AGENDA #1a

MEMORANDUM

TO:                  Roger L. Stancil, Town Manager

FROM:            Kenneth C. Pennoyer, Director of Business Management

SUBJECT:       Preliminary Report on Development of the 2008-09 Proposed Budget

DATE:             March 26, 2008

The purpose of this memorandum is to report the status of work on development of the 2008-09 budget.

The Manager’s recommended budget is scheduled to be presented to the Council on April 28, 2008.

SUMMARY

General Fund Overview

The 2008-09 budget year presents significant budgetary challenges. Additional debt and operating costs related to new facilities, specifically, the Town Operations Center and the Aquatics Center, which will both be completed in FY2007-08, doubled the Town’s debt load and significantly increased the operating budgets of the Parks & Recreation, Public Works and Transit Departments.  In addition to the new facilities, other operating costs such as employee and retiree health care and fuel have been increasing substantially.  Added to these cost issues is a stagnant revenue picture with only modest increases in property taxes and potential reductions in other key revenues such as interest earnings and sales tax.  We will face difficult decisions this year in order to balance the budget and to retain the fundamental strength of the Town’s financial position.   

At this time last year the FY2007-08 budget had an estimated $4.9 million deficit.  Fund balance, including the excess of revenues over expenditures in the FY2006-07 budget, was used to fill the gap. The reduced level of fund balance eliminates the potential for balancing the budget using mostly fund balance again.  At this point there is a structural imbalance between revenues and costs created by the additional debt load added in 2005 and operating cost increases that are outpacing the growth in revenues.  For the FY2008-09 budget a property tax rate increase will be necessary unless there are major reductions in service levels or further reductions in fund balance beyond what is considered prudent for a triple A rated municipality. 

Significant issues that need to be addressed in the general fund budget for FY2008-09 include the following:   

• Debt Service Costs. Between 2004 and 2008 debt service on outstanding debt has risen from $2.4 million to more than $6 million.  This sharp increase resulting from the financing of the Town Operations Center, the new Aquatics Center and the major Community Center renovation will continue to put pressure on the General Fund budget as new debt financing is added in future years to fund the CIP.

• Cost of operating new facilities.  In addition to debt service costs, additional operating costs associated with the Aquatics Center, Town Operations Center, and the Community Center will impact the operating budgets of the Public Works and Recreation Departments.

• Economic conditions.  Increased volatility in several sectors of the economy will impact the Town’s finances.  Energy costs continue to show instability with near term price spikes, but long term expectations are that prices will retreating to 2007 levels toward the end of the year.  Health care costs continue to outpace the rest of the economy, accounting for an ever greater share of the national GDP and the Town’s operating budget.  Deteriorating consumer confidence levels could further undermine sales tax receipts. Finally the impact of the sub-prime mortgage crisis on the Housing Market and the economy as a whole is still being realized.  The housing market in North Carolina and the Triangle may be more resistant to foreclosures and loss of value than other parts of the country, but the credit crunch will ultimately have a negative effect on property values.  If the trend continues it could impact the modest growth we are currently experiencing in our property tax base.  

• Other Post Employment Benefits (OPEB).  Changes in accounting standards require local governments to treat their liability for retiree health care in the same manner as a pension liability for the purposes of financial reporting. This includes reporting a very large liability in the Town’s annual financial statements along with calculation of an annual payment required to fund the retiree health plan on a sound actuarial basis.  The Town currently funds its OPEB liability on a pay-go basis, which is approximately one ninth the annual required contribution (ARC).  An increase to the annual contribution to partially fund the ARC and changes in the plan to reduce the liability are recommended.  Failure to develop a funding plan for OPEB obligations is considered a negative credit rating factor.     

• Pay Plan.  The Town pay plan needs to maintain competitive compensation that continues to attract quality Town employees, based on prevailing wages in the Triangle labor market.  The Town has provided annual salary increases ranging from 3% to 5% over the past 5 years in order to keep salaries at levels competitive with our peer group.  Pending further analysis of pay and benefits levels we are including a 3% salary increase effective in the second quarter of the fiscal year for planning purposes.

• Benefits.  The rate of inflation for the cost of health benefits continues to outpace all other sectors of the economy.  Benefits costs will continue to take a greater portion of the Town’s budget unless cost containment strategies are employed.  The Human Resource Development Department is working with the Town’s benefits broker/consultant to explore strategies for optimizing the health care benefits offered to Town employees and to explore other strategies to reduce costs while improving the health and health care of employees.  

