed to evaluate the agency’s long-term financial condition. A budget can be balanced during the good times but be out of balance 12 months later.
Long-term financial plans identify critical items often left out of annual budgets; these can include deferred costs, impacts of grants ending, future costs of salary and benefit agreements, and post-retirement benefits. A long-range plan serves as an early-warning system and allows localities to take corrective actions before the problems become unmanageable.
5. Staff for the minimum. Government workflow usually follows a peaks-and-valleys cycle. Some agencies staff for the peaks. A better approach is to staff for the minimum (the valleys) and use contracted services to meet peak demands.
6. Identify the true cost of employee salary and benefit packages. Public employee unions have been extremely successful at negotiating compensation packages during the past decade. Employee salaries and benefits can consume from 70 to 90 percent of a local government’s budget. Salaries are based on what the competition is paying.
The competition usually consists of neighboring local governments that recruit in the same market for the same skills and experience. Too often, this leads to escalating salaries and benefits. While this process will not be changed easily, local governments can do a better job of costing the full impact of both direct and indirect expenses before they approve negotiated salary packages.
Public employee benefit costs have been creeping upward, and in some cases, exceed more than 60 percent of salary costs. Localities should commission total-compensation studies that show the total cost of an employee compensation package, rather than just the salary portion.
It is still open to question whether many local governments can afford the retirement and post-retirement health benefits granted to employees. While not popular with unions, more places may have to resort to tiered-benefit structures, with newer employees receiving scaled-down health and retirement benefits.
7. Protect agency assets. Communities spend millions of dollars acquiring and developing capital assets—buildings, grounds, sewers, utilities, water facilities, and streets. Unfortunately, during periods of fiscal stress, infrastructure maintenance dollars are some of the first things cut or diverted in favor of other more visible programs.
The result of this diversion is not seen immediately. In some cases, it takes years before problems begin to appear, but eventually they show up in noticeable ways. Neglect of road maintenance leads to street deterioration. A simple asphalt overlay is not adequate anymore. Streets need to be totally rebuilt at a huge cost.
Or a water main replacement program is deferred. Shortly thereafter, water mains start bursting, causing thousands of dollars of damage and creating safety hazards. The multimillion-dollar lawsuits soon follow.
Good budgeting requires that a percentage of current revenues always be devoted to preserving an agency’s investment in its capital assets. Failing to protect assets not only costs more in the future, but also exacerbates community deterioration.
8. Avoid grant pitfalls. During periods of economic distress, the federal and state governments may offer grants. Paradoxically, these grants can undermine fiscal discipline. In 1994, the federal government began offering cities and counties a deal that could not be refused—federally funded police officers to fight crime through the Office of Community Oriented Policing Services (COPS).
This program comes with a huge balloon payment. Recipient agencies are expected to participate in the funding of these officers by increasing their contribution each year until they are responsible for the entire cost after the fourth year. Many agencies found that they could not afford the additional officers once the grants ran their course.
As one police chief lamented, “I truly don’t believe that many cities, including ours, thought about how we were ever going to be able to afford the additional police officers after the grants ran out.” Before pursuing any grants, a local government should publicly review its plan for paying for the new program once grant funding ceases.
The above strategies should be formalized, adopted by the governing body, and included as fiscal policies in the annual budget. During budget review, the manager or elected officials should report on these policies, indicating whether they have been complied with, and, if not, when and how compliance will be achieved.
Len Wood is interim city manager, Hemet, California (email@example.com).