Cities’ puzzle: an ever-widening gap between expenses and revenue

By Dave Earling

As has been widely reported, many cities in Washington are facing severe budget crises and have taken unprecedented measures to adjust to a “new normal.” This new normal has been described as potentially becoming a long-term structural imbalance between revenue and expenses for local government.

Since the recession began in 2008, revenue has been declining or has flatlined, unable to keep pace with the growth in expenses for local government. This difference, or imbalance, causes an ever-widening gap between revenue and expenses that cannot be addressed with one-time use of reserves or with the addition of new revenue sources alone. Let’s look at two of the major revenue sources for local government, property and sales taxes, which make up the majority of revenue in a city’s general fund, and their trends the last few years.

Property taxes

According to the Snohomish County Assessor’s Office, the assessed value of all properties in the county has declined by 16 percent since 2009. Given that there is a two-year delay between actual sales transactions and when taxes are paid (sales in 2010 are assessed in 2011 and collected in 2012), it is almost certain assessed values will continue to decline in the short term.

One might expect that the decline in assessed value would result in lower taxes for homeowners. That has not been the case, though. During the same three-year period, 2009-2011, total property taxes paid in the county increased by 3.6 percent.

There are a number of ways that lower assessed values could still result in higher taxes paid overall by property owners. These include voter support for a bond levy for schools or cities, or voter approval of special purpose districts like a regional fire authority or metropolitan parks district.

The amount of property taxes a homeowner pays is made up of levies from a number of different taxing districts. Although total taxes paid by homeowners increased between 2009-2011, taxes collected on behalf of cities has increased by just a minor amount.

In 2009, Snohomish County cities received only 11.36 percent of total property taxes collected, while that number increased slightly to 12.24 percent in 2011. The majority of property taxes collected go toward state and local education (over 61 percent in 2011). In Edmonds, for instance, the city received $2.12 (including the EMS levy) of the total $9.95 property tax levy, or just 19.8 percent in 2011. The Edmonds School District, by contrast, received $4.15 of the property tax levy, or 41.7 percent. The graphic at left shows how property taxes are collected by taxing jurisdiction.

As you can see, property taxes collected by cities are a relatively small proportion of total taxes paid.

The rate of increase for property taxes collected by cities is limited to a 1 percent increase over prior-year collections. For instance, if a city collects $10 million in property taxes one year, it would be limited to collecting $100,000 more the following year for a total of $10,100,000, not including increases related to new construction. With costs for many cities rising 3-5 percent a year, and property taxes being the major revenue source for many cities, it is difficult for cities to keep up with the rising cost of providing services to residents. Other revenue sources are also not increasing as rapidly as costs are in many cities.

Sales tax

The sales tax rate in Snohomish County ranges from 8.6 percent to 9.5 percent. The state collects the majority of the tax, 6.5 percent, with counties, cities and transit districts sharing the remainder.

Generally speaking, the amount cities receive from sales taxes is less than one penny (0.85 percent) of the total 9.5 cents collected on each $1 purchase. For example, on a sale of $10, sales tax collected by the state is as much as 95 cents; of this amount, the state gives cities approximately 8 cents.

General economic activity has declined from a high in 2007, resulting in even less sales tax revenue for cities. In Lynnwood, for instance, taxable sales went from $2.4 billion in 2007 to $1.8 billion in 2010, a decrease of almost 21 percent within three years. In Edmonds, taxable sales declined from $607 million to $499 million within the same time period, a decline of nearly 18 percent.

Implications for cities

So the two largest revenue sources for cities have either declined the last several years or increases have not kept up with the cost of providing services. Property tax increases for cities are generally limited to 1 percent per year, with costs rising anywhere from 3-5 percent per year on average, and sales tax has declined by double-digit amounts during the last three years. This places a growing burden on city councils to adapt to a new reality.

Although cities have generally taken different approaches to dealing with their budget crises, the approaches generally fall into three broad categories: revenue increases, overall spending reductions or targeted service cutbacks or elimination.

Revenue increases

Options cities have include enacting new taxes and fees on residents and businesses, or increasing existing revenue sources. Several cities have enacted or increased utility taxes that create revenue for the city’s general fund. Some cities, including Edmonds, have been unsuccessful, while others, such as Shoreline, have been successful getting voter approval of property tax levy increases. To help pay for transportation improvements, some cities have created transportation benefit districts. Lake Forest Park, Edmonds, Olympia, Shoreline, Des Moines, Snohomish, Spokane and others have enacted a $20 license tab fee.

Spending reductions

Cities have also been creative in implementing overall spending reductions. Everett and Edmonds, for instance, delayed filling, or have yet to fill, vacant positions. Everett also suspended contributions to the police and fire pension reserve. Everett and Edmonds, among many other cities, also delayed making contributions to equipment replacement funds, resulting in an aging fleet of vehicles, possibly increasing future maintenance costs at the same time. Lynnwood eliminated positions in its 2011-12 budget and Edmonds chose not to fund certain positions. Both have implemented employee furloughs and held vacant positions open in order to reduce their budgets during the past few years.

Targeted service reductions or elimination

The city of Everett delayed its sidewalk repair program after reassigning four employees to perform utility related work for several years. Similar delays have occurred in other cities as money for transportation infrastructure has dried up, and there are dwindling resources in the general fund for projects that do not already have their own dedicated revenue sources.

What the future holds

With property taxes limited to 1 percent annual increases for cities, and sales taxes not yet recovering from dramatic declines in 2008-2010, the rate of growth in revenue is lagging behind the rate of growth in expenses for most cities. For instance, Edmonds’ expenses are projected to increase on average about 3.2 percent annually while revenue is expected to increase by approximately 1.4 percent annually between 2012 and 2016. At left is an illustration of what this means for the city.

The purple line represents ending fund balance (revenue minus expenditures) in the general fund. As you can see, with expenses exceeding revenue by a growing amount, the fund balance is projected to be depleted within the next few years. Edmonds is not unique in this respect, either.

The implication of this disparity between revenue growth and expenditure growth is that cities will bring in less money than they are spending. As with a personal checking account, if the money going out exceeds the money coming in, the city’s “savings account,” or reserve, is being utilized to cover the difference. This means less money is available for future uses should it be needed. It also means there is less money available in the city’s general fund to cover shortfalls in those funds.

In addition to the sales tax, several other city revenue sources have declined the last few years, such as real estate excise tax used for maintaining or improving the city’s transportation infrastructure. This decline places pressure on the general fund to “bail out” these other funds. This at a time when revenue is already outpaced by expenses in the general fund.

The solution to the problem of expenses growing faster than revenue is to identify ways to bring expenses in line with revenue. Options include cities tying revenue increases in taxes and fees to cost of living increases; negotiating employee compensation increases tied to no more than annual cost of living increases; cutting programs and eliminating positions; hoping a general economic recovery will benefit sales tax revenue and property taxes revenue through increased assessed value within the city; and growing their way out of the recession through economic development.

City of Edmonds officials and staff are reviewing all options and working hard to minimize or reduce expenses, grow revenue, and diversify its tax base to sustain governmental operations. It will be a challenge.

About the author

Dave Earling was elected mayor of Edmonds in November. He took office in December.