Governmental Budgeting and Financial Analysis

¶ … Financial Condition City Leadership Re: Budget shortfall While the current year sees a balanced budget for Centerville, an analysis of the five-year trends for the city show that there will be a budget shortfall in each of the next four years. This memo will help to explain the problem and analyze some of the critical issues. The following trends have been noted: Revenue per household is declining Costs per household are increasing The percentage of tax-exempt households is increasing The latter point is important.

Tax exemptions are granted for low income households, and these represent an increasing percentage of Centerville's tax base. Sales tax represents the vast majority of the city's revenue, so when households are exempt from the sales tax, they are no longer contributing to the civic revenue stream. The structure of the sales tax exemption may be an issue. If this is based on income, retirees would typically be exempt from the sales tax, even if they are otherwise wealthy.

There may be a need to revisit the structure of the sales tax exemption. It is also concerning that with an expected slowdown in revenue growth -- including a couple of years of negative growth -- that the cost per household of service provision continues to increase. On the spending side, the city has to look at ways to reduce the rate of spending growth, and better align it with the rate of revenue growth.

If the city is not growing, then costs associated with running the city need to be constrained in terms of growth as well. Budget controls may be an issue worth investigating -- they may be insufficient to implement cost-cutting measures, which heretofore may not have been required but which are now required. An analysis of the city's cost structure should also be undertaken, in particular before new commitments are made.

The city has a certain amount of fixed costs -- contracts and labor agreements already in place, and physical infrastructure costs. The city at this point needs to know where it can cut on some fixed costs, and more importantly where there is flexibility to cut on variable costs. The latter are important for short-term reductions, but there is a long-term budgetary problem that will require cuts to fixed costs to reflect the lower level of economic activity in Centerville.

The decline of sales tax as a percentage of revenue hints that the city may be facing economic challenges. If there are few other revenue sources -- presumably user fees -- then a decline in the contribution that sales tax makes indicates a slowdown in economic activity. If the city is experiencing such a slowdown, that would also put more people into tax-exempt status, because the unemployment rate would be expected to rise.

This has considerable implications, in particular that spending per household needs to be constrained in a structural way --one-time cuts will not address the long-run economic issues that the city is facing. Attempts to increase revenue may also fail, if the city is faced with a depressed economy, because the people have no ability to pay more. Potentially, Centerville needs to find new means of economic growth that can increase incomes and spur more retail sales activity. Lastly, the precise nature of the economic slowdown needs to be understood.

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