Monday, September 30, 2013

Stockton's Proposed Plan of Adjustment Assumes Sales Tax Increase is Permanent. City Council Should Reject Draft Plan.

I believe a 3/4 cent sales tax increase is necessary, if not an obligation, for the City to emerge from bankruptcy.  Throughout the process, I have been supportive of the decisions by City Manager Bob Deis and the City's approach to bankruptcy, including the controversial decision to fully pay its CalPers liability. The City has made a lot of progress, and that deserves recognition.

However, after spending a good bit of my weekend reviewing the plan of adjustment released late Friday afternoon, this is the first time where I think it is appropriate for the City Council to dissent with the City Manager's bankruptcy plan.  If they don't and this plan is unchanged when the sales tax comes up for a vote, I can see cause for taxpayers to vote down Measure A (sales tax increase) this year.  The City can come back and ask for taxes again next year with a long-range financial plan that matches the promises they are making in the tax measure.

I have had concerns about the pairing of Measure A with Measure B, the advisory measure expressing that 65% of the proceeds will be spent on law enforcement and crime prevention, because of doubts of whether the City will be able to keep that promise as the bankruptcy case progresses.  This concern remains, but at least that promise is kept in the plan of adjustment.

However, Measure A has another promise written directly into the ballot question stating "it shall sunset in ten years or when economic recovery occurs."  This isn't an advisory measure, it is clearly stated in the tax measure.  The City Manager's plan of adjustment ignores this promise, and presents a budget projection with a razor thin fund balance in 2024 if the tax is extended, and will fall to a $38 million deficit if the measure expires as planned.  The huge deficit would occur even though the City will still be operating at current levels of non-police staffing and services despite a decade of population growth.  This $38 million 2024-25 deficit if the tax expires as promised is at least as large as what put the City into bankruptcy in the first place, even after accounting for inflation.  In fact, the projection shows the City's fund balance shrinking in the years leading up to the scheduled tax expiration, all the way down to a meager $8 million or 4% of expenditures. Thus, it looks like this plan sets up the City Council and management ten years from now for failure.  Not a good legacy.

If questioned on this, I suspect the City's staff response would be that their projections are really conservative, and they think positive surprises to revenue are more likely than negative.  The projections did not look overly conservative to me, but maybe I missed something.  Regardless, the City ought to go back and make reasonable revisions to their revenue and spending projections that show a balanced budget when the tax expires in 2024.  

Without getting into the details of every budget line, I will point to five issues that jumped out to me.

1.  Property Tax Projection:  This is the one revenue stream where I think the City is too conservative, at least for the next year or two.  Given the rapid recovery in the real estate market, I expect property taxes will increase significantly more than the $1.1 million (2.5%) projected for next year.  However, this short-run bump is just moving forward future appreciation, so increasing the short-run growth assumption would reduce the long-run growth levels.  Thus, I don't think the long-run projection is too conservative, in fact it projects property taxes recovering their pre-recession peak in 2022, so I don't think there should be an expectation that property taxes will close much of the 2024-25 budget hole.

2.  Employee Compensation (Non Pension): This is the biggest problem in the projection.  It assumes employee salary costs grow at a 3.2% annual rate (above inflation) even without adding any additional staff or accounting for increased pension costs.  At the same time, the City's revenue is projected to grow at a less than 3% rate.  I don't know the details of the new employee contracts, but if they call for average salaries growing faster then revenue, they are unsustainable and need to be revised down to grow below revenue growth (no more than per-capita revenue growth).  If total salaries only grew at expected inflation, individual employees could still get step and promotion increases above inflation, as higher-salaried employees retire/separate and are replaced with people lower on the salary scale.  The city presents no evidence that current salaries are too low, just that they have done a lot to curb the excesses of the past.

3.  Pension (CalPers) Costs:  These are projected to make a large $3 million (17%) jump for 2014-15, after a $3.5 million (25%) leap in 2013-14. But the killer is in 2 years,2015-16, when pension costs soar $8 million, then growth is projected to moderate after that.  Significant savings from pension reform is decades away.  I think it is fair to say the 35% of the tax increase that isn't going to police is going to cover these increased pension costs.

