INFORMATION 10-28-2002 145 University Avenue West, St. Paul, MN 55103-2044
Phone: (651) 281-1200. (800) 925-1122
TDD (651) 281-1290
LMC Fax: (651) 281-1299 LMCIT Fax: (651) 281-1298
Web Site: http://www.lmnc.org
MEMORANDUM
OCT 2 3 2002
To:
Mayors, City Managers, Administrators and Clerks
From:
Jim Miller, Executive Director
Re-'
December aid cuts becoming more likely
Date: Tuesday, October 22, 2002 ~./. ~'~/~-~ C~0"~ ~'~' j~''''''- ~
In mid-August, the League distributed a,memo outft~ing considerations for your city budget due
to the uncertainty surrounding the state s budget.' This memo is intended to update the
information contained in our previous document. The focus of this memo is not on the much-
publicized 2004-2005 biennial deficit that could exceed $3 billion. Rather the focus is on the
immediate fiscal year budget and the possibility that by the end of current fiscal year on June 30,
2003, the state could face a deficit that will require almost immediate remedial action. This
could include reductions or delay of December aid payments.
Two weeks ago, the State Department of Finance released the quarterly economic update. This
quarterly update is not formal state budget forecast. It is a report on year-to-date revenue
collections compared to previous forecasts, and makes note of any significant economic or
revenue developments that have occurred since the last formal forecast.
The news at the update was again pessimistic. The continued slow recovery from the recent
recession has translated into a slower rebound in the state's tax collections for the current fiscal
year. If current tax collections remain dampened, the state could have a deficit for the balance of
the current fiscal year.
The next official prediction of the status of the state budget will occur on December 3. The
Department of Finance will release its state budget forecast on or around that day and if the
short-term projections indicate a 2003 deficit beyond the state's budget reserve, the state will
likely have to take quick action.
Unallotment
In our discussions with administration staff, it is clear that there are at least preliminary
preparations being made should the December forecast show a deficit for the remainder of the
current biennium. The governor has the power to "unallot" or reduce state expenditures to
balance the state's budget and December state aid payments could be affected.
Although we did mention this possibility in the August memo, at that time it did not appear to be
a likely outcome. However, as each passing month ends with revenues lower than forecast, it
appears that a deficit, and therefore unallotment, is more likely.
As stated in the August memo, the governor's power to unallot is broad. Through unallotment,
the governor effectively has the power to reduce legislative appropriations to address a state
deficit that exceeds its reserves. The December 2002 Local Government Aid (LGA) and market
value homestead credit (MVHC) payments would be the last distributions to cities this biennium.
However, to further complicate matters, cities in the 19 counties affected by June flooding have,
as of this week, received their second half LGA distribution and therefore would only have
market value homestead credit outstanding and subject to cuts. In other words, the percent of cuts
conceivably could be larger since the total available has been reduced by these early payments.
Aid Payment Deferment
In addition to the governor's power to unallot (or cut) appropriations, state law allows the
governor to defer (or withhold) distributions of appropriated money. This power could be used to
delay action on unallotments while the govemor develops a proposal for cuts or it could be used
as a short-term bridge to meet the state's cash flow needs.
By delaying aid payments, the governor would have more time to make decisions on whether and
how to cut aid payments. If the December aid payments are deferred until after the legislature
convenes on January 7, it is possible that legislators and the incoming governor might also have a
role in any final decision. The law does not place limits on how long a state payment can be
deferred.
Although it currently does not appear that the state will have a cash flow problem in late
December, if a problem materializes, the governor could delay LGA and market value payments
to address the problem.
Summary
The state's budget situation has not improved and due to the increasing possibility of a shortfall
for the balance of this biennium, delay in the December distribution of LGA and MVHC or
unallotment of a portion of these payments remains a distinct possibility.
The long-term state budget outlook also looks bleak. Legislative action to address this long-term
shortfall could affect city aid distributions beginning in 2003. However, action on this long-term
deficit will not likely occur until late in the 2003 legislative session.
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145 University Avenue West, St. Paul, MN 55103-2044
Phone: (651) 281-1200. (800) 925-1122
TDD (651) 281-1290
LMC Fax: (651) 281-1299 LMCIT Fax: (651) 281-1298
Web Site: http://www.lmnc.org
MEMORANDUM
To:
Mayors, City Managers, Administrators, and Clerks
From:
3im Miller, Executive Director
Re:
2003 City Budgets
Date:
Friday, August 16, 2002
Volatility in the state's budget over the past year is now translating into uncertainty for local
budgets. Although the magnitude of the state budget deficit will not be officially revised until
late November or early December, the Commissioner of Finance has recently suggested that the
deficit could be as high as $2.7 billion for the 2004-2005 biennium. With the additional
pessimistic economic news that has been released over the past several weeks, this fall's budget
forecast could even exceed the Commissioner's gloomy figures.
