Reprioritizing in the Rebound

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

At a recent retreat, the Kirkland City Council discussed how to proactively plan what to do with increased revenues as the economy recovers; in other words, reprioritizing in the rebound. Some of the key points from that discussion are provided below and might be of use in putting recent positive economic news into context. I began the discussion of the topic with the following quote:

“Fiscal discipline is not the enemy of our good intentions but the basis for realizing them”

- Governor Jerry Brown, California State of State address, January 2013

It is ironic that California, a state so often in the news for its economic woes, would provide such an appropriate start to the conversation. One of the first places to look for guidance is your jurisdiction's adopted fiscal policies (and if you don't have them, MRSC can help you find examples. In Kirkland's case, we have a strong fabric of fiscal policies to help guide this discussion; a few of the relevant policies are excerpted below.

Operating Budget Policies

The municipal budget is the central financial planning document that embodies all operating revenue and expenditure decisions. It establishes the level of services to be provided by each department within the confines of anticipated municipal revenues.

• The City Council will establish municipal service levels and priorities for the ensuing two years prior to and during the development of the preliminary budget.
• The City Manager shall incorporate the Council's priorities in the formulation of the preliminary and final budget proposal.
• Adequate maintenance and replacement of the City's capital plant and equipment will be provided for in the biennial budget.

Revenue and Expenditure Policies

Annual revenues are conservatively estimated as a basis for preparation of the biennial budget and City service programs.

Expenditures approved by the City Council in the biennial budget define the City's spending limits for the upcoming biennium. Beyond legal requirements, the City will maintain an operating philosophy of cost control and responsible financial management.

• The City will maintain revenue and expenditure categories according to state statute and administrative regulation.
• Current revenues will be sufficient to support current expenditures.
• Revenues of a limited or indefinite term will be used for capital projects or one-time operating expenditures to ensure that no ongoing service program is lost when such revenues are reduced or discontinued.

Reserve and Fund Balance Policies

• Adequate fund balance and reserve levels are a necessary component of the City's overall financial management strategy and a key factor in external agencies' measurement of the City's financial strength.
• Maintenance of fund balance for each accounting fund assures adequate resources for cash flow and to mitigate short-term effects of revenue shortages.
• City and state regulations have been established to allow the City of Kirkland to create and maintain specific reserve funds. Prudent use of reserve funds enables the City to defray future costs, take advantage of matching funds, and beneficial (but limited) opportunities. Reserve funds provide the City with the ability to exercise flexible financial planning in developing future capital projects. Reserve funds are necessary to enable the City to deal with unforeseen emergencies or changes in condition.

(Note that the reserve policies go on to establish target reserve balances and specific policies on reserve replenishment priorities; for more details, the reserve replenishment principles are available at this link)

Taken as a whole, these policies provide a roadmap for evaluating decisions on how to prioritize investments and determine what performance the Council wants to buy as revenue becomes available, both one-time and ongoing. This distinction is important because some types of expenditures lend themselves to the use of one-time revenues (such as projects or studies), while others require some level of expectation that revenues are reliable looking into the future (such as supporting current or enhanced operations). A few potential needs to consider are:

• Reserve Replenishment - As noted above, restoring reserve levels is a high priority as additional revenues become available. In Kirkland's case, our reserves helped us weather the economic storm, but we ended up short of target levels, so building back to those targets takes first call on at least a share of the recovering revenues, especially those that may be one-time in nature.
• Current Service Levels - As with most jurisdictions, our longer range forecasts illustrate the structural imbalance in our state, specifically that revenues grow more slowly than expenditures. More specifically, wages and benefits tend to grow well in excess of the rate of inflation, while property taxes are generally limited to 1% plus new construction. While the “new construction” part can help, it can make the budget particularly vulnerable to economic activity (most of you are saying “No kidding!” given the recent economic downturn). So, additional revenues are needed each year just to maintain current service levels and this dynamic represents the first call on new on-going revenues.
• Equipment Sinking Funds - Kirkland recently established new sinking funds for the replacement of public safety equipment and information technology infrastructure, in addition to existing reserves for fleet, facilities, and PCs. In the past, these periodic equipment expenditures had been funded from intermittent or one-time revenues such as interest earnings. Keeping these reserves funded to ensure that equipment on a periodic replacement schedule can be kept up to date represents another call on operating revenues as they recover. For all types of sinking funds, it is also important to recognize the impacts that new, incremental systems, equipment, or facilities are likely to increase required funding.
• One-time Projects or Studies - For many years, Kirkland has had a number of needs that have been funded historically with one-time cash, but in reality represent ongoing commitments. Examples include funding for A Regional Coalition for Housing (ARCH) and a portion of the funding for Human Services. In addition to the need to fund these activities reliably, the city routinely has one-time projects or periodic studies that represent calls on one-time cash. Examples include strategic/master/comprehensive plan updates, changes to technology, etc.
• Funding for Capital Purposes - Unfunded capital and infrastructure needs is a looming problem faced by virtually all local governments. For example, Kirkland's 2013-2018 Capital Improvement Program reflects total capital needs of $607 million, of which $158 million are funded and $449 million (74%) are unfunded. In addition, needs can be expected to increase over time as planning documents are updated (such as the Comprehensive Plan, Parks, Recreation, and Open Space Plan, etc.). Some jurisdictions set aside a fixed portion of general fund revenue for capital purposes or set aside unanticipated or volatile revenues toward capital needs on a one-time basis. The first approach is worth considering as revenues improve, recognizing that unmet capital needs will be competing with unmet operating needs. The second approach provides a mechanism to use one-time revenues toward one-time capital projects. For example, a portion of sales tax revenues from contracting and services above a baseline level, which are highly volatile sectors related to development activity, could be set aside toward capital needs.
• Restore Previous Program Service Reductions - During the past several years, many jurisdictions have made a number of service level reductions in response to revenue declines. Consideration of whether any of these programs or service levels should be restored is likely to be a topic if overall revenues improve.
• Potential Program and Service Enhancements - Many jurisdictions have long range planning documents that identify service level needs and enhancements that far exceed your financial resources. The question of how to prioritize those needs and make progress on funding at least a portion of them is a discussion that needs to take place in context of your jurisdiction's goals, work plans, priorities, and performance metrics. There are a variety of tools available to help set priorities (surveys, strategic plans, priority-based budgeting, etc.), but these require a commitment from the elected body and its constituents to provide additional guidance on how to prioritize needs as revenues rebound.

While this article does not provide a definitive framework, it is intended to spur discussion by looking at existing policy language on how to prioritize funding and identifying a variety of needs to consider. While it is good that revenues are recovering for many agencies, it is sobering to recognize that there are a variety of unmet needs that represent a call on those resources. In addition, revenues are still well below pre-recession levels in many cases. A conversation now on how to approach prioritizing needs can help inform long range planning and budgetary decisions in the foreseeable future.