Reconciliation of Estimated FY2008-09 Budget

The following table shows the planned FY2008-09 Budget as it currently stands.  Some of these numbers may change as we accumulate data from the current year, update our assumptions, and incorporate new strategies based on decisions made by Council.

	FY2007-08 Budget	FY2008-09 Budget
Revenues	$  47,814,000	$  49,176,000
Expenditures
Base Budget	49,532,103	52,484,200
Priority Additions:
Salary Increase (1)	775,947	611,000
OPEB Contribution (2)	0	500,000
Contributions to Agencies (3)	945,000	945,000
CIP Projects	498,950	447,000
Health Benefits Incr. (4)	377,000	363,000
Total GF Budget	$  52,129,000	$  55,350,200
Deficit Before Fund Balance	4,315,000	6,174,200
Fund Balance - Current FY (5)	2,000,000	2,707,000
Residual Fund Balance	2,315,000	0
Net Deficit	0	$  3,467,200
Tax Increase needed to fund deficit		6.02
Pennies on the Tax Rate
(1 Penny = $576,000)

Major Assumptions:

1. 3% Salary Adjustment.
2. A small contribution toward OPEB ARC, over and above pay-go, will be put in trust.
3. Contributions to Agencies are the same level as current year.
4. 10% Increase in Benefits Costs included as a place holder while we work with our broker/consultant to review options.
5. Fund Balance from Current Year includes $1.3 million windfall from multi-year settlement of tax case in Durham County.  Most of this is one-time money.
6. Departmental add requests totaling $1.8 million are not included

Based on the preceding table there is a $3.1 million gap between projected revenues and the planned base budget.  With the addition of $2.9 million of priority additions the gap grows to approximately $6.0 million.  Using the estimated excess of revenues over expenditures in the current year’s budget of $2.7 million to help close the gap, brings the predicted deficit to $3.3 million or 5.80 cents on the tax rate based on a penny generating $576,000 in revenue.

Budget Balancing

Fund Balance – The only fund balance available for balancing the FY2008-09 budget is the surplus of revenues over expenditures for the current fiscal year.  This amount is comprised of an expenditure variance (expenditures less than budget) estimated at $970,000 and a revenue variance (revenues in excess of budget) of $1,737,000.  Combined this creates a $2,707,000 surplus available for balancing the FY2008-09 budget.  Please note that as we approach year end our estimates may increase or decrease as actual numbers are realized.  A large portion of the revenue variance is due to the settlement of a large tax claim in Durham County that served to increase prior year collection by almost $800,000.  These are one-time funds and therefore will not be available for future years.

As reported in the FY2006-07 CAFR, the beginning undesignated fund balance for FY2007-08 is $6,515,807 or 12.5% of FY08 appropriations.  This is down from 22% for the previous year.  Reductions below 12% would be considered a negative credit indicator inconsistent with a triple A credit rating. 

Property Tax Rate Increase – Property taxes are the largest general fund revenue, accounting for more than 50% of all revenues.  As depicted in the chart below tax rates have remained relatively stable over the past 10 years.

In recent years the growth of the property tax base has not kept pace with the increase in general fund expenses, creating the need to use fund balance to balance the budget.  An increase of one penny on the property tax rate will generate $576,000 in property tax revenue.

As part of the 2003 GO bond referendum campaign a hypothetical tax rate increase was calculated in order to show how much taxes would need to increase if the debt service on the bonds were to be paid solely from an increase in property taxes.  The amount that property taxes would need to be raised in order to pay the debt service on the total $29.36 million authorized by the referendum was calculated to be 6.9 cents.  As stated in the referendum materials the projected tax rate increase is mitigated by the growth in the tax base and other factors that may reduce or eliminate the need for a tax increase associated with these bonds. Notwithstanding the mitigating factors, the issuance of the remaining GO debt along with the other financings will continue to create pressure on the general fund budget.  To date $8,895,000 of the $29.36million authority has been issued, with $11.455 million scheduled to be issued in FY2008-09.

Planned Debt Issuance:

	FY2008-09	FY2009-10
2003 GO Bonds	$11,455,000	$8,955,000
COPs	0	7,245,000
Total	$11,455,000	$16,200,000

Reduction/Elimination of Priority Additions – For the FY2008-09 budget, priority additions total approximately $2.9 million.  This does not include more than $1.8 million in departmental add requests that are not being addressed at this time due to the magnitude of the projected deficit.  Some of the additions included in the preliminary budget can be reduced or eliminated, however there could be negative consequences.  The priority addition for OPEB funding is a new item related to the new accounting standards requirement to treat post employment health benefits in the same manner as pension obligations.  This additional funding is not a requirement of the new standard, but it is in keeping with prudent financial practices to begin to fund the $45 million OPEB obligation that we are required to report in the FY2007-08 CAFR.  In addition, the Town is also working with our Health Care Benefits Broker/Consultant to find savings in the employee health care programs for current and retired employees.   