4.  "Mission Critical":  The plan has $8 million for the next two years for short-term "mission critical" expenses, which it describes as "an allowance for unmet needs", then it gives some examples of what those unmet needs might be.  The list of examples is notably missing what I think is the most likely unmet need, paying the bankruptcy lawyers for another 1-2 years.  I would like to see a line-item contingency for bankruptcy costs, noting that the funds can go to restore the City's withered fund balance if unneeded.

5. Wishful Thinking:  There are a few smaller elements that seem to include some wishful thinking.  $3 million in unspecified efficiency savings that will be identified in current studies, and that revenue enhancements from parking garages will suddenly make these structures able to pay their bond debt and operating costs.

In short, I agree with the City's long-run need for a general 3/4 cent tax increase.  But it is more important to get the City's long-term budget in balance, and to keep the promises made to voters.  This plan fails to keep the promises made to Voters in Measure A, and thus needs significant revision.

I believe the warnings about dire cuts next year if the tax is rejected are unwarranted.  It will mean getting by for another year without a needed investment in public safety, but I think budget cuts from current service levels would probably not be necessary next year as long as the city maintains bankruptcy protection/savings since property taxes should improve.  Without new tax revenues, more cuts would be necessary in 2015-16 when pension costs spike $8 million.  It would be preferable for the City to make a better plan of adjustment now, but if not, I think it can manage to take one more year to improve its long-range budget plan and pass a clean tax increase in 2014.

Update/Postscript: This discussion is based on an assumption that the City gets what it wants from its creditors, that they will either accept the settlement offers by the City or that the City will prevail over creditor objections in court.  That's a big if, and that assumption should not be interpreted as a prediction.  A discussion of the City's offer to creditors will come in future posts as more of those details emerge.

Update 2 (10/1, 5 P.M.):  I listened to the City Manager's press conference, and he answered the question about the non-expiring tax as I guessed; by referring to the conservative revenue projections.  Pondering his answers and the spreadsheets a little more, this issue can be resolved.

I might concede that property tax revenue and maybe some small items like hotel tax could be a little higher than they project.  But I don't see that growth doing much more than offset $3-5 million in what I have described as wishful thinking like unspecified efficiency savings.  The $38 million budget hole I describe in 2024 might not be as terrible as it sounds.  If the City can just restrain spending growth by $1.5 million each year, it will have $15 million less in expenditures by the time the tax expires (covering almost half of the deficit), and will have built up a $90 million fund balance it can use to cover a potential $20m deficit when the fund expires and cushion the transition to a lower tax rate.  If the City chooses to extend tax increases at that time, there should be some significant restoration of services over the minimal bankruptcy levels.

The city could achieve something close to this level of saving by holding employee compensation and program support to about 2% rather than the 3.2% growth in the financial plan.  I don't know what kind of raises the current employee contracts call for, but 2% growth in non-pension employee costs seems very reasonable and appropriate, especially given that the City is protecting CalPers.

It would be good to see a very robust discussion of employee salary growth at the City Council meeting, and for their to be a close look at revising this aspect of the plan.  Fixing the deficit problem I referred to may be as simple as revising down the salary growth assumption.  Of course, the contracts must support that revision, so it may not be that simple.

Update 10/4: See next post.  The deal with Assured Guaranty is a big surprise, and substantially improves the case for voting for Measure A since it is contingent on its passage.  Given this news, I don't have a problem with the City Council's vote to approve the bankruptcy plan of adjustment tonight.

Thursday, September 26, 2013

Police Car Purchase Argument in Stockton

Why all the complaining about the City of Stockton's purchase of 48 new police cars from Tracy Ford instead of Big Valley Ford in Stockton?  (See here and here).

Tracy Ford underbid Stockton Ford by $10,333 for the 48 cars, so the City will buy from the Tracy dealership.  The purchase is criticized, because $10,446 according to Scott Smith's blog or "about $12,000" according to city staff of the sales tax revenue goes to the City of Tracy instead of the City of Stockton.

