MRSC has joined with Toni Nelson, Small Cities Specialist, State Auditor's Office, Tracey Dunlap, Director of Finance & Administration at the City of Kirkland, and Mike Bailey, Finance Director, City of Redmond, to bring you the "Finance Advisor" column. The "Finance Advisor" will feature a new article each month with timely local government finance information and advice you can use.*

Long-Term Budget Strategy Considerations

November 2008

By Tracey Dunlap, Director of Finance & Administration, City of Kirkland

By the end of this year, agencies throughout Washington State will have balanced their budgets under very difficult circumstances. This may be an opportune time to consider whether there are some long-term policy decisions that could be helpful in planning for such events in the future. While a future downturn cannot be avoided, it can be planned for by continuing to be prepared and pursuing conservative budget policies that may include:

• Establishing and/or replenishing reserves when times are better – Many agencies have established “rainy day” reserves and may be tapping those reserves during these challenging economic times. While it can be difficult to “pay yourself back first”, as soon as additional funds are identified when times get better, they should be used to replenish or increase reserves against future downturns.
• Addressing revenues from volatile sources – Many jurisdictions are dependent on tax revenues from volatile sources like the sales tax. Sales tax revenues can be particularly sensitive to economic conditions, especially in the volatile construction sectors and economically sensitive sectors such as automotive. Approaches for dealing with volatile revenues include:
• Put volatile revenues toward the capital improvement program (CIP), where projects can be re-prioritized or delayed to accommodate changes rather than attempting to change operating service levels. For example, an agency may want to consider putting the sales tax from the contracting category into the CIP, or at least the volatile portion, rather than a fixed dollar amount.
• Another approach for dealing with sales tax volatility is to budget sales tax on a lag (often one or two years) as a hedge against possible future economic events. This approach can help prevent an over reliance on sales tax growth, but would be difficult to implement during a downturn. However, implementation could be considered when conditions improve. Such a change could also be accompanied by a policy of placing surplus receipts over the budgeted amounts into the CIP rather than using the growth to fund operating costs on a one-time basis, which can contribute to volatility in the operating budget.
• Diversifying the revenue base – Some agencies receive a disproportionate share of their revenue from a single tax source, such as sales tax or property tax. Given the statutory limitation on property tax growth from existing property and the volatility of sales tax revenues as discussed above, this can create a particular exposure to economic changes. By diversifying revenue sources to achieve a more balanced revenue structure, greater stability might be achieved. There are a number of options that can be considered, including:
• Implementing or increasing the utility tax, which can result in a greater share of general fund revenue from this stable source that tends to grow with inflation. Note that the governing body can increase the taxes on its own utilities, but needs a vote of the people to increase taxes on private utilities above the statutory limit of 6%.
• Making sure that fees and rates include all costs that can be appropriately attributed to the services provided.
• Establishing business taxes that help to ensure that revenues from this source will increase with success in economic development activity. There are a variety of options in this category including revenue generating licensing fees that can be based on factors such as FTEs, square footage, etc. and business and occupation taxes.
• For all of these options, involving the public and business interests is key to the success (or failure) of the approach.
• Living within your means – In this category, there are a number of considerations:
• Use one-time revenues for one-time purposes or said in the reverse – do not increase on-going expenditures unless you have a stable on-going revenue source. Over time, new programs and positions can be added using one-time cash resources and those activities can be in jeopardy with the decline in economic activity. If one-time funds are available, consider the following uses: replenish reserves to target levels; fund additional identified reserve needs, such as funding for major system replacements, set asides to recognize accrued liabilities, etc.; begin setting aside funds for large projects to reduce future debt requirements; consider funding projects that are truly one-time in nature (in other words, when the project is completed, the resources go away); increase the CIP contribution on a one-time basis, possibly accelerating high priority projects; and retire long-term debt if economically advantageous to do so. Even if some or all of the options above can be pursued, avoid using one-time resources to hire staff to meet on-going needs or for new programs. New on-going needs should not be funded until on-going revenues can be identified to meet the need.
• Further, when on-going revenues increase more than budgeted in a year, do not use all of the increase in the immediate year. Save some of it to maintain current service levels and absorb increases in on-going costs in subsequent years, restore services previously reduced to desired/sustainable levels, and evaluate on-going service level enhancement needs identified in adopted planning documents. For on-going service level increases that cannot be supported from projected growth in on-going revenues, the jurisdiction could develop an election strategy to fund increased service levels with voted revenues.
• While there are some on-going “unfunded mandates” that cannot necessarily be avoided (such as those imposed by the state or federal governments), the agency can work to avoid self-imposing them. As new regulations are considered, the accompanying resource needs and on-going funding sources should be addressed. As new initiatives are undertaken, the question of “how do we fund it?” should be an integral part of the evaluation. Funding options may include imposing or increasing rates or fees (where applicable), re-prioritizing existing efforts (reducing or eliminating lower priority activities to free up funding), increasing taxes (either those that the governing body can increase or by pursuing an increase as part of a voted measure), and/or deferring implementation until on-going funding in excess of current needs becomes available.
• Economic development can be a significant contributor to assist your agency in meeting its on-going revenue needs. While new employers or commercial businesses may increase demands for service, many can also generate significant on-going revenues that help better balance the revenue structure in the long-term.

While it is difficult to think about what to do when times get better during the hard times, evaluating policy strategies for the future can help you be better equipped to deal with adversity when it occurs in the future, which recent events have proven again will happen – it is only a question of when.

Toni Nelson is the "Small Cities Specialist" for the Washington State Auditor's Office, providing both on and off site financial training and assistance to smaller cities and towns throughout the state. Ms. Nelson has been working with the Auditors office for 6 years and prior to that was the Clerk/Treasurer for a small town for 9 years. She has co-authored the "Small Cities Manual" a detailed reference guide for new clerk/treasurers on governmental accounting procedures and presents numerous training workshops throughout the state for AWC, WFOA, WMTA, WMCA and local/regional organizations such as EWFOA and SCWMCA. Ms. Nelson is also a member of and conference track coordinator for the WFOA Education Committee.

Mike Bailey is currently the Finance Director for the city of Redmond. Previously he worked as Administrator of Finance and Information Services for the city of Renton and as the Director of Finance for the city of Lynnwood. Mr. Bailey also served as president of the Washington Finance Officers Association and is the Vice Chair of the GFOA Budget Committee. An experienced CPA and GFOA budget reviewer, Mr. Bailey co-founded the annual Budget and Fiscal Management Workshops held each summer. Mr. Bailey conducts numerous workshops and has authored various articles on local government finance, including Effective Budgeting in Washington State Cities published by the Association of Washington Cities.

Tracey Dunlap, P.E. is the Director of Finance & Administration at the City of Kirkland. Prior to joining Kirkland in 2006, she was a principal and shareholder in FCS Group, a regional financial and management consulting firm (14 years). An industrial engineer registered in the state of Washington, she has worked with jurisdictions throughout the Northwest to develop and implement cost recovery and fee strategies, set utility rates, and improve organizational efficiency and effectiveness. Tracey's experience also includes working for a large defense contractor (5 years) and a major financial institution (3 years). She has presented on a wide array of topics for organizations including WFOA, APWA, APA, WABO, and AWC.

*The Articles appearing in the "Finance Advisor" column represent the opinions of the authors and do not necessarily reflect those of the Municipal Research & Services Center.