Reductions to the Base Budget – There are limited opportunities to find reductions in the base budget without impacting service delivery.  In most cases this would be an exercise in starving departmental budgets of things such as supplies, training and professional services.  This strategy may result in short term savings, but overtime this strategy will degrade a department’s ability to perform. 

General Fund Revenues for 2008-9

Property Tax

We estimate the property tax levy will grow by about $1,000,000 over the current year’s original budget to $27.15 million for FY2008-09.  In the current year, we have benefited from a one-time windfall from a large tax settlement in the Durham County area of the Town.  Because of this one-time windfall property taxes collected in FY08 will exceed projected collections in FY09 by $336,000.  Although it appears tax revenues are decreasing, after adjusting for the tax settlement, the expected collections for FY09 are increasing by 1.78% or $474,000.

Other Local Taxes

• Effective January 1, 2007, the Department of Revenue changed the distribution calculation for cable franchise revenues.  In recognition of this change, cable franchise taxes are included in the State Shared Revenues category as Utility Franchise Fees rather than Other Local Taxes.
• Revenue from the three percent Hotel/Motel occupancy tax is expected to total about $1,081,000 in 2007-08 and $1,084,000 in 2008-09.  Revenue trends are affected by University events and general economic trends.

State-Shared Revenues

Sales Taxes

Sales tax revenue is expected to fall short of budget in the current year by about $41,000.  While we estimate that the two State-wide ½ percent taxes will exceed the budget in the current year and continue to grow next year, we expect the one percent tax on Chapel Hill sales to decrease in both the current year and next year.  Combined, sales tax is estimated to increase about one percent over the current year estimate of $9.49 million, to $9.62 million in 2008-09.

Motor Fuel Taxes (known as Powell Bill funds)

Motor fuel tax revenue is based on receipts of 1¾ cents of the State gasoline tax allocated to local governments, based on population and local street mileage in each jurisdiction.  This revenue totaled $1,459,000 in the current year and we anticipate $1,500,000 for FY2008-09.

State Fire Protection Funds

We anticipate no change next year in the level of State Fire Protection Funds, totaling $1,063,000.  

Utility Franchise Tax

Utility franchise taxes are derived from a three percent tax on gross revenues from public utilities in each jurisdiction, and are collected by the State for distribution to cities and towns.  With the Department of Revenue’s change to the distribution calculation for cable franchise revenues, these fees are now included in this revenue category.  We estimate that utility franchise fee distributions will slightly exceed the current year budget at $2,940,000 and will be the same next year.  Because the fees are dependent upon utility charges, they are affected by weather conditions and can vary from year to year. 

Beer and Wine Taxes

Assuming full receipt of the Beer and Wine tax revenue normally distributed in May to cities and counties, we estimate allocations from this source of about $230,000 for the current year and approximately $232,000 for next year.

In summary, we estimate State-shared revenues would total about $15,505,000 for next year. 

Other Revenue Sources

• Service Charges for various Town services and programs (including zoning compliance permits and Parks and Recreation programs) are estimated to increase slightly from the current year’s estimated revenues of about $1,629,000 to about $1,687,000. The increase of about $58,000 from current year revenues is expected because of the (re)opening of parks facilities.
• Revenue from most licenses, permits, and fines, including privilege licenses and vehicle licenses, are expected to remain about the same as budgeted in 2007-08, with a minor decrease of about $32,000. 
• Investment income is estimated to be about $354,000 in the current year and $200,000 next year.  The significant decrease in interest revenue is due to the precipitous decline in short-term interest rates in the past few months. 

Summary of Revenues

In summary, we estimate General Fund revenues, including the use of $2,707,000 from the current year, would total about $51,883,000 million.  However, our estimates at this point are subject to change based on changing local, State and national economic conditions.

The table below shows comparative estimates of total General Fund revenues for the current year and next year.