In recent weeks, the League has received numerous inquiries from member cities seeking advice
on how to prepare for the uncertain state budget situation and the potential for state aid
reductions. The situation for larger cities is further complicated by levy limits, which will be
significantly more stringent due to a remarkably low inflation adjustment (0.76%) for 2003
levies. For many cities, levy limits will trim the list of policy alternatives available to address
possible 2003 state aid cuts.
To make matters more difficult, your city is undoubtedly facing other budget pressures such as
rising employee health insurance costs, potential volunteer relief association contribution
increases, lower investment earnings, and possible additional security costs in light of the
September terrorist attacks.
The purpose of this memo is to provide you with insights into this uncertainty based upon
conversations we have had with key state decision-makers and information available to us at this
time. The state budget situation is fluid and will undoubtedly change before the Legislature
convenes in January. Although the League will be working with legislators to reduce the size of
any proposed state aid or credit reimbursement reductions, it is important for your city to begin
preparing now for the possible effects of a cut in state aids.
State Deficit: How we got here
Last fall, the state announced a $2 billion budget deficit for the remainder of the 2002-2003
biennium. In February, the deficit estimate was increased to nearly $2.5 billion. The 2002
legislative actions to address this deficit arguably tapped most of the easy solutions, including the
use of state reserves and the elimination of automatic inflation assumptions for many state
programs. The budget solution also included the elimination of the TIY grant pool, delays in
school aid payments, and some cuts in state agency budgets.
Now, the state is facing an additional deficit for the 2004-2005 biennium. Given that many of the
easy solutions have been employed, the problem confronting the 2003 Legislature will almost
certainly be more difficult to address. State agencies are already being asked to prepare
preliminary budget proposals at a 90 percent funding level. This 10 percent planning reduction
reflects the approximate across-the-board cut necessary in state spending to address a deficit in
the $2.7 billion range.
If a 10 percent cut is extended to general city aid programs, cities would collectively lose
approximately $59 million of local government aid (LGA) and approximately $10 to $15 million
of market value homestead credit (MVHC) reimbursement. Remember, even if your city does not
receive LGA, the state effectively pays a portion of your property tax levy through the MVHC
reimbursement. The State could reduce this payment to the city, thereby reducing the amount of
property tax levy you expected when the levy was originally certified.
If the Legislature ultimately decides to make cuts in state aid and credit programs, it will have to
decide how to distribute the impact to cities and counties. If potential future cuts are computed in
a manner similar to past state aid reductions, every city would likely lose a similar percentage of
their revenue base (defined as the city's certified levy plus its certified LGA). A cut on this basis
could be between 4 percent and 5 percent of each city's revenue base. Again, that cut could
conceivably come from LGA, the MVHC, or both.
There are other state aid and revenue sharing programs that could potentially be cut, such as
police and fire aids, certain transportation aid programs including the Municipal State Aid
(MSA) program, and police training reimbursement aid. Likewise, further cuts in state agency
budgets could have a trickle-down impact on city budgets---either through higher agency fees
and assessments or through reduced services that must be picked up in local budgets.
Of course, there is no way to determine the size of the state deficit before the forecast is updated
in November, nor is there any way to predict how the Legislature might implement appropriation
reductions. Given that city aid programs were largely spared from the 2002-2003 budget cuts, we
suspect there may be political pressure to "share" the state's 2004-2005 budget woes with cities.
This uncertainty clearly makes financial planning for 2003 extremely difficult. We should know
more in late November or early December when the next state budget forecast is released.
However, you are already preparing your 2003 budget and you must set your preliminary
property tax levies long before the state budget forecast will be announced.
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Other Factors
Cuts yet this year?
Although most of the current focus on the state budget is on the 2004-05 biennium, there is still
an outside chance that the 2002 December distributions of LGA and the MVHC reimbursement
could occur IF the November 2002 state budget forecast shows a state deficit by the end of the
current biennium that exceeds the current $300 million state rainy day fund and IF the governor
decides to address the deficit through unallotment.
Through "unallotment," the governor effectively has the power to reduce legislative
appropriations to address a state deficit that exceeds its reserves. Given that the state's biennium
ends on June 30, 2003, the December 2002 LGA and MVHC payments would be the last
distributions to cities this biennium.
LGA reform
Reform of the LGA system may be a topic of legislative focus during the upcoming session. The
current formula uses statistical data from the decennial U.S. Census that has now been compiled
and released. The Department of Revenue initially used one updated statistic from the 2000
Census to compute the 2003 LGA distribution. The use of that statistic produced large,
unexpected variations in the distribution of state aids and, upon review, the Census data appeared
to have unexplainable results. Essentially, the department will use the existing 1990 data for one
more year.
At a minimum, the Legislature will likely have to address this piece of the LGA formula during
the 2003 legislative session. We also know that some legislators have indicated an interest in a
total review of the formula and the funding level-especially given the State's current fiscal
predicament. This could lead to an extensive effort to reform the system. However, unlike
possible cuts to balance the state's budget, which could be implemented immediately, any reform
of the system would not likely be effective until 2004.
