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.


  1. Jeff - considering that you are Director of the Business Forecasting Center and Associate professor @ UOP, I am disappointed. The following excerpts is the sort of gobbledygook that confuses more than it informs. And frankly, IMO, is a disservice to those who would look to you for direction. And partly, it is this sort of "lane splitting" that got us into this mess. If persons with your credentials and analytic skills would actually take a position on something backed by sound and succinct reasoning, the world would be better served.

    "I believe a 3/4 cent sales tax increase is necessary, if not an obligation, for the City to emerge from bankruptcy."

    "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."

  2. Anonymous,

    The position is this. If the City has a strong financial plan that controls costs and provides for a balanced budget out of bankruptcy and beyond the tax expiration date, then I think people should vote for Measure A. The City needs to move forward from the Marshall Plan. But people can't reasonably make a decision without seeing the City's financial plan. Bob Deis said that is why they felt compelled to release this now even though some creditor settlements are still uncertain.

    So I reviewed the City's financial plan in detail, and observed that it falls short. Don't focus on my words, read the financial projections and decide for yourself. It shows the City running budget deficits for 8 consecutive years after passing Measure A; drawing down a small fund balance created in the first two years because it will not have hired all the new police yet. In 2024, the City projections show a near zero fund balance (absolutely no buffer for a new recession or other downward surprise), and a massive deficit if the tax expires as is written directly in the ballot measure.

    Thus, my position is that the City should revise its financial plan to include more cost controls so as to provide an adequate budget reserve against contingency and a reasonable expectation that Measure A could expire in 10 years.

    If I recall, the cause of the City's mess is expenditures higher than revenues that were caused by the City making commitments that it couldn't reasonably sustain.