Thus, if you take into account the sales tax transfer, buying from Tracy cost Stockton a few hundred dollars more instead of $10,000 less.  It also has local upset that a $1.4 million went out of the City, although 90%+ of the money on a special order manufactured car is going directly to Ford Motor Company whether it is purchased in Stockton or Tracy.

The thing that concerns me with this episode is that some people interpret it as if the City's local buy ordinance is too loose by allowing bidders within the County, not just within the City.  Presumably, they think it should be further tightened to either exclude bidders from outside the City limit or provide some other preference to local bidders. 

The logic here seems to assume that the bids the City would receive would be the same if the rules were changed to favor bidders from within the City.  I doubt it. 

Big Valley Ford is the only Ford dealership in the City, and my guess is they would have bid even higher if their were no competition within the County.  Heck, the City might have gotten even lower bids than this if they wouldn't have limited the bids to inside the County.

Although it looks like Stockton has "shot itself in the foot" and unnecessarily lost a few hundred dollars, I think living with a few situations like this is inevitable if you are going to have competitive bids.  If Stockton tries to tighten up its local bid ordinance to prevent this apparent loss in revenue, it could wind up paying a lot more for everything it buys, not just cars. 

I like to buy local, and I appreciate the community spirit that motivates local bid preferences.  But you could argue that community spirit should motivate local businesses to give their police force a good deal.  The movement of cities in this direction can be a self-defeating zero sum game if it becomes too strict and every city in the region follows the same strategy. 

Tuesday, September 24, 2013

An Illustration of How Regulatory Assurance Under the BDCP is Risk Shifting, Not Risk Reduction

Bettina Boxall's article in Monday's LA Times is excellent. 

While most of her article is about the likely cost shift of the tunnels from agricultural to urban ratepayers, she may have also clarified the mysterious "note to readers" in Chapter 8 of the BDCP that suggests taxpayers might have to pay even more for BDCP environmental benefits.

Project backers are also broaching the possibility that federal and state taxpayers may be asked to buy water from irrigation districts upstream of the delta in the San Joaquin and Sacramento River basins to increase flows through the delta and out to San Francisco Bay. 
Whether that program would be a part of the tunnel proposal or stand alone is unclear. But either way, it would make the tunnel project more attractive to users because it would — at public expense — essentially increase the volume of water they could take from the delta and still meet endangered species protections. 
Cowin called the idea "very conceptual at this point." The reasoning behind public water purchases, he said, is that if the planned habitat rehabilitation work doesn't sufficiently boost the delta's imperiled native fish populations and more flows are needed through the delta, federal and state funding could be shifted from restoration to water purchases.
My initial interpretation of the "Note to Readers" was that it opened the door to taxpayers paying for the tunnels, but that appears to be the wrong interpretation. The response of Dr. Meral to questions in public meetings and this passage suggest that it means that taxpayers would agree to pay for even more habitat or water flows from upstream sources if needed to achieve BDCP recovery goals and comply with the ESA. This is due to the regulatory assurances in BDCP limiting additional contributions of water or money from the water contractors.

So this conceptual idea is a nice illustration of how the BDCP reduces regulatory uncertainty for the water contractors by increasing regulatory uncertainty for taxpayers, upstream water users, and the environment. And that transfer of risk is why I have not included any value for regulatory certainty in statewide benefit-cost analysis. If you want to count the value of this risk reduction benefit to the contractors, you also have to value the cost of the risk increase to upstream interests, taxpayers, the environment and the Delta. The BDCP economic studies released this summer do not provide this balanced assessment.

Wednesday, September 18, 2013

Listen to the Hydrowonk

Is the Hydrowonk (Dr. Rodney Smith) legit?  In a word, yes.  I highly recommend his series of posts on BDCP finance and economics.

