Is Richardson's proposed 2011-2012 budget in balance? – local blogger
Yes
Conclusion
The local blogger asks the logical question: "Is the City's proposed budget in balance?" When he subtracts the proposed expenditures from the proposed revenues, it appears to him that there is a deficit, but the City tells him that the budget is balanced.
The issue is that a balanced budget for the City is not revenues less expenses, but revenue plus draws from reserve funds less expenses. Furthermore, it is not a failing that in some years the City draws from reserve funds, as non-profits like the City government are required to draw down reserve funds in certain circumstances.
Thus, the table that the blogger shows is quite appropriate: in some years the City has more revenues than expenses - in these years, the City places funds into reserve; in other years, the City draws down on funds as part of its normal policy.
For a non-profit operating under the constraints under which municipal governments operate, the City indeed has a balanced budget. Calling this situation a "deficit" mischaracterizes the normal operation of a municipality in the eyes of voters who don't understand non-profit finances.
The Story
Recently, local blogger Mark Steger questioned whether the proposed City of Richardson budget for 2011-2012 is in balance. He recognizes that the City says that it is, but when he subtracts the proposed expenses from the expected revenues, he comes up with a slight "deficit". He wonders how this is possible, although he admits that the legal definition for a balanced budget may be different from what he thinks a balanced budget is.
Mr. Steger presents the following table (not confirmed by RumorCheck, but we are willing to run with it):
Fiscal Year
| Revenues | Expenditures | Surplus/(Deficit) |
| 2006-07 | $160,493,566 | $161,996,690 | ($1,503,124) |
| 2007-08 | $167,328,813
| $165,766,675 | $1,562,138 |
| 2008-09 | $172,077,872 | $170,483,277
| $1,594,595 |
| 2009-10 | $174,763,634 | $173,176,274 | $1,587,360 |
| 2010-11 est. | $181,789,992 | $183,707,788 | ($1,917,796) |
| 2011-12 budget | $186,906,381 | $188,561,154 | ($1,654,773) |
The City’s proposed 2011-2012 budget can be found at the City’s website.The Background
The issue at question is really rooted in the fundamental difference in the financial structure of a non-profit versus a for-profit.
A "for-profit" company is an organization or company (private, public, a family, a corporation, whatever) where the profits accrued to the benefit of the shareholders. That is, a corporation makes money year after year, and either uses the money to increase the value of the company (thus increasing the value of the stock that the shareholders have) or to disburse the profits as dividends to the shareholders, or both. There is no maximum amount of profit that such an organization can or should make.
The same is true of a family, of course, in that the family unit tries to maximize the wealth of the family, so that year after year, the family's resources increase as the family pays off the house, saves for college, and ensures a comfortable retirement.
However, a "non-profit" operates for a different purpose. The non-profit is a company or organization whose profits do not accrue to the benefit of the shareholders – because there aren't any shareholders. Instead, the non-profit uses any profits to build reserves so that the non-profit can continue to work towards its mission, even in years where expenses are larger than revenues.
It turns out that while for-profits can strive for infinite profits to build infinite reserves or distributions to shareholders, non-profits are specifically discouraged from doing the same, and indeed, can lose their non-profit status for flagrant abuse.
In the case of most non-profits, investment income (such as interest and dividends from investments representing the reserve funds) is tax-free, although if the reserves become so large such that income from the reserves is more than one-third of the non-profit's total revenue, then the non-profit may be reclassified as a "private foundation" and subject to an excise tax (see “Can Nonprofits Have Too Much In Reserve Funds?” by Michael Daily, Executive Director of the Executive Service Corps - Northern New England).
In this same article, Mr. Daily also points out there are other risks in non-profits building reserves that are too large, such as bad publicity from the press which could result in the loss of funding or "political risk" wherein state and local governments may attempt to tax "excess reserves".
Indeed, municipalities are very much subject to political risk in terms of overzealous reserve building. If a city creates reserves that are excessively large, then the taxpayers may revolt because the city is soaking up the taxpayer's money rather than letting the taxpayers keep it for themselves. Indeed, a study of municipal reserve funds in North and South Carolina contained the following observation:
"An excessively large fund balance would be one beyond the contingency and cash flow needs of the community in the short term, and which lacks any planned use for other longer term projects or expenditures. In such a case, taxpayers are either paying unnecessarily high taxes or other charges, or they are not receiving an adequate return on their tax dollars in services and facilities."