General Fund Revenues

	07-08 Original Budget	07-08 Budget as Amended	07-08 Estimated	08-09 Estimated
Property Taxes	$26,130,000	$26,130,000	$27,479,000	$27,153,000
Other Taxes	1,524,000	1,524,000	1,081,000	1,084,000
Licenses/Permits	1,604,000	1,604,000	1,606,000	1,572,000
State-Shared	14,582,000	14,582,000	15,519,000	15,505,000
Grants	416,000	523,000	482,000	374,000
Service Charges	1,664,000	1,664,000	1,629,000	1,687,000
Interest	362,000	362,000	354,000	200,000
Other	282,000	293,000	402,000	268,000
Interfund Transfers	1,250,000	1,250,000	1,284,000	1,333,000
Fund Balance	4,315,000	5,831,000	2,947,000	2,707,000
Total	$52,129,000	$53,763,000	$52,783,000	$51,883,000
(Rounded to nearest thousand.)

General Fund Costs

The preliminary estimate of General Fund costs for next year’s budget is shown in a format separating the base budget costs from optional additions to the base budget that could be considered by the Council. The table on the following page is provided to compare the preliminary base budget for next year to the current year’s base budget. 

Base Budget

The base budgets submitted by departments would allow continuation of basic services, but with little flexibility for unexpected occurrences.  The increase in the base budget is about $1.74 million or 3.4 percent.  The largest increase in operating expenses is for the Parks and Recreation Department.  The increase results in large part from the opening of the new Aquatics Center and the reopening of the Community Center.

General Fund Expenditures
Department	07-08 Base Budget	08-09 Base Budget	% Change
Mayor	112,090	111,930	-0.1%
Council	249,390	248,070	-0.5%
Manager	954,630	958,380	0.4%
Clerk	434,390	526,290	21.2%
Human Resources	854,630	858,170	0.4%
Finance	1,186,630	1,238,350	4.4%
Information Technology	1,049,920	1,074,240	2.3%
Attorney	285,350	294,590	3.2%
Planning	1,296,970	1,318,440	1.7%
Inspections	813,930	870,030	6.9%
Engineering	2,165,010	2,225,290	2.8%
Public Works	10,663,880	10,910,800	2.3%
Police	11,661,020	11,787,540	1.1%
Fire	6,813,050	6,904,600	1.3%
Parks and Recreation	2,865,090	3,380,760	18.0%
Library	2,256,830^1	2,311,620	2.4%
Non-Departmental	957,720	1,121,270	17.1%
Capital Improvements Transfer	622,000	673,000^2	8.2%
Debt Service - Base	5,536,030	5,382,830	-2.8%
Debt Service - New Bonds	-	288,000^3	N/A
Subtotal	50,778,560	52,484,200	3.4%
Costs to be distributed:
10% Medical Insurance Increase	-	363,000	N/A
3% Market/Merit Adjustments	-	611,000	N/A
Total Base Budget	50,778,560	53,458,200	5.3%
^1 Excludes Contributions to Agencies of $851,500 because similar contributions are considered an option in          2008-09 and are not included in the Base Budget.
^2CIP transfer includes debt payments only.
^3Estimated first year, interest-only payment on $11,455,000 GO bonds issued August 2008 at 6% for 20   years, level debt payments.

The base budget does not include contributions to other service agencies except $93,500 for visitor information and events as required by the laws regarding Hotel/Motel taxes.  Capital improvement costs in the base budget are limited to items involving contracts or other binding commitments made by the Council.

Total base debt service requirements rose sharply between 2006-07 and 2007-08, because of the increase in the Town Operations Center debt and because the issuance of $4.95 million of General Obligation bonds in the fall of 2006.  Debt service on the Town Operations Center debt peaked in 2007-08 and drops slightly in 2008-09.  Overall debt service will increase by 2.4% as the planned issuance of $11.4 million will add approximately $288,000 in debt service. 

The preliminary base budget includes costs necessary to continue current operations, but does not include costs for competitive employee compensation adjustments, any new positions or funding for contributions to agencies other than those listed above. 

Capital Improvement Costs

The amount included for capital improvements includes only debt service obligations.  A place-holder amount of $447,000 has been listed as a priority addition in the table on the third page. This amount approximates the amount transferred to capital in the current year’s budget.  The complete capital plan will be presented at a later budget workshop.   

Summary of Revenues and Expenditures

As described above, the preliminary General Fund Budget for FY2008-09 with priority additions is $5.9 million more than projected revenues.  With the addition of $2.7 million of expected surplus for the current year’s budget, including one-time revenues from a major tax settlement, there is still a $3.25 million funding gap. With one cent on the tax rate equal to $576,000, the base budget would require a 5.65 cent tax increase.