He has been posting detailed commentary on BDCP costs and benefits on his blog faster than I can respond.  His perspective is strictly evaluating the prospective investment from the point of view of a water agency.  Unlike me, he isn't worrying about fish, in-Delta or statewide impacts in his analysis. 

The only serious critical comment I have had about Dr. Smith's commentary until now is that he takes the exaggerated water yield estimates in the BDCP economics reports at face value.

I delivered that comment to him in San Diego last week in person, and he immediately responded with his most recent post and its very handy list of costs under different water yield assumptions.  Now, my only criticism is that his table assumes all the water yields are positive!  The EIR tables show a negative water yield under one scenario, and the biological opinions are still being litigated.

The cost per acre foot is really important.  It is why I rudely butted in for the last word at the legislative hearing last month.  I couldn't let the last word be Dr. Sunding saying the cost of water from the tunnels would only be $300 af. 

Anyway, I have been telling people for some time that my best guess for the cost of the water is around $1,700 af based on the EIR yields which looks reasonably accurate according to Dr. Smith's table.  And as the Hydrowonk notes, you shouldn't compare BDCP water to desal. (Desal is super expensive, but it is treated, drought-proof water, delivered someplace much closer to you than Clifton Court forebay, uses proven and improving technology, and doesn't require you to become business partners with dozens of other water agencies who may not be as trustworthy or financially strong as your local agency.) 

After making some calls for knowledgeable opinions about BDCP water yields, the Hydrowonk concludes that the yield is lower than Dr. Sunding's assumption but potentially more than my EIR-based assumption.  [Thus, my first question for Dr. Smith's ingenious idea for a water policy prediction market:  What are the combined SWP/CVP in 2025 if there is no BDCP and the tunnels are not built?]

His conclusion/advertisement is priceless:
For Hydrowonk, I’m concluding (as of today) that the cost of BDCP water will cost in excess of $1,000/AF (inflation adjusted).  Since this is a non-firm supply of untreated water in the Delta, I urge all parties wishing to acquire non-firm supplies at these prices to contact me immediately.  I’m sure that my firm can help meet your water needs well in advance of 2025.

The NRDC Portfolio Proposal and The Cost Allocation Problem

There is much to recommend in Kate Poole's response to the Natural Resource Agency's weak attempt to dismiss the NRDC Portfolio alternative to the Bay Delta Conservation Plan (and the first comment by Dr. Gartrell is also a must read).  The core of the portfolio plan is to save several billion dollars by building a smaller 3,000 cfs tunnel instead of the BDCP's preferred 9,000 cfs tunnels and invest the savings in alternative water supplies, storage and levee improvements. 

I agree with NRDC that alternative water supplies, storage, and levee improvements have a better return on investment than the tunnels.  I agree with NRDC that the extremely costly tidal marsh restoration with uncertain environmental benefits is another area where BDCP can produce a better return on investment by shrinking in size.  Their proposal is a major step in the right direction, and has sparked a useful discussion.

But the NRDC portfolio proposal still has tunnel vision.  I am unconvinced that the smaller tunnels have a positive benefit-cost ratio, although it may be better than the big tunnels.  Even more important, I think the proposal exacerbates the cost/benefit allocation issues between urban and agricultural contractors that doom a viable finance plan for the big tunnels.

Just like the BDCP, the NRDC tunnel plan can only demonstrate financial viability if it moves beyond the macro analysis of total cost and water supply and get into the allocation issues.  The alternative water supplies that would be paid for with the savings are all urban water supplies, so how much of the little tunnel savings will accrue to urban agencies?  It isn't the total cost reduction that matters. 

For the sake of argument, assume the small tunnels cost $9 billion and the big tunnels cost $15 billion(the state argues the cost difference is much lower).  Now apply cost allocations.  If urban agencies pay 40% of the cost of either plan, the urban costs are $3.6 billion for small tunnels versus $6 billion for big tunnels and the savings to urban agencies is only $2.4 billion.