(from “BENCHMARKING AND MUNICIPAL RESERVE FUNDS: THEORY VERSUS PRACTICE” by Michael Shelton and Charlie Tyer with the Assistance of Holly Hembree)
The City of Richardson's 2011-2012 Financial Policies
The City of Richardson's 2011-2012 Financial Policies state the goals for the desired amounts of reserves (or "fund balances") for each fund in the City's budget:
General Fund
| 60 days of expenditures |
| General Debt Service Fund | 30 days of expenditures |
Water and Sewer Fund
| 90 days of expenditures |
| Utility Debt Service | Compliance with bond covenants |
| Golf Fund | 30 days of expenditures, building towards 60 days |
| Solid Waste Fund | 60 days of expenditures, building towards 90 days |
The City describes the size of the fund balance in "days", that is, at the end of the year, the value of the general fund after the current year's revenues and expenditures have been factored in, should be at least as large as the equivalent amount expressed as 60 days of expenditures in the current year, or about 16% (365/60) of the year’s expenditures.
This very subject came up during the Council budget meetings this year. At the City Council's work session on August 15th, City Manager Bill Keffler made a presentation of the proposed budget, as amended by items brought up by the Council during the budget retreats in July. In particular, there was the following exchange:
"Mr. Omar asked for an explanation about the difference in revenues and expenditures and Mr. Keffler referred to the fund balance that is carried each year. Mr. Johnson defined fund balance and explained its usage. In years where there is a shortage, the fund balance is used and in years when there is no shortage, the balance is sustained or increased. The use of fund balance can avoid fee increases."
(can be found in the minutes of the August 15, 2011 work session)
This last point (the use of fund balance to avoid fee increases) was expanded on later by Mr. Keffler when he noted:
"He[Keffler] reviewed the Water and Sewer Fund and stated that the rate stabilization fund has allowed the City to delay a rate increase" (ibid)
Given that the underlying cost of water from the North Texas Municipal Water District increases each year, the rate stabilization fund - a kind of reserve - has allowed the City to avoid passing through this rate increase every year. The formal description of this fund can be found in the City's Financial Policies:
"The Rate Stabilization Fund (RSF) was established in Fiscal Year 1996-97 for the Water and Sewer Utility Fund. The fund provides a source of funds which can be used to address serious and unexpected conditions that may arise, such as adverse weather conditions which seriously alter expected revenue amounts. In addition, the fund alleviates the need for sudden and unexpected rate increases, allowing the City to implement needed rate increases in a phased and orderly manner. The RSF is a sub-fund of the Water and Sewer Utility Fund and shall be maintained at a targeted level of $1,700,000. If monies from the RSF are transferred to operating working capital fund balances, RSF funds will be restored to the targeted level as soon as practical."
Since the fund balances are in particular a critical part of the assessment of financial strength of a City in terms of measuring the quality of the City's debt, the fact that both Standard & Poor's and Moody's have given Richardson recent debt offerings the highest ratings possible indicates that the desired fund balances set in the City’s financial policies are equal or likely better than those of most cities in the country.
The City Charter
Now that we understand that it is normal that
- municipalities have reserve funds
- these reserve funds have targeted sizes
- excessively large reserve funds are bad
- the net difference between proposed revenues and proposed expenditures sought by the City’s budget depends on whether the City needs to grow the reserves to the target or shrink them to the target
we can better understand the language of the Charter:
"Section 11.06. - Budget appropriation; tax levy. On final adoption, the budget shall be in effect for the budget year. Final adoption of the budget by the council shall constitute the official appropriations for the current year and shall constitute the basis of the official levy of the property tax as the amount of tax to be assessed and collected for the corresponding tax year. Estimated expenditures for operating purposes will in no case exceed proposed revenue, plus reserved fund balance, and other financing sources. Unused appropriations may be transferred to any item required for the same general purpose."
"Estimated expenditures for operating purposes will in no case exceed proposed revenue, plus reserved fund balance, and other financing sources." In other words, according to the City Charter, the budget is supposed to present estimated expenditures that are equal to the proposed revenue plus any draws from reserve funds (which draws, of course, will not be required every year).
The Charter explicitly forbids planning to spend more than the sum of the proposed revenue plus the entire fund balance. Since we have clear goals on the size of the fund balances, this tells us how much of a reserve fund is available (if any) in any given year, and we adjust proposed expenditures in the budget accordingly.
So either the Charter explicitly allows what some people are calling "deficits", or - much more correctly - simply subtracting expenditures from revenues without considering the effects of the reserves and calling that a "deficit" is a mischaracterization of what is actually happening.
Summary
There is a concern expressed that in some years, the City spends more money than it takes in. In these years, the City "balances" the budget by taking money from reserves. Some people (not Mr. Steger, who is asking a legitimate question and RumorCheck appreciates the opportunity to clarify the situation) criticize the City for running a "deficit".
But if the City did not periodically take money from reserves, that would mean that the City would be increasing its reserves each year. Eventually, the result would be that the City would have hundreds of millions of dollars in cash locked up in its accounts, money that could have and should have been left in the pockets of the taxpayers.
No, the only logical thing for the City to do when reserves exceed their target, is to draw down on the reserves such that proposed revenues plus the draw down on reserves equals proposed expenditures. Calling such a situation a "deficit" mischaracterizes the normal operation of a municipality.
William J. 'Bill' McCalpin
Richardson, Texas