PRELIMINARY TRANSPORTATION FUND BUDGET

Preliminary estimates of expenditures for the Transportation Fund base budget for next year total $16.8 million and exceed current Town available revenues by about $738,000.  We do not anticipate sufficient fund balance to cover the shortfall.  At $576,000 per one cent, a 1.3 cent tax increase would be required to fund the base budget as projected for 2008-09.

Expected revenue available for the system is based on preliminary estimates of federal and State operating assistance, and assumes that contractual arrangements with Carrboro and the University would continue based on current cost sharing agreements.  Discussions are underway with the University and Carrboro regarding specific services desired for 2008-09.  The final level of State and federal operating assistance will not be known until later this spring. 

Budget Revenues

A major issue for the Transportation Fund each year is the level of federal operating assistance, federal capital grants and State operating assistance available for transportation services. Revenue estimates for the base budget include:

• Our preliminary estimate of federal operating assistance includes flat funding of $1,115,000. 
• We have received State operating assistance of $3,545,000 for 2007-08, $160,000 more than budgeted.  We are estimating 2008-09 operating assistance to remain at $3,432,000.
• University payments would be about $6.8 million based on its share of requested services.
• Carrboro payments would be about $1.3 million.
• The Town’s share of costs would be about $4.1 million.

Our preliminary estimate of total revenues available for next year is about $16.05 million including the use of vehicle license fees of $140,000 as in past years.

Transportation Budget Costs

The cost of providing the Transportation services next year is estimated to be about $16.8 million or about 14.5 percent over the current year’s original budget, with key cost increase areas as noted below:

• Anticipated property and liability increases of $18,000.
• Fuel cost increases of $564,000. 
• We have estimated the contribution to the vehicle replacement reserve at $462,360.  This preliminary estimate may be adjusted as grant awards are announced and matching requirements are verified before the Manager’s Recommended Budget is currently scheduled to be presented on April 28, 2008.
• Reserve for 3% employee pay adjustments effective October 1, 2008 for $142,000.

Based on the total preliminary estimate of costs to continue current routes and fare free service of about $16.8 million for next year, additional revenue of $738,000 is required.

Potential Additions to the Transportation Base Budget

Possible additions to the base budget include the following:

• Human Resource Staff Assistant - $39,867.
• Fully fund Schedule/Run Cut Coordinator - $13,651.
• Reclassify Project Coordinator -$11,305.
• Technology support at Town Operations Center - $39,150.
• Establish fuel reserve - $86,100.
• Join Public Transit Regional Call Center - $76,000.
• Expand service to Weaver Dairy Road - $26,119.
• Modify and extend weekend route service - $127,224.
• Modify and extend existing evening route service - $288,054.

Additions to the budget would be shared by the Town and our transit partners, the University of North Carolina at Chapel Hill and the Town of Carrboro.  The Town pays approximately one-third of the cost of any shared additions. 

Remaining Budget Schedule

The Council will conduct a community forum on the 2008-09 Budget this evening. 

Budget work sessions are currently scheduled for April 16, May 7, and May 21.  Additional sessions may be scheduled.

The Manager is scheduled to present a budget proposal on April 28; a public hearing on the recommended budget is scheduled for May 14.

The Council is scheduled to consider adoption of the budget on June 9.

OTHER FUNDS

We are developing budget recommendations for the following funds and we will present these budgets at a future budget work sessions.

• Stormwater Management Fund
• On-Street Parking Fund
• Off-Street Parking Facilities Fund 
• Housing Fund 
• Debt Service Fund
• Capital Improvements Fund
• Housing Loan Trust Fund 
• Library Gift Fund
• Downtown Service District Fund

Requests by Others

The Council has received funding requests from other agencies that are not included in the base budget or in the list of priority additions for the Council’s consideration.

Some of these requests are appropriate for consideration through Community Development or HOME Program funding and will be discussed in separate reports at future budget work sessions.  All requests will be considered as we work toward preparation of the Manager’s recommended budget.

CONCLUSION

We hope that this status report on the development of the 2008-09 budget will help the Council as it begins its deliberations.  The information presented in this report is preliminary and many of the assumptions used are subject to change as we continue to receive updated data for the current year’s budget. We look forward to receiving further feedback, advice and instruction from the Council as we continue work on the budget. The Manager’s recommended budget is currently scheduled to be presented to the Council on April 28, 2008.

ADDITIONAL INFORMATION (March 26, 2008)

1. Staff PowerPoint Presentation [500 KB pdf]