If urban agencies pay 80% of the cost in both cases, the cost difference to urban agencies is $7.2 billion versus $12 billion and the savings to urban agencies is $4.8 billion.  It is no wonder that the urban agencies that are most interested in the portfolio, like San Diego, are those that are most concerned about a cost shift towards urban users, especially if it causes other urban agencies to further cut reliance on Metropolitan's imported water.

However, a shift to a higher urban cost share is even more likely for the smaller tunnels.  In fact, many people interested in the small tunnels have suggested 100% financing by urban agencies.  If the urban agencies pay 100% of the cost of a $9 billion small tunnel, the urban savings drop to only $3 billion even if you assume they pay 80% of the large ones, and the savings drop to zero if you assume they pay 60% of the cost of the large tunnels. Whatever cost allocations you assume, the urban agency savings are a lot less than the total savings.  And thus, the funds available to invest in alternative local water supplies are less than NRDC states.

Similarly, what about the water supply allocation?  Overall, NRDC argues that the portfolio will generate a higher total water supply than BDCP.  But it appears that it will generate a lot more water for urban areas, and result in less water for agricultural users even if the total water supply is higher.

The bottom line is that I don't believe there is evidence that peripheral tunnels are financially viable at any size.

NRDC is on the right track, but they don't go far enough.  The tunnels need to be entirely eliminated from BDCP.  A smart portfolio of alternative water supplies, levees, storage, habitat and flows will provide far more benefits at lower cost than tunnel-centered proposals.  And this no-tunnel portfolio could be a habitat conservation plan under the ESA, and thus provide the more stable regulatory environment that the water contractors seek.

Friday, September 13, 2013

Substituting technology for labor in Valley agriculture

This is a good article.

With agricultural prices high and farmers increasingly comfortable with technology, it would be great for the Valley economy to see some of these profits invested to modernize the agriculture industry and help farmers adjust to a changing labor market.  In addition to these immigration and demographic patterns, farmers are adjusting to increasing responsibility for their employees healthcare costs due to the implementation of Obamacare, and California appears poised to raise the minimum wage.

For economic development in the Valley, the focus needs to shift from counting the number of agriculture jobs to a focus on raising the quality, pay and skill requirements for Valley agriculture jobs.  It would be useful to see policy to support this adjustment.  Philip Martin's ideas for modifying the Ag jobs immigration proposal is an example of a policy approach that could support this transition (link).

Tuesday, September 3, 2013

Comparing Benefit Cost Estimates of the Tunnels

Last week, the State Water Contractors' sent out an odd news release and "fact sheet" comparing estimates of the benefits and costs of Delta tunnels that have been prepared by me and David Sunding.  I guess I have got their attention.  I'm surprised that the fact sheet didn't mention that Dr. Sunding is also older, taller, thinner, and drives a cooler car than I do.  That would have been just as relevant to benefit-cost analysis as many of their comparisons.

What you will not find in the SWC releases are any numbers from the reports except the "bottom line."  Thus, I pasted a handy table below that actually compares the benefits and costs.  As you can see (click here if image is too fuzzy), almost all of the difference is in the top line, export water supply.

As discussed elsewhere on this blog and other venues, the difference in export water supply benefits is driven entirely by the BDCP economic studies' assumption about no-tunnel water supply that is completely at odds with the water supply estimates in the BDCP's EIR, and is much lower than any regulation proposed or considered by any regulatory agency.  Dr. Sunding got over $10 billion in water supply benefits and over 1 million acre feet of additional water by assuming a massive tightening of regulations will cut water exports another 25% by 2025 if the tunnels are not built.  Then, he conveniently omitted the environmental, fishing and in-Delta benefits that would occur in the unlikely case of such a dramatic reduction in water exports.

In contrast, I was much less creative and simply used the BDCP EIR estimates of water supply without the tunnels, and also used the EIR to estimate the environmental benefits generated by the tunnels themselves (nil).

If you would like more elaboration on the numbers in this table, the differences between the reports, and some comments on SWC's fact sheet, click through to this document.  (Warning! The document is only 6 pages, so it is obviously a piece of amateur garbage that does not meet BDCP consulting standards for depth.)