Other property tax pressures
Many school districts across the state are struggling to address their own financial needs. The
state takeover of the majority of school funding coupled with the state's financial troubles means
that schools will not likely find sufficient new state resources. Many school districts have already
announced they are "going to the voters" to approve new or expanded operating referendum
levies. This will place pressure on taxpayers and may result in less acceptance of city tax
increases.
Likewise, the state could tap its property tax as a potential way to address its budget problem.
Although the nearly $600 million state property tax levy is automatically indexed for inflation
each year, the state could decide to raise its levy even further to balance the budget. Again, this
could place pressure on commercial, industrial, and cabin taxpayers and make city tax increases
more difficult. Additionally, the state could expand the base of the state property tax to include
homesteads and other additional types of property.
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Strategies for Cities
For city officials who remember previous state budget shortfalls and subsequent city aid cuts,
much of this situation and the strategies that follow may sound familiar. Below are several
considerations that may help you weigh the pros and cons of revenue enhancements, expenditure
reductions, and use of reserves as you consider setting a budget for 2003. Ultimately, you will
have to make decisions that best reflect the needs of your community.
L Consider increasing your property tax levy to cover or at least partially offset potential state
aid reductions. If aid reductions do not materialize, you can adjust your 2004property tax levy
accordingly.
A.) For cities over 2,500 population, levy limits are in place for taxes payable in 2003. Due to
an extremely low inflation adjustment for this year's levy limits, cities affected by levy
limits might not have sufficient levy authority to cover even normal budgetary pressures.
Levy limits are due to expire, but they could certainly be extended by the 2003
legislature.
B.) Increasing your property tax levy could potentially result in a larger state aid reduction.
Last January, the Governor unveiled a new proposal that based a portion of each city's aid
reduction on the size of each city' s increase in property tax levy plus state aids. In other
words, the larger the city's revenue, the greater the reduction in state aids. Although the
Governor's concept was not adopted by the Legislature, this proposal could always
resurface in the 2003 legislative session.
c.)
Although property tax increases could be implemented to offset potential budget cuts, the
property tax increases of cities could be viewed as municipal preparation for state aid cuts
and legislators could rationalize cuts because cities are financially "prepared" for the
reduction.
D.)
Increasing property taxes to cover a speculative state aid cut could be criticized or
misunderstood by your citizens and business owners. You may want to consider enhanced
discussions with your citizens, businesses, and legislators about the difficulties facing the
city and setting a 2003 budget.
E.)
Consider the implications of tax reform on any tax increment financing (TIF) districts
within your city. Past tax reform efforts, including the major changes enacted in 2001,
may have severely impacted the revenue stream of TIF districts and the city may already
be committed to property tax increases to cover TIF obligations.
F.)
Given the magnitude of the state budget deficit, other local units of government may also
be considering increases in their property tax. With the new state property tax, legislators
might be considering their own property tax increase to address the shortfall. You might
want to consider the combined impact of these potential increases for your taxpayers.
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IL Consider other revenue enhancements where appropriate.
^.)
Do you have fees that are set substantially lower than the cost of the service provided?
Now may be a good time to adjust fees to more closely relate to the cost of the service,
thereby reducing the current subsidy from other revenue sources. Also, there may be
certain property tax supported services for which fees could instead be charged.
B.)
If your city makes significant capital or maintenance expenditures for storm water
control, you may wish to consider creating a storm water utility and removing these costs
from the general fund.
III. Consider developing a plan to reduce appropriations or delay future financial obligations
as a strategy to cover the potential loss of state aid payments. If aid reductions do not
materialize, you could make later adjustments in your budget.
^.)
Any state aid or credit cuts might not be enacted into law until the session ends, which
will likely be in late May. The cuts would likely be applied to the July and December
2003 LGA distributions and to the October and December 2003 MVHC reimbursement
payments. Cities will already be nearly five full months into the fiscal year, which means
that spending reductions would have to be applied to the remaining seven months of
expenditures.
B.) You may want to consider budgeting for one-time expenditures that replace long-term
ongoing costs, such as technology investments that might replace a staff position or
consultant contract.
C.) Consider delaying any hiring decisions until the Legislature crafts its budget during the
2003 session.
D.) Consider delaying major purchases, as well as delaying new or expanded program
initiatives.
IV. Consider drawing down reserves to cover the loss of state aid.
A.) Carefully consider the periodic cash flow needs of the city before deciding to draw down
reserves. City fund balances are generally measured on December 31 of each year. This is
a "high water mark" for city budgets given the structure of state aid payments and
property tax distributions. An analysis of necessary reserves on a daily or weekly basis
would provide a more accurate picture of the city's cash flow needs.
B.) State aid and credit cuts could be permanent and, ultimately, the city would have to
increase taxes or reduce spending to avoid a long-term city deficit.
C.) Drawing down reserves could potentially affect your city's credit rating and possibly
increase the cost of future borrowing for the city.
For more information
The 2003 budget year promises to be a wild ride. Keep your eye on the Cities Bulletin and visit
the LMC web site (www.lmnc.org) for the latest information about developments with city aids
and the state budget. If you have any questions, please contact Gary Carlson, Eric Willette or
Jenn O'Rourke at (651) 281-1200.
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