There has been some growing public attention to a significant financial issue discussed at the finance subcommittee last week. The city will release more information soon, but here is my view of what happened and why.
Each year, when the City Council votes on a tax levy increase, we have maintained a maximum of 2.5%. This is the limit set by law, but since in many past years we have not even reached that, we have what is called “excess capacity." This means we could raise it each year by more than 2.5%, using previous years’ savings, if we chose to. The administration has never proposed this, nor has it been part of any budget plan.
One thing that frustrates me is that the average tax bill always increases by more than 2.5%, despite the appropriation limit. There are legitimate reasons for this, including the shift between residential and commercial properties, variations in residential and commercial growth, the effects of new development, changes in average home values, and other factors. This year, it seemed a bit higher than usual, so I decided to investigate.
I quickly realized that the tax recap sheet submitted to the State by the city increased the levy by 3.15%, about $1.6 million more than the 2.5% we thought we had voted. This is the same information used by the City Council for setting the tax rate.
The obvious question is: how did this happen? It is quite complicated, but to simplify, the city reports its total appropriations (over $400 million), lists all non-real estate tax revenues it receives for the year, and subtracts those amounts from the total appropriations. The remaining amount is what is allocated to real estate taxes. This is the final calculated number in the process. The state then certifies this number as being within the total levy for Proposition 2 ½.
In the spring, when we begin the budget process, one of the very first numbers we determine for revenue is the real estate tax. This is done by taking last year's total levy (excluding capital-related debt costs) and adding a 2.5% increase, along with our estimate of the taxes from new growth.
After doing some research, I found a state report indicating that $1.6 million of our excess capacity was used in setting the levy this year, and I knew that was incorrect. Again, this may be a nuance, but about a decade ago or more, when we had no excess capacity, the state would have rejected our recap sheet for exceeding the allowable levy increase, making the mistake obvious. However, since we had over $40 million of tax levy that we had not used, the state allowed the 3.15% increase and simply reduced our excess capacity to pay for it. Essentially, use a portion of past years' savings.
Once this was clear, it was not too difficult to determine what happened. Over the last two years, the CFO's office has calculated the revenue figure for real estate taxes incorrectly at the start of the budget process. Both years, it was overstated by about $3 million. Last year, it didn't matter because other unanticipated revenue was available to cover the $3 million overestimate. This year, only about $1.5 million of additional revenue was available, and the $1.6 million shortfall was automatically offset by the excess levy capacity.
As soon as I realized what had happened, I notified the Mayor, as I knew he did not intend to raise the levy over 2.5%. He began an immediate review of the process. The Mayor has convinced the State to allow us to re-certify the tax levy at the 2.5% level. Additional local revenue has been identified to replace the $1.6 million. As a result, the average tax bill will decrease by about $50.
Once I realized the mistake in the estimated revenue for real estate taxes this year, I recognized it was a recurring error from the previous year. The issue occurred because debt-exclusion taxation was double-counted. As a city councilor reviewing the budget, if I had looked more closely at the detailed year-over-year differences on the revenue estimate sheet, I could have identified the problem. So, although anyone could have theoretically seen it, everyone else, and I too, have relied on the CFO to provide the correct numbers for basic revenue. That is a reasonable expectation. No one noticed this for two years.
We should expect our well-compensated CFO’s to avoid mistakes like this, or if they occur, to quickly notice them. When working with numbers, mistakes often stand out because they don't fit within the overall budget picture. Any experienced and capable municipal financial professional who manages the budget should see this. However, two years ago, the former CFO made a similar multi-million-dollar mistake when presenting the tax rate to the City Council. That problem was identified earlier in the process and corrected, but it remains equally unacceptable. Although the same error as this year was made last year, it ultimately had no financial impact; once the year closed out, it was balanced despite the initial overestimate.
Politically, there is a small group of people who will enjoy blaming the Mayor for this. As I mentioned, it’s not reasonable to expect the Mayor personally to have found this error, and he was able to quickly resolve the issue. The area where the Mayor has responsibility—and I am confident he will handle it—is the need to thoroughly review the financial department processes, starting with the Chief Financial Officer. I look forward to hearing about his approach.
The presentation to the Finance Subcommittee last week was the first notice of an issue that had only been known for a couple of days. The Mayor’s desire was to be immediately transparent with the City Council and the public, rather than wait for written reports. There will be a much more in-depth explanation of the problem and the solution at meetings over the next couple of weeks. There will be plenty of written background material provided I am sure.
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